Currency Swaps and Challenges

EghtesadOnline: The Monetary and Banking Research Institute (MBRI), the research arm of Central Bank of Iran, has looked into challenges ahead of Iran’s currency swap agreements and offered solutions.

News ID: ۷۵۰۹۲۲

08 September 2020

Political tensions and tough penalties imposed by the US economic sanctions, high inflation and sharp volatility in forex rates, poor performance of banks, uneven import-export numbers and skewed interest rates between trading partners are listed as the biggest challenges ahead of Tehran’s currency swap deals with other countries, the MBRI website reported.

Highlighting the role of currency swaps and “de-dollarization” in mitigating the impact of the sanctions on the economy, the MBRI said such deals can end the sanctions-hit nation’s dependence on the US dollar and help eliminate trade barriers imposed by Donald Trump’s America.

Iran has currency swap deals with several countries, namely Iraq, Turkey and Russia.

Currency swaps are relatively a new process in international trade according to which transactions are undertaken using local currencies based on mutual agreement. In other words, instead of using medium currencies (dollar or euro), the currencies of source and destination countries are used.

The think tank notes that the sanctions are one of the major hindrances to currency swap deal.

The sanctions have not only made transfer of money difficult (in many cases impossible) between trading partners, but also discourage financial institutions in the contracting country to enter a deal fearing US wrath. Penalties give further rise to trade risks due to restrictions on shipping and insurance.

“This has deterred Iran’s trade partners. Other limitations ( logistic, insurance etc.) would still be in place even if the deals are put in operation…Currency swaps are mainly about settlement of payments,” the report recalled.

MBRI suggested that currency swap deals should be made with countries that either under US sanctions themselves or are in the opposing bloc, which in Iran’s case mainly include China and Russia.

Given the overwhelming US domination over international trade, it would be unwise to pin hope on such countries, unless of course they are offered incentives, such as discount on exports and offering tax incentives to export companies, it said.

Block chain technology and digital currencies plus establishing joint banks are among other solutions that could help facilitate trade.

Inflation and Exchange Rates

Chronic inflation and unending volatility in forex rates are seen as other major obstacles to currency swap deals.

In a country with galloping inflation and a tanking currency, the possibility of trade partners being harmed is high when settling payments, which understandably makes them averse to dealing with Tehran.

For currency swap deals to be successful under such circumstances, the MBRI says, the national currency of one of the trading partners should be universal, i.e. one that is easily transacted and accepted internationally.

To overcome such a problem, the CBI’s research arm proposes that currency agreements preferably be made with countries that have a zero trade balance with Iran to minimize the need for payment settlement. Trilateral and multilateral deals can also help.

Another solution could be equalizing the national currencies of trading partners with a benchmark currency or assets to hedge inflation risks. For example, the national currency could be equalized with euro or the currency defined by the International Monetary Fund, known as Special Drawing Rights (SDR), as well as prices of commodities like oil and gold.

SDRs are supplementary foreign exchange reserve assets defined and maintained by the IMF. SDRs are units of account for the IMF, and not a currency per se.

Dysfunctional Banking System

As for other issues hampering the prospect of currency swaps with other countries, the MBRI points to the dysfunctional banking system, multiple forex rates, insufficient monetary instruments and the ballooning money supply, which can dwarf the efficacy of currency swaps or monetary agreements.

Iran and Turkey started using national currencies in two-way trade as part of their swap agreement from April 17. Additionally, as per an agreement in Sept 2016, the commercial banks of Russia and Iran agreed to pay for bilateral trade in their own currencies. This agreement is apparently in limbo, despite the CBI’s efforts.

The decision to promote currency swaps is stated in the Sixth Five-Year Economic Development Plan (2016-21) that obliges the CBI to lay the groundwork for bilateral or multilateral currency swap agreements.