The USA declared in May 2018 by an executive order that it will not fulfil the obligations of JCPOA and the Nuclear Deal. Consequently, the JCPOA has decreased in value for Iran significantly (in the context of its economic benefits), and it has become a deal just on paper. The Joe Biden administration, which took over the office after its inauguration in 2021 January, has sent several signals concerning the return of the USA to the JCPOA. As a result, the negotiations have started on April 6, in Vienna, the capital city of Australia. The parties stated that lifting the USA's sanctions, the steps for Iran and the USA to implement the deal, and the actualization of the process in an order which will satisfy both parties, have been discussed in the negotiations. There have been three rounds in the negotiations so far, and there is still no official statement. According to the personal assessments of the diplomats, who joined the talks, the negotiations seem to proceed in a positive atmosphere. However, the assessments also show that the arrival of a concrete deal text requires more time. In this context, the parties are believed to remain optimistic and vigilant at the same time. The reflections of Biden’s inauguration and the Vienna Talks on Iran’s foreign exchange market, besides other fields, draw attention. The Iranian currency unit has been observed to increase in value against the US dollar since 2020 September. This paper aims to analyze the current situation in the foreign exchange market regarding the risk perception and the ongoing developments in Iran’s foreign exchange market through the tools of the economic theory.

In contrast to the goods and labour market, pricing in the financial market and foreign exchange market is shaped by the future expectations of the market actors. In the context of Iran, if the future expectations of the market actors are optimistic, the Iranian currency unit toman gain value against foreign currencies, and if the expectations are not optimistic, it loses value.

Iran’s foreign exchange market has been facing high rates of risk-based pricing because of the rising political and economic uncertainties for the last three years. The graphic below illustrates the situation. There are two series in the graphic. The first one is the Inflation Index. The Inflation Index is calculated through the monthly Consumer Price Index (CPI) data from the Statistical Center of Iran. The second indicator represents the Exchange Rate Index which shows the value of a US dollar against Iran’s currency unit toman in the foreign exchange market in Iran. The changes in both series for the 64 months between 2016 January and 2021 May are demonstrated in the graphic. The value of both series has been calculated as 1 for 2016 January to simplify the interpretation of the calculated numbers. After the value of the series is accepted as one by 2016 January, the series has been turned into cumulative indexes until 2021 May, with the consideration of monthly changes in inflation and foreign exchange rates.

The initial term requires to be relatively stable in this type of analysis, in principle. In this regard, 2016 January needs to be a relatively stable and moderate-term as the beginning. As it may be remembered, the JCPOA was signed between Iran and P5+1 countries in 2015 and put into action in 2016. Thus, the foreign exchange market in Iran seems to be highly stable after 2015. The inflation has been also reducing since 2016 and regressed single-digit numbers by 2017. In this context, 2016 may be acknowledged as a reasonable initial term.

According to the Relative Purchasing Power Parity Theory of Economics, the changes in the exchange rate of two countries in the short term will be equal to the difference in inflation rate between these countries. In the context of this theory, if the low inflation rate of the US is ignored, the changes in Iran’s exchange rate should be in line with the inflation rate in Iran. It should be noted that the shift from the exchange rate to inflation mostly occurs with a delay. In this regard, the domestic prices are unproductive at a certain level. Even though there is an increase in the costs of imported goods (because of the rise in the exchange rate), the producers usually do not reflect it in the prices or gradually do so. Therefore, the shift from the exchange rate to inflation requires a certain amount of time and happens with delay.

Graphic 1: The Exchange Rate in Iran (1 US $/ Toman) and Inflation

Source: The Inflation Index and the Exchange Rate Index are calculated by the author thanks to the data from the Statistical Center of Iran and bonbast.com.

After the explanation of the theoretical background, now, it is possible to interpret the graphic. As seen in the graphic, the Exchange Rate Index differentiates from the Inflation Index since May 2018. The gap between the two series seems to grow significantly in certain periods due to the enormous leaps. Then, the gap is seen to be closing gradually. It may be seen in the graphic that the actors of the exchange market avoid the domestic currency (Iran’s currency unit toman) when there is a rise in the risk perception and tend to more dependable currency units (or investments). Consequently, the domestic currency (toman) seems to lose value rapidly, or the US dollars increase in value against the toman.

The sanctions were gradually enacted in August and November after US President Trump declared US withdrawal from JCPOA. The exchange market responded strongly to the first phase of the sanctions at the end of August. The gap between the Exchange Rate Index (5.01) and Inflation Index (1.40) reached 3.57. In the following months, a regression trend has become visible in the Exchange Rate Index as a result of the measures of the Rouhani administration and the Central Bank of Iran. The Inflation Index was tended to up because of the shift from the exchange rate to inflation, and thus, the gap between the two indicators closed significantly by September 2019. The Exchange Rate Index was 3.07 in September 2019, and the Inflation Index was 1.96 in the same month. After that, the gap between them regressed to 1.57.

The measures of the Rouhani government raised the fuel prices by 200% and paved the way for comprehensive protests in the country. Iran firmly quelled these protests. The increase in the prices because of the fiscal problems and the reaction of the people against it are the results of the economy’s strain due to the sanctions. The gap between the two indicators and the actors’ risk perception regarding the economy of the country seems to be increased after these protests in Iran. Furthermore, the assassination of Qasem Soleimani, the COVID-19 measures, and domestic and international developments in Iran caused the rates of risk perception to remain high, and the gap between the two indicators has grown until 2020 September. In September 2020, the Exchange Rate Index rose 7.97 and the Inflation Index increased 2.54. Thus, the gap between them reached 3.13.

The victory of Biden in the USA elections has created an optimistic atmosphere in Iran. The gap between the two indicators started to regress as a result of this atmosphere, and this regression is accelerated by the negotiations to restore the JCPOA in April. Therefore, a leap in the regression of the Exchange Rate Index may be expected as a result of possible future steps in JCPOA negotiations.

The Iranian government has attempted to protect the poor population from inflation by keeping the prices of quasi-public goods (health, education, etc.) low. Moreover, through the price policies and direct control methods, the enterprises were not allowed to make an increase in the prices in line with the rises in the cost prices. The postponed price increases due to these price control policies are expected to step in and cause the increasing trend in the Inflation Index to remain for a while. If the negotiations in Vienna turn into a deal at the end of 2021 summer, the two indexes are predicted to be balanced at 4.5-5.

1 US dollar is equal to 21,000 tomans in the market by May 5. If the optimistic expectations come true, the value of the toman will increase 15-25% against the US dollar. If this optimistic scenario becomes a reality, eventually, the exchange rate is expected to regress 16,000-18,000 tomans.