Living with lower oil prices
Iranians are more likely to complain about the prices of cucumber and watermelon, but if you ask economists what are the two most important prices in an economy, they would say the exchange rate and the interest rate. The exchange rate is the price that links Iran to the rest of the world, and the interest rate is the link between the present and the future. If a government can get these prices right, it has done half of its job in economic policy.
These two prices happen to be the two that are most wrong in Iran. The rial (at present about 10,000 per US dollar) is highly overvalued and the interest rate (averaging about 15 percent) is well below where it should be. Iran’s exchange rate has remained basically the same in the last five years while prices in Iran have outpaced prices in its trading partners by about 100 percent! So, to keep Iran’s non-oil exports competitive, a devaluation of about 100 percent is needed. The interest rates charged by government banks is about ten percentage points below the rate of inflation of 25 percent, making the real interest rate a whopping negative 10 percent, which is why banks are not inclined to lend these days.
Iran has done seemingly all right with these rates being out of whack because abundant oil money has covered up over these (and several other policies) mistakes in the past. But with oil revenues in 2009 (1388) expected to be about half of what they were a year ago, the problems with an exchange rate that makes Iranian goods expensive and foreign goods cheap and an interest rate too low for anyone to lend will soon flare up. Earlier this week I wrote in more detail about Iran’s adjustment to lower oil prices, and complained that presidential candidates have not said enough about their plans to deal with lower oil prices. But do they know and are not telling us?
No one knows enough– especially the government– about what these rates should be, which is why economists prefer to let the market –that is, people who actually deal with these things– to set them. The first problem with this option is that many economists in Iran do not believe in markets, period, while others would say that these are too important to leave to the market. You will find economists of both persuasions in the inner circle of all of the three leading candidates. The second problem is that Iran’s government is de facto involved in setting both the rate of exchange and interest. The former because it is the main supplier of foreign exchange to the market, so its expenditure decisions affect the supply of dollars and the rate of exchange. And when the government does too much spending backed by selling oil dollars, it causes the Dutch Disease.
Regarding the rate of interest, the government is constitutionally and ideologically bound to eliminate it, which is not the same as setting it to zero, but prevents interest-based transactions. This gives the state a large window for interference in the banking sector, through which Mr. Ahmadijead’s government has driven the proverbial truck. Early in his administration, he announced that banks should lower interest rate, an order that government-owned banks –which comprise more than 90% of Iran’s banking sector– had to obey.
A third problem is with the professional advice that the government gets about where these rates should be. Among the 1100 economists that Mr. Moussavi plans to call for help with economic policy are many who actually prefer a lower exchange rate (cheaper dollars) as a way to fight inflation, and to help –who else?–importers. Though the most sensible of Iran’s economists have pointed out the plight of exports under the current policy, no one of the presidential candidates has taken up the issue yet, and may avoid doing so as long as they can, fearing the wrath of Iran’s middle class. In recent years, the middle class is accustomed to the predictable exchange rate and the cheap dollar, which help it finance its appetite for foreign durable goods and pay for its children’s education abroad.