An increase in the exchange rate will not necessarily lead to an increase in exports / the government has the possibility to control the increase in the exchange rate

A member of the academic staff of Tarbiat Modares University, emphasizing that the government has the possibility to curb the increase in the exchange rate, believes that the two common views among economic policymakers, i.e. using the increase in the exchange rate to compensate for the budget deficit and adjusting it according to inflation, are based on incorrect perceptions of the mechanism of the Iranian economy. According to him, the increase in the exchange rate can not only increase the government's expenses and the budget deficit by intensifying inflation, but also in the conditions of

The increase in the exchange rate in Iran's economy has always been accompanied by two main arguments from its proponents; One group considers the increase in the currency price as a way to provide government rial resources and reduce the budget deficit, and another group believes that the exchange rate should increase according to domestic inflation in order to maintain the balance between domestic and foreign prices and increase the competitiveness of Iranian exporters. However, the experience of Iran's economy and its inflationary structure show that an increase in the exchange rate can have consequences beyond the change in the price of the dollar; From intensifying inflationary expectations and increasing the value of assets to rising government costs and disrupting economic decisions.

Morteza Ezzati, a faculty member of Tarbiat Modares University and an expert in macroeconomics, in a conversation with Ambassador Arjan, criticizing both approaches, believes that increasing the exchange rate is not a sustainable tool to compensate for the budget deficit, nor can it be the sole basis for export growth in the current situation. Also, referring to the role of the exchange rate in the formation of inflation in recent years, he emphasizes the necessity of the government to use various tools to prevent the increase in the price of currency, and believes that the evaluation of the currency market situation, regardless of the statistics of currency inflows and the amount of demand, gives an incomplete picture of the country's economic conditions.

The macroeconomic expert believes that the government has the possibility to prevent the increase of the exchange rate, but some of the economic policy makers do not agree with this approach. According to him, among the decision makers there are two main views about the exchange rate increase; One group considers it as a tool to provide government rial resources and compensate for the budget deficit, and the other group believes that the exchange rate should increase in proportion to inflation in order to maintain the balance between the domestic and foreign economies. Ezzati considers both views incorrect and believes that the increase in the exchange rate can ultimately lead to the escalation of inflation, increase in government expenses and the continuation of the budget deficit.

Two opinions about the increase in the exchange rate; Why are both wrong?

Explaining the first point of view, Ezzati says that some of the policy makers consider the exchange rate as a tool to provide the government budget and they think that the higher the price of the currency, the more rial resources the government will have and can reduce its budget deficit. According to him, this view ignores the inflationary effects of the exchange rate increase and its consequences on the government's expenses.

He explains: "This group is unaware that the resources obtained from the exchange rate increase will impose more costs on the government in the following year. Sometimes it doesn't even take a year to pass, and within a few months, the government's expenses increase drastically. As a result, the increase in the exchange rate will not only lead to the reduction of the budget deficit, but may increase the budget deficit in the space of a few months to a year.

According to this economic expert, with an increase in the exchange rate, only a part of the government's income increases, while the inflation caused by this increase affects various government expenses. Therefore, the increase in rial revenues resulting from the change in the exchange rate cannot be considered as the improvement of the government's financial situation without considering the growth of expenses.

In explaining this mechanism, Ezzati points to the position of the exchange rate in Iran's economy and says that in recent years, the exchange rate has become one of the important factors that shape inflation. According to him, the expansion of the tendency of people and economic activists to keep foreign currencies and gold has increased the position of these assets in determining inflationary expectations.

He says: "The more the exchange rate increases, the higher the inflation expectations. With the increase of the exchange rate, the valuation of assets changes and economic actors also adjust their expectations of the future with the exchange rate. Therefore, we should not expect an increase in the exchange rate without increasing inflation. "When inflation increases, the government's expenses also increase, and finally the budget deficit worsens."

From Ezzat's point of view, this cycle shows that increasing the exchange rate cannot be used as a sustainable solution to solve the budget deficit problem; Because more rial income, if inflation continues, may be neutralized very soon by the increase in current expenses and other obligations of the government.

Should the exchange rate increase in line with inflation?

This macroeconomic expert does not consider the second point of view, which emphasizes the necessity of increasing the exchange rate in line with domestic inflation, to be defensible. Proponents of this approach believe that adjusting the exchange rate based on the difference between domestic and foreign inflation can help maintain balance in foreign exchanges and increase the country's export competitiveness. However, Ezzati believes that the same rule for adjusting the exchange rate cannot be considered for all economies.

Referring to the experience of some countries in the region, he says: "It is not necessary for the exchange rate of each country to be determined according to the difference in inflation between that country and the United States. Countries like Bahrain, Saudi Arabia, Qatar and Oman have fixed their exchange rates and even when they are facing inflation, they do not necessarily adjust the exchange rate.

According to him, some countries basically try to prevent exchange rate fluctuations; Because these fluctuations can lead to economic instability and affect the decision making of economic actors. Strong exchange rate changes affect investors' calculations, business planning, and consumption patterns and can disrupt the investment process. From this point of view, the stability of the exchange rate is not only a monetary goal, but it can also help to make the environment of economic activity more predictable.

To explain his point of view, Ezzati points to the comparison of inflation and exchange rate in Iran and says that from 1356 to 1397, the price index has increased more than two thousand times, while the exchange rate has increased less than 40 times during the same period. He believes that this comparison shows that the increase in the exchange rate does not necessarily have to increase at the same rate as the domestic inflation.

Of course, this comparison alone does not determine the causal relationship between the exchange rate, inflation and economic performance, but in terms of dignity, Iran's experience also confirms that the continuous increase in the exchange rate cannot be considered the only way to maintain economic balance.

Depreciation of the national currency does not necessarily increase exports

One of the main arguments of the proponents of exchange rate adjustment is that the increase in the price of foreign currencies makes domestic goods cheaper for foreign buyers and thus leads to the growth of exports. However, Ezzati believes that the realization of such a result depends on the conditions of production and foreign trade, and simply increasing the exchange rate is not enough to increase exports.

In this regard, he says: "We can expect an increase in the exchange rate to lead to the growth of exports if we have a suitable production capacity and there are no export barriers. In Iran's economy, markets and the possibility of exporting are facing various restrictions. Therefore, we cannot expect that the theory based on which the devaluation of the national currency leads to an increase in exports will work in the same way in the current conditions of our economy."

According to this expert, if domestic companies are facing production restrictions and export barriers, increasing the exchange rate alone cannot solve these problems. In such a situation, production and import costs may increase, without increasing the supply capacity of export goods in the same proportion.

From this point of view, currency policy cannot be evaluated separately from the state of production, access to foreign markets and international trade restrictions. Ezzati emphasizes that the increase in the exchange rate, without providing the necessary conditions for production and export, will not be a guarantee for improving the trade balance or increasing the country's foreign exchange earnings.

exchange rate or liquidity; Which factor plays a greater role in inflation?

In another part of this conversation, Ezzati, referring to the developments of Iran's economy in recent years, believes that the exchange rate has played a more important role than liquidity in the formation of inflation. He says that some of the factors affecting the currency and liquidity market, including some Riyal flows and the way resources enter the economy, are not fully available to the public; However, in his opinion, liquidity alone cannot be considered the main cause of inflation or devaluation of the national currency.

He explains: "Liquidity does not necessarily lead to a devaluation of the national currency, and the relationship between the two is not one-to-one. Other important factors also play a role in this field. Surveys related to recent years show that the exchange rate has played a very important role in causing inflation, and a major part of the inflation of the past five to six years can be attributed to the increase in the exchange rate; While the share of liquidity and factors such as production reduction, in my opinion, was less."

According to Ezzati, even the increase in import cost is not as effective as the exchange rate changes in the formation of inflation. From his point of view, this issue shows the necessity of revising economic policy priorities; This means that the government and the monetary policy maker should not only focus on liquidity control and should also use effective tools to prevent the increase in the exchange rate.

However, separating the effect of exchange rate from liquidity, budget deficit, supply constraints and other inflationary factors requires detailed statistical studies; Because these variables can affect each other and part of the exchange rate changes and the general level of prices also come from common factors.

How can the government increase the supply of currency?

Ezzati believes that in order to manage the foreign exchange market, the government should take into account the expectations of economic actors in addition to intervening on the supply side. According to him, if the policymaker can create the expectation in the market that the exchange rate increase will stop and apply the necessary policies to maintain this situation, currency holders may be more willing to sell their assets.

He says: "If the market outlook goes in the direction that the value of foreign currency will decrease and the government also stands behind this policy and takes the necessary measures, the supply of foreign currencies can increase greatly."

From this expert's point of view, increasing the supply of currency can prevent the aggravation of the shortage in the market; However, in evaluating the situation of the currency market, he emphasizes that a difference must be made between the current conditions and the possibility of problems in the coming months.

Referring to the information related to the first five months of 1405, Ezzati says that according to the statistics he cites, the entry of foreign currency into the country has increased in this period compared to the same period of 1404, and at the same time, imports have also decreased. According to him, these two trends can mean reducing the demand pressure in the currency market.

He emphasizes: "I do not negate embargo, blockade and war, but these facts must also be taken into account. According to the statistics that we had until two months ago, the issue of currency shortage was not an issue as it may be imagined now. Of course, more problems may arise in the coming months."

These statements emphasize the necessity of simultaneous examination of currency supply and demand. An increase in foreign exchange entry into the country does not mean full market access to foreign exchange resources; Because the way the currency returns, the possibility of transferring resources, sanctions restrictions and the amount of currency available in the market also affect the final situation. For this reason, an accurate assessment of the foreign exchange market requires information beyond the general statistics of currency inflows.

What is the message of the supply of two billion dollars of currency?

Furthermore, Ezzati also says about the supply of two billion dollars of foreign currency by the policymaker, such an action shows that there were resources for supply at the disposal of the supplier; However, without access to information about reserves, commitments and calculations of the central bank, it is not possible to make a definitive judgment about the adequacy of these resources or the exact supply targets.

He says: "If the government offers two billion dollars of currency to the market, it means that it has currency at its disposal. "We don't have access to all the statistics and there may be limitations, but the currency supplier should naturally have more information than we do and take such action based on their own calculations."

According to this expert, the supply of currency may have been pursued with other goals and not necessarily all goals of the policy maker will be achieved. Even a wrong policy may be implemented, but the supply of currency at this level means that the central bank's hands are not empty. Therefore, the mere supply of currency should not be considered as a definitive success of the currency policy or a complete solution to market problems.

In general, Ezzati believes that in order to manage the foreign exchange market, the government should control inflationary expectations with reliable and predictable policies on the one hand, and on the other hand, provide the basis for increasing the effective supply of foreign exchange. From his point of view, relying on an increase in the exchange rate to provide the budget or its automatic adjustment based on inflation is not the only sustainable solution for the problems of Iran's economy, but it can impose more costs on the government and economic activists by intensifying inflation and instability.