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January 2018, No. 86


Economy

Dollarization of the Iranian Economy


The senior CBI expert said at that time reference currencies such as US dollar and euro as well as real estate and local and foreign luxury cars were practically used to secure capital.


Iran’s economy over the past years has been faced with the bitter experience of depreciation of the national currency and inflation due to fluctuations in prices and weaknesses in adopting the right monetary policies. This has inflicted losses on large portions of the economy and has resulted in destructive and excessive speculation in foreign exchange markets, putting aside the local currency; the strengthening of the US dollar’s role and its preference to the Iranian currency, known as ‘dollarization of the economy,’ would encourage economic activists and agents to be reluctant to work with the domestic currency.

As a result, financial resources would go to buying durable goods such as housing, cars, foreign exchange or coins, and come out of the economic cycle. In that case the economy would be plagued by Dutch Disease.

In the Iranian economy, where the exchange rate, and especially the US dollar, is of great importance, any change in market rates would entail a set of different and even controversial changes in the external and internal sectors of the economy, the consequence of which can positively or negatively affect the performance of the economy. Determining the exchange rate, on the one hand, has a significant role in export-import activities and, consequently in adjusting the balance of trade and payments, and on the other hand plays an effective part in determining the competitive strength of domestic producers against foreign competitors in domestic and foreign markets and consequently in the volume of production and employment.


If we say that forex unification means halting government subsidized rates and let the open market decide the rates and drag policymakers, then we cannot call this unification of foreign exchange.


Setting the exchange rate can also affect the general level of prices and, consequently, of inflation. Therefore, given the wide-ranging consequences of a change in the exchange rate for the Iranian economy, its optimal management is of great importance. This issue under the current state of the economy has entered a new phase, especially after the government announced it will unify the exchange rate and the decision by the establishment to achieve floating exchange market management.

This measure, if implemented properly, would be in the interest of the economy and bring Iran’s business climate to a level of stability and tranquility. But in case of ineffectiveness of executive policies it would lead to deterioration of the market conditions and economic tensions that is likely to take the country back to the bitter times of dollarization of the economy.

Fluctuations in Government Policy

In this regard, a senior researcher at the Central Bank’s Monetary and Banking Research Institute, explaining the safe conditions for implementation of the policy of foreign exchange unification said: “Iran’s economy has left the danger of dollarization behind.”

Mohammad Arbab Afzali, commenting on the situation of foreign exchange market and whether the conditions were ripe for unification of forex rates, said: “The fact is that there are still no favorable conditions for unification of the forex rates and that is the reason for the delay that has been made.”

Referring to the experience of the Iranian economy’s dollarization, he noted: “In countries with poor economic management and volatile monetary policy, the value of national currency falls and this would discourage economic agents from working with local currency. Iran experienced this situation in the 2000s and the economy was moving towards dollarization so much so that residential units in some developing areas of Tehran were priced by foreign exchange rates.

He said: “At that sensitive juncture it was felt that transactions in local currency were likely to cause losses, and in that case, hot money had been created in the economy, and under high inflationary situation, no one wanted to keep cash. In a state of hot money, the community would try to turn its financial resources into durable goods. This flourished the market for purchase of foreign cars and transactions in real estate, which were all signs of the Dutch Disease in the Iranian economy.

The senior CBI expert said at that time reference currencies such as US dollar and euro as well as real estate and local and foreign luxury cars were practically used to secure capital. It seems that the vulnerability of the Iranian economy from foreign currencies like the US dollar is such that as long as high inflation rate is normal in our country and the economy is accustomed to it, the US dollar would always be a reliable capital.

Correlation of Inflation Rate with Exchange Rate

The CBI expert said: “The government is trying to maintain and safeguard the single digit inflation that has been accomplished. Meanwhile, other economic conditions, such as recession, may also create barriers so that the government would be forced to adopt expansionary policies that could result in escalation of the inflation rate again.”

Arbab Afzali added: “With this assumption, if the single digit inflation is no more in force, we may again witness an increase in foreign exchange rates in the open market. Such conditions could make the process of forex unification difficult and delay the process.”

He noted that, of course, if we say that forex unification means halting government subsidized rates and let the open market decide the rates and drag policymakers, then we cannot call this unification of foreign exchange.

Value of Iran National Currency

Arbab Afzali said: “The fact is that we must see how much we interact with the world in the international arena, how much goods we supply to the world and how much we take and also find out the role Iran plays in global economy.

“Given such a situation, the value of our national currency is also defined.

“Over the past few decades, Iran’s economic climate has not been able to bring the country to a high level of global role playing. This generality tells us about the status of our exchange rate.”

As to whether 38000 rials per dollar is the right parity rate or 40000 rials, he said it all depends on the situation of the country in terms of forex earnings. “The economy of Iran has a situation in which the role of the government in the field of revenues is central, and in this section we do not have diversified incomes. The revenues come from oil sale, taxation, privatization and capital assets, and the share of each is also clear.

“Although the oil share has fallen in government’s revenues, in practice, we see that the oil sector still plays a primary role in the government revenues portfolio, and the share of oil and gas condensates sales in government revenues play a pivotal role. But in demand part we have diverse needs: from foreign exchange allocated to students studying abroad to cheaper hard currency given to travelers as well as the needs of the commercial sector. In this part we face a form of demand that the whole world is faced with.”

Key Role of Oil in Government’s Revenue Basket

 Arbab Afzali noted that if the foreign exchange inflows into the country were more diverse, for example, we owned stocks of international companies, which would generate foreign exchange revenues, and if the private sector was more active, and the government’s role in making revenues was minimized, competition for deciding the forex rate would be more reasonable and we would have a more realistic rate.

Commenting on vulnerability of the Iranian economy against the US dollar and in view of the efforts made to diversify the currency portfolio, he said: “We cannot deny the impact of the US dollar and euro on international relations; they enjoy high credit in international and even local transactions.”

The senior researcher noted: “At the same time, in relations with the countries of the world and given that we are the technology importer and they work with hard currencies, we cannot deny the dependence of the economy on these types of currencies. The next point is that the US dollar and euro have robust management in the markets and always stand at a certain level of credit. Policymakers and observers of these currencies are trying to keep the credit and price at a certain level and this has created a confidence point for capitals at risk from ​​these two currencies.”


Source: Jahane Sanat daily

 

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