News ID: 209637
Published: 0320 GMT February 07, 2018

Current price hikes not causing foreign currency shock

Current price hikes not causing foreign currency shock

By Pouya Jabal-Ameli*

Economic factors causing a foreign currency shock have always existed in Iran, with the most important ones always directly leading to an increase in the value of major currencies in domestic market to a level higher than the capacity of the domestic financial system. They also result in a failure to balance forex rates in proportion to that of inflation and low real interest rates.

These permanently present factors are like firewood that needs a spark, be it economic or noneconomic, to start a foreign currency shock bonfire.

Prior to the present quasi shockwave in the forex market, two foreign currency crises had occurred in Iran in the early 90s and 2011 — the former due to a debt crisis and the latter as a consequence of the intensification of Western sanctions on the country. Although it would be a hasty decision to call the present hike in foreign currency prices a period of shock, taking a glance at the coordinates of the factors creating and impacting the present balances in domestic forex market, it would be possible to make a rough prediction about the future condition of foreign currency rates in Iran.

Official figures and statistics indicate that since the beginning of the year to March 2017, the demand for using promissory notes in domestic market transactions has risen. Normally, demand in the domestic market has always been higher than the country's total imports. In addition, Iran's imports have also followed an increasing trend in the past few years.

Since October 2016, the domestic market has been under pressure by demand for imports on one hand, and that of those involved in the transactions of the stock exchange market on the other. This pressure initiated a moderating trend in foreign currency rates in the domestic market following the holding of the presidential election in May 2017, and helped rectify the market imbalances caused by the several-year-long stability maintained in the rates. This was also accompanied by an adjustment in the exchange rates to prevent rent-seeking activities.

Although very conservative in nature, this trend turned out to be a natural one to many of the market observers, with a large number of them expecting that the increasing trend in forex rates would halt in the early January.

In late December, after months, the first sign indicating that the rates had stopped following their gradual increasing trend appeared, with each dollar being sold at 42,000 rials. This formed the expectation that this price level could be maintained by mid-March 2018. However, the forex rates contradicted all expectations all of a sudden. The occurrence of a number of riots in the country and the instability caused by Trump's threats against the JCPOA, were the sparks the forex market needed to create a considerable momentum in the rates. The former gradual moderating trend turned into an unexpected leap. This was followed by the entrance of the precautionary demand into the foreign currency market, motivated by the impetus to maintain the value of the possessions. This, per se, filled the market with excitement.

In such an excited market supply does not set prices. The changes in prices are dependent on demand trends. Thus, the increasing trend started in foreign currency rates in Iran will not halt or reverse unless buyers come to this belief that the prices would not rise anymore. The only solution is to change market expectations and make buyers believe that purchasing foreign currency in hope of future hikes in prices, and thus, profit, would not be a lucrative business.

The Iranian government's success in reducing interest rates at the end of the summer completed the chain of the economic factors leading to the price hike in domestic property market. The real interest rate was negative when the domestic foreign currency market experienced the previous two shocks. This comes as at present, despite the anticipated inflation which is higher than the current rate, the real interest rate is still positive which will, most probably, prevent the price increases from leading to a condition as nasty as the ones caused by the previous shocks. Yet, in case the government manages to increase the real interest rate to its summer level, or even higher than that, there would be no reason for a rise in forex prices in the short-term. Although a high interest rate can drive up costs in the future, it is also capable of impacting anticipations in the property market.

On the other hand, in case the policymakers involved in the domestic foreign currency market manage to disclose their long-term target rate even at the cost of risking their credibility, this measure of last resort will be able to control prices by making the expectations become declining. Unless expectations wane, other sorts of interventions will fail to control the market. Anybody who is currently entering this excited market will reap profit only because he thinks that others, the same as he himself, are also expecting an increasing trend in the market. Today's market condition is different from the situation created by the previous two shocks. Thus, expectations can reverse. Perhaps, gambling on what others think about or expect from the market would not be a profitable investment in the current situation.

 

 

*Pouya Jabal-Ameli is an Iranian economist

   
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