Economy, Business And Markets

Declining Rial Hurting Manufacturing

Declining Rial Hurting ManufacturingDeclining Rial Hurting Manufacturing

The rial fell for the second day in a row against a basket of major currencies on Monday, with new analysis arguing that the depreciation hurts manufacturing.

Demand for foreign currencies is growing as Iranians approach the two week Nowruz festivities, beginning March 21.

The US dollar rose 0.32 percent to 34,290 rials by 13:52 GMT on Monday, recouping losses it incurred following Friday’s deal on Greece. Prices briefly touched a three-week high of 34,400 rials in the morning.

“The 34,000 rial has become a key support level for the dollar,” a veteran trader told the Financial Tribune, “the dollar has tried to break below the level in the past two months, to no avail.”

Many analysts believe the greenback is headed for over 40,000 rials. They cite the widening budget deficit, shrinking oil revenues, geopolitical turmoil and economic sanctions as reasons behind the imminent depreciation.

Other currencies also had a bullish run versus the rial, with the euro rising 0.28 percent to 39,290 rials and sterling gaining 0.21 percent to 52,810 rials by 13:52 GMT on Monday.

The rial lost the most against the Emirati dirham, the United Arab Emirates being a major business and holiday destination for Iranians. The dirham advanced three quarters of a percent to 9,420 rials, highest since February 4.

 Impact on Manufacturing

Despite popular belief, a weaker rial damages manufacturing output, a new study by the Monetary and Banking Research Institute (MBRI) on the performance of Iran’s economy during 1990-2012 has found.

The report confirms that injecting foreign exchange revenues from oil sales into the economy drives production. However, the heavy reliance of Iran’s manufacturing sector on imports of raw materials has created a negative correlation between the rial’s value and economic growth. This highlights the need to restructure the economy and reduce reliance on oil revenues, in the long run, the study suggests.

The report also sheds light on the impact of exchange rate fluctuations on inflation and GDP growth. “As the US dollar’s exchange rate is decided on a daily and is publicly advertised, any volatility immediately sends ripples through the manufacturing sector, given its heavy reliance on the import of raw materials, intermediate and capital goods.” This also adversely impacts inflation expectations and inflation itself, according to the research.

 Inflation Hurts

The study also reveals that inflation does not encourage economic growth; in fact it hampers it, rejecting the long-held assumption that economic growth is aided by inflationary policies.

“There is a direct and strong correlation between inflation and growth in money supply in less-than-a-year time frames,” but printing money and hikes in inflation do not lead to economic boom in Iran, the report says.

Some economic theories inspired by Keynes suggest that a slight increase in inflation (when it is below the customary rate of five percent) can boost economic growth; however, similar measure in economies with high inflation (over five percent), as many economists believe, weakens production.

The MBRI study also endorses the idea in the case of Iran by saying that “inflation has slowed down economic growth in the long run by reducing investment on one hand and reducing labor supply through real wage reduction on the other.