• Sun / 18 October 2020 / 15:39
  • Category: Economy
  • News Code: 99072719812
  • Journalist : 71600

A brief review of the Rial’s crisis

A brief review of the Rial’s crisis

Tehran (ISNA) - The enthusiasm for the Iranians to hold Dollar may be strange at the first glance but considering the long-run trend, the ordinary people may have right to do so. Historical overview of the last four decades shows us that Rial wasn’t so much reliable most of the time.

The first step to solve the crisis is identifying the main reasons of the Rial depreciation, studying the historical backgrounds and comparing the using methods with the more successful methods using by other countries.

Most significant currency shocks after the Islamic revolution and prior to the JCPOA

Following the Islamic revolution in 1978, the Iranian Rial which was once among the top 16 world’s currencies, began to lose its value against the greenback sharply. 

In 1988 (in which, the war between Iran and Iraq ended), each USD was equal to 960 IRR, the year later (1989) the USD gained more than 20 percent against the IRR and reached to 1200 IRR. After this year, Rial’s depreciation trend against USD never stopped: the next shock occurred in 1995 in which the USD reached to 4030 IRR (about 54% more than the previous year). In 2009, each dollar was traded 10000 IRR for the first time and it just took 3 years for the dollar to reach 38000 IRR.

The golden period (2013-2016)

The positive trend in the nuclear negotiations and the hope to the future helps a lot to calm down markets. During these four years, the Iranian economy experienced high rates of growth, lower inflation and stable currency market. * There is no doubt that the JCPOA played pivotal role in this period and the Dollar rate not only ceased to increase but also declined. (From 36000 Rial in 2013 to 34250 rial in 2016)

* According to the World Bank, the Iranian economy experienced 13.396% growth rate in 2016. At that time, the inflation rate was measured 7.245%. For comparison, the inflation rate reached 39.907% and the economy contracted about 10% in 2019.

Recent years

In 14th July 2015, after 2 years of negotiations, Iran and world powers agreed to sign a new deal. For Iran, the main advantage of the JCPOA was releasing its economy from the heavy sanction’s pressure. The news has its effect on foreign currency market too but following the U.S withdrawal in 2018, the Iranian Rial (also known as IRR) experienced dramatic decline.

After the U.S presidential election in 2016 and choosing strict approach toward Iran by Donald Trump, the Rial started to depreciate again. Following U.S withdrawal from the JCPOA in 2018, USD rate reached 150000 rial in the black market. In addition to U.S maximum pressure campaign, FATF decision to add Iran’s name to it’s blacklist, Corona’s affect on businesses and the ways of financing government’s budget deficit, resulted to more depreciation of Rial.

Floating rate or fixed rate, which is better?

As shown above, UAE and Saudi Arabia experienced very low volatile in their currency markets during recent years. Why? One main factor is that they pegged their currency to USD so they can be sure that they will have a strong currency.

Today we have two main exchange rate systems: Floating and fixed rate systems. In the fixed system, the central bank pegged the currency to another currency or asset (usually USD) and maintains it as the official exchange rate. Floating system on the hand, means the exchange rate will be determined by the supply and demand mechanism.

The main reason to choose fixed rate system is stability: this way the economy will be predictable and investors invest more. It also helps the policy makers to set lower inflation rate goal. But whenever investors feel that the local currency is overvalued, they change as much as local currency to the foreign currency. This phenomenon was seen in Iran after the government decided to declare fixed exchange rate. As the fixed 42000 Rial rate seem illogical for the investors, many of the investors changed their Rial to USD and the gap between official and unofficial rates skyrocketed. 

Floating system on the contrary, enables the governments to reassess the value of the peg occasionally or periodically. There are cons and pros for both systems. It can be said that overall, Countries prefer fixed rate system but this is not always true. Due to this fact that pegged exchange rate requires a large amount of reserves; many countries can’t choose this system. It also lessens exporter’s motivation in the long term so it may lower overall growth rate too.

It is also important that using pegging system requires a high-developed open market. So for countries like Iran, developing an open market must be a priority before using pegged system. Sanctions also make it difficult for the Iranian authority to pegged Rial to other currencies like Dollar or Euro. So what should be Rial’s anchor?

What to do next?

As it’s not possible for Iran to peg its currency to Dollar or Euro, it should consider other valuable assets such as gold or crypto currency. Gold seems more advantageous because it is more acceptable worldwide and Iran has sufficient gold reserve.  Some well-known experts and economists have suggested this solution.*  Adopting a gold-backed currency needs a currency-board. Currency-board, which is established to issue notes and coins can work separately or parallel to the central bank.

Independency of the currency board and its authority to making policies are crucial for its success. By issuing a currency, which is anchored to a strong currency or commodity, the local currency will be as well good and valuable as them.

The currency board must have enough reserves to defend the local currency (minimum 100% of all local money in circulation) and be committed to convert the local currency to the anchor currency or commodity.

*One of the best studies done in this field is professor Steve Hanke and Kurt Schuler ‘s book named “currency boards for developing countries”. In my interviews with professor Hanke, we have discussed a gold-backed currency board for Iran more. 

It’s time to reform

It is true that currency boards have their own disadvantages such as limiting the policy maker’s ability to set the interest rate but they might be the best possible solution for Iran’s economy today.

Also the Government and the central bank must take some painful decisions to reform some of monetary infrastructures. These reforms are but not limited to:

1-Encouraging investors to enter to the stock market

2- Increasing the attractiveness of debt bonds

3- improving the public expectations by starting new round of reforms both domestically and internationally

4- increasing the role of bond market in financing the government’s budget deficit

5- decreasing the speed of creating new liquidity, reforming the banks balance sheets and preventing banks from doing Ponzi scheme

6- diversifying the offshore currency markets by increasing the financial network abroad and managing foreign remittance

7- unifying official and unofficial currency markets

8- Using crypto currencies capacity more

9- start negotiation with the United States to lift the financial sanctions

10- decrease public expenditures and implanting more austere fiscal policy  

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