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October 2018, No. 89


Opinion

National Currency Value
A Lesson Not Learned!

Four decades of mistakes and repetition of currency crises and observation of the events of last two months must have been enough for the statesmen.


Dr. Alinaqi Mashayekhi says: Iran has been suffering from a blunder committed by its politicians about “the value of the national currency” for more than four decades. The “value of the national currency”, which is the result of economic factors, is considered to be an honor in terms of the performance of the political system of the country and is treated as cause; the reason is poor economic management!
In order to maintain the value of the national currency, the authorities instead of focusing attention on the causes of its depreciation focus on the effect, which is the value of the national currency itself and thus cause a further decrease in the value of the national currency and further weakening of the economy.
The roots and causes of the devaluation of the national currency come from growing liquidity against the growth of national production. When liquidity grows faster than production, the money in the hands of the people grow faster than the amount of goods and services that are supplied in the economy. As a result, there is more money available for existing goods and services. In fact, there is more money for purchase of a specific basket of goods; therefore, commodity prices go up, inflation is created and the value of the national currency goes down.
As the value of the money goes down, politicians, by focusing on the value of money and in order to maintain its value, instead of curing the causes, inject foreign exchange (dollar or euro) into the currency market. They want to maintain the value of the national currency by increasing the supply of foreign exchange and prevent the exchange rate from rising. But this has several destructive consequences. First, by stabilizing the exchange rate, while the prices of domestic manufactured goods have increased due to domestic inflation, the prices of foreign goods, which have grown with less inflation, have not risen as much as domestic goods; as a result the purchase of foreign goods is cost-effective, and the foreign commodities enter the country formally or are smuggled and oust domestically made goods from the market.

The uproar over the closure of production units, unemployment of Iranian workers and increased smuggling go up. National production is harmed and reduced. With the weakening of domestic production, “the cause of devaluation of the national currency” is strengthened, and more foreign exchange should be injected in order to maintain the value of the national currency. Imports – authorized or smuggled – increase and this further harms domestic production; As a result, economic activists come to the conclusion that production is problematic and detrimental and therefore not wise; so it would better to go after import of goods and distribute them.

The second destructive effect is on exports. Due to domestic inflation and the fixing of the exchange rate, the price of domestic goods abroad goes up and demand for Iranian goods and services in foreign markets goes down. As a result, domestic production cannot be exported and it gets weak and foreign exchange earnings from export of products decline. With the weakening of production the “cause of devaluation of the national currency” is boosted. More foreign exchange should be injected into the market to keep the exchange rate constant. However, with lower exports and less foreign exchange earnings, there will be less foreign currency to supply to the forex market; and the supply of more foreign currency eventually stops.
In addition, when production becomes weak then less taxes are collected and the budget deficit increases. This in turn would increases liquidity and thus another cause of devaluation of national currency which is the growth of liquidity is strengthened.
Therefore, in order to preserve the value of the national currency, the statesmen will strengthen the depreciation of the currency without paying attention to its causes, and merely through the injection of foreign currency into the foreign exchange market.

But since forex reserves are limited and foreign exchange inflows into the market cannot continue, the exchange rate will eventually jump and the value of the national currency will fall. The fall in the value of the national currency would cause economic instability, and public confidence in the economy and economic growth is harmed.

This experience has been repeated four or five times since the 1979 Islamic Revolution and strangely enough our politicians have not yet learned from it. As a result, over the past four decades, production has always been weak, and instead imports, smuggling and rent-seeking from foreign exchange have been rampant. As a result of these experiences, we often hear from the economic activists that production in Iran is problematic and not cost-effective. Funds are spent more on leaving the country by using cheap currency, imports, speculation, land and construction.

The volume of capital spent on construction of expensive residential units, villas and commercial centers, which are mostly unused, is estimated at up to $250 billion. With the sound management of the foreign exchange market, these funds should have gone towards production and boosted production, employment and exports.

Four decades of mistakes and repetition of currency crises and observation of the events of last two months must have been enough for the statesmen. They must have learned that when liquidity grows more than production and domestic potential inflation is higher than the global average, they should take the following appropriate approach:

1. As it has been recommended in the development plans, the authorities must allow the foreign exchange rate to be gradually increased in proportion to the difference in potential inflation, which is calculated on the basis of liquidity in order not to lose domestic production against imports and Iranian goods and services in other countries would not lose their competitiveness in terms of price. To sum it up, action must be taken so that national production, which is the infrastructure of the country’s economic power, would not be harmed.

2. With the intensification of financial discipline in the government, budget deficit and rising liquidity beyond national growth would be avoided. Sound monetary policies too would prevent more money to be generated by the banking system.

3. With the improvement of the business environment by strengthening the competitive environment inside, deregulation and facilitation and acceleration of economic activities, there would be more transparency in government transactions, and a fierce campaign against corruption would allow faster growth of production.

4. Only in emergencies and states of war, part of the proceeds from oil and major commodities derived from oil and gas be allocated to the supply of basic goods. Of course, the pricing of basic goods and how to help low-income groups to buy those goods is a separate issue. This should be done in a way to ensure the supply of those goods to low-income groups and at the same time not let any harm to production of basic goods in the country.

 

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  October 2018
No. 89