Tyranny of numbers

Prices in Iran and what they mean for the PPP exchange rate

Posted in General, Macroeconomy, Sanctions by Djavad on November 4, 2012

As I have argued in this blog and elsewhere, there is not a single equilibrium exchange rate for the rial. If you believed my rough calculations in my previous post, and if you needed to report only one number, the exchange rate would be something around 20,000 rials per dollar (about 96.5% increase over the old exchange rate of a little over 10,000). The next best thing after an equilibrium exchange rate (ER), one that is actually more useful for welfare comparisons, is the Purchasing Power Parity ER. Here are my back-of-the-envelop calculations of the PPP rate for Iran in 2012.

The PPP is the rate that equalizes the value of the same basket of goods and services, one purchased in Iran and another in the US. For example, if the same basket of food, clothing and rent costs \$100 in the US and, say, 2,000,000 rials in Tehran, then the PPP rate would be 20,000. The World Bank calculates these rates for Iran and more than 100 other countries using the differences in inflation rates between that country and the US. Since the Central Bank of Iran is no longer publishing detailed reports on prices, I have been collecting price information on some key items in Iran (mostly Neishabour) when I call friends and family (see table below). These prices help me get a rough idea of what the PPP exchange rate may be these days.

To get your own estimate of the PPP rate, you can average the numbers in the third column (Implicit ER) using whatever weights you think are appropriate for the type of income class you have in mind (such as a basket for the poor). There are lots of important items missing from the table, such as education, services, durables and clothing. It is reasonable to take all the tradable goods, such as TV’s at the 30,000 exchange rate, but non-traded items should get something closer to 20,000 rials per \$. So, for example, if a poor person spends most of his money on food (say 40% of his total expenditures), things like bread and chicken with implicit ER’s between 2,500-10,000, then you know that the PPP is much less than the current free market rate of 31,000. Services probably have PPP rates less than 10,000 (for example, the rate for haircut is about 3,000 rials). Let us assume that food and services (including rent), account for 80% of this person’s budget have a PPP of 10,000 rials and the other 20% are goods with a PPP of 30,000 rials. Then the average PPP for this basket is 14,000 rials per \$. For comparison, note that the World Bank estimate of the average PPP rate for Iran in 2010 was 5006 rials. To get to 14,000 rials in 2012 you would have to assume that inflation in Iran exceeded that in the US (close to zero) by 140% in the last two years, or roughly 70% per year. These are very high numbers, so I would assume that the PPP number of 14,000 is an upper bound.

Of course if you take a rich person’s basked, you would get a higher PPP than 14,000 rials. It would be useful if someone could prepare and post an (excel) table like the one below for Tehran. You can post it into the comment section directly or send it to me to post it here.

Another value of my anecdotal method of collecting price information is that it helps me keep track of inflation. Some of the prices I report, such as taxi rides and the unskilled wage are price aggregators themselves and act like a price index (similar to Economist’s Big Mac index). In the last two months that I have been collecting these data I have noticed that inflation has slowed down, after its sharp increase following subsidy reform and devaluation. So, no hyperinflation so far.

The observation that inflation has slowed down is consistent with the hypothesis (to which I subscribe) that the high rates of inflation in Iran in the last two years were in large part the result of two important adjustments in energy prices and the exchange rate, both of which were necessary for long run economic growth. The former needed to be adjusted by a factor of about 5 and the other by about 2-3, so the level of inflation Iran has experienced in recent years is not out of line with these huge adjustments.

The sad thing is that Iran is getting its prices right at a time when its ability to take advantage of them is very low, thanks to sanctions and economic policy paralysis in Tehran.

Table of prices in Iran and US with their implied exchange rates

 1-Nov-12 Neishabour Blacksburg Implicit ER Notes Bread (kg) 10,000 4 2,500 Rice 40,000 2 20,000 Cooking oil 40,000 4 10,000 Eggs (dozen) 30,000 3 10,000 Chicken 50,000 5 10,000 Red meat 220,000 10 22,000 Potato 7,000 2 3,500 Onion 9,000 1.5 6,000 Carrots 12,500 2 6,250 Eggplant 14,000 2 7,000 Tomato 10,000 2 5,000 Apple 15,000 2 7,500 Persimons 26,000 8 3,250 Pomegrantes 26,000 5 5,200 Gasoline (liter) 6,000 1 6,000 Average of 4000 and 7000 prices Electricity (kwh) 700 0.1 7,000 Average price Public transportation 1,000 1 1,000 City bus Taxi (service line) 3,500 2 1,750 Set short city routes Inter city taxi (Mashad-Neishabour) 60,000 10 6,000 1.5 hours ride Airport taxi in Tehran 350,000 70 5,000 45 minute ride Train (Tehran-Mashad) 350,000 100 3,500 600 miles Bus (Kerman-Tehran) 280,000 50 5,600 600 miles Doctor’s visit 100,000 50 2,000 Hair cut 30,000 10 3,000 Rent (2 bdrm) 8,000,000 800 10,000 Per month Unskilled wage 250,000 50 5,000 Per day in construction

Notes: All units are in kilograms unless otherwise noted. Iran prices are in rials and US prices in dollars.

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17 Responses

1. […] all, as he points out, Iran employs a multiple-exchange-rate regime. In consequence, he argues, a standard PPP calculation will not work for […]

2. Rd. said, on December 21, 2012 at 2:55 pm

Iran’s budgetary outlook for the coming year…

http://www.al-monitor.com/pulse/originals/2012/al-monitor/iran-economic-war.html

3. William said, on November 12, 2012 at 10:11 pm

Iran can not take many dividends you mentioned on it’s long term economic strategy with the economic sanctions and mounting international pressure. “So, no hyperinflation for now.” Is there a barrier at which you think hyperinflation will occur, and what would have to happen to Iran’s currency, much less the economy? I think there is this perception that their economy is on the verge of collapse – but I find that hard to believe. You make great points in this article.

• Djavad said, on November 14, 2012 at 12:00 pm

Thanks for your comment. Ironically, half of the battle toward economic growth has been won because devaluation has set prices right (though it has caused high inflation and much hardship), and incentives to produce a variety of goods that were previously imported is now there. There is even a greater understanding by the government that it cannot replace the private sector, something that I had feared would occur as sanctions marginalized the latter. But the external and internal barriers to private investment remain, so I am not optimistic that the economy will improve anytime soon. Perhaps if there is some movement on the diplomatic front followed by easing of sanctions we may see some improvement.

• Baddu said, on November 30, 2012 at 1:57 pm

Rial Devaluation Helps Farming, Mining and Cement:

• Djavad said, on December 3, 2012 at 12:00 pm

Very interesting table. Thanks for posting it. People tell me that the TSE is not a reliable source for gauging private sector sentiments in Iran because mostly government entities trade in it, like large government banks and pension funds. But perhaps their optimism for specific sectors as you noted are credible signs.

4. Baddu said, on November 6, 2012 at 5:51 pm

Dear Dr. Salehi,
If your figure for Iran GDP of USD 400 billion be correct then GDP/barrel would be USD 235. We are not consuming oil and gas, we are squandering both. For most efficient economies GDP/barrel is 10-15 times higher! Please also note that above I was calculating the value of energy subsidies in the national economy and not how much these subsidies are (opportunity) costing the government. The two are not the same.

5. Baddu said, on November 5, 2012 at 4:13 pm

How does the huge energy subsidy of around USD 120,000,000,000 stil being pumped yearly into the national economy contribute to keep the calculated PPP low? Am I right in thinking that were we footing that bill, PPP would be another animal?

• Djavad said, on November 5, 2012 at 4:28 pm

I am not sure where you get your \$120 billion. Way overstated. At their height, subsides were about \$70 billion, now much lower. PPP is lower than the equilibrium exchange rate because non traded prices are lower in Iran and because of subsidies.

• Baddu said, on November 6, 2012 at 8:17 am

Good you asked! I would like to see if there is any big hole in the following back-of-the-envelop estimate.
Iran is daily delivering about 2 million bls of crude oil domestically. This would amount to about 700 million bls annually. Add to this the annual natural gas consumption of equivalent to 1,000 million bls of oil and you get the figure of 1,700 million bls for domestic consumption per annum. At an average FOB price of USD 88 per bl, the total value would be about USD 150 billion per annum. I have estimated that not more than USD 30 billion (i.e. 20%) is charged to the domestic buyer (I consider this as an over-estimate, even when we use your ER 23,000 Rial to the dollar for converting domestic oil and gas selling prices back to USD, more below). This is how I have arrived at USD 120 billion subsidy.
Two points need clarification. Firstly, annual domestic natural gas consumption is given as 162 b cu m. This is energy equivalent to 160 b lit of crude oil which would come to exactly one billion barrels of oil. Secondly, the domestic prices for some items of energy are given here to enable the reader to check my ceilling of USD 30 billion in the calculation above. Gas: Rls 700 per cubic meter, energy equivalent to one litre of crude. Diesel fuel: Rls 1500 to Rls 3000 per litre according to ration or open rate. Fuel oil: Rls 2000 per litre. Petrol: Rls 4000 to Rls7000 per litre. I do not have the quantities for each item but since natural gas makes almost 60% of the total my guess is that the average would not be more than Rls 2300. At ER rate of Rls23,000 per dollar this would come to 10 cents per litre. Compare this to lowest FOB Persian Gulf prices. Not more than 15%.

• Djavad said, on November 6, 2012 at 9:38 am

Thank you for sharing your detailed information. I am no expert when it comes to these numbers, but I would add one point: we have to be careful in taking the FOB prices are opportunity cost. Today, Iran’s oil exports are limited, so it is not the FOB price but the future value of oil that is the proper opportunity cost. This may be lower. Natural gas is not really exportable, except at high cost, so I am not sure if you are taking at the right value of its opportunity cost. Not easy to estimate these things. But overall I still think your estimate of \$120 billion is too high for a country with GDP of \$400 billion.

6. arghami said, on November 5, 2012 at 11:22 am

Thank you for a most convincing post. Some people are just not convinced unless they see some calculations (even of the kind that are done on the back of envelopes). I can confirm the input, because I have some reporters of my own in Neyshaboor, and the arithmetic is, of course, straight forward.

There is one point, though. PPP exchange rate is not going to stay as it is now, even if Rial stops falling tomorrow and remains so. In other words, as the economy adjusts itself to the new exchange rate (moves towards equilibrium), PPP exchange rate is going to change, even if ER remains constant.

There is yet another point. You seem to be implying that a fall in ER is not of any dire economic consequence, as long as PPP ER remains contained (forgive the home made abbreviation). In case I am right in believing that you are so implying, is what you seem to be implying an economic fact?
I would be most obliged if you could shed some light on these points.

With regards

• Djavad said, on November 5, 2012 at 4:26 pm

Thanks for your good questions. On the first, yes, as Iran’s inflation is likely to exceed US inflation, the PPP rate will keep rising, as it has in the past.

On the second, the fall in ER is actually good for the economy because it restores better relative prices internally, with greater incentives for local production than imports. The free market rate that fell precipitously should not be confused with “the value of the rial”, which is more accurately reflected in the PPP rate.

7. Mehdi said, on November 5, 2012 at 12:08 am

Why don’t you use official rates for inflation that still are being published by cbi? As I guess you are not so pessimist about the reliability of those rates.

• Djavad said, on November 5, 2012 at 3:15 am

For two reasons: The official monthly reports that I have seen do not publish CPI components — by items or categories — so I can change the weights as I want. Also, they come a month or two after the fact. I am a bit skeptical of the official numbers when they become too political.

8. Dr. Hamid H said, on November 4, 2012 at 8:14 pm

I can not take part in this research experiment since I am not in Iran. All the prices are for goods and services that are made in Iran. What about products that are not made in Iran? Do they not count in PPP calculation?

• Djavad said, on November 5, 2012 at 3:07 am

In my example, imported goods are those that would use the 30,000 ER and account for 20% of the budget.