Economy, Business And Markets

Budget and Pattern of Forex Fluctuations

Budget and Pattern of Forex FluctuationsBudget and Pattern of Forex Fluctuations

Determining the official dollar exchange rate for next year’s budget is a daunting task. A slight miscalculation by the government or the central bank would cause severe economic problems, says a university professor.

A correct determination of the exchange rate in the budget would result in future stability of the currency, a positive balance of payments and an increase of exports while also helping imports, according to Mehdi Taqavi of Allameh Tabataba’i University.

“The [dollar’s] budget exchange rate of 28,500 rials, set by the central bank for next year, sounds quite reasonable and shows a reasonable increase,” Taqavi said to IRNA.

According to Taqavi, a depreciation of the greenback versus the rial depends on “political stability” in Iran, especially in terms of the country’s foreign relations. “If talks between the P5+1 and Iran reach a final deal we will witness a drop in the price of the dollar in Iran’s currency market.”

 Sanctions in Perspective

Sanctions, imposed over Tehran’s nuclear energy program, were kept in place and the negotiations over their lifting was extended by seven months on November 24, when Iran and six powers -- the United States, Britain, France, Germany, China and Russia -- failed to agree on a “comprehensive deal”.

This new wave of negotiations between Iran and the six nations, also known as the P5+1, started in 2013. It culminated into the signing of the so-called Joint Plan of Action (JPOA) in Geneva, in November of that year. Under the Geneva accord, in exchange for partial easing of sanctions, Iran halted certain aspects of its nuclear energy program. Thus, Iran received seven billion dollars of its close to $100 billion in frozen overseas assets, in the year following the JPOA’s signing.

After the Geneva agreement Iran saw a gradual release of its frozen oil revenues, which led to the appreciation of the rial. “Now with forecasts of a final accord within seven months, which will lead to further release of Iran’s frozen assets, the central bank’s estimate of a 28,500-rial dollar is logical,” Taqavi said.

The influx of these released foreign reserves into Iran’s currency market will continue to pressure the dollar’s price, though part of this pressure will be nullified due to the drop in crude oil prices. “But the continuous stream of foreign currencies to the economy will create a currency shockwave that will depreciate the price of currencies [against the rial],” the economist predicted.

 The Crude Effect

The rial fell to an 18-month low versus the dollar, after OPEC decided on November 28, to keep current crude oil production output despite a huge global oversupply. The West Texas Intermediate fell 10 percent on the following day, settling at $66.15 a barrel while the Brent proved more resilient declining by 3.35 percent to $70.15 a barrel.

The fall fuelled speculation that the Iranian government – for whom oil sales constitute around 65 percent of its total revenues – would struggle to cover its widening budget deficit.

Iranian Oil Minister Bijan Zanganeh said on Sunday OPEC’s decision was not to the benefit of all OPEC members, but that Iran had refrained from protesting in order to maintain group solidarity. According to the International Monetary Fund’s estimate, Iran needs oil to be around $140 a barrel to balance its budget and finance all its profligate projects.

The central bank recently reported that the budget had actually gone into deficit in spring (the first quarter of the fiscal year). It was $671.8 million in the negative and the deficit is likely to grow as government expenses were double its income. This was before the drop in oil prices.

 Factoring in the Factors

The factors that decide the real value of the dollar versus the rial can be put into two groups: monetary causes and purchasing power parity. Based on purchasing power parity, a comparison between inflation in Iran and the United States is necessary.

Numerous factors determine the exchange rates, and all are related to trade interrelationship. As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. On the other hand interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates.

“These two foreign exchange factors are the roots of current rhetoric about foreign exchange rates, and these reasons influence both the official and market rates of currencies,” the university professor said. “The central bank governor’s recent comments will help calm the markets,” which saw great turmoil pending news of the seven-month extension in talks between Iran and the six world powers on November 24.

In the week after November 24, news of the extension of talks between Iran and the West coupled with OPEC’s decision sent the dollar soaring 8.5 percent to hit an 18-month high of 35,230 rials. The euro surged a staggering seven percent that week, while the Azadi bullion coin went up from 9.14 million rials to a seven-month high of 9.62 million rials during the period – a 5.2 percent gain – despite gold slipping versus the greenback, internationally.

To make better foreign exchange polices, Taqavi suggests that the central bank take next year’s inflation expectations into account while considering the changes in monetary policy in the near future.

Such an approach will help curb inflation and remove the adverse effects on currency exchange rates. Thus, exchange rates will be closer to real parity values and in turn help manufacturing and exports as a stronger rial value will kill exports and manufacturing by raising the price of Iranian exported goods in other countries, negatively impacting their competitiveness.

 Those Who Say Otherwise

Recently, the central bank governor Valiollah Seif, came under fire for his comments on the situation in the currency market and his valuation of the rial.

The criticism came as the bank acted in line with what Seif had said earlier and did not intervene in the market. “Supply and demand will determine currency prices but we want stability in the market” said central bank governor Valiollah Seif, a few months back. Contrariwise, sources close to the bank say the reason behind the bank’s passivity was because it was incapacitated to intervene.

Seif also recently said that “soon the foreign exchange market will reach a new equilibrium,” while commenting on the uproar in the market after November 24. The governor expects Iran to resolve the nuclear dispute within the predetermined seven months.

According to analysts, given the forecast of 15 percent inflation in Iran for next year while average world inflation is predicted to be around two percent, the official exchange rate of the US dollar set by the central bank does not corroborate “economic reality.”