Central Bank of Iran Says Subsidized Forex Policy a Short-Term Strategy

EghtesadOnline: In a report to the decision-making Money and Credit Council, the Central Bank of Iran outlined the effects of subsidized foreign exchange on the price of essential goods and food.

News ID: ۷۴۶۵۷۸

29 January 2019

The report was released by the CBI on its website amid growing criticism about the ostensible merits of the scheme that apparently failed to perform as a cushion in the wake of ongoing dramatic price hikes of basic goods.

With the help of hard evidence, the CBI tires to show that forex allocations at the preferential rate of 42,000 rials was successful in fulfilling its pivotal objectives, i.e. keeping the price surge of essential goods in check and supporting poor and vulnerable households.

However, it admits that such decisions are mostly stop-gap measures and emphasizes that alternative support policies should be in place in the medium-term to avert unfair and privileged grants, stop disruptions in pricing mechanisms and not let production units fold, according to Financial Tribune.

“It is worth noting that the supportive forex policy is a short-term measure to avert the price surge of essential goods due to the sharp decline on the supply side during sanctions, and to help support vulnerable groups,” the report said.

The CBI report notes that the subsidized forex policy succeeded “to a great extent” in curbing the momentum in rising prices of basic goods.

“In the first nine months of the current fiscal (March-December 2018), the rising pace of prices of essential goods was significantly lower compared to the speed at which prices of other goods jumped.”

The report presents the result of the study in two categories:  essential goods that are “directly subsidized by cheap foreign currency” and goods “indirectly benefitting from cheap currency.”

It reveals that the Producer Price Index for both directly and indirectly-benefited goods in the Iranian month of Azar (Nov.22-Dec.21) increased 38.3% compared with the end of the last fiscal (March 2018) which was lower than the 61.7% rise for non-subsidized goods during the same period.

Slower Pace

Similarly, the Consumer Price Inflation in Azar increased 40.4% over the previous year for subsidized goods, registering a slower pace compared to the 73.9% rise in the prices of non-subsidized goods.

The CBI said subsidized forex proved to be effective, in that the price of subsidized goods would have surged to the level of other goods if the subsidized forex policy was missing.

“Galloping inflation would indeed target the welfare of vulnerable groups” in the absence of cheaper forex.

The top bank believes that overall price rises should be attributed to the increase in official forex rates, which rose 12% compared to the previous fiscal end plus the increase in production costs such as packaging, wages and transportation among others.

It says the recent relative stability in the forex market in Azar reduced the PPI by 4.5%, compared to a month earlier.

In addition, the price of subsidized goods increased 5.3% while non-subsidized goods were 4.6% costlier in Azar compared to a month before.

The fact that the price rise in subsidized goods was higher than non-subsidized goods reveals malfunctioning in market mechanisms and regulations which is worth consideration.

Unable to Deliver

In a series of studies undertaken by the Majlis Research Center to delve into the pluses and minuses of the proposed budget bill for the next fiscal (March 2019-20), the parliamentary wing has regularly questioned the preferential forex policy that has been in place for decades.

In a recent report, the MRC points to the perpetuation of the policy in the coming year as the government has proposed $14 billion for importing essential goods.

It acknowledges the policy was initially a measure to stabilize the price of essential goods that “albeit failed to achieve the desired results.”

The influential think tank argues that the “preferential forex allocation” is obviously more in the interest of business tycoons who are everywhere when it comes to business and trade of essential goods.

“Implementation of this policy was not in the interest of  consumers, rather it benefited privileged groups who had access to subsidized forex and got fatter.”

According to the MRC, the price of essential goods shot up 42% on average in Azar compared to the same month in the previous fiscal – that ironically was higher than the 39% growth in overall prices.

The research arm of the parliament reckons corruption, multiple forex rates, hoarding, smuggling and price gauging as some of the inauspicious results of subsidized forex policies.

As a first step, MRC proposes the elimination of the policy in its entirety and insists on forex rate unification. Instead, to support end consumers, it favors direct measures in the form of supportive (food) packages.

However, it notes that if the government is adamant on sustaining the forex subsidy policy, it would do better to allocate subsidized currency to selected goods that are less susceptible to corruption and price abuse.