Wiping zeroes off currency won't fix Iran's underlying economic issues, analysts say

The approval to knock four zeroes off Iran’s currency will make day-to-day life easier for its people, but will do little to solve the country’s underlying economic woes without meaningful reform, analysts say.

The rial “has lost so much value against the US dollar [that] if you take some zeroes off it helps to make it look as if the currency is so much stronger,” Barbara Slavin, director of the Future of Iran Initiative at the Atlantic Council, said.

Iran’s parliament passed a bill allowing the government to change its national currency to the toman, which is equal to about 10,000 rials, Reuters reported on Monday, citing the official Students News Agency, although the decision still needs to be approved by a clerical body that vets legislation before it takes effect.

“Iranians have continued, and this is something that goes back to before the revolution, to refer to tomans, not rials. So it’s a familiar currency,” Ms Slavin said, adding that the change of currency also gave the opportunity to replace old banknotes in a country that has been hit hard by the Covid-19 outbreak.

Esfandyar Batmanghelid, founder of Bourse & Bazaar, a think tank focused on Iran's economy, believes the redenomination is "part of the groundwork being laid for the possible unification of the official and free-market exchange rates”.

Iran’s official exchange rate is 42,000 to the US dollar, but on the black market it trades at about 156,000 rials per dollar.

A plan to unify the two will only work if it goes hand-in-hand with structural reforms, he said.

“Encouragingly, the central bank and the Rouhani administration understand this, but there are vested interests that benefit from the dual rates and the reforms will be hard fought,” he said.

“The big problem is this is just one, tiny initiative," said Robert Mogielnicki, resident scholar of the Arab Gulf States Institute in Washington.

"The redenomination of Iran’s currency does not address the underlying weaknesses at the heart of Iran’s fragile financial system: economic isolation owing to sanctions and, to a certain extent, economic policy mismanagement," Mr Mogielnicki said. "Believing that this decision alone will have a positive impact is roughly equivalent to thinking that one can extinguish a fire by painting the fire hydrant a new colour.”

Iran’s economy has been weakened by US sanctions imposed by president Donald Trump’s government on the country and its policy of exerting “maximum pressure” on Tehran. Lower oil prices and the economic impact caused by the Covid-19 outbreak have exacerbated its problems. Iran has reported more than 98,000 Covid-19 infections and 68,000 deaths.

The International Monetary Fund had forecast a return to growth after a 7.6 per cent slump in GDP last year, but revised its forecast in last month’s World Economic Outlook to a further 6 per cent decline.

Inflation is set to come down, but only marginally, to 34.2 per cent this year from 41.1 per cent and unemployment is forecast to continue rising, to reach 16.3 per cent of the total labour force during 2020, according to the fund.

The government's fiscal deficit is set to widen to 9.9 per cent of GDP this year, an increase from 5.7 per cent last year, according to the lender's projections.

“Iran was showing signs of recovery in the later half of 2019, with key sectors like manufacturing growing again after a painful adjustment to the reimposition of secondary sanctions by the United States. But the Covid-19 outbreak has derailed that recovery,” said Mr Batmanghelid.

Mr Mogielnicki said that key to reforms should be a strengthening of its fragile banking sector, which has suffered from “heavy state involvement”.

Official records for banks’ non-performing loans for 2017 stood at 11.4 per cent in 2017, while capital adequacy ratios for some banks remain significantly below the 10.5 per cent recommended under Basel III global standards.

Reforms to cut Iran's deficit and reduce subsidies are also needed, but could be difficult to implement, Mr Mogielnicki said.

"I am very pessimistic about policymakers’ ability to confront these issues. If we see some of these NPLs starting to tank and there is a collapse of trust in the banking sector more generally, which leads to a run on banks, this is something that is going to be very difficult [to contain]," Mr Mogielnicki said.

"The country has limited tools at its disposal for conducting additional monetary policy measures," he said, adding "we’re still going to see a situation in 2020 where the government is really going to be scrambling for financial resources. The outlook has gone from grim to quite dire."