Forex Rate Unification Requirements from Business Leaders' Perspective

The Money and Capital Markets Commission of Iran Chamber of Commerce, Industries, Mines and Agriculture–known as the country's private-sector Parliament–has published a report on Iran's foreign exchange policies and the effects of those decisions on the business climate. 

The report also outlines the requirements for unifying foreign exchange rates, explicating the optimal way a single exchange rate regime can be adopted, ICCIMA's website reported.  

Deciding the best course for the foreign exchange market has always been one of the biggest concerns of economic policymakers in every country and Iran is no exception. The issue has gained renewed attention in the wake of currency market fluctuations in the final months of 2016, which saw rial sink to record lows against the greenback. 

In its findings, the Money and Capital Markets Commission has floated the idea that a single exchange rate system should be both "managed" and "floating". It also outlines seven factors needed for the single exchange rate regime to move forward.  

Why Unification? 

According to the report, there are many reasons for following a multiple exchange rate regime. 

One main reason could be that using this system helps cover up the negative consequences of ineffective monetary policies.  This includes, for instance, countering runaway domestic inflation through cheap imports, using a lower and subsidized exchange rate. 

The report quotes Dr. Mohammad Jafar Mojarrad, a former deputy governor of Central Bank of Iran, as saying that a multiple exchange rate policy is necessitated by domestic or foreign economic shocks, but is also carried out to support domestic industries and direct resources toward specific economic enterprises.

Mojarrad, however, noted that empirical research has shown that the benign effect of multiple exchange rates over the market lasts only for six to nine months and after that, only their adverse effects are felt in the economy. 

This, he maintains, is mainly due to direct and indirect restrictions on foreign currency allocation and quotas on imports.

"The experience of other countries on the matter also reflects the fact that the multiple exchange rate policy has not been an efficient and sustainable system but it has been used as a stopgap, aiming to eliminate imbalance of payments and also in high-inflation situations," he said.    

Exchange rate regimes are mostly among three groups, namely fixed, multiple and floating. 

Iran had been used a "managed floating" exchange regime twice in the past. The first experience dates back to 1993 when it did not last more than a few months due to economic turmoil and the exchange rate regime went back to multiple rates. 

The second time though, following the experience gained from previous setbacks and reforming forex and trade policies in order to facilitate and deregulate foreign trade, foreign exchange rate unification was successfully implemented and a "managed floating system" was announced in 2002. 

Unfortunately, it only lasted until 2010 when the next administration failed to observe financial and budgetary discipline, and overvalued the rial. 

The Central Bank of Iran's authority as the main money and exchange rate policymaker was stripped and the heavy international sanctions diverted the exchange rate regime from its original path. Eventually, after some severe fluctuations, Iran's exchange rate regime went back to multiple exchange rates.     

Prerequisites 

Currently, Iran has two exchange rates, with market rates varying based on where you are shopping. The official CBI rate is fixed at 32,367 rials and the free market rate is over 38,510 rials, which shows a difference of 18%. 

Now the question is, "What requirements can guarantee the successful implementation of a unified single exchange rate system, with managed float?" 

According to the report, six factors should be observed:

1. Access to sufficient financial resources

2. Curbing the inflation rate

3. Effective management of currency market fluctuations

4. Fiscal discipline of the government and deficit reduction

5. Establishing correspondent banking relations

6. Forming an organized foreign exchange market

The results of global research and studies show that adopting a single exchange rate system, targeting inflation and implementing complementary policies could work since it is reasonable in many ways and make the decision feasible. 

Although using a single exchange rate regime is not probably practical at all times, a managed floating rate allows the economy to achieve its growth targets and control inflation. There is ample evidence that show a multiple exchange rate system or a fixed exchange rate only lead to corruption. 

Non-optimal allocation of financial resources undermines the competitiveness of exports and increases imports, which eventually create many problems for economy, such as severe fluctuations in the currency market.