Changes of forex rates and CBI’s responsibility

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On December 22, 2015, Posted by , In News, With No Comments

Every now and then, Iranian politicians and economic experts react to fluctuations in the rial’s parity rate against that of the dollar, demanding the government or the Central Bank of Iran to stem the decline in the national currency’s value.

Apparently, such reactions stem from an old belief that relationship between the rial and the world’s strongest currency should be stable.

In view of the economic exigencies and conditions prevailing in the post-World War II era, ‘fixed exchange-rate system’ was used to determine the value of national currencies. Also called a ‘pegged exchange rate’, the system is a type of exchange rate regime where a currency’s value is fixed against either the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold.

In 1971, the US stopped using the system, following which ‘floating exchange rate’ system or ‘fluctuating exchange rate’ gradually became popular. Later on, a number of countries decided to replace the system with ‘special drawing rights’ — supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund — regime, whose efforts fell flat. Eventually, most currencies’ parity rate was calculated by the market.

Prior to the victory of the Islamic Revolution (1979), due to the increase in Iran’s oil revenues, the country used the ‘fixed exchange-rate system’ to estimate the rial’s parity rate against other major currencies. The trend continued to be used for a couple of years after 1979. Following this, Iran replaced the ‘fixed exchange-rate system’ with ‘multiple exchange rate system’.

The Central Bank of Iran set and announced an official exchange rate for importing certain goods, while the free-market rate was a different figure. Later on, the CBI set other rates for exports, passengers and purchasing medicines as well as paper. In 1993, due to its inefficiency and massive corruption and misuse, the system was substituted by a single-exchange rate regime which failed to endure for more than six months due a shortage in forex reserves, despite considerable efforts by the central bank. Eventually, the regime was once again replaced by the ‘multiple exchange rate system’.

Following that, due to an inflation rate of 50 percent, the government changed its economic plan and adopted an economic stabilization policy to stem rises in prices by applying the ‘single-exchange rate’ system and tolerating free market rate fluctuations. Nevertheless, after a while, due to supply-demand imbalance and high inflation, the CBI inevitably made several changes in official rates. This was while, the dual exchange rate was still the domestic economy’s dominant system pushing down the value of the rial against the dollar.

Following an improvement in economic conditions resulting from the hike in oil prices, a decline in foreign debts and an increase in the forex reserves, the government and CBI began to implement a single-rate system again in 2002, despite the opposition from some conservative politicians and experts who were concerned about higher inflation rate and viewed a decrease in the value of the national currency as a mishap which went totally against national interests. The government initiated the move, this time, with greater knowledge and experience about the condition of the economy as well as the forex market and managed to prevent inefficiencies and corruptions.

The government gave the new regime the title of ‘managed floating exchange rate system’. This meant that the CBI was able to manage forex rates through market supply-demand mechanisms and, thus, do away with wild fluctuations in hard currency rates.
The policy was soundly pursued until 2011, thus, enabling the CBI and government to reduce speculation and inflation. The CBI steered the forex market based on the difference between domestic and foreign inflation with a slight delay and, therefore, prevented black market activities or dual forex rates. In addition, due to a reduction in the number of cumbersome rules and regulations on exports and imports, such as doing away with the purchase order registration procedure, more demands were directed towards the official forex market and, consequently, unofficial market lost its popularity.

Nevertheless, the intensification of Western sanctions and adoption of imprudent economic policies, led to a number of limitations on the forex market and development of black market.

As the helmsman of forex policies, the CBI could not endure the outcomes of the past government’s flawed economic policies which led to a chaos in the market. Frequent changes in CBI policies and instructions heightened concerns among the people and banks. In the meantime, the government’s persistence on maintaining stable official rates, widened the gap between official and free-market rates. In successive stages, the value of the dollar reached 36,500 rials from 12,000 rials. It was a sudden change which was brought about due to the country’s political and economic condition. In addition, the government adopted a ‘multiple exchange rate system’ again and introduced ‘reference rate’ and ‘exchange rate’ as the two main forex rates in the market. During this period, speculations easily caused considerable fluctuations in the free-market rates. Moreover, the CBI failed to bring down the value of the dollar against the rial by injecting hard currency into the market.

The Rouhani administration, however, managed to restore stability to the market and bring forex rates down. In two years, the 11th government cut down inflation from 40 percent to 13 percent. This success was an outcome of a greater concordance among the government’s monetary, financial and forex policies.

Unlike the past, the CBI did not insist on keeping the rial’s parity rate stable against that of the dollar, which helped narrow the gap between the free-market, official and exchange rates. Moreover, the remarkable difference between the domestic and foreign inflation and the use of market mechanism further helped reduce the gap between the rial and other currencies, which is necessary for striking a balance in the forex market.

Given that oil prices have dropped drastically and the global markets have fallen into an unprecedented recession, raising non-oil exports will be necessary. Following the removal of the sanctions, the CBI will be able to exercise a more efficient management over the forex market and further narrow the gap between the rial and other currencies.

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