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Comment | Funny Money: The Rial Is Rolling for a Reason

by CONTRIBUTOR in Tehran

04 Jan 2012 23:33Comments

Follow the petrodollars...

photo+1.jpg[ comment ] I think there are fundamental structural problems in the Iranian economy caused by some of the policies of the Ahmadinejad administration. What you have in Iran is not a lack of cash, but rather a huge amount of cash floating around. Let's call it the liquidity stream. This huge stream of money moves in search of interest, interest higher than inflation.

In the past, this stream was locked in by the offering of rial-based savings accounts and participation bonds that offered interest higher than inflation. But when Ahmadinejad vetoed the raising of interest rates -- part of his broader policy of prioritizing growth over inflation concerns -- that flow of liquidity went wild.

The Central Bank of Iran first tried to contain it by selling large amounts of cheap gold, but then the price of gold collapsed. The housing market is dead, so there is no outlet for the stream there.

The only place left for that liquidity flow, then, is foreign currency. We are talking about billion-dollar speculative flows being forced to turn to the purchase of U.S. dollars, because there is no other outlet to secure your assets against inflation.

Separately, the administration proposed and got a fantasy budget passed for the current Persian year, 1390, which began last March. Its "total" budget, including spending for state-owned enterprises, grew by some 40 percent over the previous Persian year. That's huge. Now it faces a major budget deficit, in the range of $10-30 billion -- the estimates vary widely.

The administration and the Majles agreed to base that budget, largely financed by oil revenues, on an exchange rate of 10,500 rials per dollar. Iran gets paid for its oil in dollars. So how do you get more rials for dollars?

You let the rial loose, and you start selling petrodollars for free market rates way above the official rate of 10,500 rials. You let it go so far that the CBI, in a desperate attempt to close the gap between the official rate and open market rate, has turned to raising the official rate.

Voilà! You've suddenly got that budget deficit of yours plugged up (the administration has until end of February to fill it).

With the Majles elections coming up on March 3, we can expect more developments. Ahmadinejad will make a strong move to boost the rial's value just before the polls. Meanwhile, he has allowed his many former friends turned foes to profit immensely from the dual exchange rate, hopefully enough to keep them satisfied to not bite at him or pluck off his candidates like feathers.

Ultimately, I think, the rial will settle around 13,000-14,000 per dollar by the beginning of the new Persian year, March 20, probably at a unified exchange rate. That higher exchange rate will allow Ahmadinejad to boost his budget even more for the coming year.

To be clear, this has nothing to do with sanctions on the CBI. They haven't even started. It's a shame to see every single iran "analyst" out there blaming this on the sanctions. The cherry on top is that ordinary people blame Obama for all this while Ahmadinejad is busy filling his government's coffers.

There are rumors that certain candidates whose connections give them access to dollars at the official exchange rate are selling those dollars on the open market for huge profits, which they are using to fund their campaigns for parliament. Just rumors...I guess.

Copyright © 2012 Tehran Bureau

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