FROM THE ECONOMIST INTELLIGENCE  UNIT
Iran has taken its first policy steps to offset the impact international sanctions have had on its deteriorating economy. The president, Mahmoud Ahmadinejad, approved on January 25th a 600 basis point increase in the deposit rate offered by banks in an attempt to prevent the Iranian rial falling any further. The rate hike may act as a temporary brake on the rial's fall but the underlying weakness of Iran's economy will mean the government will have little firepower to control the currency's slide. One of the side-effects of the foreign exchange crisis in Iran (and in Syria) has been to create a surge in demand for dollars in Iraq, which has also seen the value of its currency plummet.
The Money and Credit Council, Iran's equivalent of a monetary policy committee, agreed on January 21st to raise the rate on interest-bearing accounts to 21% from 15%. Banks in Iran have long complained of interference in interest rate policy in Mr Ahmadinejad's tenure, during which he has sometimes forced banks to offer lower lending rates than deposit rates. The president has sought to position himself at times as a populist leader, spending on poorer regions despite often running against conventional economic wisdom. Deposit rates have been below inflation for several years, meaning Iranians keeping their savings in rial-denominated accounts have been facing negative returns and encouraging investment in foreign currency, gold as well as other assets such as the stock market. Mr Ahmadinejad's approval of the rate rise is a tactical retreat, seemingly necessary in light of the plummeting currency.
Steep slide
The rial has fallen dramatically since December, in parallel with increasingly restrictive sanctions and statements from the US and its allies over Iran's nuclear programme. On December 13th, Reuters cited a rate of IR13,400:US$1; a week later the rial reached IR15,300:US$1. Since the announcement of US sanctions targeting Iran's central bank, Bank Markazi, and the EU's ban on imports of Iranian oil, the currency has continued to fall, reaching a record low of IR23,000:US$1 in the week starting January 23rd. There have been anecdotal reports of Iranians being unable to source enough foreign exchange to pay for trips abroad or to finance the cost of imports. The government's move is an attempt to encourage Iranians to put their savings back in rials, rather than dollars or gold coins, but there has so far been little immediate impact. The government-backed Iranian Student News Agency reported on January 25th that the rial:dollar rate had improved only slightly to IR22,500:US$1 from IR23,000:US$1. The rial/gold price dropped more, to IR8.5m for an 8.133 gram gold coin, from IR10.1m a week earlier.
Cunning plan
The weakened currency has been the point of much conspiracy in Iranian politics over the past few weeks, with one outspoken MR, Ahmad Tavakoli, suggesting the devaluation was based on government manipulation of the currency. A weaker rial with still high, dollar-denominated international oil prices would mean the government would have an easier time covering its deficit. Mr Tavakoli went as far as to call this type of behaviour "treason" but was rebuked by the minister of economy Shamsoddin Hosseini, saying such claims were "a libel which can be prosecuted." There has also been suspicion in the notoriously rumour-prone Iranian domestic political scene that the devaluation is an attempt by Ahmadinejad allies to build up a large supply of rials with which they would be able to buy votes during the upcoming March elections.
Multi-tiered
The government has allowed a nominal devaluation in the official exchange rate over the past few years in an attempt to support Iran's non-oil exporters. However, the differential with the black market has become so wide that Iran has in effect returned to a period of multiple exchange rates, in which government-related enterprises can take advantage of the stronger official rate (making their purchases of foreign goods cheaper) while most Iranians must make do with the much weaker black-market rate. Accompanying the rate rise, the governor of Bank Markazi, Mahmoud Bahmani, said new restrictions would be put in place on foreign currency transactions, with Iranians prohibited on using "foreign currency for storage" and that travellers, students and patients would be supplied "at an appropriate rate." Mr Bahmani also announced a new official rate of the rial at IR12260:US$1.
Well-stocked
The government has not released data on its stock of foreign reserves but the IMF estimated Iran had a stock of US$78.9bn in the fiscal year 2010/11. We expect this figure will drop significantly in 2011/12 and 2012/13 as Iranians call on banks and money changers to provide them with the more secure dollars and also as Iran faces tough export conditions in light of sanctions on the finance system, an EU ban on Iranian oil and declining purchases from other Asian consumers.
Iran's ability to access foreign currency, either through export receipts or international bank transfers, has been severely interrupted with the introduction of US sanctions targeting any firm that does business with Bank Markazi, which acts as a clearing-house for Iran's oil sales, and the EU's ban on imports of Iranian oil. The government has been exploring alternatives to get around these sanctions but the avenues for trade with Iran have been getting narrower and narrower. Transactions through Turkey may now cease as the government there responds to US pressure. Other routes, such as a Germany-based, Iranian-state run bank and the Asian Clearing Union, a regional payments facility, have also been blocked in the past two years.
Plundering Iraq
Faced with the shortage of dollars in their home market, many Iranians have been turning to Iraq, which has a more open foreign exchange system and relatively plentiful supply of foreign exchange. The extra demand from Iranians as well as from Syrians, who are facing similar problems, has had a marked effect on the Iraqi exchange rate, which has tumbled from ID1170:US$1 to around ID2000:US$1 in recent weeks. The government will be well placed to shore up the dinar— its foreign exchange reserves were up by an estimated 10% last year on the back of higher oil revenue. However, the effects of regional instability on Iraq's own currency will be a stark reminder of the risks of wider contagion, both political and economic, of long-term unrest on its borders.