Bourse and Bazaar | Esfandyar Batmanghelidj: The Iranian rial has hit a historic low against the dollar, adding to the perception that the country is in the throes of a deepening economic crisis. But the figures that are most concerning for Iranian economic policymakers (there are many) are rarely the most dramatic or those that make the headlines. The rollercoaster ride that has taken the rial to a historic low of IRR 215,000 to the dollar does not tell us as much about the health of the Iranian economy as is widely assumed.
Reporting on Iran’s currency focuses on the azad or free market rate, which is the price of purchasing a single, physical dollar bill at an exchange bureau in Tehran. The buying and selling of eskenas, or hard currency, represents a small proportion of the overall foreign exchange market in Iran, likely accounting for less than 20 percent of all foreign exchange transactions.
There is also a fixed subsidized rate of IRR 42,000 for each dollar. This rate is made available to importers of critical goods such as food and pharmaceutical products, but the Iranian government has been seeking to shrink the number of goods eligible to be imported at this rate.
The most important rate, which is rarely cited in reporting on Iran’s currency woes, is the rate available in the NIMA exchange, a centralized electronic system established by the Central Bank of Iran in 2018 to streamline the purchase and sale of foreign exchange among Iranian companies. The NIMA rate has hit just over IRR 168,000 in the past week, also a historic low.
The NIMA rate has also risen in recent months, reflecting the reported shortages of foreign exchange available in the market due to trade disruptions brought-on by COVID-19 as well as the underlying difficulties facing Iranian banks, and particularly the Central Bank of Iran, in accessing foreign exchange held in accounts at foreign financial institutions.
After approaching convergence in the summer of 2019, the spread between the free market and NIMA rates has widened considerably, meaning that the devaluation of the rial in the free market is not the best indicator of the strength of the rial, nor an accurate reflection of concerns around inflation.
Since the NIMA exchange began operating in earnest in the last quarter of 2019, inflation, as measured by the consumer price index, has tracked most closely the NIMA rate and not the free market rate. This is to be expected. The NIMA rate reflects the price at which most foreign currency is bought and sold in Iran and crucially it reflects the price at which Iranian companies purchase foreign exchange in order to pay for imported goods.
On one hand, the devaluation of the rial over the last decade has benefited Iranian exporters, making their goods more attractive to foreign buyers. The more liberal approach to foreign exchange policy has helped Iran grow its non-oil exports—a lifeline for the economy as oil exports are constrained by sanctions.
But on the other hand, the more liberal approach to the exchange rate has had an impact on the price of imported goods, whether those are finished goods or raw materials and parts used in the manufacturing of finished goods in Iran. This relationship is most clear when comparing the changes in the NIMA rate with the price index for consumer durables, a category of goods more likely to have imported parts content. When the NIMA rate increases, so does the price of durable goods, contributing to the total cost of the consumer basket.
Often, reports about the plunging value of the rial suggest that the appreciation of the dollar in the free market reflects the erosion of Iranian purchasing power. But the relationship between the rial’s free market rate and inflation is limited. Unlike in other economies that have experienced currency crises, such as Lebanon, Iran’s economy is not dollarized. When ordinary Iranians exchange rials for physical dollars, they are acquiring an asset that they will most likely exchange back into rials at some future point, preserving the value of their savings in the process. Iranians purchase dollars for the same reason they purchase gold, real estate, and even used cars—they are seeking a hedge against inflation. Hard currency dollar appreciation does not depress the value of the rial as a medium of exchange.
However, the free market rate could be a signal for price makers about expectations of future inflation, and therefore may influence producers and retailers to increase prices. Moreover, the free market rate may also have an impact on the price of real estate, which is also used as a hedge against inflation. In both instances, the devaluation of the rial in the free market could contribute to higher prices for Iranian households.
But when considering that the free market represents a small proportion of the overall foreign exchange market in Iran, fluctuations in the free market rate are perhaps best understood as a response to inflation, among other economic indicators. In fact, at a time when the central bank is pumping historic amounts of liquidity into the Iranian economy, the conversion of rials into dollars may actually serve to absorb some liquidity.
This is perhaps the other parallel that can be drawn between the purchase of dollars and assets such as stocks and gold—the currency free market has some of the hallmarks of a bubble, particularly as the spread with the rates available on the NIMA exchange widen. The devaluation of the rial that can be observed in the NIMA exchange, which is equivalent to the rial losing about a third of its value since Iran reported its first two cases of COVID-19 in February, lags behind the devaluation in the free market exchanges, which has seen the rial lose half of its value in the same period.
Given the media attention both inside and outside of Iran to the rial’s free market fluctuations, it is perhaps no surprise that psychological factors may be responsible for the recent devaluation episode. Given that the NIMA rate is a better indicator of the vulnerability of the Iranian economy to inflation, both when considering how much foreign exchange is available in the market, but also when considering changes in the money supply in Iran, it is notable that the free market rate has deteriorated more sharply.
This divergence, which the central bank had worked hard to limit, is beneficial to a wide range of actors within Iran’s financial system, including those engaged in corruption. The arbitrage between the two rates incentivizes commercial enterprises that earn foreign exchange revenue to circumvent the NIMA system. The panic buying of dollars by working class Iranians benefits wealthy Iranians who are more likely to maintain a large portion of their savings in hard currency, or who can bring hard currency back to the country from abroad. Ironically, in the short term, the devaluation of the rial has probably created more wealth than it has destroyed
Nonetheless, Iranians should be worried about inflation. The COVID-19 crisis has widened Iran’s fiscal deficit and also given rise to balance of payments challenges. There is growing concern that inflation will rise in the coming months as the central bank prints money.
Iran’s central bank governor, Abdolnasser Hemmati, has sought to calm nerves by arguing that increased liquidity is a “structural phenomenon” in the Iranian economy. His statements have yet to reduce demand for dollars, which has risen in anticipation of increased inflation. Nonetheless, the increased demand does not itself mean that Iran is presently experiencing or is set to experience the scenarios of “hyperinflation” that have been long predicted. Rather, those purchasing dollars in the free market are betting that the policymakers will fail to keep inflation under control as it edges towards 30 percent.