The rial has plunged to record lows in the past six months and the central bank is under pressure to fix an economic predicament
Explainer: the collapse of the Iranian rial
Iran’s national currency is in crisis. Already fragile due to persistent economic and political uncertainty, the rial plummeted in value after US President Donald Trump’s decision to exit the Joint Comprehensive Plan of Action (JCPOA) in May and reimpose economic sanctions on Iran. The rial has lost almost half of its value in less than a year and is expected to continue falling throughout 2018.
Last week, Iranian President Hassan Rouhani appointed a new central bank governor, Abdolnasser Hemmati, as the currency continues its downward spiral to record lows. The National explores what has happened to the Iranian rial and the effect of an ongoing depreciation.
Why has the rial devalued?
“The Iranian rial has been sensitive to deteriorating economic sentiment and domestic political uncertainty even prior to President Trump’s announcement,” says Gaurav Kashyap, head of futures at EGM Futures. Inflation is at around 13 per cent in Iran and unemployment is estimated at a high of 12.1 per cent, according to Trading Economics.
Real gross domestic product growth has been slower than expected when sanctions were lifted in 2016, and street protests erupted this year over the rising cost of living, high unemployment and alleged state corruption, increasing currency volatility. “With the country plagued by internal economic problems, the new US-imposed sanctions will continue to cripple the rial,” says Mr Kashyap.
In April, Iran’s central bank started applying restrictions on foreign currency transactions in an effort to shut down a flourishing black market and halt the rial’s slump. “These factors have discouraged rial-denominated investments and led to a surge in demand for hard currency,” says Andrine Skjelland, country risk analyst at BMI Research.
How steep is the decline?
There are two exchange rates for the rial. The official rate is what the government has access to, to buy imports and so on. The "parallel market" rate applies to an open market of licensed exchange offices (and unlicensed, or black market and street traders), used by individuals and corporates. Rising economic unrest has widened the gap between the two rates.
The government decided to unify the two-tier exchange rate at 42,000 rials to the dollar from in April. “The authorities had originally planned to implement a unified rate by March 2019, and the quicker roll-out of the policy demonstrated the president’s intensifying concern with the currency’s weakness,” says Ehsan Khoman, head of research and Mena strategist at Japanese lender MUFG. “Unification attempts have not proven successful to date.”
The failed attempt of unifying the exchange rate has pushed all but official rial trade into an expanded black market still subject to volatility, prompting Iran this month to open a secondary market for hard currency.
“The rial has devalued in large part due to uncertainty over Iran’s economic trajectory following the US nuclear deal exit, but also given the forceful implementation of the ban on trade outside the official exchange rate in April, and considerable speculative activity,” says Ms Skjelland.
Prior to April, the official rate was around 38,000 to the dollar, while the open market rate was 56,000. Since then, the currency has lost more than 40 per cent of its value in the unofficial market and now hovers at around 90,000 to the dollar. In the official market, the currency has dropped 20 per cent to 43,880 to the dollar [as of July 25], from 35,186 on January 1.
Has the US decision made things worse?
Yes. Mr Trump’s decision to exit the US-Iran nuclear agreement signed in 2015 has dented Iran’s economic outlook and set in motion a cascade of damaging effects. It has deterred global companies from doing business with Iran, leading to a liquidity crunch and a lack of foreign exchange in the country. US measures also put pressure on a banking system already strained by the previous sanctions regime before the adoption of the JCPOA in January 2016.
A re-imposition of sanctions is expected to cause a drop in Iranian oil exports, with severe repercussions. Iran is home to the world’s largest reserves of gas and is the Middle East’s third-largest oil producer. In May, BMI downgraded its GDP growth forecast for Iran to 3.1 per cent in 2018 and 0.8 per cent in 2019, from 4.3 per cent and 4.5 per cent previously.
“Iran is likely to experience depreciatory pressures on the rial and rising inflation as a result of lower foreign currency inflows that will constrain domestic investment and consumption,” BMI said.
What other steps has the government taken to curb depreciation?
In June, Iran said it was banning imports of more than 1,300 products to prepare its economy for the impact of sanctions. The government has also sought to wean the economy off the dollar by doing more trade in the euro and other currencies. More recently, outgoing CBI governor Valiollah Seif announced plans to establish a secondary market for foreign exchange in response to the dollar shortage, allowing exporters of non-oil commodities to sell foreign currency earnings to importers of consumer products. A new online system would allocate foreign currency at the official rate.
The CBI also said it will allow overseas visitors to carry foreign money provided they declare it on entering Iran, to increase supply.
Will the rial fall further?
BMI expects the official rate to depreciate by 5 to 10 per cent against the dollar over the next six months. “The rial looks set to remain on a depreciatory trend for the rest of 2018, as the re-imposition of US sanctions spurs a reduction in hard currency earnings from oil exports, and further complicates cross-border financial transactions,” says Ms Skjelland. There could be further weakness going forward if there is another spell of political unrest, but the rial is unlikely to devaluate below 45,000 to the dollar, adds Mr Kashyap from EGM Futures.
Immediate government measures should help calm financial markets, notes Mr Khoman. “The authorities will likely accelerate efforts to streamline the new system for allocating foreign currency at the government’s rate, which would go a long way toward clearing up confusion about which companies can access the preferential rate for which imports.”
Where can you get the rial in the UAE?
None of the largest currency houses facilitate rial exchanges or transfers from the UAE. This has been the case historically, as under the previous sanctions regime most exchange houses deemed it too risky to deal in the rial. Iranian expatriates typically send remittances via the two Iranian banks operating in the UAE, Bank Melli Iran and Bank Saderat Iran.
A small number of Iranian exchange houses offer services in the UAE. A spokesman for the Central Bank of the UAE told The National that the bank has placed “no restrictions on the Iranian rial”. In the longer term, alternative networks are likely to develop in countries with friendlier ties to Tehran, says Ms Skjelland.