Iran Low on Options as Hyperinflation Concerns Spark Gold Dash

Iran has very few policy options to end turmoil in its currency markets. The rial has depreciated as much as 40 percent against the dollar in street markets since August and gold purchases have surged as residents seek to protect their savings.

By Dana El Baltaji
Oct 7, 2012 1:00 PM MT
Bloomberg

Iran has few policy options to end turmoil in its currency markets, as the U.S. and allies seek to inflict enough economic pain to force the Islamic republic into concessions over its nuclear plans, analysts said.

The rial has depreciated as much as 40 percent against the dollar in street markets since August and gold purchases have surged as residents seek to shield savings. The currency plunge led to unrest in Tehran’s markets last week as police used tear gas to end protests. Iran has raised interest rates on deposits and opened an exchange center to stabilize the currency market.

The U.S. and European Union are starving Iran of foreign currency by blocking sales of oil, its main export, and other transactions in dollars and euros. Israel has threatened to attack to stop Iran’s nuclear program if the sanctions don’t succeed in curbing it. Iranian leaders say they won’t bow to the pressure, even as the country’s crude output plunges to the lowest in more than two decades.

“I don’t see what Iran can do on the economic front other than try to avoid sanctions by exporting to countries that are prepared to use their currency as payment,” said John Williamson, a senior fellow at the Peterson Institute for International Economics in Washington. “I don’t think monetary policy changes will make any difference. People aren’t going to examine interest rates when their savings are being confiscated.”

‘Hyper-Inflation’

The run on the rial has exacerbated inflation that had already been pushed up by the removal of subsidies on energy and food. The official rate rose to 23.5 percent in August. The real rate, which adjusts for the currency depreciation, is three times that, according to Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore.

“We’re getting into what is technically hyper-inflation,” with an “implied inflation rate” of about 70 percent a month, Hanke said.

Concern that savings are being eroded is leading Iranians to other assets, including gold and property.

Turkish sales of precious metals to Iran jumped to $6.2 billion through July from $21.9 million in the same period last year. Wealthy Iranians in Turkey are collecting gold and exporting it to Iran, the Istanbul-based Zaman newspaper said July 11. Iranians in Dubai and India are also collecting gold and sending it to the central bank, Zaman said, citing a Turkish economy administration official it didn’t name.

‘Out of Options’

The currency decline is reminiscent of Iran’s economic crisis in the 1980s, when its eight-year long war with neighboring Iraq prompted a rush to buy gold and dollars.

“Iranians have made some very big purchases recently,” said Mohamed Zahran, a shopkeeper at Al Matroushi Jewellery FZCO at Dubai’s Gold and Diamond Park said by telephone Oct. 7. “Definitely more than before. Although Iranians have always been good customers, it’s just that we’ve seen more sales.”

While foreign-currency traders and bazaar merchants in Tehran opened their shops this week, prices are climbing so fast that the price of milk jumped 9 percent in a single day last week. The risk of protests spurred President Mahmoud Ahmadinejad to call for calm on Oct. 2, blaming the weakening of the rial on foreign pressures.

More than 200 policemen were stationed around Ferdowsi Street, near one of the main trading areas in the capital, on Oct. 4. Earlier in the day, police used teargas to disperse a crowd at the currency market, and were also sent to the city’s bazaar after shopkeepers refused to open.

“If some believe that through pressure they can push Iranians to the negotiating table they are certainly mistaken,” Ahmadinejad, 55, said.

Foreign Reserves

Still, some analysts say that behind the scenes Iran may take a more flexible line.

“They’re running out of options, no one is going to realistically help shore up their foreign currency reserves,” said Ghanem Nuseibeh, founder of political risk analyst Cornerstone Global Associates. Making concessions on Iran’s nuclear program “will probably be their way out,” he said.

The rial traded at about 30,000 per dollar yesterday in the streets of Tehran. That compares with the official rate of 12,260 rials set by the central bank. Importers of essential goods including medicines, meat and grains have access to that rate at an exchange center opened by the government last month, while other importers of goods such as industrial and agricultural machinery enjoy a smaller discount.

Camouflage the Problem

Edward Bell, an analyst at the Economist Intelligence Unit in London, said Iran’s “strong manufacturing and industrial base” and agricultural output leaves it better placed than most regional economies to be self-sufficient for a period. He said another round of sanctions flagged by the EU would impose a “sharper squeeze on the economy, and that might bring the government back to some negotiations.”

The new exchange center “has clearly not been up to the task” of meeting demand, Bell said. To steady the rial, Iran would have to “inject a lot more money into the market to support the currency, and that means injecting foreign currency reserves into the market to meet demands.”

It’s not clear how much cash would be needed or how much the authorities have at their disposal, he said.

The EIU estimates Iran’s foreign reserves will drop to $70 billion this year from $80 billion in 2011 as sanctions reduce oil exports. Ahmadinejad said in January that the country has $90 billion in reserves earned from crude sales.

Without recourse to hard currency, Iran’s response may be limited to stop-gap measures, such as the new exchange centers or a January move to raise interest rates on rial accounts to as much as 21 percent.

“The direction they will go won’t solve the problem, it will repress” it, Hanke said. “All they will they be able to do is camouflage the problem.”

To contact the reporter on this story: Dana El Baltaji in Dubai at delbaltaji@bloomberg.net

To contact the editor responsible for this story: Andrew J. Barden at barden@bloomberg.net

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