Subsidized Currency Hurting Domestic Production

EghtesadOnline: Domestic production in Iran is highly subsidized by the state, which is borne out by the fact that the country is not a member of World Trade Organization and the significantly high tariffs it slaps on imports.

News ID: ۷۷۶۹۰۷

11 June 2017

However, overshadowing the country's protectionist policies is the practice of allocating cheap, subsidized foreign exchange by the government to imports, which runs counter to the spirit of boosting domestic industries.

According to a report by the Institute for Trade Studies and Research (affiliated with the Ministry of Industries, Mining and Trade), import tariffs levied during the year to March 20, 2017, amounted to 115.5 trillion rials ($3.1 billion) that accounted for 14.6% of the government's total tax income, 10.3% of the country's total income and 5.5% of the government's budget.

The ratio of import tariff income to total value of imports stood at 7.4%, Financial Tribune reported.

This is while during the period, the value of smuggled commodities to Iran hit $15 billion, which is equivalent to 22% of all imports (both legal and smuggled) to the country and reduces that ratio from 7.4% to 5.7%.

Back then, the gap between the official and free market forex rates was about 4,921 rials ($0.13). If only half the total imports benefited from the official rate, the amount of currency subsidy spent  during the 12-month period  would have reached  129 trillion rials ($3.44 billion)–12% more than all the import revenues in that year.

So in reality, import-export policies (especially when it concerns the currency measures) were not only uneconomical but were also detrimental to domestic production.

The report says that based on the difference between the rate of domestic and foreign inflation, the government has kept the exchange rate lower than its real value by 38% and 11% in 2013 and 2016, respectively.

Iran currently uses two exchange rates: the free market rate, which stood at 37,380 rials to the US dollar on Wednesday, and another official exchange rate for a number of state transactions. CBI fixed the official rate at 32,451 rials on Wednesday.

In order to bridge the gap between the two rates, the government began to gradually increase the official exchange rate for it to get closer to the unofficial market rate and tried to shorten the list of imports eligible to receive foreign currency at official rates.

Top economic officials, including CBI Governor Valiollah Seif and Economy Minister Ali Tayyebnia, had repeatedly promised that the forex rate will be unified soon after all the prerequisites are in place.

Lack of Competition

In its 2016-17 Global Competitiveness Report, the World Economy Forum ranked Iran 76th among 138 countries with regard to competitive economy.

As cited in the report, Iran has the highest trade tariffs whereas the average figure stands at 28% while Switzerland, Singapore and the United States remain the most competitive economies with a nearly 0% trade duty.

The most problematic factors for doing business in Iran cited by WEF are access to financing, inflation, government bureaucracy, policy instability and corruption. The report indicates that prevalence of foreign ownership in Iran is the least in the world. Reliance on professional management, intensity of local competition and labor market efficiency are also assessed as poor.

The figures point to the fact that lack of economic openness could threaten growth and prosperity. It also highlights that protectionist measures such as allocation of subsidized currency and high import tariffs are not sufficient to sustain growth and must be accompanied by measures fostering competitiveness.

The ITSR report also points to other hurdles in the way of  domestic production such as currency devaluation by Iran's major trade partner China while dumping practices by trade partners are also hurting domestic economy.

Dumping is the practice of selling goods in export markets for prices lower than in the producer’s home market or below the cost of production.

According to experts, in order to support domestic producers and manage imports while maintaining market balance, forex rate unification should be placed on the policymakers' agenda as soon as possible.