Iran's currency: Why did the rial tumble so precipitously?

US sanctions played a role. However, Iranians aren't blaming the US, they're blaming their own government.

The value of Iran’s national currency, the rial, plunged to its lowest against the dollar in more than two decades this week, plummeting by an estimated 40 percent in the past four days. And while the precipitous drop has been brought on by US sanctions, Iranians are in large part blaming the government's massive economic mismanagement.  

The rial has declined roughly 80 percent in the past year, and the street rate is now around 37,000 rials to the dollar. But economists and oil officials in Tehran say they were less surprised by the breadth of the currency’s depreciation than by the rapid speed at which it fell. Indeed, many have predicted the rial’s continued, albeit gradual, decline for more than a year.

The greatest shock has been on the Iranian street, where people, panicked by the sudden drop in the national currency’s value, have been scrambling to trade their rials for safe currencies such as the dollar and euro.

“Before, the currency situation was dysfunctional, but bearable: The rial was getting worse, but gradually. Now, it’s just falling,” says a Tehran-based businessman who runs a factory outside the capital.  

Though what exactly triggered the sudden currency decline is still unclear, some speculate that the Central Bank’s launch last week of a formal currency “exchange center” may have inadvertantly fed the frenzy for dollars. Intended to control fluctuations in the exchange rate, the center allows importers of basic necessities, such as meat, rice, or oil to purchase foreign currency at a “preferential” rate that is actually only slightly below the street rate.  

“The center made it seem like the government is giving up trying to manage the rate, and is allowing the exchange rate to stay at these numbers,” says a veteran Tehran-based analyst, speaking by telephone on condition of anonymity. “It gave the message to the business community that the government does not have the currency to keep up with the market. Now there is panic.”  

The role of US sanctions 

Economic pressure resulting from US Treasury sanctions is widely recognized as a significant force behind the rial’s massive decline. But the blame for Tehran’s deteriorating economy is being resoundingly placed on the Iranian government itself for failing to cushion the country against the impact of sanctions many viewed as inevitable. Much of the criticism is based on the fact that the government seems to have done little to prepare for a situation it must have seen coming.      

Washington sanctions foreign firms that purchase Iranian oil and penalizes banks engaging in financial transactions with the Islamic Republic. It first implemented financial sanctions on Iran in 2006, and four rounds of sanctions by the United Nations Security Council followed. 

Tehran’s banking system became increasingly squeezed after 2007, as Washington boosted efforts to get US allies and other foreign governments and private entitites to implement unilateral financial sanctions imposed by the US Treasury.

“This government has been the richest in the history of the Islamic Republic, and while it should have reserved billions of dollars for a future day like today, it did not,” says the Tehran-based analyst. 

Between 2005 and 2011, Tehran earned an estimated $465 billion from oil exports alone, according to data from the Organization of Petroleum Exporting Countries. Critics of Iranian President Mahmoud Ahmadinejad say his administration’s extravagant spending during this period – on infrastructure and housing projects, subsidized loans, and cash handouts to lower-income and working-class Iranians – boosted inflation and diminished Iran’s currency reserves. 

For the past two years, as US allies in western Europe and Asia deepened their implementation of US Treasury sanctions against the Islamic Republic – essentially isolating Iran from much of the global financial system – the Central Bank’s access to foreign exchange reserves held in accounts overseas has become severely constrained.

Vulnerable Iran

This has left Iran vulnerable to currency speculation because it doesn’t have a thriving private sector, and unlike other oil producers in the Persian Gulf, hasn’t built up its foreign assets or laid aside enough oil earnings to be able to support its currency, says Hossein Askari, an economist at George Washington University. 

At the same time, Iran has endured a sharp decline in oil sales, which started to fall in late 2010 due to the rise in transaction costs for purchases of Iranian oil resulting from sanctions.  A European embargo against purchases of Iranian oil, imposed in July 2012, has pushed Iran’s oil sales down even further.  Today, primary purchasers of Iranian oil are refineries from Turkey, Japan, South Korea, China, Taiwan and India.

The country’s oil exports, which fluctuate between 900,000 to 1.1 million barrels a day, are 55 percent lower than what they were at this time last year. 

“The country has mismanaged countering the sanctions…and today, we are faced with a situation where oil sales are down, the country has less foreign currency, and the government can’t even transfer [most of] the money for oil it does sell back into the country,” the Tehran-based analyst says. 

Liquidity is now estimated by local economists to be seven times higher than what it was when Mr. Ahmadinejad first ascended to Iran’s presidency, in 2005. Though the official inflation rate stands at roughly 24 percent, economists such as Askari of George Washington University say that given the extent of currency depreciation, inflation in Iran is actually double that figure. 

Protesting the government 

Yesterday protests broke out in Tehran’s Grand Bazaar, one of the country’s most important financial hubs, after dozens of people started chanting slogans around the area housing gold merchants, asking store owners to close their stores. 

While some shops in that section of the Bazaar closed down as a show of sympathy with demonstrators, many closed for fear of looters, according to a family of gold merchants. 

Protests also broke out yesterday on the blocks surrounding the area, and demonstrators were aggressively pushed back by riot police with tear gas, witnesses said. Iran’s semi-official Fars News Agency, citing Iran’s judiciary, said security forces arrested 16 “illegal” street money traders and speculators. 

Many shops stayed closed today, the first day of the Iranian weekend, when Bazaar merchants typically open for half the day.

“People were just fed up with the dollar inflation … and were asking for support from the Bazaaris,” says a business owner in the Grand Bazaar. “Right now, the government doesn’t care. Hopefully, now that the people are out protesting, they might be pushed to sit up and actually do something.”

Analysts in Iran say that, for the time being, there are stringent limits to what the government can actually do to try and stem the tide of depreciation.  

“They’re running out of dollars and simply do not have enough foreign currency to service the market,” says a Tehran-based analyst.