May 28, 2017 1010 GMT
Following the wild fluctuations in Iran's forex market over the past few weeks, it has become a preoccupation for economists and those interested in economic issues to seek ways to boost the value of the national currency.
Many — including the layman and knowledgeable people, the latter for its benefits — still compute the value of the national currency in terms of its parity rate against foreign exchanges; whereas, it has a different concept.
The concept is independent of the parity rate and has greater priority. It can be very misleading to use the rates of major foreign exchanges as a criterion for estimating the value of the national currency.
During 2005-2011, the general price index of consumer products and services rose from 40 units to 100 units indicating a 2.5-fold growth. The change showed that the purchasing power of 1,000 toman in 2011 equaled that of 400 toman in 2005. This is while, the rial's parity rate against the US dollar did not change during the same time-span. In case this parity rate had been used for calculating the value of Iran's currency, it should have been acknowledged that the value of the rial had not been subject to a noticeable change over the period, which does not hold true given the realities of national economy.
The truth is inflation brings people's purchasing power as well as the value of the national currency down. This also holds true in the case of the purchasing power for 1,000 toman in 2011 when changed into the dollar, it had more or less the same purchasing power as that of 2005. Nonetheless, this almost unchanged purchasing power was due to the subsidies paid out by the government to those who demanded foreign currencies given the high oil revenues. In fact, the money used for paying the subsidies on foreign exchanges were spent from the pocket of all the people of Iran, irrespective of whether they were interested in purchasing it or not.
This wrong policy strongly encouraged imports at the expense of domestic production and caused the delusion that the government had managed to maintain the value of the national currency.
The truth is that curbing inflation and raising domestic production are the sole factors contributing to maintaining a currency's purchasing power.
The Rouhani administration has made great achievements to this end over the past three years, managing to control the massive inflation the country was struggling with at the beginning of the 10-year period to 2021.
However, the 11th government's achievements — the persistence of which is an indication of success in affording true protection for the value of the national currency — is menaced by two serious threats:
1. The first is the unrestricted growth in liquidity due to the pressure to use the resources of the Central Bank of Iran. 2. The temptation to keep the parity rate of foreign currencies down using oil revenues.
The antidotes to the first menace are carrying out stringent reforms in domestic banking system, adopting disciplined and effective monetary policies and expanding the debt market systematically and rapidly. The Iranian government will have to, once for all, do away with the readily available policy of channeling funds into the national economy using cheap money which has caused a chronic two-digit inflation for the past four decades.
The second serious threat to the government's achievement in curbing inflation pertains to certain short-term political expediencies. Over the past few days, state officials have, apparently, been determined to bring forex rates, which had witnessed a remarkable increase, down to where they were. This policy is only possible through using oil exports revenues but the outcome of this would be an unreal and temporary rise in the value of the national currency. As experienced frequently before, this will lead to dire consequences for the country's economic function.
True that achieving stability in the forex market is absolutely crucial to restoring safety and tranquility to business atmosphere; but this stability is required to be achieved in proportion to the realities of Iran's economy.
To maintain the value of the national currency, forex policies are required to make foreign currency rates stable and in proportion to the realities of the domestic economy to prevent wild and destructive fluctuations in the country's business market. Such a policy will also protect the domestic economy from Dutch disease, uphold domestic production, prepare the ground for inflow of foreign funds and ensure stability in the Iran's macroeconomy.