by Sara Vakhshouri

This week Iranians began dealing with a new phase of reduced fuel subsidies and increased gasoline prices. The new gasoline prices were announced at midnight on April 24 by the National Iranian Oil Refining and Distribution Company (NIORDC).The price for the semi-subsidized gasoline will be 7,000 rials per liter [...]]]> via LobeLog

by Sara Vakhshouri

This week Iranians began dealing with a new phase of reduced fuel subsidies and increased gasoline prices. The new gasoline prices were announced at midnight on April 24 by the National Iranian Oil Refining and Distribution Company (NIORDC).The price for the semi-subsidized gasoline will be 7,000 rials per liter (27 cents) and 10,000 rials (42 cents) for free market price gasoline. That’s a considerable jump from the 4,000 rials (16 cents) per litre for the semi-subsidized gasoline and 7,000 rials for free market price gasoline.

The current gasoline subsidy reductions are part of the “second phase” of the subsidies reform plan in Iran, which was passed by the Parliament on January 5, 2010. The government announced that people could still use the remaining share of the subsidized gasoline with the previous price in their fuel cards after the price change. Each car has a fuel card with 60 liters of semi-subsidized gasoline a month and once they use up their share, they will have to purchase gasoline at the free market price.

Following the price increase announcement, the average consumption of gasoline in Iran spiked massively. Average gasoline consumption in Iran fluctuates between 66 and 70 million liters per day. This number reaches over 70 million during seasons of high demand, particularly around the Persian New Year in March. Of course, this past week average gasoline consumption increased significantly. According to the NIORD, gasoline consumption on Saturday, April 19, rose to 80.7 million liters — and the next day it reached 94 million. Although this number eventually dropped back to 76 million liters, it was still up 6 million a day from the previous week. The spike in gasoline consumption strongly suggests that people are storing gasoline in anticipation of their remaining subsidized shares being cancelled. The head of Iran’s Gas Station Owners Association, Bijan Haj Mohammadreza, said that Iranians are “storing gasoline in non-standard containers” in anticipation of rising prices.

Indeed, domestic gasoline supply and the direct influence of its prices on inflation and standards of living have always been Iran’s Achilles’ heel. Subsidized gasoline prices have created an expectation of, if not demand for, lower prices. This is something that the government in Tehran has to manage. The subsidies reform plan has thus far helped the Iranian government somewhat control domestic gasoline consumption, and to a certain degree also aided efforts aimed at preventing smuggling to neighboring countries.

Why Iran needs subsidy reform

Reducing Iran’s gasoline subsidies would initially reduce the gap between international and domestic prices. It would also help the government save money and better manage its domestic consumption. According to Iran’s Fifth Five-Year Development Plan, domestic gasoline prices should rise to about 90 percent of the free on board prices of the Persian Gulf by the end of the fifth plan in the next year and half.

However, Iran’s current gasoline prices lag far behind the plan. The inflation resulting from sanctions, coupled with currency devaluation, has prevented the government from increasing gasoline prices since 2011. The rial’s devaluation has also increased the gap between international and domestic gasoline prices. The first phase of Iran’s subsidies reform was attempted by former President Mahmoud Ahmadinejad. At that time, the US dollar amounted to about 1,000 rials, and Iran could mange an increase in gasoline prices from 10 to 40 cents a liter (at the previous price of 4,000 rials a liter). Yet for the past two years, with gasoline prices at the same rate of 4,000 rials, prices once again were forced down to 16 cents a liter.

Petrochemical facilities halting gasoline production

Iran’s dependency on gasoline imports has been a bottleneck issue for the country. During the Ahmadinejad government, Iranian petrochemical factories started to change their production line in order to produce gasoline and reduce their dependency on imports. Iranian petrochemical facilities managed to produce gasoline with 95 octanes, which is generally considered a good quality gasoline. However, the aromatic contents of this gasoline fell well short of international standards, and significantly contributed to air pollution, particularly in Tehran.

However, the “petroleum team” of Iran’s new president has stated on different occasions that Iran is planning to increase its gasoline imports to reduce air pollution. Aside from making air more breathable, this would also, crucially, allow petrochemical factories to return to their planned production line and produce higher profits by exporting their products to the international markets.

Iran currently imports around 3.5 million liters of gasoline a day. According to the director of NIORDC, Abbas Kazemi, this number will increase almost threefold to almost 10 million liters per day. Iranian refineries currently produce around 60 million liters of gasoline a day, up from the 48 million liters per day they produced in 2012.

Over the past few years Iran has been planning to increase its refinery capacity and gasoline production. Iranian petroleum officials are aiming for self-sufficiency by March of 2015, when construction on the Persian Gulf Star Refinery is expected to be complete. Based in Assalouyeh, South Pars, this refinery has a total capacity of processing 360,000 barrels of gas condensate. Seventy-five percent of this gas condensate will be converted to gasoline and diesel oil.

Iran’s current gasoline subsidies reduction plan, which is part of a broader attempt at reforming Iran’s subsidies, could stoke inflation, which will be tough for average Iranian families. But in the long-term, this strategy will help Iran manage its domestic fuel consumption, which will save money for the Iranian government and increase the value of its petroleum products.

by Robin M. Mills

Iran’s new oil minister, Bijan Zanganeh, cancelled plans to attend September’s United Nations meeting in New York. But the much-heralded thaw in US-Iranian relations has led to a remarkably quick revival in Western oil companies’ interest.

At least one large European firm is already rumoured to be looking [...]]]> via LobeLog

by Robin M. Mills

Iran’s new oil minister, Bijan Zanganeh, cancelled plans to attend September’s United Nations meeting in New York. But the much-heralded thaw in US-Iranian relations has led to a remarkably quick revival in Western oil companies’ interest.

At least one large European firm is already rumoured to be looking at re-opening its Tehran office, and “There is no embargo on talks,” one European oil executive told Reuters.

The oil companies’ memories may be short. In the late 1990s, beset by low oil prices and outmoded technology, Iran sought to sidestep constitutional restrictions on foreign investment to bring in international oil companies (IOCs).

Under Zanganeh’s first tenure as oil minister, from 1997-2005, France’s Total, Anglo-Dutch Shell, Norway’s Statoil, ENI of Italy, Spain’s Repsol, Petronas from Malaysia, Gazprom from Russia and others came in to work on major oil fields, conduct new exploration, and develop South Pars, Iran’s sector of the world’s largest gas field, which it shares with Qatar.

But the biggest prize was lost when US corporation Conoco had to withdraw from a $1 billion deal to develop the Sirri offshore fields after being blocked by president Bill Clinton’s executive order. Total stepped in instead, and a chance of US-Iranian engagement was forfeited.

The international companies did not find the going easy. The Iranian constitution was interpreted as banning foreign ownership of hydrocarbon reserves or even a contractual right to a portion of oil and gas a company extracted — the “production sharing contract” (PSC) used by Qatar and many other major producers.

Instead, Iran devised its own formula, the “buyback”, where the contracting company committed to delivering a set development plan for a fixed price, receiving a defined profit margin, and then handing over the field to the National Iranian Oil Company (NIOC).

A more lose-lose formula could hardly have been devised. According to those terms, the international company assumed all the risks of cost overruns and technical problems without any share of a potential upside from larger reserves or higher prices. The Iranians meanwhile missed out on a transfer of skills and a chance to optimise development or operations as the international operator learnt more about each field’s geology. Each contract took years to negotiate, trying the patience of IOCs who saw more attractive opportunities elsewhere as oil prices recovered.

The buybacks were attacked on nationalist grounds, and Zanganeh and his associates were accused of corruption. Their quasi-privatisation of parts of the oil industry into companies such as PetroPars and PetroIran — in fact controlled by government organs — was problematic. Nevertheless, oil production increased from 3.8 to 4.2 million barrels per day, and gas output more than doubled. Iran developed a substantial, if rather expensive, domestic oil engineering capability.

But under the Ahmadinejad administration — amid an increasingly politicised oil ministry and NIOC, a hostile Majles, and ever-tighter international and US sanctions — progress ground to a halt. In 2010, Shell halted new business development in Iran and finally gave up on its “Persian LNG” (liquefied natural gas) joint venture with Repsol. Some other oil companies, particularly Chinese ones, continued operations at a low level but did not make major new commitments.

If Western oil companies are to return to Iran, the prerequisite will be a relaxation of many of the US and EU sanctions on oil trade, investments in the energy sector and financial transactions. The Europeans, at least, could operate with some continuation of the much milder sanctions of the early 2000s, which mostly affect technology transfers. But to make large investments, these companies would have to be confident that harsh sanctions would be unlikely to return.

Just as importantly, IOCs would have to be confident that contractual terms will be reasonably attractive and balanced. They will want to negotiate contracts within reasonable time frames.

The competitive landscape for Iran is much tougher than during its last opening. Lucrative — albeit high-cost — investment opportunities have sprung up in North American shale oil and gas. Next-door Iraq also offers access to giant, low-cost fields — though on tough terms and with serious political and security risks. The sector of the Zagros Mountains in the Kurdistan region of Iraq shows just how successful modern exploration techniques can be. And the gas market is much more crowded, with the US, East Africa and Australia all seeking to rival Qatar as global LNG giants.

Zanganeh’s deputy, Mehdi Hosseini, is well-known to Western IOCs. But he has praised Iraq’s service contracts, which will not excite them. Production sharing contracts seem still to be off the table, for now — though there was talk earlier this year about using them for an Indian consortium’s offshore field.

More feasible would be a contractual form that mimics the financial returns from a PSC while honouring nationalist sensitivities. IOCs would like to be able to book reserves but can manage without this if profits are sufficient. The key is to give international companies a long-term stake in fields that encourages them to bring their best technology, maximise recovery in Iran’s mature oil-fields and explore new prospects. In gas, Iran can use the commercial skills of IOCs to develop exports to its neighbours, which will re-integrate it into the regional and global economy.

If the political stars align, the return of Western IOCs to Iran can bring them benefits while also benefiting Iran and the global economy. Zanganeh and his team have learnt lessons from their successes and failures in the early 2000s. But domestic realities on both sides may mean it’s a long time before ExxonMobil and Chevron are drilling just over the border from their Iraqi operations.

– Robin M. Mills is Head of Consulting at Manaar Energy and author of The Myth of the Oil Crisis and Capturing Carbon. Email him or follow him on Twitter.

by Farideh Farhi

Others have written about the gist of a new report by the National Iranian American Council (NIAC) on the impact of sanctions (here, here and here), so I am not going to provide a summary. But some points are worth reiterating. As Stephen Walt points out, the report [...]]]> via Lobe Log

by Farideh Farhi

Others have written about the gist of a new report by the National Iranian American Council (NIAC) on the impact of sanctions (here, here and here), so I am not going to provide a summary. But some points are worth reiterating. As Stephen Walt points out, the report offers ample evidence for why our current policy of punishing sanctions combined with scant tangible carrots is unlikely to achieve its stated objective of changing the Iranian leadership’s calculations. If anything, this approach reinforces Iran’s current “path of resistance”, which stems from the fear that submission to threats invites more pressure, encourages Iran to advance its nuclear program as a bargaining chip, and arms proponents of an aggressive Iran policy with the easy argument that our professed interest in resolving the nuclear issue is simply empty talk.

Just look at the speech made by Ayatollah Ali Khamenei in Mashhad a few days ago and you will see how his argument is based on a close reading of statements by various US officials. By zooming in on the disconnect between President Obama’s celebration of his sanctions policy as a successful instrument for crippling Iran’s economy — made in front of his American audience — and his message of compassion for the welfare of Iranian citizens — directed at an Iranian audience — Khamenei unpacks what he identifies as a “lack of sincerity” from the Americans.

Let me add that the report’s discussion of the narrative that the current Iranian leaders have developed and the lack of a compelling counter-narrative is not only important for understanding why the sanctions regime has not worked, but also for what it reveals about Iranian politics in general.

As the report points out, while Iran’s so-called pragmatic conservatives or centrists may be more amenable to negotiations and nuclear compromise, they have been unable to formulate a strategy that proposes a way out of the impasse. How could they? If the intent of sanctions in the publicly stated Western narrative is to change the calculus of the Iranian leadership through destructive measures, no politically viable counter-narrative can be constructed. These players can’t simply call for giving in to Western demands, such as giving up uranium enrichment, or submitting to any kind of agreement that treats Iran differently than other countries that have signed the Nuclear Non-Proliferation Treaty (NPT). Even if Western demands are complemented with promises of rich rewards, this dynamic will remain the same. The most critics of Iran’s current approach can do — and have done — is argue that the kind of rhetorically belligerent approach taken by folks like President Mahmoud Ahmadinejad has facilitated the imposition of multilateral sanctions on Iran. Or, in the words of one critic, turned “the opposition to the Islamic Republic from the American-Israeli position into an international issue.”

As the NIAC report points out, in Iran’s contested political terrain, what movers and shakers cannot do and have not done is call upon Iran’s leadership to give in to demands and pressures that are identified as both unreasonable and harmful. The reality is that no viable political force in any contested polity can take a public stance for “giving in” to external pressure and powers. To be sure, an argument could be made that in some countries such a stance can be taken behind closed doors where influence is really wielded. But Iran is not one of those countries. In Iran, public narratives matter and serve to bolster pursued policies. In fact, the case for sanctions as an instrument for changing the Iranian calculus, as pointed out by the NIAC report, is premised at least partially on the hope that resulting hardship will provide an argument “in favor of de-escalation and détente with the West – by serving as a demonstration of the consequences that hard-line Iranian policies produce.” Such hardship has undoubtedly facilitated criticism of hard-line tactics in Iran, but it has also served to undercut the more strategic call for trusting US intentions and plans.

The situation would have perhaps been different if the sanctions regime had really “crippled” the Iranian economy. But as the NIAC report shows, the government “has adapted the economy to bend but not break.” And, in the current context of economic downturn and difficulties, it makes perfect sense even for the private sector to focus on trying to improve its lot through securing economic concessions from the government rather than trying to change the country’s nuclear policy, which they have little influence over. To cope with the pressure they have developed incentives to collaborate with the government to devise effective policies that can counter the immediate impact of sanctions rather than pushed for a more distant and abstract change in the country’s political policies.

All in all, the argument that sanctions have impacted the Iranian calculus to function in a manner that’s opposite to the policy’s publicly stated goals is amply supported by this report. So much so that one has to wonder about the real intent of sanctions on Iran and whether US officials actually believe what they declare in public.

by Sara Vakhshouri

Sanctions against Iran by the European Union and the United States, which aim to change Iran’s attitude toward its nuclear program, have increased pressure on its oil export and revenue. This resulted in the reduction of Iran’s oil exports from 2.2 million barrels per day (bpd) in late 2011 [...]]]> via Lobe Log

by Sara Vakhshouri

Sanctions against Iran by the European Union and the United States, which aim to change Iran’s attitude toward its nuclear program, have increased pressure on its oil export and revenue. This resulted in the reduction of Iran’s oil exports from 2.2 million barrels per day (bpd) in late 2011 to around between 900 thousand to slightly above 1 million bpd until October 2012. On 30 January 2013, Reuters reported that Iran’s crude oil exports hit its highest level in December, at around 1.4 million bpd since EU sanctions took effect last July. What was the reason for this sudden hike?

Seasonal Demand

Winter and summer months traditionally mark peaks in global fuel demand. The cold weather during November and December, compared to September and October, usually creates higher energy demand and consumption. As expected, heating fuel consumption increased during the last two months of 2012, particularly in the US, Japan and other members of the Organisation for Economic Co-operation and Development (OECD), due to colder than normal weather conditions. According to the Energy Information Administration (EIA), the global demand for liquid fuels surpassed production in November and December 2012 due to seasonal increases in consumption. This caused a 1.4 million bpd draw from the global oil stocks. The average global demand for liquid fuels in November and December 2012 was estimated at around 90.2 million bpd, or about 0.9 million bpd higher than the consumption of September and October. However, the global supply outside of Iran was about 86.7 million bpd during this period.

Easing of Shipping Restrictions

Iran has increased its shipping capacity by purchasing super tankers from China. It also decreased its oil production, which eased the country’s shipping capacity. Beginning with the EU oil embargo in July 2012, Iran had to use some of its tanker capacity to store its extra production while searching for buyers. After it made an adjustment between its production, domestic consumption and average monthly export, this shipping capacity was free to transport crude oil. Increases in Iran’s tanker capacity allowed Iran and its customers to skirt the EU ban on tanker insurance. Iranian tankers could, in some degree, transfer oil to its customers. Market data suggest that China, Iran’s biggest oil customer, imported 593,400 bpd of oil in December. According to Chinese officials, an easing of shipping delays was the reason behind this increase. This could suggest that some of this amount might have been from purchases made in previous months that reached China with a delay.

US Waivers

The US State Department grants 180-day waivers on Iran sanctions to countries that prove they have reduced their Iranian purchases. State Department officials, though, have not insisted on any specific percentages for these waivers. Countries are expected to reduce the average amount of their purchases from Iran compared to previous purchases. These countries can adjust their purchase amount from Iran based on their monthly demand and the available supply in the market. This means they can increase their purchase of oil during high demand season and adjust it during the months when demand is relatively lower.

Senators Robert Menendez, an architect of US sanctions legislation, and Mark Kirk, have urged President Obama to require oil importers to reduce purchases by 18 percent or more to qualify for further waivers. Iranian oil customers are expected to maintain the average of their purchase from Iran at around at least 18 to 20 percent lower than pre-sanctions purchases during each period of 180 days in order to have their waivers renewed. We are therefore expecting the average Iranian oil exports to remain at around 1.1-1.2 million bpd throughout 2013.

The Western members of the P5+1 are showing signs of serious intent, if re-election of President Barack Obama allows nuclear-related talks with Iran to resume in the next few months.

This ought to be cheering news for all who believe that this dispute can be resolved according to the provisions of [...]]]> via Lobe Log

The Western members of the P5+1 are showing signs of serious intent, if re-election of President Barack Obama allows nuclear-related talks with Iran to resume in the next few months.

This ought to be cheering news for all who believe that this dispute can be resolved according to the provisions of the Nuclear Non-Proliferation Treaty (NPT), enhanced by some well-chosen, voluntary confidence-building measures.

Yet scepticism remains in order. Why? Several past opportunities to resolve the dispute through negotiation and confidence-building have been squandered. Two vital questions also remain imponderable: is Iran’s Supreme Leader really interested in a nuclear settlement, and will Israeli politicians resist the urge to exercise Israel’s formidable powers of influence in Western capitals to close down the political space for a negotiated outcome?

The Supreme Leader has not hidden his distrust of the United States and his aversion to the West’s “dual-track” approach. In August 2010, for instance, he is reported to have said: “We have rejected negotiations with the US for clear reasons. Engaging in negotiations under threats and pressure is not in fact negotiating.” And at Friday Prayers on 3 February 2012 he said:

We should not fall for the smile on the face of the enemy. We have had experience of them over the last 30 years… We should not be cheated by their false promises and words; they break their promises very easily. They feel no shame. They simply utter lies.

Does he, in addition, calculate that a nuclear settlement would not be in the interest of the Islamic Republic, even if the terms were fair and consistent with the NPT?

I have come across people who believe that this is the case. They argue that Iran’s leaders need the nuclear dispute to prevent a thaw in relations with the US which might bring about unwelcome social change; to mobilise popular support for the Islamic Republic; to distract attention from political repression, human rights abuses and the corrupt practices of an elite; and to excuse economic mismanagement.

I have no evidence for saying that this view is mistaken. If, however, I try to look at the issue “from the other side of the hill”, it seems to me that the Supreme Leader could afford to give up the nuclear dispute as a domestic political instrument; he would still be left with several other ways of arousing indignation against the West and of avoiding a thaw in relations with the US. And in cost/benefit terms, the gain from a nuclear settlement — if it results in the lifting of all nuclear-related sanctions —  looks to me enticing.

On the other side of the equation, we are all familiar with the arguments Israel’s leaders will deploy if they do not want a nuclear settlement. They will claim that an Iranian enrichment capacity, though not outlawed by the NPT, and even if subject to international inspection, represents a threat to Israel’s survival.  They will remind us that Iran is the world’s “leading sponsor of terror”, even though many of us know that the process which leads to a state being branded a “sponsor of terror” is highly political and highly partial. They will assert that continuing uranium enrichment in Iran will compel Saudi Arabia and Turkey to violate their NPT obligations and become nuclear-armed. They will point to Iran’s lamentable human rights record.

We are also familiar with their motives: to convince the US that Iran remains a threat to US interests in the Middle East, against which an indispensible ally, Israel, is a necessity (cf. Trita Parsi’s A Single Roll of the Dice); to justify an absence of progress in the Middle East peace process; to distract attention from their lack of interest in a Middle East free of Israel’s nuclear weapons; and to create common ground with Gulf monarchs who fear and loath Iran.

Until now Israel’s political harvest from keeping the Iran Nuclear pot at simmering temperature has been rich (I hope I can be forgiven a mixed metaphor). So it is hard to imagine that Israeli politicians will abstain from applying pressure on the West in 2013, if Iran fails to do their job for them by aborting renewed negotiations, and if things appear to be heading towards a settlement.

Yet the story could have another ending. Perhaps this time Western politicians will recall their primary responsibility: the welfare of those who elect them. Safeguarded Iranian nuclear activities pose no threat to the security of these voters. These voters are paying a price for the imposition on Iran of oil and other trading and investment sanctions. And a war on Iran, inevitable in the absence of a negotiated settlement, would entail risks to Western living standards, as well as to Western lives.

But enough! These musings will seem the stuff that dreams are made of if Governor Romney is elected and some of his neoconservative advisers are let loose on Iran policy.

- Peter Jenkins was a British career diplomat for 33 years. He specialized in global economic and security issues. His last assignment (2001-06) was that of UK Ambassador to the IAEA and UN (Vienna).

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 [...]]]> Iran’s economy is not on the verge of collapse

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. 

The Iranian rial has been in free fall for the last few days. Inflation has been ramping up for the last few months as the rial has lost more than 50 percent of its value over the last year. Unemployment is up to maybe 25 percent plus, and quite a [...]]]> via Lobe Log

The Iranian rial has been in free fall for the last few days. Inflation has been ramping up for the last few months as the rial has lost more than 50 percent of its value over the last year. Unemployment is up to maybe 25 percent plus, and quite a bit higher in some of the poorer parts of the country.

Iran’s oil exports have been slammed by sanctions. Even with Iran’s attempts to sneak some out in various ways, such as registering tankers in Mongolia of all places; the sanctions hunters found out about that one fairly quickly and shut it down with some diplomatic moves in Ulan Baator.

Then there is the purchase of 2 million barrels of stranded oil in Sid Krir in Egypt that the Egyptian government wants to purchase. US-Egyptian relations are not exactly the best these days and President Morsi visited Tehran recently. He might have embarrassed his host by mentioning his views on Syria, but he still went. Egypt also looks like it might be working towards improving relations with Iran. Turkey may be buying some oil from Iran with gold or other barter methods. Other states may be setting grain and goods for oil barter arrangements.

The financial system of Iran has been hit hard with the sanctions. The closing down of Iran’s access to the SWIFT system was significant. This may have done more damage to Iran’s ability to do business internationally than many of the other sanctions combined. The sanctions focused on persons and banks are good politics, but have historically not been that effective. Closing the country from a major clearing house is like slamming a large financial door in their faces.

Indeed, Iran is in a tight spot. I would expect runs on banks to follow on to this if the government cannot stem the flow of the psychology of financial contagion that seems to be sweeping the country. The government is clearly in a panic. They are blaming the usual “outside forces” and “22 conspirators” who of course were arrested quite publicly today. Then they blamed the black market money changers in the bazaars of Tehran for the collapse. This last one makes less than no sense. The bazaaris do not exchange enough money to make this sort of a dent in the US dollar-Iranian rial exchange rate. The currency drop has a lot more to do with hyper-expansive monetary policy pushing inflation. There is clearly a sense that there are way too many rials chasing at a faster velocity the goods that are in stock and are flowing into Iran. See this article for some supporting monetary and other data.

The huge rise in the stock market of Tehran is also due to nominal reasons, as we economists would like to say in such circumstances. The money flowing into the economy via the policies of the Central Bank of Iran has pumped up not only the prices of goods, but also stocks. This huge increase in money supply has also pumped up the price of land and housing in Iran. Also driving the stock, land and housing costs is the shortage of alternative investments. Sanctions have taken a bit out of the Iranian economy on that account.

Iran’s economic policies have actually magnified, not countered, the effects of the sanctions. One of the major culprits was expanding the broad money supply by 100 percent in the last 5 years.

This said, what is happening now shows not only the results of sanctions but counterproductive economic policies and more. The current economic status of Iran also shows how the credibility of the regime is weakening.

I am certain that there are many people in Iran who are questioning the worth of the country’s nuclear program and especially the leadership’s global defiance on this issue in light of the growing resulting problems they’re facing.

Developing about 90 percent of the entire nuclear fuel cycle is very expensive. This could have been costing Iran about 10 percent or more of its GDP for many years. That is 10 percent that could have been invested in industries that produce jobs, agriculture, education, and more.

Expansive nuclear infrastructure development is not necessary given the existence of global trade in low enriched uranium for nuclear plants. It is also unnecessary given the small amount of raw uranium that exists in Iran. This is also counter-intuitive given that Iran flares off the equivalent of four nuclear power plants of 1200 MW each of natural gas.

There are many reasons why Iran’s government should focus on its economy and its people, rather than on defiant nuclear brinksmanship.

The Iranian leadership may find that their brinkmanship is about to bring their country to the brink.

This past week a couple of articles have been published that hint at the central incoherence of the United States’ Iran policy. The arguments are not necessarily new, but they show in concrete terms how the stated objective of US sanctions, which is to change the calculations and behavior of Iran’s [...]]]> via Lobe Log

This past week a couple of articles have been published that hint at the central incoherence of the United States’ Iran policy. The arguments are not necessarily new, but they show in concrete terms how the stated objective of US sanctions, which is to change the calculations and behavior of Iran’s leaders, is undermined by the same sanctions that end up weakening – at times even endangering – the domestic forces presumably required to leverage the sanctions’ power and result in a change of behavior.

Virginia Tech economist Djavad Salehi-Isfahani explains how the sanctions regime is threatening Iran’s bond to the global economy, not only through the straight-jacketing of the middle class and private sector, which is the promoter of that bond, but also hindering the point of view that is supportive of that bond. In other words, instead of helping to promote a developmental state whose behavior is moderated by the multi-faceted links created, the sanctions regime strives to sever those links based on the claim that severing those links will eventually make the Islamic Republic a better global citizen!

James Ball’s article in the Washington Post is even more damning. The domestic actors striving to change the behavior of the Iranian state, it turns out, do not merely constitute unfortunate collateral damage. They are the direct recipients of policies that deny them protective tools, leaving them vulnerable to significantly more powerful entities which always find ways to get around sanctions and access the instruments of repression that they need to carry out their objectives.

These arguments are slightly different from the suggestion that sanctions are a form of collective punishment with the Iranian population ending up as the victims of Iranian leaders and foreign powers locking horns. The sanctions policy is assessed in the way that all policies should be assessed: What is the policy intended to do, who is supposed to benefit from it or be harmed by it, and are the policy instruments aligned with the policy objectives. In this case, the evidence offered suggests they are not.

There are, however, other ways of addressing the question of inconsistency between instruments and objectives. One way is to ignore the inconsistency while giving rhetorical lip service to the sublime cause of the Iranian people freeing themselves from the yoke of dictatorship. The objective of this policy, it is said, is to change the behavior of the Iranian government. External pressure will also eventually payoff on its own. No need to worry about what sanctions will do to Iran’s social fabric, economy, and the private sector in the meanwhile. Sanctions are both feasible and effective given American muscularity and the Iranian historical tendency to give in to overwhelming pressure eventually. This formulation is apparently based on a joke Iranians make about themselves: “Iranians never give in to pressure unless it is lots of pressure.” As for those freedom-loving Iranians, they’ll find a way to foment change in Iran and aim it in a favorable direction even in spite of us making their path more difficult because of their incredible desire and energy to be free.

The problem with this argument lies first in giving a lofty role to desire (as opposed to instruments for fulfilling that desire) and second, in refusing to acknowledge that in no country is there “a people” with a collective desire. Iran, like elsewhere, is a country consisting of a multiplicity of interests, desires, power centers, and a differentiated population with vastly different means of access to resources. Democracy, like elsewhere, will not arise out of Iranian collective desire but out of negotiations and accommodations among these multiple interests. This very basic point is not rocket science – especially given the US’ own experience with democracy. The refusal to understand this point reveals either the shallowness of the commitment to any kind of democratic project in Iran or a naïve hope that external pressure will delegitimize the regime and open a path for a more democratic Iran.

But perhaps I am searching for coherence in the wrong places. The US’ Iran policy is not that incoherent if the objective is not aimed at changing the calculus of the Iranian government and rather intended to simply harass, isolate, or even destabilize Iran. In fact, one can argue that the Obama Administration, unlike the Bush Administration, has found a perfect formula for this intent, which is also a good fit for the way the American bureaucratic structure works.

Rather than confronting Iran with an all-out sanctions regime, the US has settled on an escalating sanctions regime. Every couple of month or so, it announces a new set of sanctions to keep the Islamic Republic off balance and in search of new ways to get around sanctions. Of course, this is partly necessitated by the reality of the oil market. The complete shut off of Iran’s oil exports would have had a drastic effect on oil prices. But in any case, an escalating sanctions regime is a much better tool for harassment – or what some in Iran call psychological and economic warfare – than an all-out sanctions regime.

The Iraqi sanctions regime is a good example of why going for an all-out sanctions regime is not a good instrument; after a while, the sting wears off and ways are found around it. Even Donald Rumsfeld, by July 2001, was suggesting that one US policy option was to “publicly acknowledge that sanctions don’t work over extended periods and stop the pretense of having a policy that is keeping Saddam in the box when we know he has crawled a good distance out of the box”.

An escalating sanctions regime, on the other hand, assures that the initiative remains in US hands and the Islamic Republic – and by implication the people who live and work in the Islamic Republic – are kept off balance. It also has the added value of making a whole lot of people in various bureaucracies work hard for their paycheck.

The folks at the Treasury Department strive hard to find new ways and new entities to sanction; folks in the State Department work hard to get exemptions for allies (and even non-allies) who presumably have done well in reducing their oil imports from Iran exactly at the same time that the Treasury is tightening the noose in some other areas. Folks in the Department of Energy also work hard to determine exactly how much of Iranian oil can be kept off the market before prices rise.

And the game continues.  Just watch to see what happens after the six-month exemption period is up for Japan, South Korea, and…

The US’ Iran policy cannot be considered incoherent if the policy objectives and the instruments have become the same. It can still be considered immoral for trying to add to the economic woes of a good part of the Iranian population – irrespective of the fact that the Iranian government is most responsible for those economic woes – particularly at a time when so many people in the world are already suffering from unemployment and economic downturn. But it is not incoherent. It is intended to harass and it is doing so in a calculated and now rather routine, bureaucratic way. Weaning from routines and habits will be hard.

By Jahangir Amuzegar

*Dr. Amuzegar is a distinguished economist and former member of the IMF Executive Board.

During the last 12 months, and particularly since January 2012, the erratic and unhinged behavior of the Iranian currency, the rial, has been added to the Islamic Republic’s other thorny and protracted [...]]]> via Middle East Economic Survey

By Jahangir Amuzegar

*Dr. Amuzegar is a distinguished economist and former member of the IMF Executive Board.

During the last 12 months, and particularly since January 2012, the erratic and unhinged behavior of the Iranian currency, the rial, has been added to the Islamic Republic’s other thorny and protracted economic woes. After nearly a decade of relative stability in both the official and free market, the rial experienced a precipitous plunge in late December 2011, and subsequently lost nearly half of its value within a short time. With far-reaching effects not only on external trade, but also on domestic prices, interest rates, savings, investments and capital flows, the rial’s value has become the Mahmoud Ahmadinejad administration’s biggest daily economic headache.

While the explanations, reasons, and guesses so far offered for the upheaval have ranged from the probable (eg deteriorating business climate and political uncertainties) to the bizarre (eg sabotage by government “enemies”, manipulation by local currency dealers, and the administration’s own stratagem to make up for budget deficits), the real reasons are more numerous and far more complicated. This review attempts to seek the underlying causes of the recent events in a number of deeper-rooted and interrelated phenomena not so far sufficiently scrutinized.

The Unfolding Drama

The fall of the rial’s value has a long history. On the eve of the 1979 revolution, Iran’s domestic exchange rate for the US dollar was IR70.6. The revolution’s subsequent economic disasters – the bureaucracy’s massive upheaval, wholesale nationalization of banks, industries, and commercial enterprises, the exodus of nearly all experienced industrial managers, and massive capital flights exerted relentless daily pressure on the rial. The ruinous 1980-88 Iran/Iraq war and the drastic fall in Iran’s annual oil exports, accompanied by lower oil prices in the mid 1980s, imposed further heavy burdens on the Iranian currency. A series of misguided economic policies followed by Mir Hossein Mousavi’s left-center government during the 1980s, designed to control prices and wages, resulted in the rise of a multiple exchange rate system. So, by the end of the war, the Islamic Republic had 12 different official exchange rates for the US dollar. Subsequent attempts by the postwar government of President Hashemi Rafsanjani designed to cope with rent-seeking activities, spreading corruption, and economic injustices gradually reduced the exchange number to four. Under President Mohammad Khatami’s “reformist” government, the last four exchange rates were finally unified in 2002.

During 1978-2002 the rial lost its foreign exchange value steadily year after year. While the official dollar rate – announced by the Central Bank of Iran (CBI) under its so-called “managed float” system – started weakening from $1=IR70 in 1978 to $1=IR1,750 in 2001, the free market rate rose from $1=IR100 to $1=IR7,920 during the same 23 years. As the free market rate had reached $1=IR8,000 by 2002, the new unified rate was set at $1=IR7,950 and was periodically raised by small increments.

In the meantime, the free market rate’s difference with the official rate was virtually eliminated until September 2010 when a relatively modest difference of about IR1,300 began between the two rates, and repeated attempts to eliminate the daily difference were not successful. On 7 June 2011, the rial unexpectedly crashed on the open market and traded near $1=IR11,800. The CBI, moving to eliminate the difference and unify the two rates, raised the ongoing official rate from $1=IR10,590 to $1=IR11,740 – a 10.5% devaluation. In a matter of days, due to the CBI’s massive market interventions, a new stability was established. In order to minimize future rate differences, the CBI opened a “secondary” exchange window designed to deal with dollar demands for services (eg travel) at a third rate between official and free.

In early November 2011, while the foreign political climate became cloudier, the dollar rate in the secondary and free markets registered IR12,800, and IR13,300 respectively while the official dollar rate was fixed at IR10,850. By 30 November, while the official rate was $1=IR10,900 the free market rate climbed to $1=IR13,300. In the third week of December 2011, the free market rate climbed to $1=IR14,300 and by 30 December it reached $1=IR15,480. On 2 January the US currency sold at IR18,000 and climbed to $1=IR22,100 by 24 January. A series of panicked reactions by the CBI (eg frequently adjusting the official rate up and down) were of no avail, and market volatility intensified. Failing to calm the situation through monetary interventions and a sizeable injection of dollars in the market, the government resorted to a coercive policy. The Majlis passed legislation forbidding street venders (ie unlicensed money changers) from selling foreign currencies, ordering licensed dealers to sell dollars at no more than the specified rate, and blocking websites that reported hourly dollar prices. The Judiciary chief threatened execution of currency manipulators.

On 18 January 2012, failing to stop the currency’s continued decline, the central bank lowered the official rate by 8.5% to $1=IR12,260, and promised to offer unlimited dollars for current transactions. Then the Council on Money and Credit on 25 January 2012 changed its long-held policy of fixing deposit interest rates, allowing both government and private banks to set their own competitive rates. While the official rate was kept unchanged, the rial continued to slip and slide in the free market as the CBI was not prepared to meet all daily dollar demands. Powerless to maintain parity between official and free market rates, the CBI finally sanctified the coexistence of the “dual markets” on 14 March 2012, and let private money changers handle dollar demands for “non-essential” imports. The free market rate in late March 2012 fell to $1=IR19,000, or about 55% of its 2002-11 value. Five months after the previous high in January, the dollar rate was ranging between IR17,000 and IR19,000, surpassing $1=IR20,000 for a brief period. It has hovered around $1=IR19,000 since, with no particular direction and responsive mainly to current political events.

Leading Causes

The official explanations of the rial’s turbulence are few, far between and occasionally even bizarre. Despite reams of theoretical proofs, and decades of practical evidence to the contrary, President Ahmadinejad has linked the currency upheaval to a conspiracy between private exchange dealers, opposition politicians and the hostile press. The Central Bank governor has called it the reflection of a mob mentality, and the product of a “defective exchange market” where “hoarders, smugglers and soulless speculators” are trying to create “a false demand” for dollars as a “venue for investment”.

An objective and realistic look at the recent events, however, seems to show that the real factors behind the precipitous fall in the rial’s exchange value should be traced to: (1) a mistaken belief in the high value of the national currency as an economic desideratum; (2) a series of wrongheaded economic policies pursued by the Ahmadinejad administration to deal with both inflation and unemployment; (3) the perseverant pursuit of a national nuclear power policy, inviting the West’s wrath and resulting in a series of hardening economic sanctions; and (4) significant loss of  public confidence in the government’s ability to support the official exchange rate in the face of external pressures.

The ‘Strong Currency’ Myth

The strength of the national currency and the high exchange value of the rial has always been more of a political, rather than a monetary or market phenomenon, in Iran. A strong rial, in the eyes of both the man in the street and the seasoned politicians, has always been a clear sign of economic vigor, and a symbol of political power and prestige. The intensity of faith in this myth has also been related to the believers’ economic literacy. Keeping the dollar/rial rate deliberately (and artificially) low, while one of the clearest economic policy mistakes of the past decade, is still widely demanded and revered. A current Persian website – Asr-e Iran – nostalgically laments that while the Iranian national currency unit – the Shahi – was equal to one shilling or one-twentieth of the English pound in the 16^th century, the value of today’s rial is officially equal to 1/19,500 of the British currency and its free market rate as little as1/30,000.

Due to the pervasive influence of this myth, there were neither any effective business demands, nor any urgent political will, to adjust the exchange rate to its proper level after the 2002 rate unification – although all leading economic indicators warranted such realignment. There were faint voices of advice by private economists, and desperate pleas by disadvantaged exporters for the rate adjustment. The first group was contemptuously ignored by the authorities, and the second was partly silenced through the so-called “export prizes” and subsidies.

Neglecting Realities

Handicapped by the nostalgic feeling about the high national currency value, and obsessed by certain “out-of-the-box” economic convictions, President Ahmadinejad began his tenure in 2005 by following a populist and welfare-oriented economic policy, promising to “put the oil money on everyone’s table.” His economic agenda included: (a) an expansionist fiscal policy aimed at “eradicating poverty;” (b) a distinctly overvalued rial to reduce imports’ cost; (c) a mandatory low interest rates policy to minimize capital costs of business; and (d) the use of bank loans, bond issues, and sale of state enterprise to finance budget deficits – instead of tax hikes or more efficient tax collection.

The expansionist binge began with: (i) extensive and poorly supervised loans to the so-called “quick-return projects” in order to increase employment; (ii) an immense nationwide housing project (Maskan-e-Mehr) to increase home ownership; (iii) hundreds of half-baked local development projects to satisfy the crowds who greeted the president in his countrywide tours; and (iv) a “subsidies reform program” involving monthly cash payments to nearly the entire population to make up for higher energy and bread prices. As a result, the national budget rose from IR1,590 trillion in 2005 to IR5,100 trillion in 2011 – or more than three times in seven years. With annual budget deficits running at more than 4% of GDP each year, total liquidity rose from IR921 trillion in 2005 to IR3,720 trillion in 2011, or nearly fourfold.

Protracted budget deficits and liquidity expansion during 2005-11 caused the average officialcost of living index to rise by nearly 17% a year – with the most conservative privateestimate showing 22%. During the same period, Iran’s main trading partners had price increases of 2-4% a year. By a simple calculation, the difference between Iran’s cumulated inflation during the seven-year period compared with those of its trade partners would have warranted some 90% devaluation of the Iranian rial. In actuality, the exchange rate only rose from $1=IR9,025 in 2005 to $1=IR10,445 before the December crash, or a total correction of less than 16%. Thus, the government not only ignored the facts; it also violated the clear mandates of both the Fourth and Fifth Economic Development Plans, requiring annual adjustments of the rial’s exchange rate in line with the differences between domestic and foreign inflation rates. Curiously enough, in December 2010, while announcing his subsidies reform program, President Ahmadinejad asked the head of the CBI to come up with a new and “realistic” exchange rate in view of Iran’s “ample foreign exchange reserves” – an order which  some of his aides at the time interpreted to mean revaluing the rial towards $1=IR5,000!

The same incongruous treatment greeted the government’s regulations of bank interest rates. During the first six years of the Ahmadinejad administration, the authorized interest rate on short term savings deposits frequently trailed the annual inflation rate, eroding the net value of the depositors’ wealth. The maximum interest rate (called “profit share” to comply with Islamic principles) payable by commercial banks on short term (less than five years) deposits during 2005-10 averaged 13% per annum, while the corresponding inflation rate registered 17-22%. In the highly inflationary year 2008, the negative spread reached 10%. As a result, there was a steady decline in the growth of savings deposits during the entire period. Despite these warning signs, however, and even ignoring the mandates of the Fifth Economic Development Plan (2010-15), requiring periodic adjustments of the deposit rates in line with the inflation rate, the Council on Money and Credit, chaired by the president, refused to budge. Even when faced with continued turmoil in the exchange market in early January 2012, the Council (in the absence of the president) allowed interest rates paid on savings deposits to be left at the individual bank’s discretion (in order to divert liquidity from gold and dollars markets). The decision was vetoed once the president returned from a foreign trip. It was only after strong public pressures that on 25 January 2012 the president finally approved the rate adjustments.

President Ahmadinejad’s third gamble with the teetering economy was to fight a virulent and cumulative inflation with the wrong weapon. Instead of controlling consumer prices through conventional means, eg balancing the budget, raising interest rates, reducing bank borrowings, controlling liquidity, or raising factor efficiency, he chose the easy way. Blessed by the best six years of oil export receipts from Iran’s 106-year-old oil industry, he opened the imports’ floodgate. Iran’s revenues during the first six years of the Ahmadinejad administration reached $560bn, compared to only $433bn by all the eight previous governments since the 1979 revolution. In the same six years, imports amounted to $330bn – three times those of the Khatami and Rafsanjani administrations. Yet, during the same six-year period, the government debt to the banking system rose from IR113 trillion to IR403 trillion – or four times. The pernicious policy of trying to fight domestic inflation through cheap imports required the rial to be kept highly overvalued.

Sanctions As Catalyst

The Islamic Republic’s nuclear development program has been the third factor in the exchange rate drama. Widespread suspicion in the West regarding the ultimate objective of Iran’s uranium enrichment activities initially led the United Nations Security Council to issue four consecutive sanctions resolutions. And the move was subsequently followed by the US, the European Union and others. Thus, the original “targeted” and “smart” penalties gradually morphed into the current “crippling” restrictions. They currently consist of stiff and extensive restrictions on travel, trade, banking, finance, shipping, insurance, investment, and transfers of nuclear technology involving hundreds of individuals, businesses, and agencies associated with the Tehran government. Their sole objective has been to dissuade Iran from pursuing its nuclear program – a program which Tehran claims to be for purely civilian energy research and production, but the “sanctioneers” suspect it to involve certain military objectives and possibly even nuclear weapons ambitions.

Although the current sanctions have not targeted the exchange rate in any direct way, their indirect impact on the rate’s movement has been notable. While the rial’s equilibrium exchange rate was due for a substantial correction and for a long time, the plunge would not have occurred without a catalyst. The currency could still have remained out of equilibrium for a while thanks to rising oil export earnings. The trigger for the precipitous plunge was supplied by the news of forthcoming new crippling American and European sanctions in early December 2011 – particularly the oil embargo. The exchange market was visibly rattled. And, on 31 December, when US President Barack Obama signed into law the new (and unprecedented) sanctions involving Iran’s central bank, the exchange dam burst, and the downward movement began.

In the same vein, while negative interest rates on bank deposits were not unique to the Ahmadinejad administration, and never a lever for a game change, two specific factors related to sanctions heralded a dynamic change. The first was a shift in the investment climate, shaken by the threatening sanctions. Prior to 2010, when there was relative political calm, the real estate market was flourishing, and rising liquidity would flow into land, apartment building, and the Tehran Stock Exchange. With the news of ominous times ahead, the funds started to invade the gold and foreign exchange markets as far safer and better havens. The second factor was a bewildering and untimely decision by the Council on Money and Credit, aimed at compensating the effects of sanctions, to lower short term interest rates from 16% in 2008 and 13% in 2009, down to11% in 2010 and 10% in 2011, at the very time that consumer prices had begun to rise from 12% towards 22%!

Loss Of Market Confidence

The fourth factor in the rial’s declining value has been the loss of people’s confidence in the CBI’s ability to cope with the crisis. The bank officials’ frequent empty promises, inadequate determination to follow declared policies, insufficient action to deal with the crisis, and inadequate supply of dollars to stem the growing speculative demand have all been major sources of popular disappointment. To wit, when the free market rate for the dollar dropped by more than 10% in less of a day in late December 2011, the CBI governor responded with a firm promise to bring it back even below the official rate. Yet nothing happened. On 5 January 2011, the bank ordered private exchange dealers to charge no more than IR14,000 for the dollar. The order was totally ignored. And the rate by the street vendors jumped to $1=IR16,250. The governor said he had firm plans to stabilize the market, but it was not in the public interest to reveal them. On 25 January 2012, the governor said the four demerged exchange rates (reference, official free, travelers, and open market) would be unified in 48 hours, and there would be no limitation in the dollar supply for various current transactions. It proved to be an empty gesture. And there was mistake after mistake. For example, one of the reasons for the people’s rush to buy dollars in the first days of the new year was their lack of confidence in the CBI’s claim of ample gold and dollar reserves. Yet, instead of reducing this skepticism by showing resolve to meet all dollar demands, the central bank on 6 January 2012 cut the travelers’ ongoing $2,000 allowance down to $1,000 – thus reinforcing the people’s conviction that the bank was running out of dollars. As a result, the public was convinced that due to hardening sanctions, Iran’s oil exports would be drastically reduced, and higher oil prices caused by global tensions would not be enough to compensate for total receipts, thus, sooner or later, forcing the CBI to ration foreign exchange sale.

The Ideal Exchange Rate

The hottest current economic issue in Iran is the proper exchange value of the rial in terms of the US dollar. In the absence of an objective determinant of the equilibrium exchange rate, suggestions about the right number abound. Private analysts, on the basis of rapid inflation and sluggish exchange rate adjustments in the last few years, argue for a rial devaluation towards the current free market rate of about $1=IR19,000. Government officials, aware of the devaluation’s effect on import costs and further domestic inflation, favor the opposite course and hope to bring the free market rate down towards the official rate. Traders are also divided on the basis of strict self-interests. Exporters and domestic producers of tradable goods are demanding a lower rial rate in order to become more competitive abroad. Importers, on the other hand, argue that since the bulk of Iran’s imports consist of raw materials and semi processed goods, a strong rial is in the national interest as it keeps down producers’ costs. Anti-devaluation groups also argue that since Iran is dependent on imports for 30% of its food consumption, any upward adjustment of the exchange rate would add to the already high domestic consumer living costs. They similarly allude to the low price elasticity of both Iran’s exports and imports as a significant disincentive for devaluation.

Private market analysts also argue for substantial devaluation, pointing to the fact that due to cheap dollars, Iran’s imports have increased from $18bn in 2001 to more than $64bn in 2010 (not including payments of $19bn for services, and an estimated $20bn in smuggling). The latest imports roster, mostly from China, comprises items that have never been on Iran’s import list. As a result, not only have traditional exporters been unable to compete in foreign markets due to the overvalued national currency, domestic producers have also lost their competitive power, gone bankrupt, or become packagers and handlers of foreign articles. Domestic industry has become increasingly hallowed.

Determining the right rate of exchange for the Iranian currency, however, is difficult due to the country’s heavily oil-based economy, and the unpredictable effects of sanctions. Iran’s oil industry – responsible for more than 85% of the country’s annual foreign exchange earnings – is state-owned. The government is the sole arbiter of daily oil extraction, and the sole dispenser of oil export receipts (ie injection into the economy). The government’s decision to sell more or less oil thus influences the exchange rate automatically. The small “free market” plays only a marginal role. In such a case, where the main provider of the foreign exchange is the treasury, and the major users of the foreign money are state enterprises, whatever rate the central bank might set would be arbitrary and not necessarily the “equilibrium” rate. The rate that is determined in the “free market” by private importers, travelers, students, smugglers, and capital movers is marginal. The free market’s difference with the official rate at any given time is only indicative of the fact that the official rate is “out of range” and that the government is not willing (or able) to meet the entire “discretionary” demand.

Searching For The Right Exchange Number

Already five months into the Persian New Year, there is still no clearly declared exchange rate policy by the CBI, and the dollar rate is drifting up and down with no clear direction. On 27 July 2012 the deputy director of Iran’s Export Promotion Organization announced a “consensus agreement” among the CBI and other government agencies to divide the entire imports list into 10 main categories, with the first five (comprising a list of specific consumer staples and industrial necessities) eligible to receive dollars at the official rate, and the other five (discretionary and luxury items) supplied with the dollars earned from non-oil exports and other free market sources. The secondary market is closed, and foreign exchange at the official rate will now be sold only for travel to religious destinations.

A successful and orderly administration of such a complex exchange regime is highly difficult in normal times. It would be extremely complicated and hazardous in the present domestic economic conditions. Under the strain of biting sanctions, Iran’s economy is experiencing an unprecedented anemic economic growth, disturbing double-digit inflation, worsening youth unemployment, falling oil output, reduced oil exports, and lower oil prices. GDP growth this year is estimated to be no more than 1%. Unemployment among 18-25 year-olds is officially 29.1%, with many analysts estimating much higher rates. Press reports point to a large portion of the production sector operating at half-capacity, with a wave of bankruptcies and business closures. The latest CBI data show wholesale prices up by 33.4% and the consumer price index by 22.4%, with certain food items (eg chicken, red meat, and milk) up by a staggering 30-80%. OPEC and other sources report Iran’s daily oil production (the economy’s life blood) at 2.9mn b/d, down from 3.9mn b/d last year. Oil exports (the country’s main foreign exchange source) are reportedly at 1.2mn b/d, compared to 2.3mn b/d prior to the oil embargo. Oil export earnings (the annual budget’s major source of income) are reduced considerably due largely to the European oil embargo, and partly to lower oil prices (from the record $126/B in March to $96/B in June). According to reliable estimates, the Islamic Republic needs a $117/B price to finance its current fiscal budget, while market prices have lately been running at $105-111/B.

The sanctions’ role in these setbacks is coming to light as days go by. After years of defiantly denying the stiffening results of universal restriction, and in fact welcoming them as a spur to national self-sufficiency, a chorus of influential voices is now openly showing concern. Supreme Leader Ali Khamenei himself still remains defiant, and claims that Iran is currently “100 times stronger” than before, and that “Westerners” themselves have “vaccinated” the country against sanctions through their 30 years of censure – arguing that an oil-less, and knowledge-based economy could well resist any sanctions. But a growing group of top civilian and military leaders, Majlis lawmakers, and even high-ranking clergy show clear signs of unease and openly bemoan current economic hardships.  President Ahmadinejad has recently acknowledged serious financial impact of what he called the “toughest” measures ever imposed on the Iranian economy. The Minister of Industry and Trade has called them “devastating.” The Majlis speaker has acknowledged the sanctions’ share in the current plight.

The Insoluble Dilemma

The central bank’s latest de facto acceptance of a multi-tiered official exchange regime has now reopened the old Pandora’s Box of economic rents, appropriation of cheaper dollars to insiders, and widespread corruption – reminiscent of the 1980s as a major source of ill-gotten wealth for the Islamic Republic’s current financial moguls. There are already press reports regarding industrial producers complaining about lack of access to the official rate, the necessity of bribing bank officials to receive cheaper dollars, and the growth of under-the-table deals. The current IR7,000 difference between official and free market rates, if continued, would promise to generate billions of new “rent” to materialize in the next few months to be grabbed by insiders.

However, despite strong verbal objections to the current multiple exchange system by certain influential groups in and out of the government, and strong popular demands for the return to currency unification, the dilemma continues insoluble. An early return by the CBI to a single rate around the current official rate would seem out of the question without prior easing of the crushing sanctions, eg the oil embargo and central bank operations. On the other hand, a more logical realignment towards the free market rate would also be nearly impossible at this juncture without first taming the intolerable high domestic inflation.

What seems certain is that in the next few months and beyond, the Islamic Republic is going to face its toughest and most troublesome economic challenge since the end of Iran/Iraq war, with unprecedented major headwinds. The fate of the rial also will, by more than any other factor, be directly tied to the course of Tehran’s relations with the 5+1 group, and the resolution of the nuclear issue.