Lost in translation: A quick note on exchange rate policy in Iran
Something important was lost in translation in an article of mine published in yesterday’s Donayey Eghtesad, which discussed the dual exchange rate system in Iran, and which I needs to correct. The article discusses the perils of the two tier-exchange rate policy, emphasizing the difficulty of preventing inefficiency and corruption when the Central Bank provides foreign exchange at a discount of 80% relative to private sellers. Who should be getting the discounted dollars and euros is a task no government should undertake, unless under emergency conditions. Iran has been under emergency conditions for the past several months, so exchange rate unification may not be the most important objective to pursue; having enough foreign exchange for basic imports and fighting inflation are.
The translated article departs from my views where it implies that Iran can revert back to the unified exchange rate system, by the Central Bank selling its foreign currency at a higher rate, say 15000 rials per US dollar, without noting the important qualifier of emergency conditions. I doubt very much that, under the present conditions dictated by the draconian sanctions imposed by the US and the European Union, Iran’s Central Bank can or should try to sell its dollars to lower the parallel market rate, to a rate between the low official rate of 12,260 and the 20,000 rials per dollar that the dollar has been trading in recent days.
Unification makes a lot of sense when other markets function properly, not when sanctions have closed many markets and caused others to not operate normally. Under sanctions, the objectives of the Central Bank should be to make sure that there is enough foreign exchange for the country to continue to import the basic and strategic goods from abroad, and at a low enough price to prevent spiraling inflation.
The inefficiencies caused by a dual rate system can be minimized but not completely avoided. These are costs to being denied access to global markets; a dual exchange rate system is one of them. While all dual exchange rate systems are inefficient and costly, some are better than others. There are ways to minimize misallocation and corruption, for example by publishing a complete list of all official foreign exchange sold to private importers along with the list of the items they import. The alternative, which is to sell all currencies at the rate set in the parallel market, is to give too much influence to sanctions and to sentiments that underly capital flight. Neither of these should be allowed to set internal prices in Iran or to fuel inflation.
This statement does not negate the important role of markets in allocating foreign exchange, nor does it contradict the point in the DE article regarding the perils of a dual rate system. The point I raise here is very similar to the familiar second-best argument in economics: when some markets do not work well, seeking efficiency in one — a unified exchange rate — may not be the best option.