Challenges of Exchange Rate Unification in Iran

Exchange rate unification—moving from a multi-tiered system to a single exchange rate—is one of the most significant yet challenging reforms for Iran’s economy. Multiple exchange rates in Iran have historically aimed to stabilize essential imports and control inflation. However, this system has created serious distortions in resource allocation, weakened transparency, and fostered opportunities for rent-seeking and corruption. This policy note provides an analytical overview of the key challenges, international experiences, and potential policy directions for Iran.

1. Structural Challenges

1. Dependence on Oil Revenues: Iran’s foreign exchange earnings are highly volatile due to oil price fluctuations. A single exchange rate regime requires stable reserves, which may not be guaranteed in the current context of sanctions and uncertain oil revenues.

2. Inflationary Pressures: Unification usually leads to a significant upward adjustment in the official exchange rate, increasing the cost of imports. This could accelerate inflation in an already high-inflation environment.

3. Fiscal Discipline: A unified rate reduces the implicit subsidies embedded in preferential exchange rates. This requires fiscal consolidation and targeted social policies to protect vulnerable groups.

2. Market and Institutional Challenges

1. Currency Market Depth: A credible unified exchange rate requires a transparent, liquid, and competitive foreign exchange market. Iran’s currency market remains shallow, with limited instruments and a strong role for administrative allocation.

2. Banking System Fragility: The banking sector is burdened with non-performing loans, capital adequacy problems, and weak risk management. Exchange rate shocks could exacerbate financial instability.

3. Expectations and Credibility: Without credible monetary and fiscal anchors, market participants may not trust the sustainability of unification, leading to speculative behavior.

3. Social and Political Challenges

1. Distributional Effects: Exchange rate unification increases the price of essential goods previously subsidized by preferential rates, disproportionately affecting low-income households.

2. Political Economy Resistance: Groups benefiting from arbitrage opportunities in the multi-tiered system resist reform, creating institutional inertia.

3. Public Perception: If reforms are perceived as abrupt or unjust, they may face social and political backlash.

4. International Lessons

Turkey (2001–2005): Successful unification was accompanied by strict fiscal discipline, inflation targeting, and institutional reforms.

Egypt (2016): Floatation of the pound unified rates but initially triggered high inflation; stability was achieved through IMF support and structural reforms.

Nigeria & Argentina: Repeated failures highlight that without macroeconomic stability and credibility, unification can collapse and worsen volatility.

5. Policy Implications for Iran

1. Preconditions for Success: Strengthening foreign reserves, reducing fiscal deficits, and ensuring an independent and credible central bank are necessary before unification.

2. Gradual vs. Shock Therapy: Gradual adjustment with clear communication may help manage inflation expectations, but prolonged delays risk deepening distortions.

3. Targeted Compensation: Direct cash transfers or smart subsidies should mitigate the impact on vulnerable groups.

4. Institutional Reforms: Developing a transparent and market-based foreign exchange system, improving banking sector resilience, and enforcing fiscal discipline are essential.

Conclusion

Exchange rate unification is both a necessary and inevitable reform for Iran, but it cannot succeed without comprehensive economic and institutional adjustments. A purely administrative decree will not ensure sustainability; instead, macroeconomic stability, credibility, and social protection policies must accompany the transition. Lessons from international experience show that unification is not merely a technical issue but a deeply political and institutional reform.