Iran's Rial Gripe

Headlines around the world have been abuzz since Tuesday about the precarious state of Iran's economy, after the market rate for the Islamic Republic's currency, the rial, dropped over 10 percent in less than a day to its lowest level ever against the dollar.

The catalyst behind the sudden drop in Iran's currency was a report by the semi-official Mehr News Agency, citing Iran's Ambassador in the Emirate of Abu Dhabi as saying that Tehran's Trade Promotion Organization would no longer allow registration for imports routed through Iran's third-largest trading partner, the United Arab Emirates (UAE). Mehr also reported the Iran-United Arab Emirates Chamber of Commerce as saying on Tueday that Iran's Central Bank has ordered local businesses to stop using UAE currency, the dirham, for financial transactions. The report has since been removed from Mehr's website.

The UAE, which is Iran's third largest trade partner, is a major route for re-exports into Iran. In the eight months since March 2011, roughly $13 billion worth of registered imports have been routed through the UAE into the Islamic Republic.

Since Tuesday, Tehran's market exchange rate has stabilized -- falling from as high as 15,300 to slightly above its initial 13,800 rials per dollar value -- after Iran's Foreign Ministry formally denied reports of any trade cuts with the UAE or halts in registration. 

Nevertheless, the sudden panic that ensued serves as a gauge -- to both Iran's financial markets and the government -- of how another political shock to the market will impact Iran's currency. "If there's another shock, the rate won't fall back down again; it'll stay around 15,000 rials to the dollar," one prominent financial expert in Tehran tells me.

Had Tehran not canceled its ban, then local Iranian importers seeking to register with the government for transactions with the Emirates would no longer have had access to foreign exchange -- whether in the form of the U.S. dollar, euro or the Emirati dirham -- at the stronger official government exchange rate. Instead, they would have had to sell their rials at the weaker market exchange rate, which would have dramatically raised business costs.

Iranian economists and experts on the Islamic Republic's monetary policies say the initial decision to halt registration of imports was primarily political, resulting from pressure by many Iranian parliamentarians to enact the ban in retaliation for payment restrictions imposed on Iran's banking system by the UAE due to UN sanctions and the US Treasury's financial sanctions.

Tehran's market-rattling media reports coincided with the end of a two-day meeting of the Gulf Cooperation Council (GCC), a bloc of six countries bordering the Persian Gulf which excludes Iran, that convened this week to discuss the unification of regional security. The GCC conference took place on the back of new legislation being considered by the U.S. Congress which, if enacted, will severely penalize any banks in U.S.-allied countries that engage in financial transactions with Iran's Central Bank.

Such legislation from the U.S. will be crucial for Tehran because, if implemented, the law could theoretically target the smaller, local banks in the United Arab Emirates and other countries such as Turkey and Malaysia that Iran, in the wake of U.S. Treasury sanctions, must use to transfer cash back into the Islamic Republic.

With Iran's Central Bank already facing difficulties facilitating foreign currency transactions overseas, reduced financial relations with any of Tehran's remaining trading partners will further weaken the capacity of monetary policy makers to regulate the depreciation of Iran's currency.