Ezzati: An increase in the exchange rate does not solve the budget deficit, nor does it increase exports

Academic faculty member of Tarbiat Modares University, criticizing the two common views about the exchange rate increase, says that the exchange rate increase neither solves the budget deficit, nor increases exports.

According to Ambassador Arjan, the increase in the exchange rate in Iran's economy has always been accompanied by two main arguments; One group considers it a way to provide the government's riyal resources and compensate for the budget deficit, and another group believes that the currency price should increase according to domestic inflation in order to maintain the economic balance and competitiveness of exporters. Morteza Ezzati, a faculty member of Tarbiat Modares University and a macroeconomic expert, criticizes both approaches in a conversation with Ambassador Arjan and says that increasing the exchange rate is not a sustainable solution to compensate for the budget deficit, nor does it necessarily lead to the growth of exports in the current conditions of Iran's economy.

Morteza Ezzati, a faculty member of Tarbiat Modares University, believes that increasing the exchange rate is not only a sustainable solution to compensate for the government's budget deficit, but it can also put more pressure on the government's financial resources by increasing inflation and increasing public expenses. He also emphasizes that devaluation of the national currency, without removing production and export barriers, will not necessarily lead to an increase in exports, and the government should use more effective tools to manage the currency market.

Why does the increase in the exchange rate not compensate for the budget deficit?

Referring to two common viewpoints among economic policy makers, Ezzati says that a group considers the increase in the exchange rate as a way to provide the government with rial resources and imagine that as the currency becomes more expensive, the government's income will increase and the budget deficit will decrease. According to him, this view ignores the inflationary effects of the exchange rate increase and its effect on the government's expenses.

This economic expert explains that the increase in the exchange rate may increase the rial income of some government departments in the short term, but the resulting inflation will also increase the government's current expenses and other obligations. As a result, the additional revenue may be offset within a few months to a year by growth in spending, and the budget deficit may even increase.

He also considers the exchange rate as one of the important factors shaping inflation expectations in recent years. According to Ezzati, the increase in the currency price affects the valuation of assets and the expectations of economic operators, and for this reason, it is not possible to expect an increase in the exchange rate without intensifying inflation.

Should the exchange rate increase in line with inflation?

Ezzati does not consider the second point of view, i.e. the necessity of increasing the exchange rate in proportion to domestic inflation, to be defensible either. Proponents of this approach believe that adjusting the exchange rate based on the difference between domestic and foreign inflation helps to maintain balance in foreign exchanges and increase the strength of export competition; But this expert says that such a rule cannot be extended to all economies.

Referring to countries such as Saudi Arabia, Qatar, Bahrain and Oman, he says that these countries have stabilized their exchange rates and do not necessarily change their exchange rates when inflation increases. In terms of reputation, currency stability can increase the predictability of economic activities and prevent disruptions in the decision-making of companies and investors.

To explain his point of view, this expert points to the trend of price index 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 grown less than 40 times during the same period. He considers this comparison as a sign that the increase in the exchange rate does not necessarily equal domestic inflation.

Depreciation of the national currency does not necessarily increase exports

One of the arguments of those in favor of increasing the exchange rate is that the more expensive foreign currencies make Iranian goods cheaper for foreign buyers, and as a result, exports increase. Ezzati believes that the realization of this result depends on the production capacity and foreign trade conditions.

According to him, it can be expected that the devaluation of the national currency will lead to an increase in exports when producers have sufficient capacity and there are no export barriers. In Iran's economy, production limitations and access to foreign markets prevent the exchange rate increase alone to guarantee export growth.

He emphasizes that the increase in the exchange rate can increase the cost of import and production, without increasing the supply capacity of export goods in the same proportion. Therefore, foreign exchange policy should be evaluated in relation to the production situation, access to foreign markets and international trade restrictions.

Read the full text of this conversation here.