The exchange rate for Iran’s national currency, the rial, fell 17 percent in trading Monday, closing at 34,700 rials to the dollar, compared to the previous day's rate of 29,600. Officials from both Israel and the United States declared that the rapid fall of the rial is evidence that international sanctions against Iran are having their desired effect. However, instability in the foreign exchange market is hardly a major concern for the regime. Economic sanctions are an effective tool of diplomacy only when their effects become so unbearable to individual citizens that the state must change its behavior or else risk its legitimacy. Sanctions are, so far, not impacting Iran to this degree. In fact, as long as Iranian citizens can provide for their families, increasing the severity of sanctions will do more to bolster nationalist sentiment in Iran than undermine it.
What is a Geopolitical Diary? George Friedman explains.
The rial's value has been declining for more than a year, but it dropped precipitously over the past week after Tehran introduced a new "exchange center" designed to supply importers of basic goods with dollars at a rate of 2 percent less than the market rate. According to media reports, government officials in recent weeks have blocked nearly all importers from buying dollars through the central bank at the official rate of 12,260 rials per dollar. Instead, they have been directing importers to the new exchange centers. However, the exchange center's fixed daily rate is only slightly less than the open market value, which has diverged so significantly from the official rate as to make the discount almost negligible. Officially registered money exchangers are also reportedly no longer selling dollars, forcing more and more of the market over to informal trading channels and exacerbating the scarcity of dollars even further. Instead of allaying fears about the availability of dollars, the government-initiated center seems to have intensified the race for hard currency by linking the special rate to the much higher market rate.
The Iranian government still has a large financial cushion to soften the domestic effects of an increasingly devalued rial. But the further the rial falls, the faster those reserves will be depleted, most likely in the form of domestic subsidies and price controls.
Still, we are not seeing any significant shortages of basic goods in Iran. At the end of last year, the International Monetary Fund estimated that Iran had roughly $106 billion in official currency reserves, enough to cover Iran's goods and services imports for at least 13 months, barring an extraordinary shift in the international market. Economists now estimate those reserves stand at about $50 billion to $70 billion. Iran's ability to acquire dollars through energy trades and international banking has been affected by international sanctions. Dollars still come through, but apparently not at the same rate as the end of last year. The Iranian government still has a large financial cushion to soften the domestic effects of an increasingly devalued rial. But the further the rial falls, the faster those reserves will be depleted, most likely in the form of domestic subsidies and price controls. As the rial continues to weaken, it becomes an increasingly less effective tool in Iranian efforts to regulate the domestic economy.
However, there are still a number of factors working in Iran's favor against international sanctions efforts. First, the Iranian government and the Iranian people have effectively dealt with international sanctions for decades. In anticipation of further U.S. and EU sanctions, the Iranian government has been stockpiling basic goods for more than a year. The government would likely ration goods if there was a fear that shortages were becoming a problem, but we have yet to see such a move. Second, the amount of dollars circulating in Afghanistan and Iraq after nearly a decade of U.S. occupation makes them still relatively easy to obtain by simply crossing the border. Third, the Iranian regime's extensive smuggling networks in Iraq and elsewhere remain a major source of government revenue that cannot be affected by sanctions.
None of this is to say that the sanctions are not having a real impact on the Iranian economy. They are, which is wearing on the regime financially and politically. But sanctions are meant to wear down their target by attrition, which means their effects will only take hold over time. Ultimately, if sanctions are going to threaten the Iranian regime, that threat will come from the streets of Tehran, not from foreign currency traders.