The Job of Iran's Central Bank Governor Just Got Harder

Last Friday, Iran’s Supreme Leader, Ali Khamenei, declared that negotiations with the United States were “not smart, wise, or honourable.” Addressing an audience of Iranian military brass, Khamenei did not explicitly rule out negotiations. But his tone made it clear that Iran was not about to begin talks with the Americans, despite American President Donald Trump stating just two days earlier that he wishes to start working on a nuclear deal with Iran “immediately.”

As is the case in sanctioned economies, when hopes deflate, prices inflate. Within the few days following Khamenei’s speech, the dollar appreciated nearly 7 percent against the Iranian rial, pushing the free-market exchange rate towards the threshold of 1 million rials to the dollar.

The free market accounts for a very small proportion of Iran’s multi-faceted foreign exchange market, generally reflecting the prices available to individuals purchasing physical bills at exchange bureaus. The free market dollar is the dollar that ordinary Iranians use to protect their savings in the face of chronic inflation (dollars stuffed under the mattress, so to speak) or to take their wealth abroad (dollars hidden in a briefcase, so to speak). These limited uses explain why the price of the free market dollar is such an important signal in the Iranian economy: it is the country’s highest-frequency measure of economic sentiments.

In this respect, Khamenei’s speech appears to have gifted Trump the first victory of his renewed “maximum pressure” policy. Despite Trump indicating he was “unhappy” to sign the presidential memo which directed his cabinet to increase pressure on Iran—and despite the limited scope and impact of his only enforcement action so far, the designation of three oil tankers—the rial plummeted against the dollar. Sometimes maximum pressure is self-inflicted. 

Now that Iranian leaders appear to have rejected the opportunity to negotiate with Trump, at least for now, the question becomes whether maximum pressure policies will begin to have more than psychological impacts for Iran’s economy.

This question can be answered by monitoring the indicator that really matters for Iran’s economy— the commercial foreign exchange rate. Until recently, this was called the NIMA rate. The NIMA foreign exchange market was a centralized electronic system established by the Central Bank of Iran in 2018 to streamline the purchase and sale of foreign exchange among Iranian companies. The commercial exchange rate has been notably stable in recent weeks, showing little movement after Trump signed his presidential memo or after Khamenei declared that negotiating with the United States is “not smart.” This is not because Iran’s central bankers have managed to inure the commercial exchange rate to psychological impacts—it is because the impact was preempted in December.

The NIMA rate began to slide in the days after Trump’s election victory on November 4, 2024. This may indicate that, like in the free market, Trump’s victory spurred more demand for hard currency. Iranian companies, anticipating the return of maximum pressure, may have sought to import more goods and build-up inventories in order to mitigate future disruptions in their supply chains. Though, it is also possible that the election outcome led to a change in foreign exchange supply. For example, financial institutions facilitating Iran’s access to hard currency may have grown wary of future sanctions enforcement and could have begun to throttle payments flowing from customers to Iranian exporters. Whatever the reason, the commercial exchange rate was rising at a steady clip.

By mid-December, as rolling blackouts began to hit Tehran, the Central Bank made a dramatic move to devalue the rial. Between December 12 and December 16, the dollar price rose nearly 10 percent—the sharpest such increase since the NIMA rate was established. On December 14, the Central Bank issued an announcement about the new price-level and a plan to restructure the centralized foreign exchange market under the Iran Currency and Gold Exchange Center. Central bank governor Mohammad Reza Farzin, like his predecessors, has instituted new rules and names for Iran’s multi-level foreign exchange market; the aim is for these largely superficial changes to help the central bank manage the largely intractable structural imbalances of the foreign exchange market.

The central bank aims to encourage Iran’s major exporters, such as firms exporting petrochemical products and steel, to sell their foreign exchange earnings through the new Iranian Commercial Foreign Exchange Market. From the outset, Iran’s major exporters have been reluctant to supply the central bank’s foreign exchange market, despite regulations mandating them to repatriate foreign exchange earnings. Managers at these firms who had the political weight to ignore regulations have known that, in an environment where the rial was expected to continually weaken, holding onto dollars was a smart bet.

By allowing a sudden devaluation of the rial in December, the central bank made a major concession to the major exporters. The move may help the bank keep the foreign exchange market supplied with dollars and euros, but it fails to address the fundamental issue which is found on the other side of the ledger—there is no underlying demand for rials given the dim prospects for the Iranian economy.

It is yet to be determined what “maximum pressure” will mean during the second Trump term. Unlike in the first term, there is no Mike Pompeo and Brian Hook to lead the pressure campaign. Plus, little had to be done to restore maximum pressure, as the new presidential memo set out, given that the Biden administration had never rolled back the sanctions imposed during Trump’s first term.

Still, if Trump decides he has been jilted by the Iranians, he could take a more forceful approach to maximum pressure. Any such shift in rhetoric will no doubt push the free-market exchange rate to new highs. The real indicator of whether maximum pressure is hitting Iran’s economy will be the movement of the commercial foreign exchange rate. If the free market rate reflects the mood of Iran’s economy, the commercial rate measures its pulse.

Photo: IRNA

Did Presidential Hopeful Hemmati Successfully Defend Iran's Currency?

Iran’s economic stagnation and widening inequality are top concerns for Iranian voters ahead of the presidential election on Friday. It is therefore no surprise that during three televised debates, candidates ganged up on Abdolnasser Hemmati, until recently Iran’s central bank governor. Frontrunner and head of the judiciary Ebrahim Raisi railed against Hemmati, promising voters that he would reduce the impact of exchange rates on prices, succeeding where Hemmati failed. Former IRGC officer Mohsen Rezaei claimed that Iran’s currency had lost so much value under Hemmati’s watch “the train of the revolution has turned into a scooter.”

It is true that Iran’s currency suffered a steep devaluation while Hemmati was central bank governor, but the attacks from the likes of Raisi and Rezaei are spurred not by the failure, but rather the demonstrable success of Hemmati’s management of Iran’s economic crisis. At least in the narrow area of currency policy, Hemmati made considerable progress in returning stability to foreign exchange markets at each point of crisis, meanwhile reducing the ability for special interests to profit from Iran’s system of multiple exchange rates.    

When Hemmati was appointed governor of the Central Bank of Iran in July 2018, Iran’s currency had already begun to lose value. Beginning in April 2018, Iran’s currency markets responded to the news that the Trump administration was to reimpose secondary sanctions on the country. The accelerating currency crisis would be the first test of a platform the Central Bank of Iran had introduced earlier that year—a new Integrated Foreign Currency Trading System, known by its Persian acronym “NIMA.”  

NIMA is part of Iran’s Comprehensive Trade Platform (NTSW), a set of registries and systems that enable companies to receive licenses to conduct certain kinds of trade and to purchase and sell foreign exchange as part of that trade. NIMA is paired with another platform called “SANA,” the Persian acronym for Foreign Currency Control System. The main difference between these two platforms is that NIMA is for international transactions with importers and exporters, while SANA is for transactions of foreign currency within the country, for instance between exchange bureaus. 

Using NIMA companies no longer needed to seek allocations of foreign exchange from the Central Bank of Iran or commercial banks, a system that disadvantaged companies with less established banking relationships and less political clout. All importers and exporters are required to use NIMA.  

The implementation of NIMA was slow and Hemmati, coming into office at a moment of crisis, struggled to get companies to use the new platform. By September 2018, the price of the dollar had reached a historic high of IRR 170,000 as supply-side pressure grew in advance of the full reimposition of secondary sanctions in November 2018. Imported intermediate and finished goods grew more expensive as suppliers dropped out of the market. At the same time, the Iranian financial system faced reduced liquidity in key currencies such as the Euro. As foreign exchange revenues declined, the central bank was unable to tap into foreign reserves. The Trump administration moved aggressively to freeze these reserves, even for use in humanitarian trade, leading just 10 percent of Iran’s overall reserves freely accessible by the end of 2019. To address these pressures, Hemmati sought to ensure that Iranian companies earning foreign currency made that currency available for sale through NIMA.

As per the guidelines issued by the central bank in November 2018, all exporters have a “foreign currency repatriation obligation.” According to these regulations, companies earning more than EUR 10 million a year in export revenue are obligated to repatriate 90 percent of those earnings through NIMA.

At first, adherence to the guidelines was disappointing. Hemmati publicly criticised large exporters, particularly petrochemical companies, that were failing to repatriate revenues. These companies were delaying in order to profit in rial terms as the currency continued its slide. In February 2019, CBI made a further announcement and instituted an incentive package, in which the exporters were categorised based on their performance in complying with the rules set in the market. Exporters with higher compliance—those who repatriated funds most reliably—would benefit from lower obligations for supply of foreign currency in NIMA.  

Over time, the public pressure and improved incentives led to greater uptake of the NIMA system. The electronic platform significantly increased transparency in Iran’s foreign exchange market. The earnings of exporters are linked to their export licenses, exchange bureaus bought foreign currency according to offers in which the currency, exchange rate, total value, and origin of funds are all known. Importers register their offers to buy foreign currency from exchange bureaus. Each transaction is duly recorded in NIMA.

Hemmati claimed moderate success by March 2019, noting that $19 billion of export revenue had been repatriated via the NIMA system. This was still just a fraction of Iran’s overall export revenue. But the impact of the foreign exchange market was noticeable. When combined with the economy’s structural adjustments to the reimposition of sanctions, the currency policy instituted by Hemmati saw the value of the currency remain below the September 2018 peak for the duration of the next year. A steady decline in the price of the dollar began in May 2019, at which point the price reached IRR 160,000 following the Trump administration’s revocation of waivers permitting Iran to export limited volumes of oil. By the end of 2019 the dollar price was around IRR 130,000.

In the first quarter of 2020, Iran’s economy faced a new shock—the pandemic. The impact of the pandemic was in many respects similar to the impact of sanctions—supply chain disruptions made imported goods more expensive. But at the same time, Iran’s non-oil exports fell due to the impact of lockdowns on production, logistical constraints, and reduced demand, particularly in regional markets. Iran was facing an acute balance of payments crisis. The value of the rial began to slide in earnest around February 2020, when the pandemic hit Iran. The value of the dollar peaked in October 2020 at IRR 330,000, an increase that had contributed to high rates of inflation. The situation may have been worse had NIMA not been in place. During the Iranian calendar year ending March 2021, Iranian exporters repatriated 72 percent of their foreign exchange earnings, around $52 billion.

After the dollar hit its peak price in October 2020, the rial recovered value quickly because of two factors. Iran’s economic recovery was picking-up steam. Greater oil exports to China and greater regional demand for non-oil goods had buoyed export revenue. Iran’s economic was actually returning to growth. Meanwhile, in Washington, the re-election prospects for Donald Trump were fading, and the notion that Iran could once again benefit from sanctions relief reduced demand for foreign currency, especially among ordinary Iranians who frequent exchange bureaus and purchase dollars and euros as a hedge against inflation.

Iran’s currency has been remarkably stable since October and in another indication of the success of the NIMA platform, the spread between the free market rate and the NIMA rate has been reduced significantly. Combined with a reduction in the number of goods eligible for the subsidised exchange rate of IRR 42,000, this has resulted in a de facto unification of Iran’s three-tiered exchange rate system. Given that one of the largest sources of corruption in the country has been the arbitrage between these rates, including situations in which companies would receive fraudulent allocations of foreign currency at the subsidised rate only to turn around and sell that currency at the free market rate, Hemmati’s interventions can be said to have had a significant impact on corruption—a point he alluded to during the debates.  

To understand Hemmati’s impact, it is perhaps best to compare the case of Iran with that of Turkey or Lebanon, two countries where the devaluation of national currencies is continuing unabated, precisely because leaders at the central bank lack the means or the might to arrest the decline. Hemmati saw that the train of the revolution was at risk of careening into the abyss and at least he sought to keep it on track. His opponents may not prove so adept.

Photo: IRNA

Iran’s Currency Begins to Shrug Off Trump’s ‘Battle Rial’

Over the last 18 months, the Iranian rial has lost nearly 70 percent of its value, hammered by the Trump administration’s decision to reimpose secondary sanctions on Iran in violation of the  Joint Comprehensive Plan of Action (JCPOA).

A darkening economic outlook and rising inflation led Iranians to rush to exchange bureaus in order to purchase dollars, considered a safe-haven asset. Iranian companies struggled, or in some cases refused, to repatriate their foreign currency earnings, constraining supply in the foreign exchange market and leaving the market vulnerable to shocks.

Each time the Trump administration announced a new aspect of its maximum pressure campaign; the value of the rial would fluctuate. When the Trump administration took the dramatic step of targeting the IRGC under a new terrorist designation, the rial lost 4 percent of its value in just a few hours.

But there is a growing sense in Tehran that the currency market may have stabilized. When two oil tankers were attacked in the Sea of Oman on June 13—attacks widely attributed to Iran—the United States vowed a forceful response. But there was surprisingly little movement in the value of the rial.

Two weeks later, when the Islamic Revolutionary Guard Corps (IRGC) shot down a US spy drone near the strategic Strait of Hormuz, ordinary Iranians and currency speculators again braced themselves for a free-fall in the rial’s value. But the foreign exchange market barely moved—even after news broke that the US had been minutes from executing a retaliatory strike. 

That the rial has strengthened about 13 percent since the first week of May, corresponding to a period in which the United States revoked waivers permitting purchases of Iranian oil and in which Iran announced it would begin loosening its compliance with the JCPOA, has led some economic commentators in Iran to conjecture that the Iran’s foreign exchange market has developed an immunity to the escalating political tensions. The rial may be shrugging off the Trump administration’s “maximum pressure” campaign.

One possible explanation for the newfound stability in Iran’s currency markets is that while the Trump administration has nearly maxed-out its own maximum pressure sanctions campaign, the Central Bank of Iran has only recently begun to assert its control over the foreign exchange market. Late last month, Abdolnasser Hemmati, the governor of Iran’s central bank, struck a confident tone in an interview with state broadcaster IRIB, stating, “I promise to strengthen the value of the national currency—the situation is improving, the recovery can be felt.”

To defend the rial, the Central Bank has made several interventions. It has implemented a central marketplace to increase transparency and reduce arbitrage in Iran’s foreign exchange market. The Integrated Foreign Exchange Deals System, known by its Persian acronym, NIMA, has improved the reliability with which Iranian importers in need of foreign exchange can purchase currency, taking advantage of a rate slightly lower than the free market rate. Iranian exporters are required to sell their foreign exchange earnings through the NIMA system, ensuring that vital foreign exchange is not sold to currency speculators on the free market. Additionally, the central bank has for the first time engaged in open market operations, in an attempt to try and slow the inflation that has fed demand for foreign exchange.

While some of the stabilization is likely attributable to these interventions, it is also possible that the rial has stabilized due to the fact that the current exchange rate better reflects the relative purchasing power of the rial and the dollar. The rial had long been kept artificially strong by the Iranian government.

Looking at the demand side, it may be the case that the Iranian public has been inured to the economic uncertainty brought about by the reimposed US sanctions or that there is greater confidence in the management of the foreign exchange market by authorities. In both cases, individuals and companies are less inclined to flock to the dollar as a safe-haven asset, even if Iran’s general economic malaise—marked by high unemployment—persists.

The stability of the currency is all the more remarkable as the Trump administration drives down Iran’s oil exports. The revocation of waivers covering imports of Iranian crude has left China and Syria as Iran’s sole customers. Iran’s oil minister, Bijan Zanganeh, has insisted that Iran has the means to get its oil to global markets, though it is clear that exports have fallen sharply. While the Trump administration has crowed that reduced oil sales deprive Iran of vital foreign currency, it is worth considering that under the waiver system that governed Iran’s oil exports for much of the last decade, Iran had a limited ability to repatriate its foreign currency earnings. In that sense the current circumstances are not new.

There remain measures that the Trump administration can pursue to try and spur a new devaluation episode in Iran. Reports that the White House may finalize the designation of Iran as a “primary money laundering concern,” a move that could cut the country’s few remaining correspondent banking links, reflect one such measure. But for now, as economist Djavad Salehi-Esfahani has recently written, “Fears of ‘Venezuelaization’ of the Iranian economy (collapse) have subsided, allowing the government to revive its long neglected public investment program, which could boost employment and production.” The Iranian public, made weary by a year of economic hardship, will certainly hope that the stabilization of the currency is the first step to a broader recovery.

Photo: IRNA

Confronting Failure, Iran Government Mulls New Currency Policy

Despite mounting evidence that the Iranian government’s policy of allocating subsidized foreign currency for the importation of essential goods has failed, the Rouhani administration has signaled that it plans to maintain the policy for at least another year. But lawmakers and Rouhani’s own cabinet ministers may force the administration to change course.

On March 2, Iran’s parliament approved the allocation of USD 14 billion in oil export revenues for the import of essential goods, including food and medicine, during the upcoming Iranian year (beginning March 20). In doing so, MPs gave the green light for the Rouhani administration to continue to make foreign exchange available to importers of essential goods at the subsidized rate of IRR 42,000 to the dollar.

However, lawmakers also encouraged the government to consider an alternative approach that would require essential goods importers to purchase foreign exchange at the IRR 90,000 rate available on the centralized NIMA marketplace. The government would then redirect the savings from the elimination of the currency subsidy towards programs that directly assist Iranian consumers and manufacturers.

Despite the nudge from parliament to consider a new approach, it appears that the administration is intent on maintaining the subsidy for at least another year. The head of the Management and Planning Organization, Mohammad Baqer Nobakht, confirmed this to be the administration’s position in an interview just prior to the parliamentary vote.

The Rouhani government “unified” the country’s dual foreign exchange rates at IRR 42,000 to the dollar in early April as the rial hit new lows due to political uncertainty surrounding Iran’s nuclear deal and the possible reimposition of sanctions by the United States. The foreign exchange rates diverged again shortly thereafter, but the Rouhani administration has persisted in using the “unified” fixed rate for the importation of essential goods.

Rouhani recently claimed that he personally disagreed with the fixed rate when it was first proposed and only consented to rate unification after dozens of top economists backed the move. His administration has since maintained that the allocation of subsidized foreign exchange continues to be the best policy to stabilize prices of essential goods.

Meanwhile, high levels of inflation have dimmed prospects for Iran’s middle and lower classes. The Iranian public has felt the pressure of price hikes, and essential goods have not been spared, despite Rouhani promising otherwise on national television.

Beyond the lived experience of Iranians, new research has also cast doubt on the effectiveness of subsidization. On February 22, the Parliament Research Center published its findings of the government subsidized currency allocation policy. According to the PRC, the price of essential goods as a category increased by 42 percent during the first three quarters of the current Iranian year that ended on December 21.

By comparison, the price of imported goods not eligible for the subsidized rate increased 73 percent in the same period. However, the consumer price index increased by nearly 40 percent, meaning that the increase in the price of essential goods still outpaced general inflation by a significant margin. The question for policymakers is whether this minimal impact on the price of essential imports is worth the many adverse side effects for the wider economy.

At time when Iran’s foreign exchange revenues are being squeezed by  the Trump administration’s “maximum pressure” policy, the Iranian government cannot afford to misallocate USD 14 billion in oil revenue to a subsidization program that may serve to increase corruption and rent-seeking.

Iran’s central bank governor Abdolnasser Hemmati also admitted as much in a frank statement. “In effect, allocating subsidized currency to essential goods has failed to prevent their price hikes in the medium term due to the nature of market in the economy and the weakness of the distribution and supervision systems,” he wrote in a March 9 Instagram post. “Therefore, in most cases the subsidies have gradually moved away from consumers and benefited importers.” Hemmati signaled that a change in the policy may be in order by stating the government will “make the best decision.”

Economy minister Farhad Dejpasand later echoed Hemmati’s view, stating that “The government is currently studying several policies, and we definitely will adopt an approach to minimize the pressure on the poorest sections of society.

“Based on competitive open market principles, any fixed rates that diverge from the open market rate, such as the subsidized IRR 42,000 dollar exchange rate, are a mistake,” Mohammad Mahidashti, a macroeconomic analyst currently serving as an advisor at Iran’s Ministry of Economic Affairs and Finance told Bourse & Bazaar.

“There is simply no positive aspect in this subsidized currency allocation by the government, perhaps save for giving it a justification and a populist slogan to show that the administration is trying to decrease prices of essential goods,” he said.

Mahidashti believes the way forward is for the government to cut its losses as soon as possible by eliminating the subsidized rate and moving toward true rate unification, which he considers both doable and absolutely necessary.

Indeed, the PRC report also called on the Rouhani administration to either fully eliminate subsidized currency allocation or significantly trim the list of essential goods eligible to receive cheap currency. Even in the event of choosing the second route, the parliamentary think-tank said the subsidized rate must be higher and the IRR 42,000 rate is no longer justifiable.

Iran’s private sector, which has for years called for true rate unification would surely embrace such a move. Shortly after Hemmati’s admission of the failure of the subsidized foreign exchange policy, deputy president of the Iran Chamber of Commerce Pedram Soltani welcomed the announcement as a sign that things may be changing. He tweeted, “Subsidized currency is the source of rent and misuse. Let’s stop the flow!”

Photo Credit: IRNA

How Europe’s Forthcoming SPV Can Help Iran Fight Inflation

Europe has yet to launch its special purpose vehicle (SPV) to support trade with Iran and while Iranian stakeholders grow increasingly impatient, some have begun to question the likely impact of the new mechanism. The chief complaint is that the initial SPV, if limited to humanitarian trade, will not have a meaningful economic impact for Iran, which had sought to maintain oil exports to Europe in the face of US sanctions.

As recently argued in a joint report from Bourse & Bazaar and the European Leadership Network, the creation of a humanitarian SPV (H-SPV) has important advantages from the standpoint of protecting the new trade mechanism from interference by the United States. A focus on non-sanctionable trade will enable Europe and Iran to develop a more robust mechanism that delivers practical value for businesses. When a truly useful mechanism has been devised, subsequent SPVs can be established to facilitate what the United States considers sanctionable trade. 

Nonetheless, in order to be welcomed by a broad spectrum of Iran’s political and business establishment, the initial SPV, especially if limited to non-sanctionable trade, must demonstrate a positive impact on Iran’s economy in the near term. An examination of the nature of Europe-Iran trade and the impact of this trade on Iran’s currency markets, suggests that the SPV could have a significant and stabilizing impact on Iran’s economy by helping to fight runaway inflation, the foremost economic challenge facing Iran’s leadership.

Trade Deficits and Inflation

Since early 2018, Iran has been struggling to contain rising inflation exacerbated by rapid currency devaluation. Rising costs of imports have impacted the costs of goods in the consumer basket. The year-on-year increase in the consumer price index in Aban (October 23 - November 22), the most recent period for which data is available, was 39.9 percent. This increase was driven by year-on-year rises in categories including food and beverages (59.9 percent), tobacco (150.8 percent), clothing and footwear (48.5 percent), and furnishings and household goods (83.1 percent). The increase in the health category, which includes medicine, was a significant 19.6 percent.

These categories represent the daily needs of Iran’s households. They are also, broadly speaking, goods which do not fall under the restrictions of US secondary sanctions. Not only are the goods themselves not sanctioned, but the larger role of the private sector within the food, pharmaceutical, and FMCG sectors in Iran means that the Iranian corporate entities active in these sectors are typically not subject to secondary sanctions. On this basis, a humanitarian SPV which would focus on non-sanctionable trade, would be well-suited to support Europe-Iran trade related to these elements of the consumer basket.

While Iran does manufacture many of these goods domestically, overall consumption still relies on a significant volume of imports of food and medicine, with the European Union (EU) the most important trading partner. Even the domestically produced products rely on imports of raw materials which mainly originate in the EU. In 2017, the most recent full year of trade without sanctions, Iran faced a trade deficit with Europe of just under EUR 1 billion in the food and beverage, medicine, clothing and footwear, and furniture categories, based on imports of EUR 1.3 billion and exports of approximately EUR 300 million. Importantly, this figure does not include Iranian imports from Switzerland, a major source of pharmaceutical products with about as much export volume as Germany. But given that the SPV is an EU undertaking, and given that the Swiss are working on a separate banking channel to support their humanitarian trade with Iran, it can be kept separate for the purposes of this analysis.

Beyond humanitarian goods, Iran has typically run a trade deficit of about EUR 1 billion with Europe, even in those years that Iran has been able to export significant volumes of oil to European buyers. The trade imbalance with the EU has a direct impact on inflationary pressures in three areas. First, the euro is a strong currency and the rapid devaluation of the rial has made imports considerably more expensive over the last year. Second, purchasing European goods generally involves higher transaction costs for Iranian importers related to the restrictions on banking channels between Europe and Iran. Finally, Europe is the only source for a number of imports, particularly medicines, meaning that a fall in exports will have a direct and often unmitigable impact on available supply in Iran, pushing prices higher and creating black markets for some specialized medicine. All three phenomena can be seen in the Iranian market today.

There are other indirect drivers as well. As is common for countries at the same level of development, Iran’s process of industrialization is import-intensive. New technologies are acquired to produce a wider range of foods, medicines, and consumer goods domestically, often in accordance with licenses for European formulations or technology. Iran imported EUR 5.5 billion in industrial machinery and equipment in 2017 in order to support domestic industrial capacity. When this equipment or the relevant services, spare parts and training are unavailable, it has a knock-on effect on manufacturing output, available supply, and the market price for consumers.

On one hand, the fall of Iranian imports of European machinery from their 20-year high of over EUR 8 billion in 2004, suggests that Iran is increasingly sourcing such machinery from other markets, especially China. But, Europe retains a technological advantage over China for the manufacturing of food and medicine and the most popular brands in Iran in these categories are often European brands or formulations. This means that substitutions cannot be easily made for the equipment necessary in the domestic production of these goods. Moreover, Iran also relies on European technology for the storage and distribution of food and medicine across the supply chain.

The SPV Intervention

Given these challenges, the appeal of Europe’s SPV, if properly operationalized, is clear. The SPV can help alleviate inflationary pressures by empowering European and Iranian policymakers to better manage foreign exchange risks, reduce transaction costs, and address the trade deficit, particularly around key items within the consumer basket.

First, in the area of foreign exchange, the SPV could reduce pressure on the Central Bank of Iran to source and allocate euros for importers of so-called “essential goods.” Presently, delays in the allocation of foreign exchange are leading to payment issues on the part of Iranian importers of both food commodities and pharmaceuticals. In one manifestation of these delays, cargo ships are remaining anchored off of Iran’s coast for as many as sixty days, incurring demurrage costs.

If the SPV oversees a ledger of trade between Europe and Iran, a role which some have compared with that of a “clearing house,” it would be able to coordinate a version of book transfers, which would enable Iranian importers to pay European exporters indirectly with the SPV coordinating a euro-denominated payment by a European importer on behalf of the Iranian importer. In turn, the Iranian importer would make a rial-denominated payment on behalf of the European importer to its counterparty in Iran (an exporter). Through such a mechanism, there would be no need for the Central Bank of Iran to source and allocate Euros for the purchase by the Iranian importer, as monies already in Europe would be used to make the payment. In this way, reducing demand for euro allocations among Iranian importers should help the CBI more effectively operate the NIMA system, its central marketplace for foreign exchange, thereby reducing the significant inflationary pressures arising from foreign exchange markets.

In a related fashion, the facilitation of book transfers by the SPV would also help eliminate the additional transaction costs currently incurred when arranging cross-border financial transactions between Europe and Iran. Due to the higher compliance risks associated with accepting Iranian-origin funds, the few European banks that do continue to transact with Iran impose fees on clients of up to three percent of the total transaction amount. Some routine and low-risk trade currently facilitated by the few correspondent banking channels that remain between Europe and Iran could be shifted to the SPV, reducing the compliance costs associated with cross-border transactions that can depress export volumes.

Finally, the SPV will only truly succeed if it is operationalized alongside an effort to shrink Iran’s approximate EUR 1 billion trade deficit with Europe in non-sanctionable goods by increasing Iran’s non-oil exports. To be clear, it is highly unlikely that the full volume of Europe-Iran trade will run through the SPV. Where possible, companies will certainly favor using normal channels, facilitating payments through the small number of European banks that will remain willing to process payments for humanitarian trade. Nonetheless, the fundamental problem faced by Iranian importers is access to the euros necessary to sustain purchases from Europe. In this case, in the absence of oil sales, foreign finance, or foreign direct investment, Iran’s exports to Europe will remain the only reliable source of euros for the Central Bank of Iran which is responsible for making foreign exchange available to Iranian importers. 

A New Vision for Europe-Iran Trade

As such, it should be a primary goal of the SPV to increase the volume of European imports from Iran, helping to minimize the trade balance and increase the supply—and thereby reduce the cost—of Euros for Iranian importers. This may seem a difficult task. Iran’s manufacturing output is generally inferior in quality and higher in cost than that available from EU member states and from other countries with active trading relationships with the bloc.

But there are a few product categories where Iranian producers could regain or establish market share in Europe. In 2000, Iran exported EUR 316 million worth of “floor coverings” to Europe, a figure which primarily reflects the sale of traditional Persian wool rugs. By 2017, the sales amounted to just EUR 28 million. The collapse in Persian rug exports may reflect changing tastes among European consumers, as similar decreases can be seen for the same product category as exported by India, Pakistan, and China. An industry-led campaign to boost the popularity of Persian rugs among younger consumers could help reverse the trend.

Iran’s loss of market share in the export of key foodstuffs is harder to explain. European consumption of pistachios has exploded in the past 20 years, but the increase demand has been met by supply from the United States, the only other major producer of pistachios in the world. Iran lost its mantle as top exporter of pistachios to the EU in 2004. Had it captured just half of the growth in European imports since that date, pistachio exports would be around EUR 150 million higher.

Similarly, Iran’s exports of caviar to Europe have fallen from EUR 26 million in 2000 to just EUR 700,000 in 2017. In the same period, exports from the United States have risen from EUR 11 million to EUR 26 million. Exports from China have risen from less than EUR 500,000 to EUR 7 million. It is also notable that Iran’s export of shrimp to Europe has collapsed from EUR 40 million to EUR 2.7 million since 2000, despite the fact that Iran’s seafood industry remains healthy.

Altogether, by dramatically ceding market share, Iran has likely failed to realize around EUR 250 million of export potential in these categories. However, Iran’s growing exports of saffron, which have risen from EUR 24 million in 2000 to EUR 67 million in 2017, help illustrate that Iranian suppliers can achieve significant growth in the European market. This analysis does not account for the many categories of foodstuffs such as nuts and fruits where Iran’s exports to Europe remain very low, but where Iran ranks among the top global producers.  Generally, Iran could become a reliable supplier of food ingredients and herbal medicine to Europe, but it will require an effort from both sides to facilitate the growth. Iran also exported just over EUR 30 million in pharmaceutical products to the EU in 2017—another potential area for growth. Organizing relevant delegations in both directions to expand commercial ties in these sectors would be an important step.

The non-oil trade deficit has been the subject of some attention among Iranian authorities. The National Development Fund of Iran, the country’s sovereign wealth fund, has a program to provide capital to Iranian commercial banks in order to fund loans for private sector export-oriented enterprises. Many of these projects are focused on agricultural production, where loans are used to implement new (often European) technology in order to increase the quality or quality of production while also creating jobs.

Nonetheless, the primary instinct for Iranian officials has been to try and reduce import demand. Recently, the government announced a measure to ban the advertisement of foreign products for which there exists a domestically manufactured equivalent. But given that demand for many imports will prove inelastic, a focus on boosting exports would be a far more prudent strategy for dealing with the trade deficit.

When looking to non-sanctionable goods and the current trade deficit of EUR 1 billion within this category, the possibility of boosting Iranian exports by EUR 250 million is significant from the standpoint of reducing pressure on foreign exchange markets. Add to this other intended improvements to the cost efficiency of trade, and it becomes clear how the forthcoming H-SPV could help Iran address some of the external drivers of inflation. Most importantly, this analysis shows that the launch of the SPV is not the end of an implementation process. It is just the first step in a much-needed reimagining of Europe-Iran trade relations and a process in which the EU can showcase its commitment to a working partnership with Iran.

Photo Credit: IRNA

Iran’s Currency Crisis Spurs Action in Financial Reform Efforts

In the 2017 anti-money laundering (AML) index report published by the Basel Institute on Governance, which develops standards for financial regulations and compliance, Iran topped the list of the world’s 10 highest-risk countries failing to comply with AML standards. This index, published since 2007, ranks 140 countries in terms of their efforts combatting dirty money transactions and countering terrorist financing (CTF). Iran has made little progress to date in improving its standing. Yet, the recent reunification of Iran’s exchange rates by central bank is seen to be an effective step toward more economic transparency and part of wider efforts against smuggling and rent seeking in their diverse forms.

The high-risk assessment of Iran highlighted in the Basel Institute report is primarily due to weak AML/CFT regimes practiced in the jurisdiction. High rates of perceived corruption combined with poor financial sector regulations are major drivers of the structural and functional failures in the Iranian economy. Importantly, these are among the critical issues, which the Financial Action Task Force (FATF), an intergovernmental organization which develops politics to combat financial crime, had mandated Iran to address as part of its "action plan."

Following an extension granted in February, the deadline for Iran’s compliance with FATF’s action plans is set for June 2018. This means that Iranian authorities have limited time at their disposal to earn the continued suspension of counter measures against Iran. Lack of membership in organizations such as the World Trade Organization and the FATF, in particular, has led to a myriad of problems in the implementation of the Joint Comprehensive Plan of Action (JCPOA) nuclear deal agreed by Iran and E3+3 in 2015. Due to shortcomings in meeting FATF technical requirements and Basel II and III banking regulations, Iran has failed to expand its business and correspondent banking ties with International financial institutions, with significant consequences. For example, the number of letters of credit  opened since “Implementation Day” has been far lower than expected.

As such, financial reform in Iran is motivated by the need to spur economic growth. The mandate that the Supreme Leader of Iran Ali Khamenei gave to the Rouhani government to start negotiations with world powers over Iran’s nuclear program reflects the wider policy of the state to continue interacting with the international bodies on economic matters. To that end, cooperation with the FATF is set to carry on unless that authorization is withdrawn. Yet given the importance of such reforms, this authorization may remain in place regardless of what happens on May 12 with respect to President Trump’s decision to extend sanctions waivers issued as part of the JCPOA.

According to some estimates, the magnitude of organized money laundering in Iran amounts to some USD 26 billion per year. Transacting such sizeable amount of money outside the official financial system is impractical and requires that criminals abuse the conventional financial system to support their illegal activities. The Central Bank of Iran is seeking to increase its powers of supervision to monitor and prevent suspicious money transfers and smuggling of goods, ensuring the integrity of Iran’s financial system.

The central bank's recent moves to stem currency market volatility will make financing of illegal businesses in the economy more difficult. CBI’s new policies prohibit purchasing or holding of more than USD 10,000 or its equivalent in international currencies. In the same parallel, any bank account that whose aggregate debits and credits exceed IRR 50 billion rials  will be subject to anti-money laundering probes to monitor for suspicious activities.

Although it will remain possible to find loopholes in the new regulations, these moves reflect significant progress after years of unfulfilled promises to unify the dual foreign exchange rate regime. The move is also viewed as an important step towards obtaining approval from FATF in respect to countering money laundering and removing the rentierism prevalent in the country’s largely state-controlled economy.

In addition, based on the new legislation, revenues from petrochemical exports that are not repatriated to the country will be subject to greater supervision. Firms in the industry will now be required to report their trade transactions in the same system used to record the oil companies’ export revenues.  Previously earnings from petrochemical products sales were kept outside Iran in offshore bank accounts in the absence of proper supervision over their transactions and trades.

Interestingly, to further reinforce its oversight, the central bank has launched the an integrated system for monitoring foreign exchange deals or known as NIMA. This is a system which will monitor the activities of four groups of actors who shape the currency market: merchandise and service importers who purchase foreign currency, exporters of goods and services who earn foreign currency, banks and brokerages who act as intermediaries, and the policymakers who seek to manage supply and demand.

According to CBI governor, Valiollah Seif, the operationalization of the NIMA, will change CBI’s current reactionary response mechanism to one that is more proactive and will make controlling hazardous speculative or systematic fluctuations in foreign exchange markets possible by enabling the calculation of the effective demand so that the bank can aptly manage the available foreign exchange reserves.

In sum, the implementation of these targeted measures by CBI is expected to gradually put an end to capital flight and massive conversion of rial to other hard currencies. These moves can also undercut crimes such as smuggling and money laundering by increasing oversight and the likelihood of penalties for their perpetrators. But the effectiveness of CBI’s mandate will be determined by the political will of both the government and the state to fully enforce the letter and spirit of the new regulations and laws. A great deal is at stake. If the Rouhani government can continue to persist in its long-awaited macroeconomic policies and resist pressure from vested interests, then it remains possible that Iran’s economy could find new momentum after years of recession.

Photo Credit: Tasnim