The Iranian economic crisis under the spotlight

Tehran, Iran's capital.

In this article Ahmad Abdul-Rahman explains the geopolitical roots of the Iranian economic crisis.

The Covid-19 pandemic has caused the further deterioration of the Iranian economy. But the country's economic crisis is rooted in factors beyond the repercussions of the pandemic. Since the US withdrew from the Joint Comprehensive Plan of Action in 2018, it has become clear that Iran's economic difficulties, particularly the devaluation of its currency, are closely linked to key political and geopolitical events High government debt and the devaluation of the Iranian currency are indicators of Iran's poor economy.

The sharp deterioration in the value of the Iranian rial against other currencies over the past decade highlights the decline in the terms of trade compared to the rest of the world. Therefore, it is important to improve them, perhaps by exporting more advanced products and achieving a more sustainable development path. A large number of emerging and industrialized economies have done this.

Iran's trade balance should improve because of the nominal depreciation of its currency, which would make exports cheaper and lead to an increase in total exports. Iranian imports would became more expensive, causing the volume to decline. But because Iran depends on the import of a large number of advanced products such as medicines, medical equipment and machinery, the fall in the currency leads to an increase in the price of these products.

Since January 2018, the value of the rial has fallen by 450 per cent against the US dollar, from 42,880 rials to 318,560 rials on October 18, 2020. The first decline began in the months leading up to the US withdrawal from the Joint Comprehensive Plan of Action in May 2018.

Extreme pressure campaign

The devaluation of the rial against the dollar is neither unprecedented nor unexpected. Iran has lost a significant portion of its export revenue due to the secondary sanctions that the US re-imposed on it in May 2018. These secondary sanctions target third-country companies doing business and trade with Iran. These sanctions do not allow Iran to export its goods easily. According to the World Bank, Iran's economy was expected to shrink by 5.3% in 2020, particularly due to the Covid-19 pandemic and its impact on domestic consumption and the services sector

The US maximum pressure campaign has wiped out Iranian oil exports, which have fallen from 2.6 million barrels per day in May 2018 to between 600,000 and 700,000 barrels per day for much of this year. Despite the recent increase in exports of hydrocarbons, Iran's hard currency earnings remain very limited, given that access to these funds continues to falter. Iran has steadily increased the amount of products it exports to neighbouring countries in order to finance its imports. However, due to the coronavirus pandemic and the closing of borders with these countries, these exports are limited. As a result, Iran's foreign exchange reserves are shrinking, causing a large trade deficit.

Rising geopolitical tensions

Another reason behind Iran's faltering economy is heightened geopolitical tensions with the country. Besides the scarcity of hard currency due to declining export revenues, the decision by the International Atomic Energy Agency's Board of Governors against Iran's Safeguards Agreement under the Non-Proliferation Treaty is also causing the rial's depreciation.

Harmful internal policies

Moreover, inflationary pressures caused by bad domestic policies are exacerbating the country's economic downturn. Since the price of imported goods have risen sharply, the government can no longer finance the fiscal stimulus package, because US sanctions have cut off oil revenues from the country.

To support its expenditure, the country issued bonds through open market operations. These bonds may be added to the government debt owed to public institutions such as the Social Security Organization. However, the remainder of the government budget and the fiscal stimulus plan aimed at countering the effects of the pandemic must be financed by increasing the monetary supply. Considering the decline in GDP and the increase in the money supply in the economy, the result of this increase in the volume of money in circulation is increasing prices.

Accordingly, in light of a rise in inflation, and the fact that the nominal interest rate is less than inflation, savings are not being put into banks. Instead, there is a flight of capital towards unproductive and speculative investments in the foreign exchange market and the Tehran Stock Exchange.

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Friday, 24 September 2021