by Djavad Salehi-Isfahani
The decision announced last Monday in Vienna to extend the talks aimed at a compressive agreement on Iran’s nuclear program for an additional seven months has resulted in Iran’s currency taking dive. In one week, the rial lost more than 5% of its value in the unofficial market. The devaluation has clear political and economic implications: it will revive inflation, slow or stop economic growth, and increase the pressure on Iranian President Hassan Rouhani as his government tries to make good on the election promises he made 18 months ago.
But will this soften Iran’s negotiating position? To answer this question, we need to look at the basis of this phase of the rial’s devaluation and what it means for ordinary Iranians.
The drop in the value of the rial after the extension was announced on Nov. 24 indicates that expectations in Iran for a final deal were high before the deal failed to materialize. This optimism had kept the rial’s value above what the economics of the situation warranted. In other words, rather than being in “free fall,” as several reports in the press have suggested, the rial is actually adjusting to a new equilibrium.
Two major factors have been putting pressure on the rial in the last few months, neither of which is related to the negotiations or the sanctions. The first is the decline of the price of oil, by more than 30% since this summer, which has reduced the already strained supply of foreign currency to the Iranian economy. As I noted in my previous post, prior to Nov. 24, the rial had remained surprisingly stable despite the falling price of oil.
The rial was also under pressure because Iran’s inflation exceeded that of its major trading partners, making Iranian producers less competitive. Prices in Iran have increased by 23% since Rouhani’s election in June 2013 when the rial traded around 31,000 per dollar. All else the same, the rial would have to fall by 23% to keep Iranian production competitive. That would mean an exchange rate of over 38,000 rials per dollar in the unofficial market and 32,500 in the official market. Presently, these rates are at 34,000 and 26,500.
Of course, all else is not the same. The price of oil is lower, Iran has started receiving around $700 million a month of its unfrozen assets, and there have been changes in economic policy. Some of these changes, like the lower price of oil, would require the rial to devalue further, while others would have the opposite effect.
At the same time, although the rial could continue to decline, currently it’s certainly not in free fall.
An overlooked fact in Western press reports on this issue is that the Rouhani government, populated in part by economists focused on the competitiveness of Iranian producers, had signaled its intention to officially devalue the rial before the Nov. 24 extension was announced. Indeed, officials spoke publicly last month about a (modest) 7.5% increase in the official exchange rate to be used in the 1394 (2015/2016) budget to 28,500 rials to the dollar.
Now on to that burning question: How long will this crisis last?
The pace of devaluation in the free market has quickly slowed down—the rial even rose against the dollar on Dec. 1—but as I mentioned earlier, further drops in the value of the rial are still possible as the reality of the lower price of oil sinks in.
Devaluation is a sign of an underlying imbalance in the economy, so when it happens, people are naturally alarmed. But it is also part of the solution to the same imbalances that need correcting. Consider, for example, that a cheaper rial is good for production and employment, even in a poor business environment hampered by international sanctions and domestic impediments to production, which business people refer to as “internal sanctions.”
Devaluations also redistribute income. In the short-run, inflation, which dropped last year below 20%, will rise as prices for goods bought and sold at the unofficial rate increase. The burden of the higher inflation will fall primarily on people living on fixed incomes, on the public payroll, and those who travel abroad or send money to their children abroad—all of whom compose the better part of the middle class.
Unlike former President Mahmoud Ahmadinejad, Rouhani does not believe in directly paying the poor, so what happens to this segment—about 10-20%— of the Iranian population is less certain. Wages of unskilled workers usually increase with inflation, though not always in tandem. They also rise with demand for labor, which could get a boost from devaluation. However, the 30% increase in the price of bread that was quietly implemented earlier this week, on Dec. 1, will hurt the poor disproportionately, as it was put through without any compensatory mechanism.
Of course, if the Rouhani government is forced to reduce the country’s much larger energy subsidies to balance its budget in the face of falling oil revenues, it may ultimately have to swallow its pride and take up the Ahmadinejad cash transfer mechanism, which Rouhani strongly criticized during his presidential campaign.
Ultimately, the drop in the price of oil will result in lower economic growth and loss of income across the country. But there is no policy that can fully compensate for a large decline in the terms of trade, which the recent decline in the price of oil represents—there are only good and bad policy responses. Allowing the rial to devalue is a good start, but not enough. The government should also be planning policies to help domestic producers rise to the occasion and measures required to protect the poor as prices for basic goods such as bread and energy rise.
]]>by Djavad Salehi-Isfahani
The latest round of talks between the P5+1 (the US, Russia, China, Britain, France, and Germany) and Iran in Kazakhstan concluded on Saturday without any tangible progress. While details of the reciprocal offers remain unclear, what we have learned indicates that neither side is in any particular hurry [...]]]>
by Djavad Salehi-Isfahani
The latest round of talks between the P5+1 (the US, Russia, China, Britain, France, and Germany) and Iran in Kazakhstan concluded on Saturday without any tangible progress. While details of the reciprocal offers remain unclear, what we have learned indicates that neither side is in any particular hurry to conclude the lengthy negotiations. In the meantime international sanctions, which have plunged Iran’s economy into its deepest crisis since the war with Iraq, will remain in force and may even be tightened. An important question now is whether the delay in resolving the crisis favors Iran or its Western foes, and the answer has to do in part with what one believes is happening to Iran’s economy.
Just before the talks restarted, a report in the New York Times entitled “Double-Digit Inflation Worsens in Iran” may have strengthened the belief of those in the US who think that time is on their side. If inflation — the most obvious, if not the most painful, effect of sanctions — has gotten worse for the sixth month in a row, then waiting a few more months might weaken Iran’s position. The article was based on new data released by Iran’s Statistical Center, which, when looked at more closely actually shows that inflation has been up and down in the last six months, falling as many times as it went up, though prices go only up (see a detailed graph of monthly inflation rates here). The persistence of high inflation has as much to do with sanctions as with Mr. Mahmoud Ahmadinejad’s insistence on making good before he leaves office and ahead of the June presidential election by pushing ahead with his unfunded (and therefore inflationary) promises of cash transfers and low-cost housing.
Iranian officials who were last year denying the impact of sanctions now praise them for helping Iran wean its economy from oil. Last month, Iran’s Minister of Economy, Shamseddin Hosseini, said that “Thanks to the sanctions [imposed] by enemies, a historical dream of Iran is being realized as the oil revenues’ share in the administration of the country’s affairs has been reduced.” The Minister for Industry, Mining and Commerce also added a humbling note, “What we had been unable to achieve on our own, sanctions have done for us.” He was referring to the huge inflow of cheap imports paid for by the oil revenues over which he has presided since 2009.
As these officials have discovered lately, oil money can stock the kitchens and living rooms of the average family while keeping their educated son or daughter out of a job. While imports increased eightfold over the last ten years, many local producers in agriculture or industry have either shut down or increased the import content of their production. Either way, jobs have been lost. Between 2006 and 2011, census figures show that Iran’s economy created zero new jobs, as the working age population increased by 3.5 million.
As I have argued before, the devaluation of the rial, which many saw as the reason why Iran restarted negotiating, is actually a reason why it may not be in such a hurry to resume its oil exports. A study last week that was surprising for its source — the Washington Institute for Near East Policy, which has always pushed for tougher sanctions on Iran — admitted that Iran is doing a good job of adjusting to reduced oil revenues. It shows how the balance of trade in non-oil items is improving and how the government budget is becoming less dependent on oil.
But adjusting to the financial sanctions is an entirely different story. After being cut off from the international banking system and with limited access to global markets, Iran is finding it extremely hard to turn its import-dependent economy around. If Iran could choose which of the two sets of sanctions to lose first, oil or financial, it would definitely be the latter.
]]>via USIP
What is the state of Iran’s economy in 2013 compared to a year ago?
Iran’s economy enters 2013 significantly worse than a year ago, particularly with higher inflation and unemployment than at the beginning of 2012. The rial also plunged from around 11,000 to the dollar at [...]]]>
via USIP
What is the state of Iran’s economy in 2013 compared to a year ago?
Iran’s economy enters 2013 significantly worse than a year ago, particularly with higher inflation and unemployment than at the beginning of 2012. The rial also plunged from around 11,000 to the dollar at the beginning of 2012 down to between 22,500 and 31,000 at the beginning of 2013, depending on the type of transaction. The past year was probably the most tumultuous economically for Iran since 1994, when an external debt crisis triggered a serious inflationary shock and a recession.
At the outset of 2012, many Iranians expected another economic shock due to the growing array of sanctions on Tehran’s oil sales and financial transactions led by the United States and European Union. In 2013, many now expect the international economic cordon to be further tightened. The 2012 squeeze did not produce a hyperinflationary spiral, but annual overall inflation in 2012 was estimated to hit between 40 percent and 60 percent, according to Iran’s business media. Tehran was forced to limit foreign exchange transactions and the export of strategic goods in response to the effect of sanctions on Iran’s currency market.
Due to sanctions, Iran’s oil exports were also basically cut in half in 2012, from 2.3 million barrels a day at the beginning of 2012 down to around 1 million barrels a day at year’s end, according to the International Energy Agency. The accumulated impact of revenue declines is likely to produce two additional problems in 2013.
First, the national budget deficit is expected to increase to around 30 percent of the current budget (in the Persian year ending in March 2013), which means that President Mahmoud Ahmadinejad will be forced next year to cut spending, raise revenue, and prop up state banks with new cash injections. Iran’s parliament wants to put as much control over the government budget as it can, since many members of parliament contend that Ahmadinejad’s use of revenue is opaque at best.
Second, further changes in subsidies for basic commodities—which date back to hardships during the eight-year Iran-Iraq war in the 1980s—are on hold. Ahmadinejad introduced changes to this subsidy program over 2011-2012, including liberalization of some prices combined with monthly stipends for the entire Iranian population. But he only got through one round of subsidy cuts before Iran’s parliament halted further increases in fuel prices as well as higher stipends. Inflation had whittled away the benefits of both, although the idea is not dead.
Iranian economists are divided about subsidy reforms. Some think the subsidy cutbacks generated an inflationary shock at a time that the domestic economy—both the manufacturing and agricultural sectors—were unprepared for higher production and raw material costs that they then either had to absorb or pass along to consumers. So sanctions were not the only driver of inflation in 2012.
Other economists are more sanguine about the reforms, given the difficulties of enacting any economic policy changes in Iran. The ill-effects are temporary, they contend, and many other developing countries use stipends as part of their welfare programs. A diplomatic solution about Iran’s controversial nuclear program over the next year, they say, would lessen the pain and other subsidies could then be removed.
What is the debate within the government over what to do about the current economic situation?
The admission of economic woes by most of Iran’s political class has opened up space for debate over economic policy. Some officials, including the president, now argue that reducing Iran’s reliance on oil revenues, a byproduct of international sanctions, is a blessing in disguise. Private sector representatives in Iran’s Chamber of Commerce counter that they could manage the economy better than the state does. Both claims are seriously exaggerated, but the rival positions reflect the political impact of the deepening economic crisis in a presidential election year.
A viable solution may depend less on economic policy than on the outcome of Iran’s negotiations on its nuclear program, several Iranian officials have admitted publicly. Iranian officials are now gearing up for talks with the world’s major powers—the so-called P5+1—from the United States, Britain, China, France, Germany and Russia. Iranian negotiators want sanctions relief in exchange for any concessions limiting its nuclear program.
How much influence does the economic situation have on the presidential election due in June 2013?
The economy will clearly be one of the main issues in the election. Unlike many developing countries, however, Iran does not have a large external debt. It has a porous, open economy, which helps the country’s 79 million people deal with the negative effects of financial sanctions. So the situation is not yet dire. But people may vote for a candidate who they believe can actually get something done in the economic arena.
Many candidates will likely run against Ahmadinejad—notably his economic policies—even though he is not allowed to run again under a constitutional limit of two consecutive terms. Across the political spectrum, Ahmadinejad’s administration is now widely associated with failed policies and gross mismanagement. In 2012, most conservative media blasted the president and his staff for Iran’s growing economic woes.
Indeed, Iran’s economic policy debate has often served as a cover for political criticism since the 1979 revolution. The 2013 presidential election will almost certainly follow the same pattern, given growing economic woes and the linking of their alleviation with a resolution of the nuclear issue.
By Richard Javad Heydarian
A key foreign policy consequence of President Barak Obama’s reelection is the growing possibility of face-to-face talks between the United States. and Iran. Both the US Secretary of State Hillary Clinton and Iran’s Foreign Minister Ali Akbar Salehi have expressed, albeit conditionally, their respective governments’ openness [...]]]>
By Richard Javad Heydarian
A key foreign policy consequence of President Barak Obama’s reelection is the growing possibility of face-to-face talks between the United States. and Iran. Both the US Secretary of State Hillary Clinton and Iran’s Foreign Minister Ali Akbar Salehi have expressed, albeit conditionally, their respective governments’ openness to engage in comprehensive bilateral talks — for the first time in almost three decades — to primarily resolve the ongoing nuclear standoff.
Beyond the issue of urgently resolving the Iranian nuclear question, purportedly to prevent an Israeli pre-emptive strike and an Iranian nuclear bomb, the Obama administration’s growing interest in directly engaging Iran may have something to do with timing, opportunity, and leverage.
There is a feeling in Washington that the recent transatlantic sanctions may have created enough pressure — and damage to Iran’s economy — to potentially extract major unilateral concessions from the Iranian regime. Namely, a “stop-shut-ship scenario”, whereby Iran would curb its enrichment capacity, open up all aspects of its nuclear program, shut down its heavily-fortified nuclear facilities, and ship out its stockpile of above 3-5 percent enriched uranium in exchange for some nominal — yet to be clarified — incentives from the West.
Since the imposition of Western sanctions against Iran, beginning in late-2011 and intensifying by mid-2012, the Iranian economy has begun whimpering on an unprecedented scale. Iran’s oil output is at its lowest in more than two decades, while oil exports have been halved; the inflation rate has surpassed the 25 percent barrier, while the budget-deficit is reaching its highest level in the last decade; and, the Iranian currency (rial) has lost about 80 percent of its value in less than a year. The sanctions against Iran’s ports, shipping industry, financial sectors, and central bank, Bank-e-Markazi, have also made it increasingly difficult to conduct even the most benign kind of international transactions, from the import of medicines, to food, diapers and medical equipments.
However, there are some recent indications that Iran’s economy is not exactly in a desperate shape, or at least not as frail and fragile as the Obama administrations hopes it to be.
According to the Paris-based International Energy Agency’s (IEA) most recent report, Iran’s oil exports have rebounded sharply – by around 30 percent – after seven months of steady decline, thanks to new contracts with giant Asian customers, China and South Korea. With oil exports constituting more than three-quarters of export earnings, Tehran is now in a relatively better position to defend its falling currency. In fact, the rial has indeed experienced some recovery in recent weeks, appreciating from the record-low of 37,000 rials against 1 dollar in early October to around 27,000 rials against 1 dollar today. Of course, the most recent financial and hydrocarbon sanctions by the European Union will further complicate the process by which Iran intends to translate its rising exports into a stronger local currency.
Another surprising development is in the tourism sector, which has also experienced an unexpected spike. “Although most sectors of Iran’s economy are struggling and oil revenue has steeply declined, foreign purchasing power is at an all-time high in Iran due to a plunge in the value of the Iranian currency, the rial,” reported Jason Rezaian of the Washington Post.
The Iranian government has circumvented transatlantic sanctions by an ingenious mixture of manifold countermeasures. It has negotiated sovereign insurance deals with major customers such as China, India, Japan, and South Korea, while considering barter deals (sweetened by heavy discounts and flexible payment arrangements) to woo major customers and continue large-scale oil trade. Iran has also expanded its tanker storage capacity by purchasing/building new oil-transporting vessels, smuggled oil through neighboring countries like Iraq, and stealthily transported oil — with off-the-radar and/or or ‘foreign flagged’ ships — from its ports to major destinations in East Asia. This explains Iran’s ability to increase oil exports by almost 30 percent in November, compared to previous months.
Moreover, the government has instituted some draconian measures to stave-off the impact of sanctions. It has further slashed imports, postponed its subsidy cuts, reduced money supply, raised interest rates, and jailed so-called ‘currency manipulators’. It has also encouraged domestic manufacturing. Aside from the government’s recent ban on imports of around 77 luxury products, atop reductions in 52 other non-essential goods, the fall of the Iranian currency — especially in the black market – has also eroded the competitiveness of imported capital goods, which have hammered local producers in recent years.
It’s important to note that the Iranian government has considerable foreign exchange reserves, estimated at between $80-100 billion, giving it significant ability to sustain imports for an extended period and defend its currency amid growing international restrictions. With a multi-tiered foreign exchange system, the government has an ability to cushion the most vulnerable sectors — incidentally, the backbone of the regime – against major disruptions in the import of basic commodities. After all, Iran’s structurally high inflation more the product of a loose monetary policy and major subsidy cuts that begun in 2010.
In some ways, it is Iran’s relative resilience — and ability to avoid a total collapse — that may explain its willingness to explore direct talks with Washington. Tehran feels that it has enough wiggle room to avoid total unilateral concessions and negotiate a more mutually-favorable, face-saving outcome — perhaps, before it’s tool late.
- Richard Javad Heydarian is a Philippine-based foreign affairs analyst, specializing on international security and economics. He can be reached at jrheydarian@gmail.com
]]>via Lobe Log
The sharp drop in the value of the rial in the last two weeks has created much excitement in Iran and abroad, but mostly for the wrong reasons. In the parallel (or free) market for foreign currencies, the [...]]]>
via Lobe Log
The sharp drop in the value of the rial in the last two weeks has created much excitement in Iran and abroad, but mostly for the wrong reasons. In the parallel (or free) market for foreign currencies, the rial fell by 15% in one day this week, reaching its lowest value ever — 35,000 rials per US dollar — down by more than 50% compared to a month ago and 300% to last December when international sanctions tightened against Iran.
What all the related excitement overshadows is that this devaluation is not comparable to those in other countries where large devaluations caused severe shocks to the economy, such as those that swept through Asia in 1997-98. That’s because in those situations all prices were affected because all foreign exchange was traded at the same (rising) rate. This is not the case in Iran because nearly all foreign exchange is earned by the government, which has decided to sell most of it at a lower rate for the import of goods and services that it deems essential.
The rial devaluation that has created the media excitement is actually taking place in a narrow market that is shrinking in size and diminishing in importance. Iran’s Central Bank has classified a long list of goods into categories with priorities 1 through 10, leaving it to the parallel market to take of all other needs. Priorities 1 and 2 are food and medicine, receiving foreign exchange at the official rate of 12,260 rials per dollar, followed by other categories with lower priorities, which are mostly intermediate goods used in industrial production.
The government has been promising to do something for the import of these non-essential but important commodities, which account for about two-thirds of Iran’s imports, offering them some sort of preferential treatment. But the Central Bank was slow to respond and those producers who did not want to wait bought their currency needs in the parallel market, competing with speculators and people taking their money out of the country. The uncertainty about the sanctions, bewildering pronouncements from government officials in Iran, and hype over a possible Israeli attack, all combined to throw this market into chaos.
To protect Iran’s producers from what the government considers the consequences of “psychological war”, the Central Bank set up a “Currency Exchange Center” and invited licensed importers and exporters to trade their foreign currencies there, hoping that the auction rates reached there would be more stable and lower than the parallel market rate. When the Exchange Center opened just two weeks ago, the volume of transactions quickly jumped from $10 to $181 million per day, with most of the supply likely coming from the Central Bank. The Exchange Center diverted some of the supply of currency away from the parallel market, which I believe caused the rate there to soar.
Curiously, the Central Bank had predicted the opposite: that by arranging trade in the Exchange Center it would help lower the rate in the parallel market. This miscalculation added to the confusion and fear that the government did not know what it was doing. While the Exchange Center has produced a lower rate than the parallel market and can potentially shield producers from the worst psychological effects of sanctions and war, the shock to the parallel market has caused a serious political if not economic crisis for the government of Mr. Ahmadinejad.
Does all this mean that Iran’s economy is on the verge of collapse, as Israel’s Finance Minster reportedly said? The answer is no, because most of the economy is shielded from this exchange rate, though not from the ill effects of the sanctions, which will continue to bite for a while. Would it cause sufficient economic pain that would push the Iranian government to make concessions in its nuclear standoff with the West? The answer is not likely. The multiple exchange rate system, as inefficient as it is, will protect the people below the median income, to whom the Ahmadinejad government is most responsive.
But the government can ill afford to ignore millions of Iranians, mostly upper income Iranians, who are affected by the gyrations of the parallel market. Among them are millions of people who are seeking a safe place for their savings, parents who send money to their children for education abroad or need to travel there to see them. They are not all importers of luxury items or those who want to take their money out of Iran. In allocating its limited — perhaps shrinking supply of for foreign currency — the government has a difficult time balancing the needs of the lower middle class and the poor with those of upper income Iranians that it cannot rely on for political support.
- Djavad Salehi-Isfahani is a professor of economics at Virginia Tech and a nonresident senior fellow at the Brookings Institution.
]]>via the United States Institute of Peace
What are the primary reasons that the Iranian rial has lost half of its value against the U.S. dollar in just one year? Iran’s currency was valued at about 10,000 rials to the dollar in the summer of 2011. It plummeted to more than [...]]]>
via the United States Institute of Peace
What are the primary reasons that the Iranian rial has lost half of its value against the U.S. dollar in just one year? Iran’s currency was valued at about 10,000 rials to the dollar in the summer of 2011. It plummeted to more than 20,000 to the dollar in the summer of 2012.
Inflation in Iran’s economy has not been this bad since the end of the Iran-Iraq War or the economic crisis of the early 1990s, which also caused high inflation. The rial’s value began to slide rapidly at the beginning of 2012 after the United States announced new sanctions above and beyond the latest U.N. sanctions. The slide was due partly to the psychology of sanctions.
The government also went back to a tiered currency regime similar to what it had in the 1980s, during the Iraq-Iran War, and through the 1990s. Various types of imports and transactions had different exchange rates. Today, the official exchange rate is used for strategic imports such as food and medicine. That is another reason the price of rice did not go up a lot.
The price of chicken went up a lot, however, because Iran is not a socialist country. It cannot control the price of everything. Chicken farmers and wholesale buyers respond to market prices. The government capped the store price of chicken, but the price of chicken feed was going up because much of it is imported.
The state also stopped its phased subsidy reductions. It had planned to further cut longstanding subsidies for electricity, gasoline and utilities, but parliament told the president in the spring to continue the current level of subsidies. The president initially refused, but under parliamentary pressure has deferred any new price hikes. So U.S. and E.U. sanctions have forced the Islamic Republic to stop the subsidy reduction program that the International Monetary Fund and the Ahmadinejad government had been working on for years.
What roles have U.S. and international sanctions played in Iran’s currency drama? In July 2012, Parliamentary Speaker Ali Larijani said that only 20 percent of Iran’s economic problems were due to international sanctions. What is your assessment?
It is hard to put a number on what percentage U.S. and E.U. sanctions have on currency devaluation and inflation because both are produced by a combination of factors– what individuals do based on future uncertainty and the sometimes contradictory policies of the government.
The Central Bank has suggested that it may change the official exchange rate. What impact will that have? Will it solve the problem? Are there any side effects or dangers?
Some economists, including many in Iran, say the country needs a single rate. People make money playing the official and unofficial currency rates off each other. But the state does not have the luxury of unifying the rial’s value. So it is trying all sorts of stop-gap measures, which in the long term are harmful. They create opportunities for speculation. But the state, which is dealing in the short term, is in a double bind. Letting the official rate devalue would lead to such an inflationary burst that prices could go up even more.