Courtesy of STRATFOR (subscription required) a detailed analysis of the Iranian currency crisis:

Since late September, the Iranian rial has lost as much as 40 percent of its value against the U.S. dollar. The precipitous decline in the rial’s value broadly stems from the U.S.-led economic sanctions campaign against Iran and the imperfect options at Tehran’s disposal to defend the rial.

Sanctions Hit Iran’s Financial System

The most recent phase of the sanctions campaign targeted the heart of the Iranian financial system. The Islamic Revolutionary Guard Corps-run national oil company sells the bulk of Iran’s oil to foreigners in exchange for dollars. And since earlier sanctions pushed most private Iranian banks out of the oil business, the Central Bank of Iran is the primary institution to manage the transactions.

However, the sanctions are not airtight. The West has little appetite for the high oil prices that a complete embargo would entail, and sanctions can be difficult to sustain politically. The sanctions therefore allow waivers to be granted to importers that keep more than 1 million barrels per day of Iranian crude flowing into the market. On top of this permitted trade, Iran has developed a number of alternative payment methods and smuggling operations to maintain oil exports, albeit at greater difficulty and higher cost. 

Despite these methods, the sanctions do appear to be having enough of an impact to undermine Iranian oil revenue and constrain Iran’s ability to obtain enough of the hard currency it needs to defend the rial. Official Iranian crude exports have been cut roughly in half — from slightly more than 2 million barrels per day to 1 million barrels per day — though volumes fluctuate on a monthly basis.

With the rial coming under increased pressure, the Central Bank of Iran had to draw from its foreign exchange reserves to subsidize the exchange rate and to fix prices of staple goods. The exact value of Iran’s foreign exchange reserves is disputed, but a range of estimates indicates a decline from approximately $100 billion to $65 billion since January. Using foreign exchange reserves to prop up the currency is an expensive policy to maintain, and the central bank adopted an approach meant to ensure that the subsidization was targeted toward essential goods. This was first manifested in the July 2012 shift from a two-tiered exchange rate system to a three-tiered system. The policy entailed maintaining the official rate for imports of basic goods, imposing a 15,000 rial-per-dollar rate for imports of capital and intermediate goods and allowing access to a market rate for imports of non-essential goods.

This second tier is the most critical to examine. Iran’s Islamic Revolutionary Guard Corps holds significant clout in Iranian industry, parallel financing and smuggling operations. The import of capital and intermediate goods for the Iranian economy is largely a Revolutionary Guard operation. Many members of the Revolutionary Guard have exploited their ability to access dollars cheaply and exchange them at a market rate to earn a profit through the tiered exchange system. This has allowed them to personally profit from Iran’s premier state asset, its oil revenue, and has eroded the government’s ability to redirect its wealth toward the wider population. Such speculators and black market traders form the “invisible mafia” that some Iranian government officials have blamed for the current crisis. Its presence could be tolerated during better times, but with the economy besieged by sanctions, Tehran’s willingness to endure this activity has disappeared.

The pressure of sanctions and the loss of foreign exchange reserves due to the subsidized exchange rate have now reportedly led to the removal of the middle exchange rate and a drastic restriction of foreign exchange transactions throughout the economy. At the same time, a notable increase in government rhetoric about “economic jihad” and self-sustainability induced more panic in the market. Perception spread domestically that foreign exchange reserves were running out and the rial would soon collapse, leading Iranians to rush to currency exchange centers to trade their money for dollars.

The State’s Response

As of Oct. 4, most currency exchange centers have reportedly shut down and police are barring access to these facilities as part of a state effort to constrain access to subsidized dollars and stop the outflow of dollars from Iran’s foreign exchange reserves. Merchants at Tehran’s Grand Bazaar — whose continued participation in protests could provide the necessary momentum to sustain wider social turmoil — have closed their shops over the past few days in protest of the currency depreciation. Security forces have been deployed to the bazaar in response, but the state is also actively trying to avoid a confrontation with the merchants that could trigger widespread unrest.

Stratfor has received indications that the government is quietly negotiating with merchants and offering access to dollars at subsidized exchange rates to compel them to reopen their shops. So far, the strategy appears to be working. Merchant associations held a meeting Oct. 4 and reportedly agreed to resume activity at the Grand Bazaar on Oct. 6. The government has ordered the deployment of Revolutionary Guard forces and police to the bazaar to ensure this remains the case. However, the sustainability of this strategy depends on three principal factors: the ability to apply physical force, continued oil sales and the maintenance of foreign exchange reserves.

The Islamic Revolutionary Guard Corps

The thread tying the currency crisis together is the Revolutionary Guard. Iran’s increased economic isolation due to sanctions over the years empowered the Islamic Revolutionary Guard Corps. The military force runs a sprawling business conglomerate that encompasses everything from insurance, construction, banking and energy. The Revolutionary Guard also plays an instrumental role in the smuggling of oil exports and consumer goods imports to sustain oil revenues and keep shelves stocked amid tightening sanctions. At the same time, members of the force at varying levels are in a prime position to exploit the currency exchange rates for personal gain. Finally, the Revolutionary Guard is the main security branch that the state will rely on to contain social unrest stemming from major economic disruptions.

In other words, the Islamic Revolutionary Guard Corps may have to rein in its privately accumulated profits before it can effectively manage this widening economic crisis. This has significant implications for Iran’s intensifying power struggle. In this latest bout of economic unease, Iranian President Mahmoud Ahmadinejad has once again become the scapegoat for the country’s growing economic problems, a trend that has been in place for several years. Iran’s clerical authorities have used a number of institutional levers to discredit the president’s populist platform, which Ahmadinejad had framed as an alternative to the corrupted clerical elite. The Revolutionary Guard initially exploited this rift within the Iranian regime to strengthen its own position in the political affairs of the state; it has now aligned itself more closely with the clerics to isolate Ahmadinejad’s faction.

Results from recent parliamentary elections indicate that the scapegoating strategy is working in the clerics’ favor. However, the entire government will face a major crisis of confidence if it is unable to contain a currency crisis that could lead to more widespread unrest. The regime now appears to be trying to strike a deal with merchants to provide controlled access to imports. This strategy will require a consolidated security effort and a continued stream of oil revenue to allow the clerics to endure this crisis. And ultimately, that effort will rely on the security and business management abilities of the Islamic Revolutionary Guard Corps.