IMF: Early Forex Rate Unification Possible in Iran

EghtesadOnline: The International Monetary Fund is optimistic that Iran can unify its dual foreign exchange rates in 2017-18 despite recent challenges facing the country, such as currency market volatility.

News ID: ۷۴۰۳۲۳

12 March 2017

In an interview with Financial Tribune, Catriona Purfield, a senior economist at IMF, said since the Iranian government has already done a lot of preparations to adopt a single exchange rate regime, the country is capable of making an early move in this regard.

"Half of imports has been put on the market rate and most of the goods are now at the flexible rate. Interbank FX market has been reestablished. Therefore all the elements are there, so an early move is possible," she said.

Purfield , who led a recent Article IV mission to Iran– an annual health check on the Iranian economy as she puts it, added that in its earlier report, IMF had urged Iran to unify the exchange rates and have "a managed float" to have an early move benefit.

After completing a two-week Article IV consultation with Iran, IMF released its concluding statement on Feb. 27 in which it commended Iran for its "impressive recovery" from recession after the lifting of sanctions in 2016.

In preparing its report, the Article IV team had policy discussions with the Central Bank of Iran, ministries and agencies, private sector, Chamber of Commerce, NGOs, entrepreneurs, Cooperatives Ministry and social organizations.

"We witnessed a fundamental difference in this year's Iran performance compared to last year ... We're seeing growth in the range of 6.5-6.6%, which is the forecast figure for this year … a huge turnaround  from last year when the economy actually contracted," Purfield said.

According to the economist, if Iran had unified its exchange rates at the time of the oil price crash, it would have had an extra tool to respond to that shock.

"IMF has been strong in its language advocating for an early move to unify the rates and doing it within a year because the dual exchange rates vary by more than 2%," Purfield said.

Asked why IMF did not advise a specific date for the unification, she noted that "we did not advise on an exact timing for unification because at the end, the government has to make sure the FX market is stable and it has good access to international reserves to prevent unexpected spikes in the exchange rate".

Article IV also had discussions with Iranian authorities to have better regulations to control the FX market to have more transparency by moving transactions to the banking sector, having real-time monitoring of foreign exchange within the market and setting up the infrastructure to monitor the market.

"They should come up with regular publication of FX reserves data and that information should be available and we had discussions to have a more transparent framework," she said.

Purfield cautioned that reforming the monetary policy framework and moving away from fixing an exchange rate were contingent upon the market exchange rate being stable and having a good monetary policy and a good grip on inflation.

Growth and Other Aspects

However impressive Iran's economic growth in 2016-17, it cannot be denied that thanks to a surge in oil exports, Iran clawed back its share from the market or as Purfield puts it as an "oil story".

"Oil data show a 52% jump in value-added to the economy  (oil exports nearly doubled this year) and that growth is not seen in the rest of the economy," she said.

"The non-oil sector has been quite weak and we have pointed that in the report and we have been more modest in the growth uptick for 2016/17 than the government."

Purfield noted that IMF is keen that there should be reforms to support growth and to be able to allow the non-oil economy to expand.

The non-oil sector only registered a 0.9% growth in the first half of 2016-17, which was attributed by IMF to difficulties in accessing finance and domestic financial sector, and structural weaknesses.

"We have been more conservative in our medium-term forecast (4.4%) and the figure for next year's headline growth (3.3%), which will be lower or on the downtrend unless oil prices increase or there is expansion in that sector," she said.

"Otherwise, there's no way that oil can grow again by 52% and that's why we have emphasized growth in the non-oil sector."

Banking Woes

A good part of IMF advice this year focuses on the condition of Iranian banks and the serous struggles they are facing.

As the economist puts it, they urged problem solving in the banking system to safeguard the achievements of financial stability and low inflation.

"Interest rates are now in the 20% range and without inflation that implies a real rate of nearly 10% that is strangling the private sector and the recovery," she said.

Purfield recommends that now that the economy is beginning to recover and external relations are improving, it is time to address the challenges in the banking sector.

"One thing we advised is to handpick distressed banks and put them on enhanced supervisory administration–the very banks which are competing for deposits by offering you some very nice interest rate and that makes interest rates rising fast because other banks try to compete with them," she said.

"Another key advice is to conduct an Asset Quality Review: an independent auditor going into each bank and doing a forensic on each of the bank's balance sheets. So you can get an exact sense of how the problem of non-performing assets is and where the problem is coming from."

The economist stressed that that's when one can determine which of the banks can be saved and which of the banks may not be viable so they can be resolved: merged or closed.

She is also comforted by the fact that the Iranian government has begun to take some of the steps for this by implementing International Financial Reporting Standards, which is the first step for being more transparent.

The two banking laws (the Banking Reform Bill and the Central Bank Bill) will be very helpful, as they will strengthen the tools to deal with the banks and also enhance supervision over them.

The government is seeking IMF technical advice regarding these issues so they can be in line with international standards and the bills will ensure that the banking system gets back into shape again.

As for addressing the external threats that Iran is facing, the economist believes the country will have to begin domestic reforms like reducing dependence on oil, strengthening the financial sector, expanding the role of private sector and reducing the government's role in the economy.

"Other measures include creating buffers and savings so you have something to draw from when there is a shock," she said.

Precedent shows, Purefield says, that on the whole Iran has been relatively good at taking IMF advice.

Will Iran follow embrace these recommendations too? Here's hoping.