International economic sanctions and Iran: Are there positive side effects? Part Two – Monetary Policy & the Rial

Editor’s noteThis is the second part of a three part mini-series by economist Radman Sam on the possible “positive side-effects” of international economic sanctions on Iran. Part two focuses the ways in which sanctions may be creating impetus for better management of the national currency, the rial, in Iran.

Part One: Tax Reform

Part Three: Domestic Manufacturing

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By Radman Sam

In a study about the possible positive effects of international economic sanctions on Iran, one of the subjects that should be discussed is the exchange rate. For a long time liberalization of the exchange rate has been considered a necessity for the Iranian economy. One of the consequences of the lack of real exchange rate in Iran has been the strengthening and encouragement of imports and the weakening the exports. The exchange rate has always been one of the main concerns in economic development plans in Iran. In the Fourth Development Plan, in order to control severe exchange rate fluctuations and enhance the competitive power of exporting firms, the implementation of a managed floating exchange rate through the supply and demand mechanism became mandatory for the government.

Nevertheless, the government not only failed to take any steps in this respect but also kept the exchange rate fixed due to the considerable growth of foreign exchange revenues in the last years that resulted in the significant losses for exporters and profit for importers. This issue, which stemmed from the government’s mismanagement of spending petro-dollars, led to soaring imports that were mainly consumer goods rather than goods used in domestic production, ruining many domestic firms in a wide range of industries. After the removal of subsidies beginning in 2010, given that the government had not considered any mechanisms to support domestic producers, these firms and national production as a whole were severely damaged. The global financial crisis and economic downturn coupled with the reduction of foreign goods prices accelerated this trend.

As Iran’s revenues have begun drying up due to oil sanctions, the government has no longer been able to defend its fixed exchange rate. This, alongside falling foreign exchange reserves and financial sanctions which have made basic import-export transactions difficult even if the entities or items are not sanctioned, has led to turbulence in the exchange market, creating a serious bottleneck for imports. The Iranian government has responded to these circumstances by establishing the Currency Exchange Room, which places constraints on foreign exchange allocation to importers and new limitations for importation of non-essential goods (such as luxury items). The government also plans to limit imports and improve domestic industries to serve as substitutes. To this end, president Mahmoud Ahmadinejad has emphasized that supporting national production is regarded as a strategy to deal with sanctions in the budget circular 1392 (2013-2014) that he recently delivered to senior officials. Accordingly, the basic policies and goals of the budget bill for 1392 include enhancing the productivity of domestic industries, improving the business environment, increasing competitiveness, supporting the active participation of the private sector, reducing governmental red-tape, developing the financial markets with an emphasis on efficiency, and better transparency and safety.

The Currency Exchange Room, first established by the Central Bank to control the exchange market turmoil, has in practice turned into the place for executing the new import control policies by the government. In fact, the so-called non-reference rates in the Currency Exchange Center are far more than official exchange rates and much closer to free (black) market rates. Additionally, it has been announced that the Currency Exchange Room rates will soon become the official exchange rates of the country. At this time, with the exception of some essential goods, imported goods which are from the prioritized commodity groups are allocated foreign exchange at the non-reference rates and the remaining allowed imports are to be financed from the free exchange market. All these strategies are the signs of the gradual movement of the Iranian government towards the liberalization of currency.

Evidently, the pressures resulting from international economic sanctions have not left any choice for the Iranian regime but to make changes in their economic policies, amounting to reforms which have always been badly needed by the Iranian economy. In this context, sanctions can be regarded as having positive effects. However, it cannot be said with absolute certainty if Iranian authorities will be able to carry out these reforms in the midst of such harsh sanctions. Because the economic imbalances arising as a result of carrying these reforms could be very extensive, it may be extremely difficult to manage these reforms well in short- and medium-terms.

Part three of this mini-series will deal with possible impacts economic sanctions, directly and indirectly, may be having on the resurrection of Iranian domestic industries which have suffered as a result of mass cheap imports in recent years. 

Radman Sam is an economist in Iran.