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Trouble in Iran could mean trouble for the world

11.07.2018 11:44|Marcin Lipka

"Although the US sanctions on Iranian oil exports have not yet come into force, the Iranian economy is already in crisis, which is best reflected in the dramatic weakness of the local currency. The escalation of economic tensions in Iran is also a risk of extremely serious repercussions in the oil market," writes Marcin Lipka, Conotoxia Senior Analyst.

The report of the International Monetary Fund (IMF) on Iran, published at the end of March, contained positive information on changes in the Islamic Republic. "The directors welcomed the macroeconomic progress made by Iran, in particular the expansion of the non-fuel sector," said the IMF. However, this statement will become obsolete quite quickly due to the risks associated with the US sanctions. The economic situation in Iran will deteriorate rapidly, as is best demonstrated by the behaviour of the local currency.

The dollar is double the price of the official rate

Physically, the US sanctions against the Iranian economy are to be imposed in two rounds, on August 6th and November 4th. However, the very announcement of restrictions on the Iranian financial sector, the car industry and oil exports has serious economic repercussions.

At the end of March, a growing difference could already be observed between the official exchange rate of the US dollar against the Iranian currency and its black market valuation. When it became clear, in the weeks following, that sanctions were inevitable, the dollar could be bought one and a half times more than central bank quotations showed. Why did the Iranians throw themselves at foreign currencies?

First of all, fearing that the rial (IRR) will decrease in value, as was the case during the sanctions introduced in 2012. At that time, inflation reached 40% per year. This effectively reduced the real value of the local currency and the official IRR rate had little to do with reality (even after its devaluation by half in July 2013). Nervousness among the citizens increased further when the authorities banned exchange offices from operating in order to reduce the demand for currencies. The fact that it was not possible to buy dollars or euros officially did not help to halt the decline in the value of the rial, but only to the development of activities outside the official sphere of trade, which further increased the Iranian people's concern.

In addition, Tehran has also banned the population from holding more than the equivalent of 10 000 EUR outside the bank. Iranian analysts, (anonymously) quoted by Reuters back in May, said that all these restrictions would not reduce the pressure on the local currency because people remember that in the past “when they deposited their dollars in bank accounts, they could have not withdrawn them out later”.

Speculation on iPhones

As one could guess, any attempt to stabilise the exchange rate failed. The black market exchange rate of the dollar has risen and exceeded 80,000 rials in June, according to the leading service for analysing the black market exchange rate of the Iranian currency (Bonbast.com). This is almost twice as much as the figure published by the central bank (43,000).

However, it is worth noting that the official rate is not entirely virtual. Some importers have access to it. The Iranian Minister of Information and Communication, Jalal Azari Jahromi, quoted by the Bloomberg agency, claimed that entrepreneurs could, for example, import iPhones, paying for them in dollars purchased at the official exchange rate. Then they would sell them, taking the black market USD exchange rate into account. According to the minister, hundreds of iPhones are being held in storage pending further rial weakening.

In early July, the Central Bank also published a list of more than 1,400 companies that purchased goods worth hundreds of millions of euros at the official exchange rate. However, speculation by business people or the desire to circumvent the ban on foreign currency purchases by households is only natural in the current situation and the government restrictions are only exacerbating panic and the temptation to make an extraordinary profit in fear of further restrictions.

Crude oil will become 100% more expensive! This has been the case in the past

IMF figures show that with limited oil revenues (sanctions will reduce oil exports), the financial and economic situation in Iran will clearly deteriorate. Sales of energy resources abroad account for about half of the budget revenue, and without these funds the public finance deficit would reach 15% of GDP. Restrictions in industry and in the banking sector will also hamper the functioning of the hydrocarbon economy.

Risks for global business and households in the context of Iranian developments are mainly from the oil market. Limiting Tehran exports of this raw material to around 1 billion barrels per day will maintain high fuel prices throughout the world.

There is also a risk that, due to economic problems, the authorities in Iran will pursue a more confrontational policy in the region. All Gulf oil exports (almost 20 million barrels per day at the closure of the Strait of Hormuz) would then be endangered. These developments would cause huge imbalances in the balance between world oil supply and demand, with price increases sometimes reaching as high as 100%, as in the summer of 1990.


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