Iran FX and Inflation Report - Shahrivar 1399 (Aug 22 - Sep 21)
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Since the reimposition of secondary sanctions in November 2018, the Iranian economy has experienced many fluctuations in the exchange rate followed by impacts on other macroeconomic variables. Following the depreciation of the rial which began in 2018 and the adoption of a revised multiple exchange rate system, the Iranian economy has experienced significant increases in the price of goods and services. While the rial regained some value over the course of the Iranian calendar year ending in March 2020, the COVID-19 outbreak contributed to sharp rises in the exchange rate and the Consumer Price Index (CPI).
These trends have had significant impacts on the welfare of Iranian households. According to the World Bank’s 2020 Iran Economic Monitor, the composition of the food basket of the average Iranian households has changed significantly in response to food price inflation. The recent trends in Iran’s real estate and capital markets, which many economists and financial market experts believe to be bubbles, have also been largely influenced by changes in the exchange rate.
The significance of these impacts on the Iranian economy calls for regular tracking of the dynamics of foreign exchange and its relationship to prices. This series of reports series aims to track the FX market dynamics and the relationship with goods and services prices on a monthly basis.
In order to understand the dynamics of the FX market, it is critical to understand the multiple exchange rate system in place. This system consists of three main rates, namely the official, the NIMA, and the free market (azad) rates. The official USD/IRR rate is set at 42,000—dollars are allocated by the government at this subsidized rate to importers of emergency and vital goods and services. The NIMA rate is determined by importers and exporters of goods and services through a market mechanism overseen by the Central Bank of Iran. The free market rate reflects the price at which people buy and sell foreign currency, particularly hard currency, for reasons other than official imports and exports. The free market rate is most widely report, although it represents just a fraction of Iran’s FX market.
Before the first case of COVID-19 was reported in Iran, the USD/IRR free market exchange rate was relatively stable, with sell prices sitting below IRR 140,000. The economic uncertainty related to COVID-19 and the disruption in trade led to the rise of the free market rate to over IRR 160,000, while the NIMA sell price rose to new level of just below IRR 140,000, up from IRR 120,000.
The devaluation of the rial accelerated between May and mid-July, with the USD/IRR free market rate hitting a high of IRR 248,500 on July 19. On the same day, the NIMA sell price surged to IRR 207,000. Meanwhile, the spread between the free market rate and the NIMA rate reached a peak of IRR 69,839 on July 16, reflecting how the free market rate was rising faster than the NIMA rate.
During this period, Abdolnasser Hemmati, the Governor of the Central Bank of Iran (CBI), warned the public several times that the rates did not reflect market fundamentals and were the result of short-term disequilibria of demand and supply. Later, Hemmati announced that the bank had gained access to previously-blocked foreign reserves and that exporters had been instructed to supply their foreign currency in the NIMA market in a timely manner—suggesting that the supply of foreign currency would increase in the near future. He also emphasised that the bank would “impose targeted interventions in the FX market at its own discretion, taking into account the highest interests of the country.” He added that “CBI proved its capacity in October 2018,” an apparent reference to the bank’s success in stabilizing FX markets in the lead-up to the reimposition of secondary sanctions.
These announcements may explain why the FX market fluctuations between mid-July and September took place below the high rates seen earlier in the year. However, in the final days of the Iranian calendar month of Shahrivar (August 22 - September 21) the USD/IRR free market and NIMA sell prices increased to IRR 272,500 and IRR 235,968 respectively, marking new records in the history of exchange rate in Iran.
Most importantly, time series data makes clear that the devaluation of the rial has a direct and substantial impact on inflation. Based on inflation data reported by the Statistical Centre of Iran (SCI), the price of goods and services as measured by general CPI was increasing by an average of 1.5 percent per month prior to the COVID-19 outbreak. Since the outbreak and the further devaluation of the rial, the average monthly rate of inflation has more than doubled, although it has recently slowed from its high of a 6.4 percent monthly increase in the Iranian calendar month of Tir (June 21 – July 21). This was the same month in which the NIMA sell price surged by IRR 40,000, the largest such increase in the first half of the Iranian calendar year of 1399. This suggests that the inflationary impact of FX market volatility (a pass-through effect) can manifest in less than four weeks. Therefore, recent volatility in in the USD/IRR prices can be expected to lead to inflation quickening again.
