How Iran Is Using Currency Reforms to Withstand Trump
U.S. sanctions
are battering Iran’s economy. They have all but stopped Western companies from
investing in the Islamic Republic, sent oil production crashing to its lowest
level in more than three decades and led to a dire scarcity of foreign
exchange. Inflation has accelerated to more than 50%, and some foods and
medicines are running short. So far, Tehran is hunkering down rather than
buckling to U.S. pressure to change its foreign policy, retreat from the region
and renegotiate the 2015 nuclear accord abandoned by President
Donald Trump. Iran’s latest attempt to ease the pain has been a reform of its
currency system.
1. Why is Iran making changes to its
currency?
The rial has come
under severe pressure from tightening sanctions and the subsequent collapse in
oil revenue. Iran has long kept a tight grip on its currency and has been
reluctant to let it devalue, maintaining the official exchange rate at 42,000
per U.S. dollar since mid-2018. As supplies of foreign exchange in the banking
system dried up, Iranians increasingly turned to the unregulated black market
to pay for everything from imported cars to overseas college fees. From the
start of 2019 to early May, the rial plummeted almost 30% on Tehran’s streets
to 156,500 against the dollar. That caused prices to soar and led to social unrest.
2. What has Iran done?
It essentially
created a system of multiple exchange rates, with the aim of taming the black
market. It introduced a currency-trading platform known as Nima for local businesses last year.
But most exporters preferred to sell their euros or dollars on the unregulated
market, since the rial’s Nima rate was too close to the official one, and thus
seen as overvalued. In recent months, the central bank has allowed the Nima
rate to weaken substantially to encourage more companies to sell foreign
exchange. President Hassan Rouhani’s cabinet has also announced that the rial
will be redenominated by slashing four zeros off it.
3. Has there been any effect so far?
The plan
has succeeded in bolstering the rial on the
unregulated market. Since May, it has appreciated more than 30% to 118,000,
which is more or less the same as the Nima rate, even though tensions have
worsened in the period with Iran shooting down a U.S. drone and seizing vessels in or near the Strait of Hormuz. That has helped slow inflation,
according to Steve H. Hanke, a professor of applied economics at Johns Hopkins
University in Baltimore. By his reckoning, the annual inflation rate, which peaked at 400% last year, fell to 24% by
early August.
4. Will it work in the longer run?
The
redenomination might have a psychological effect, albeit a minor one, if
Iranians perceive a currency worth 12 per dollar to be a better store of value
than one worth 120,000, says Renaissance Capital’s chief economist, Charles
Robertson. But Iran will struggle to keep the Nima and unregulated markets
stable as long as it can’t access enough foreign exchange with which to supply
them. And that won’t change until sanctions are eased and energy exports pick
up.
5. Why doesn’t Iran float the rial?
Iranian officials
worry that the rial would tank if its value were fully determined by markets,
which would cause inflation to accelerate again. It’s also politically
sensitive. Much of the establishment sees any weakening of the currency as a
sign of the nation’s diminishing power and inability to stand up to the U.S. In
addition, the central bank’s system of allocating foreign exchange at the
official rate is opaque. Analysts have said it fuels corruption, with
politically connected Iranians getting cheap dollars while most legitimate
business requests are turned down. Those vested interests are unlikely to
readily accept a floating currency.
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