Currency Market and the Folly of Old Ways

The past two weeks saw the US dollar surge to a historic high in Tehran’s market, unleashing the usual panic emblematic of all currency upheavals elsewhere.

The occasion was reminiscent of the currency crisis of 2012 when the rial lost 57% of its value over three months in the thick of sanctions against the country’s nuclear program. 

Although what transpired in the past couple of days is not nearly as dire as the ordeal of the sanctions years, the reactions were almost similar: a cat-and-mouse game erupted in the media to find the culprit, with the Central Bank of Iran and the government awkwardly moving to assuage fears by claiming their oft-repeated mantra of “this too shall pass”. 

But the market seems after all to have a mind of its own, which means it responds primarily to investors’ sentiments. And the recent geopolitical developments had plenty of grist for their mills: from the election of  Donald Trump in America and the renewal of Iran Sanctions Act by a hostile US Congress to the higher rate set for the US dollar in the 2017-18 budget bill unveiled on Sunday, all joined forces to fan the flames of uncertainty. And uncertainty they unleashed. 

After all indecision is part of the world and the inevitable could happen at any moment: It happened in the aftermath of the Brexit vote when the pound fell to a three-decade low against the dollar and as of this writing, the euro has slid to a 20-month low against the greenback after the constitutional reforms proposed by the Italian Premier Metteo Renzi failed to win broad support in a referendum.  

  False Comfort 

Every market volatility has both upsides and downsides, but the bigger question is whether the government is prepared to deal with such fluctuations. 

The CBI and the government have been oblivious to repeated urgings from independent observers and private-sector leaders to let go of currency controls that have over the years kept the rial overvalued. The government has cited inflationary fears to justify its foreign exchange controls–which pundits strongly dispute would have any lasting disinflationary effects–but at a visceral level it is fueled by a decades-old policy of playing to popular sentiments that view the rial’s value as a matter of national pride and a sign of economic stability. This may be relatively true, but these strategies have come at a ruinous cost to domestic production. 

As most economists point out, the rial’s overvaluation has made imports cheaper all these years while Iranian manufacturers have had to wrestle with sky-high inflation. Add to this the dual exchange rate regime that allocates subsidized hard currency to a select few and ends up lining the pockets of rent-seeking individuals.   

The fact is that the current administration is continuing down the path of its predecessors, but expecting different results. By delaying difficult decisions that may prove painful in the short run, the government is opting to defer reforms until an unknown futurity.  And when a market shock sends the rial tumbling, hand-wringing and blame games ensue. One wonders how long this could continue. 

In recent days, analysts and pundits have written extensively, pontificating on the follies of currency controls and recommending an approach that would allow for floating yet managed forex rates. 

When the rial oscillates in accordance with the difference between the domestic and global inflation, a sudden shock will not merit wild fluctuations that even CBI’s injection of foreign exchange would not allay. 

Albert Einstein rightly observed that insanity is doing something over and over again and expecting a different result. The latest blow of discredited policies to CBI has been the indefinite suspension of its much-hailed plan to unify the exchange rates–a pledge that was to be fulfilled at the end of the current fiscal in March. 

Einstein’s concept of insanity becomes all the more poignant as the go-go oil prices has become a thing of the past and the government simply does not have enough maneuver room to bend the markets to its will as in the past. 

If the government wishes to be able to forestall future storms, it should be willing to loosen its grip on the market while the sun still shines.