MRC Censures Policy of Curbing Currency Rates

EghtesadOnline: The Majlis Research Center scrutinized the policy of “curbing exchange rates” adopted by successive governments and concluded that it has harmed the economy in more ways than one.

News ID: ۷۸۷۱۴۸

16 October 2021

In a report the parliamentary think tank reflected on how the people have become sensitive to the unending volatility in foreign currency rates and how central banks in all previous governments manipulated forex rates to appease the public and tame inflation expectation.

“In their approach to the currency market, governments suppressed forex rates without considering the monetary dynamics, such as the unprecedented growth in money supply,” the MRC said.

Increase in forex rates under such circumstances is construed as unhelpful and an indication of the policymakers’ inability to control rates and causing inflation expectations to rise.

“Without considering the macroeconomic conditions, this strategy had economic ramifications, in particular on domestic production and increased reliance on imports.”

Curbing exchange rates at a time when most fundamental economic factors, such as growth and expansion of money supply, entail increase in forex rates, harmed the economy on two fronts.

First, when the Central Bank of Iran had enough forex reserves to intervene in the currency market and restrain rates.

Curbing forex rates in this way undermines domestic production and weakens competition ability with foreign peers.

Second, a situation arises when it is no more possible for the CBI to intervene in the market because either its forex reserves are insufficient due to foreign sanctions or it has not properly managed its limited reserves.

The latter scenario eventually leads to “a sudden jump in forex rates” and worsens uncertainty and volatility undermining the economy in its entirety.

“At a time when the country is grappling with high inflation, this strategy was tantamount to undermining the economy harming exports and giving rise to imports. This essentially inflicted a more devastating blow to the economy as forex rates jumped rather than rise at a slow pace,” the MRC said.

Impact on Foreign Trade

The think tank noted that the policy of rate suppression will only curb nominal forex rates with manufactures as the main victims because nominal increase in forex rates is incongruent with inflation rate.

For example, domestic manufacturers grappled with 15% inflation in 2014 while forex rates rose 3%. “This undermined competitive power in foreign markets”.

When manufacturers are saddled with price inflation inside the country, the goods they are produce are costlier, which obviously are unattractive in international markets.

A weak export sector means decline in export income, which by extension increases demand for foreign currency for import, thus adding further pressure on CBI reserves.

As such, stifling forex rates is not the best way to protect the national currency “because spike in forex rates per se is not the cause but the effect and the external manifestation of national currency devaluation.”

The rial has lost its value due to an “ingrained lack of balance in the economy and the ballooning money supply that is incompatible with the real economic growth,” the MRC warned.

Efforts to control inflation and boost the national currency should stem from “improving efficiency” and create conditions for sustainable economic growth. “Stabilizing exchange rates will impede such efforts.”

Nominal Anchor

Due to public sensitivity to rising forex rates, the CBI has often used the rates as a nominal anchor to harness inflation expectations.

While restricting forex rates may curb inflation in the short term, the MRC said it will not deliver in the long-term and postpone inflation to the future.

Nominal anchor is a variable policymakers use to tie down price levels. One nominal anchor central banks used in the past was a currency peg—which linked the value of the domestic currency to the value of the currency of a low-inflation country. In other words, it is a country’s policy whereby its exchange rate with another country is fixed.

Inhibiting forex rates has been a permanent policy of all previous governments in Tehran while the central bank has made has done all it can to stabilize rates within a specified range. However, the pattern of financial crises, such as the US economic blockade, has put forex rates on a permanent ascending order for decades.

The dollar surged 92% in the first round of US sanctions in 2011. It was relatively stable between 2014 and 2016 barely rising 5% before skyrocketing 155% in 2018 when the US administration under Donald Trump abandoned the Iran nuclear deal and imposed a new round of tough economic sanctions.