Tyranny of numbers

Iran’s economy after the Lausanne accord

Posted in General by Djavad on April 16, 2015

This week I published this oped in the UAE newspaper, The National.  Referring to Rouhani’s famous refrain that as the centrifuges turn so should the wheels of the economy, I asked if “he can take much of the turning to production lines rather than shopping malls.”  I would like to expand on that question here.

The answer depends on the extent to which any easing of sanction will help stimulate production instead of consumption.  Everyone expects a huge inflow of foreign exchange as a result of the release of Iran’s frozen funds abroad — some $100 billion according to reports, though none with a reliable source.  This is about the highest Iran has earned in oil revenues in any one year.  Adding oil exports of about $50 billion, we are talking major stimulus.

Or at least these are the expectations that have kept the dollar steady at the 33000 rial mark for the past several months as optimistic news from the nuclear talks has been trickling in.

But the current value of the dollar in Tehran is at least 25% below what it should be given that Iran’s higher inflation has outpaced that of its trading partners by a factor of 5 in the last dozen years.  The graph below shows how much faster Iran’s prices have risen relative to prices in US and OECD (5.7 times in the last 12 years) and that the exchange rate adjustments have failed to keep up with the difference.  As a result Iranian goods are about 37% more expensive relative to foreign goods than they were 12 years ago.  Assuming that the exchange rate unification in 2002 put the rial at its correct value relative to the US dollar that year, the rial should be trading at 45532 rials per USD now, not 33000 rials.

CPI_ExchRate
Notes: All price indices are normalized to 100 in 2002.  US and OECD CPI are virtually the same.  The exchange rate (ER) is rials per dollar normalized to 100 in 2002.

So why are so many Iranians expecting the dollar to become even cheaper?  Is their priority to make weekend trips to Dubai and Istanbul as cheap as it was before the sanctions?  How is the economy going to create 3 million news jobs for the country’s unemployed youth?

Iran’s middle class, about 45% of the population, meets all the criteria defined by its international counterpart except one — productivity.   All over the world the value of a country’s currency has close relation to its citizen’s productivity.  Not in Iran.  Instead it depends on productivity in other countries, who buy Iran’s oil.  The more productive they become the more they are willing to pay for imported oil and the richer are the people in oil exporting countries.

Cheap dollar — sustained by high oil prices — is one important reason behind Iran’s continuing economic malaise, and, unfortunately, the ailment gets worse precisely when its citizens think they are doing well.

Rouhani’s challenge is to get the middle class, who are among his more steadfast supporters, to take the high road to prosperity, to strive for higher productivity rather than quick benefits from the likely inflow of cash; look for jobs for their young instead of furniture for their living rooms.

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2 Responses

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  1. Mehdi Soltanmohammadi said, on April 23, 2015 at 9:01 pm

    Hello Dr. Salehi,
    I used the same methodology to evaluate the desired exchange rate that can keep Iran in the same route that was before recent sanctions. If we change the base year from 2002 to more recent years we will reach to different rates as follows:
    2002 43,959
    2003 40,475
    2004 37,801
    2005 37,136
    2006 34,044
    2007 30,336
    2008 24,893
    2009 24,137
    2010 23,349
    2011 24,126
    2012 42,932
    2013 32,069
    2014 30,991
    The average is 32778 Rials per USD. So I guess that the equilibrium point will be far less than 45000 Rials that you have already suggested. Taking into account huge inflow resulted frozen funds abroad and probably foreign investments as well as non crude oil exports that are estimated 60-70 billion dollars for this year.

    • Djavad said, on May 19, 2015 at 2:02 am

      Thanks for your input. The problem with taking a more recent year is that the rial started to appreciate after 2002, so obviously one gets a lower number the later you start. I think 2002 (1381) is a safer bet for an equilibrium year.


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