Context

Iran’s parliament has passed a bill allowing the government to slash four zeros from the rial and authorizing its replacement with another basic unit of currency called the toman (redenomination).

Background

  • The rial has been Iran’s official currency since 1932.
  • The toman was the national currency during the Qajar dynasty (1785-1925) and the first few years of the Pahlavi dynasty (1925-1979).
  • Iran changed its basic monetary unit from dinar to the rial in 1932 as part of the modernisation of the economy undertaken by the Pahlavi dynasty, which was overthrown by the revolution in 1979.
  • Iran has seen the value of its national currency decline steadily since the Islamic Revolution brought the religious government to power in 1979.
  • Iran had been mulling over the idea of cutting four zeros from its currency since 2008.

Redenomination:

It is the process whereby a country’s currency is revalued due to significant inflation and currency devaluation, or when a country adopts a new currency and needs to exchange the old currency for a new one at a fixed rate.

The devaluation of the rial has been marked by four key turning points:

  1. The Islamic Revolution of 1979. When the government of the Western-allied Shah collapsed and an ideological cadre of mullahs took over, many entrepreneurs and business moguls left the country for fear of persecution, and they took their wealth with them.
  2. The end of the Iran-Iraq war in 1989. It took Iran almost eight years to rebuild its shattered economy, during which time the rial lost almost 100% of its value compared to the US dollar thanks to rampant inflation and the unchecked printing of cash.
  3. The third and worst devaluation came during the last years of President Mahmoud Ahmadinejad’s tenure. Before he left power in 2013, Iran was slammed with severe international sanctions that saw the rial hemorrhage almost 400% more of its value on global currency markets. The economic crisis forced Iran’s leaders to reconsider their stubborn refusal to negotiate limits to their nuclear program. In 2015, under intense pressure, Iran agreed to the now-defunct nuclear pact with the U.S., Europe, China and Russia.
  4. The last major turning point, which is still playing out, came when President Donald Trump pulled the U.S. out of the nuclear deal. It adversely affected every aspect of Iran’s already beleaguered economy. The rial’s plunge has continued as it lost more than 60% of its value

Reasons for the currency change

The efficiency of the Iranian currency has declined due to chronic inflation over five decades.

  1. The currency has been devalued 3,500 times since 1971. It declined steadily since the Iranian Revolution, 1979 brought the religious government to power.
  2. Crippling effect of American sanctions, which have severely limited the country’s ability to sell oil or to conduct international financial transactions
  3. The government has also implemented strict rules on access to foreign currency, leading to a flourishing black market for non-Iranian cash inside the country and further eroding the value of the national currency.
  4. The coronavirus pandemic, which turned Iran into a regional epicenter of the disease, appears to have played a decisive role, contributing to a further devaluation of the rial since February.
  5. Slashing the extra zeros would vastly simplify financial calculations in Iran by eliminating the need for Iranian shoppers to carry loads of rials to make purchases, which they must do now because of inflation.
  6. The currency redenomination bill could become a good addition to much larger banking and monetary reforms that are the product of active cooperation between the government and parliament
  7. It would help decrease money printing costs as total money supply in Iran has been growing at an alarming annual rate of about 30 percent for the past decade.
  8. Furthermore, if the redenomination bill is passed into law, all monetary regulations and auditing books will also be changed to facilitate transactions. That will make accounting and auditing processes much easier.
  9. It could have a positive psychological impact on the Iranian people. They are increasingly dissatisfied with the fact that a single U.S. dollar fetches tens of thousands of their national currency.

Chronology of Iran and USA conflict

Challenges and Criticism

  1. President Hassan Rouhani, who must step down next year after serving two terms, will have no time to carry out the currency reform, which they say could cause confusion in the currency markets.
  2. Reforms will be troublesome at a time when the government is struggling with US sanctions and the economic consequences of Covid- Iran’s jobless figure — already at 17.9 per cent for youth unemployment — is expected to worsen as a result of the pandemic.
  3. The government has stepped up its privatization scheme through the capital market to generate new income as tax revenues are expected to drop significantly.
  4. Tehran has already been deprived of most of its petrodollars because of the sanctions and now is even less able to rely on crude oil exports because of the plunge in global demand and prices.
  5. The change of the currency may create unnecessary fluctuations in the economic and social structures and will even fuel the inflation
  6. The initial positive psychological impact of currency redenomination will be short-lived, and could be quickly reversed, if high inflation persists.

Way Forward

To ensure a smooth transition process and to prevent a rebound that would force another redenomination and massive implementation costs a decade down the line, Iran’s government and parliament need to reach a united vision. They need to aim for macroeconomic stability through local reforms on the national scale and weather the sanctions storm by working with foreign partners to keep the nuclear deal alive and buoy trade. Only after achieving those things can they take four zeros off the rial and rebuild public trust in a reinvented national currency.

Other Recent Examples of redenomination

  1. In 2005, Turkey took six zeros off its currency and redenominated the lira in response to an inflation rate of higher than 50 percent. The move was relatively successful because it was implemented in tandem with wider reforms. But Turkey’s 2018 currency crisis proved immensely challenging and again decreased confidence in the lira mostly due to a problematic banking system.
  2. Zimbabwe slashed 12 zeros off its currency at the height of an economic crisis in 2009. Dealing with an astronomical inflation rate that was estimated at 89.7 sextillion percent by the Cato Institute meant that the move was an absolute failure. Zimbabwe was forced to ditch its currency altogether in 2009 and opt for the U.S. dollar, South African rand, and a basket of other currencies.
  3. Venezuela cut five zeros off its national currency August 2018 in a move socialist President Nicolás Maduro said would turn the faltering economy around. It came as little surprise that it did nothing to curb the country’s hyperinflation that has reached 10 million percent in 2019.
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