Iran's New Budget and Forex Rate
Dec., 2015
By: Vistar Business Minitor
Although oil prices have been plunging in the past two years and despite the fact that Iran’s oil sales have considerably been cut due to crippling economic sanctions, the Iranian currency has experienced a relatively stable situation. Yet, the foreign exchange market’s stability will be the most challenging issue the Iranian government will face in the coming year.
Every single factor that could affect the forex market in one way or another are expected to be changed next year, jeopardizing market stability. So, there will be a need for the government to take an action and address the challenges immediately. Some of the factors that would cause a volatile currency market, and therefore, need to be addressed in a proper way are as follows:
1. Sanctions Relief: The first factor affecting the forex market in Iran is the lifting of sanctions, which would lead to the release of the assets frozen overseas from the one hand and the increase in oil exports from the other hand – two consequences of the sanctions relief that would increase Iran’s revenues in foreign currency. While the government is dealing with financial constraints, the revenues could upset the balance of the market. Of not, under the Budget Bill of 1394, only 20 percent of oil revenue can be deposited in the National Development Plan. That means the extra money earned from oil sales will be added to an already high liquidity in the country. The excessive supply of foreign currencies will lead to a drop in their value against the rial, making the currency market volatile.
2. Plunging Oil Prices: Of course, Iran’s revenues from oil sales could be not that much as crude price has been falling in global market in the past two years. However, if the oil prices continue to plunge further it could have negative impacts on the Iranian forex market, adding to the price fluctuations.
3. Likely Cut in Interest Rate: Among the most effective factors is the likely cut in the interest rate, which is now hovering at 20 percent for one-year deposits and 24 percent for business loans offered by banks. Observers expect more cuts are on the way, predicting that further cuts in interest rates can fluctuate the forex market. The argument behind this prediction is that the money to be freed from banks will have no place to go but the forex market, since the capital and property markets are already in deep recession. If the prediction is fulfilled, price fluctuation in the currency market will increase. The rising money supply in the second half of this fiscal year can deteriorate the situation unless the extra liquidity is attracted by the projects predicted in the government’s latest plan which seeks to pull the economy out of recession.
4. Dual Foreign Exchange Rate System: As the Rouhani administration has been in office for more than two years, the dual forex rate system is still in place. The current system could increase price fluctuations in the currency market, if the two official and unofficial rates widen, since the situation will encourage speculation activity, fueling a possible crisis. This issue is of much importance as the differential between the two rates could increase rent-seeking activity, putting market officials in trouble to control price fluctuations.
The above mentioned factors among others are enough for the policymakers to pay special attention to forex market management in the coming fiscal year.
What could be the consequences of the rial rate of lower than 30,000 to the US dollar in the 1395 budget bill?
The rial rate to the US dollar is said to be fixed at 29,970 in the budget bill of 1395. This is the case while the dollar rate in the interbank market is about 30,110 rials. The question is why the administration has proposed a rate lower than the interbank market, while it is allowed by the law to increase the rate by at least 10 percent in the budget draft.
Given the differential between the official and market rates of the US dollar, we forecast the dollar will reach 40,000 rials by the end of next fiscal year. The administration’s intention to keep the US dollar’s value lower than expected will cause it to sell its resources billions of rials cheaper in the next year. The free market can offer a more reasonable rate for the dollar, and the right thing to do is the unification of all forex rates and to stick to the market rate.
If forex rates are unified now, the economy will receive no shock what so ever. At present, if a unification system is adopted, the currency market will go in a silent mode for a few days, and come on stream afterwards at reasonable prices. In that case, the pace of depreciation of the rial could also be slowed.
Considering the fact of high inflation in Iran, the rial depreciates against the US dollars by about 15 percent each year. So, it sounds reasonable that the Iranian currency’s value would reach 40,000 to the dollar by the end of next fiscal year, which starts on March 20. However, if the administration keeps the dollar rate at 29,970 rials, the dollar rate in the free market could even reach 41,000 rials by March 2016.
Determination of oil price and the dollar value against the rial has always been a controversial issue in the budget law in Iran. This year, the issue seems to be more important, as the administration is seeking to unify the forex rates, while oil prices are at record lows in the past several years.
What is decisive is how realistic the administration would be when it comes to the unification of the forex rates, and whether it would consider the economic realities on the ground. The less differential is there between the official rate set in the budget law and the free market rate, the situation will be more prepared for the government to adopt a unified forex rate system.
However, the emerging official exchange rate of 29,970 rials is too low, given the exchange demand in the Iranian economy. The administration may ask the parliament to set the official rate; yet, the 29,970 rial rate is considered low for a government which will definitely have a budget deficit and currently needs to pay 420 trillion rials in cash subsidy to the citizens every month.
The administration will certainly face serious challenges in the next fiscal year to provide financial resources in the national currency for development projects. The proposed rate is even lower than that currently offered by the Central Bank. This shows there is a contradiction in the policies set by the monetary regulator and the administration. It is predictable that the dollar rate would reach 40,000 rials or higher in the coming year, given the inflation differential between Iran and the US – which is about 15 percent.