The tradition of international economics science suggests that adopting a fixed exchange rate mechanism will inevitably lead to periodic currency crises unless a country has significant God-given resources per capita.
As a consequence, such an exchange rate policy will lead to Dutch disease and decline of production, a phenomenon, what has happened to the countries bordering the Persian Gulf.
Hence, the Islamic country must move towards a managed floating exchange rate system. The long-run exchange rate must be determined by market's natural forces of the economy (the balance of money, product and capital markets).
The central bank, emphasizing on the strategy of maintaining and enhancing foreign exchange reserves, should only seek to smooth short-run exchange rate fluctuations in the framework of foreign exchange and on the basis of the long-run exchange rate.
Because of happening currency fluctuations after every crisis, the change of the currency system and structural reforms in the Iranian economy is completely possible.
The worst measure to do in such a situation is to determine multiple exchange rates and the government's refusal for freeing the official exchange rate (different from the free market rate).
Because the move will cause the central bank to lose foreign exchange resources and create an unclear outlook in the foreign exchange market and economic activities. As a result, the tendency to withdraw capital will amplify.
Another significant topic would be the self-adjusting mechanism of the transaction account and the exchange rate that is activated in currency shocks.
When the exchange rate mounts, the attractiveness of Iranian commodities will increase in the eyes of foreigners and consequently the volume of exports will increase. As well, an increase in the exchange rate because of mounting rial price of imported cargos will lead to a decrease in imports sooner or later.
The mixture of the mentioned issues will lead to an hike in the transaction account, which will add to the net supply of foreign exchange in the domestic market.
Thus, the exchange rate will shrink and part of the consequence of currency shock will be balanced. The Iranian governments have usually paralyzed the natural mechanism by setting preferential rates on the one hand and tightening trade exchanges on the other hand.
Mechanical strategies might bear fruit in the short-run, but their medium- and long-run costs will gravely damage the economy.
The experience of such states in particular Turkey indicates that reducing budget deficit of the government and controlling money supply to the economy are the real ways to manage the prices of all goods and assets, including the price of currency.
Plummeting budget deficits of the government in countries such as Iran and Turkey, which have huge governmental structures, could potentially decrease largely economic demand, recession and unemployment as well.
In a bid to reverse the trend, the government needs cooperation and trust of the people as a vital parameter, and without the social capital, reforming the budget structure and improving the situation seems to be impossible. If people of a country trust their government, they will not decrease their productive consumption and investment; therefore, budget reform will be implemented in an easier and less difficult way.
The status of social capital of the Iranian administrations is not fine and the events happened in recent years have dealt a big blow to public confidence, but as it was examined in the case of Argentina, governments in other countries have a history of more irrational decisions that have damaged public confidence.
It seems to be noteworthy to compare Malaysia and Indonesia during the Asian financial crisis in 1997 and 1998. The policies and decisions of the two states in the crisis were completely different.
Resorting to methods like stabilizing the exchange rate and closing foreign exchange market as well as freezing foreign capital in its banks, Malaysia virtually implemented strict capital control strategies, but the Indonesian government did not implement a particular strategy to control capital outflows and exchange rates, when the exchange rate reached 7 times the pre-crisis period in the peak of Indonesia's financial crisis from time to time.
The Malaysian government could control inflation in the crisis era via enacting capital control laws, preventing the Malaysian economy from declining like Indonesia, but instead the policies hurt the confidence of investors.
Consequently, Malaysian companies were forced to compensate for higher interest rates in the years following the financial crisis. Indonesia, in contrast, endured the pressures of the crisis in a year, but this crisis has not had a major effect on its long-run growth trend. This point shows the importance of long-run outlook and a broad horizon in economic affairs and governance of a state.
To mention another noteworthy point, it is obvious that the Malaysian government's plan of controlling capital market and the decisions made by the Argentine government have both been of the similar sort, and both have been somehow impinging on people's capital and interfering with their property rights; so, both governments damaged public trust as a result of adopting such harsh policies.
However, the dissimilarity is that Malaysian law is more disciplined, more rational and more transparent, and does not undermine public confidence in the government by any means.
In 2019, Indonesia enacted laws to return foreign exchange from exports, which was in many ways similar to Iran's policies for the last two or three years. However, comparison of the regulations ratified in both countries indicate two key points:
In the regulations enacted by the Central Bank of Indonesia, exporters of mineral and natural products (which someway use natural resources) are examined separately and subject to special rules that are more rigorous than others.
According to Iran's laws, all companies, apart from the amount that they receive different subsidies, are required to supply currency in the Forex Management Integrated System, locally known as NIMA, and there would be no major difference between the various firms, and all are subject to a series of regulations that are illogical and unjust. Additionally, the laws have negative impacts on the motivations and behavior of producers and exporters.
According to Indonesian law, exporters are not demanded to convert their currency into Indonesian rupiah and are only asked to transfer export revenues to banks of the country (which is applicable for even exporters of mineral and natural products).
For that reason, these laws do not create strong conflict of interests for exporters. Inflation expectations have also been much lower than the figures in Iran, but the Iranian exporters have been forced to sell export earnings at a lower price than the prices in free market despite high inflation expectations in the last two years.
The theoretical literature, similar international experiences and the record of administrations actions in Iran indicate that in a bid to deal with currency crises, the country must relinquish the fixed currency policy and replace it with a controlled floating currency regime. Plus supporting producers, the measure will allow a government to reduce tariffs and customs formalities without exacerbating concerns and pressures, hence, this way can ensure consumer welfare.
The major challenge in any currency crisis is the imposition of preferential rates as well as austerity on tradesmen, which damages the commerce environment and erodes business activities, while wasting the central bank's foreign exchange reserves and disabling the mechanism of increasing the transaction account because of rising exchange rates.
The in detail account eventually deals with the problem identification of the central bank's foreign exchange package for the return of foreign exchange from exports, suggesting corrective proposals.
As a consequence, such an exchange rate policy will lead to Dutch disease and decline of production, a phenomenon, what has happened to the countries bordering the Persian Gulf.
Hence, the Islamic country must move towards a managed floating exchange rate system. The long-run exchange rate must be determined by market's natural forces of the economy (the balance of money, product and capital markets).
The central bank, emphasizing on the strategy of maintaining and enhancing foreign exchange reserves, should only seek to smooth short-run exchange rate fluctuations in the framework of foreign exchange and on the basis of the long-run exchange rate.
Because of happening currency fluctuations after every crisis, the change of the currency system and structural reforms in the Iranian economy is completely possible.
The worst measure to do in such a situation is to determine multiple exchange rates and the government's refusal for freeing the official exchange rate (different from the free market rate).
Because the move will cause the central bank to lose foreign exchange resources and create an unclear outlook in the foreign exchange market and economic activities. As a result, the tendency to withdraw capital will amplify.
Another significant topic would be the self-adjusting mechanism of the transaction account and the exchange rate that is activated in currency shocks.
When the exchange rate mounts, the attractiveness of Iranian commodities will increase in the eyes of foreigners and consequently the volume of exports will increase. As well, an increase in the exchange rate because of mounting rial price of imported cargos will lead to a decrease in imports sooner or later.
The mixture of the mentioned issues will lead to an hike in the transaction account, which will add to the net supply of foreign exchange in the domestic market.
Thus, the exchange rate will shrink and part of the consequence of currency shock will be balanced. The Iranian governments have usually paralyzed the natural mechanism by setting preferential rates on the one hand and tightening trade exchanges on the other hand.
Mechanical strategies might bear fruit in the short-run, but their medium- and long-run costs will gravely damage the economy.
The experience of such states in particular Turkey indicates that reducing budget deficit of the government and controlling money supply to the economy are the real ways to manage the prices of all goods and assets, including the price of currency.
Plummeting budget deficits of the government in countries such as Iran and Turkey, which have huge governmental structures, could potentially decrease largely economic demand, recession and unemployment as well.
In a bid to reverse the trend, the government needs cooperation and trust of the people as a vital parameter, and without the social capital, reforming the budget structure and improving the situation seems to be impossible. If people of a country trust their government, they will not decrease their productive consumption and investment; therefore, budget reform will be implemented in an easier and less difficult way.
The status of social capital of the Iranian administrations is not fine and the events happened in recent years have dealt a big blow to public confidence, but as it was examined in the case of Argentina, governments in other countries have a history of more irrational decisions that have damaged public confidence.
It seems to be noteworthy to compare Malaysia and Indonesia during the Asian financial crisis in 1997 and 1998. The policies and decisions of the two states in the crisis were completely different.
Resorting to methods like stabilizing the exchange rate and closing foreign exchange market as well as freezing foreign capital in its banks, Malaysia virtually implemented strict capital control strategies, but the Indonesian government did not implement a particular strategy to control capital outflows and exchange rates, when the exchange rate reached 7 times the pre-crisis period in the peak of Indonesia's financial crisis from time to time.
The Malaysian government could control inflation in the crisis era via enacting capital control laws, preventing the Malaysian economy from declining like Indonesia, but instead the policies hurt the confidence of investors.
Consequently, Malaysian companies were forced to compensate for higher interest rates in the years following the financial crisis. Indonesia, in contrast, endured the pressures of the crisis in a year, but this crisis has not had a major effect on its long-run growth trend. This point shows the importance of long-run outlook and a broad horizon in economic affairs and governance of a state.
To mention another noteworthy point, it is obvious that the Malaysian government's plan of controlling capital market and the decisions made by the Argentine government have both been of the similar sort, and both have been somehow impinging on people's capital and interfering with their property rights; so, both governments damaged public trust as a result of adopting such harsh policies.
However, the dissimilarity is that Malaysian law is more disciplined, more rational and more transparent, and does not undermine public confidence in the government by any means.
In 2019, Indonesia enacted laws to return foreign exchange from exports, which was in many ways similar to Iran's policies for the last two or three years. However, comparison of the regulations ratified in both countries indicate two key points:
In the regulations enacted by the Central Bank of Indonesia, exporters of mineral and natural products (which someway use natural resources) are examined separately and subject to special rules that are more rigorous than others.
According to Iran's laws, all companies, apart from the amount that they receive different subsidies, are required to supply currency in the Forex Management Integrated System, locally known as NIMA, and there would be no major difference between the various firms, and all are subject to a series of regulations that are illogical and unjust. Additionally, the laws have negative impacts on the motivations and behavior of producers and exporters.
According to Indonesian law, exporters are not demanded to convert their currency into Indonesian rupiah and are only asked to transfer export revenues to banks of the country (which is applicable for even exporters of mineral and natural products).
For that reason, these laws do not create strong conflict of interests for exporters. Inflation expectations have also been much lower than the figures in Iran, but the Iranian exporters have been forced to sell export earnings at a lower price than the prices in free market despite high inflation expectations in the last two years.
The theoretical literature, similar international experiences and the record of administrations actions in Iran indicate that in a bid to deal with currency crises, the country must relinquish the fixed currency policy and replace it with a controlled floating currency regime. Plus supporting producers, the measure will allow a government to reduce tariffs and customs formalities without exacerbating concerns and pressures, hence, this way can ensure consumer welfare.
The major challenge in any currency crisis is the imposition of preferential rates as well as austerity on tradesmen, which damages the commerce environment and erodes business activities, while wasting the central bank's foreign exchange reserves and disabling the mechanism of increasing the transaction account because of rising exchange rates.
The in detail account eventually deals with the problem identification of the central bank's foreign exchange package for the return of foreign exchange from exports, suggesting corrective proposals.