Tehran likely to devalue currency in 2019 as US sanctions bite

Iranians check the currency rates around an exchange shop in Tehran. EPA

The Iranian authorities are likely to devalue the official exchange rate of its battered currency and may narrow the definition of "basic goods" that qualify for imports at the current rate in 2019.

The re-imposition and further tightening of US sanctions since November last year will drastically reduce oil export earnings and restrict cross-border financial transactions, sharply reducing the foreign currency inflows into Iran, Fitch Solutions, a unit of Fitch Ratings, said on Thursday.

As the pressure mounts, it will limit Tehran’s ability to import basic goods, Fitch said.

Iran's rial hit record lows last year against the US dollar. Demand for the dollar is stoked by concerns that the impact of US sanctions would be felt beyond the country’s crude shipments and will affect Iran’s broader export sector.

The government had to authorise the central bank to intervene in the foreign exchange market in defence of its currency in October. Iran's official exchange rate for the rial is 42,000 against the dollar versus a free market rate of 110,000 rials against the greenback as of January 1, Fitch said.

"As such, the authorities may move to devalue the official rate, as they did under the previous round of nuclear-related sanctions [prior to the 2016 nuclear deal]," it said. "The Rouhani administration’s proposed budget for financial year 2019-20, yet to be approved by parliament, is referencing an exchange rate of 58,000 rial / US dollar, suggesting a devaluation could be in the pipeline. Alternatively, we may see a reduction in the number of subsidised basic goods imports.”

Tehran has tried to unify the multiple exchange rate system, which in addition to the official and free market rates also includes a secondary market rate for transactions between licensed exporters and importers. However, with the gap between the official and free-market rates now at 62 per cent, unification appears unfeasible.

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"Any devaluation of the official rate will likely be relatively limited in size in order to limit its inflationary impact and thus contain social discontent," Fitch said.

"We forecast the official rate to end 2019 around the IRR55,000/US dollar level. Meanwhile, the appreciatory trend recorded in the free market rate in recent months is unlikely to be sustained amid deteriorating trade and investment dynamics, a subdued oil price outlook, and elevated inflation."

The multiple exchange rate system will continue to distort the economy, limiting the availability of some goods and promote profitmaking in the free market by those receiving foreign currency at preferential rates. Private companies will also increasingly struggle to compete with establishment-linked counterparts that have access to subsidised goods imports, constraining overall private sector activity, the Fitch report added.

Iran’s economy is likely to go into recession on the back of sharp declines in oil exports and a further slump in already-low foreign investment inflows. After steadily growing in 2017, economic activity in Iran is forecast to contract by 1.5 per cent and 3.6 per cent in 2018-19, the World Bank said in October's World Economic Outlook.

Fitch Solutions at the time estimated Iranian gross domestic product to contract by 4.3 per cent in 2019 and expand beyond that time frame – albeit at a modest rate.