Economy, Business And Markets

The Dollar Debate

Post-Doc and Teaching Fellow at Alzahra University
The Dollar DebateThe Dollar Debate

The official exchange rate of the US dollar having crossed the 30,000-rial barrier is evaluated as a positive sign more so because the market exchange rate is experiencing an upward move. While the market exchange rate has surged by 6% over the past two months, the official exchange rate has increased by 3%.  It is generally believed that the official-market gap leads to rent-seeking normally packaged and sold under the guise of importing basic goods.

Without having to say it in as many words, the government is more than willing to gradually reduce the gulf between the official and the market rates and deliver on its oft-mentioned policy of a unified forex rate after the sanctions end.

For obvious reasons the gap will be reduced and eventually eliminated by increasing the official rates. Hard currency rates in the market are ostensibly not the business of the state, or so we are told. Before the recent increase in dollar price, the Central Bank of Iran was perceived as wanting to stabilize the forex market with the declared aim of taming the galloping inflation. However, as dollar has been gaining strength globally in recent months there seems to be a tendency to move toward and embrace the floating rate system.  

Add to this the new mantra that we are “entering a new era” and are in the process of reintegrating with the global economy. If this is valid by any leap of imagination and not a by-product of paroxysm following the July nuclear deal with the six major powers, then the role of international developments becomes all the more critical.

Throughout this year the US dollar has become dearer and there is an increasing global demand for the greenback that has further added to its appeal across continents.  During the recovery era after the last financial crisis in 2007, the money injected into the sputtering US economy fled to emerging markets for higher returns. With emerging markets slowing down, the credit risk attached to this debt will further push the dollar upwards as repayments become more difficult.

There is another reason behind the surge for dollars. After the terrorist attacks in Paris last month and more countries joining the fight against IS, there is an unprecedented surge in demand for modern weapons of all shapes and sizes, especially US-made.

According to Reuters, there is rapid increase in US arm sales, which surged 36% to $46.6 billion in fiscal 2015 and the requested demand amounts to $461 billion that is higher than the value of Iran’s GDP and even higher than the US budget deficit in the outgoing year. At the same time, as there is high chance of Fed increasing interest rates the greenback allure is here to stay at least in the foreseeable future.

For Iran, with the USD surging, it is more difficult to further cut the interest rate because of the risk that would entail for heightened speculation in the forex market and lead to new capital outflows.  On the other hand, higher exchange rate means a better competitive edge for Iran’s non-oil exports and higher prices of imports that apparently should underpin domestic manufactures.

 The projected exchange rate in next year budget bill will be announced in the coming days, a rate that could well be in the neighborhood of 31000 rials or above. While the official rate normally does little to impress and intimidate the free market rates, it will signal how the government intends to plug the budget deficit and “manage” the permanently hypersensitive forex market.  

To get a better idea of what lies ahead for Iran and other crude oil exporters, keep in mind how poor oil is getting hammered in the international markets since the summer of last year.