The Removal of Preferential Exchange Rates in Iran: A Critical Examination of an Inevitable yet Costly Reform

Marzieh Tajmiri

PhD Candidate in International Relations, University of Isfahan

Abstract

The policy of preferential exchange rates, which for decades in Iran was employed as an instrument to control the prices of essential goods and to protect people’s livelihoods, has in recent years in practice turned into a mechanism for price distortions, unequal distribution of resources, and the expansion of rent-seeking. Accordingly, this article adopts a descriptive–analytical approach to examine the historical, economic, and social dimensions of removing this policy. The findings indicate that despite its stated objective of supporting vulnerable groups, the multiple exchange rate system has in practice become a driver of inequality and economic instability. Although the removal of preferential exchange rates was inevitable in the long run, its implementation without adequate planning and under the severe constraints of international sanctions generated a significant inflationary shock, the primary burden of which fell on middle- and low-income deciles. Therefore, the results emphasize the necessity of synchronizing exchange rate reforms with targeted social protection policies and strengthening market regulatory institutions.

Keywords: Preferential exchange rate, Multiple exchange rate system, Inflationary shock, Social justice.

Introduction

In the economies of developing countries, one of the enduring challenges of policymaking is striking a balance between ensuring social justice—by supporting the livelihoods of vulnerable groups—and maintaining economic efficiency through the optimal allocation of scarce resources. Governments therefore constantly seek policy instruments capable of managing this tension, particularly in the face of external shocks such as fluctuations in global commodity prices or international sanctions. Among such instruments, direct and indirect subsidy policies have often been adopted as rapid and readily available solutions. One prominent example is the policy of preferential exchange rates or a multiple exchange rate system, whereby the government sets a specific official exchange rate for the import of certain goods—typically well below the market rate—with the aim of reducing domestic prices and ensuring broad public access to essential commodities (IMF, 2023: 7).

In practice, however, this policy tends to become a source of price distortions, rent creation, and unequal resource distribution. In Iran, particularly during periods of intensified sanctions, this instrument assumed a central role in the subsidy distribution system. Consequently, the removal of preferential exchange rates became not a discretionary policy choice but an unavoidable response to a structural crisis with extensive economic, social, and political dimensions. A policy originally designed to support the poor ultimately became a driver of inequality, while resources that should have been allocated to infrastructure development and productive investment were dissipated through networks of rent-seeking and corruption. Understanding the depth of this contradiction and analyzing the process of exiting such a system are essential for both assessing past policies and designing future reforms.

The Use of Preferential Exchange Rates in Developing Countries: A Comparative Perspective

The experience of multiple exchange rate systems and preferential exchange rates is by no means unique to Iran. This policy instrument has been employed in various regions of the world across different periods, and its outcomes have largely served as cautionary examples. Examining these experiences—whether as warnings or as partial models—offers important lessons for many developing countries that remain trapped in such seemingly attractive yet fundamentally destructive mechanisms.

Venezuela represents an extreme case of the prolonged maintenance of preferential exchange rates alongside declining foreign exchange revenues. Artificially fixing the official exchange rate ultimately resulted in a deep divergence from the free market rate, widespread rent-seeking, and the collapse of domestic production, leaving the country plagued by severe shortages and hyperinflation. This experience demonstrates that, in the absence of fiscal and institutional discipline, preferential exchange rates can precipitate economic collapse (IMF, 2016: 6–8).

By contrast, Egypt provides an example of a difficult yet relatively successful reform. Following a currency crisis, Egypt unified its exchange rate in 2016 with the support of the International Monetary Fund, while simultaneously expanding targeted social protection mechanisms such as cash transfer programs. Although inflation increased in the short term, the reform contributed in the medium term to exchange rate stability, improved balance of payments, and renewed investor confidence. This case illustrates that the success of exchange rate reform depends on its alignment with social support measures and firm yet gradual implementation (IMF, 2018: 3–4; World Bank, 2017: 8–9).

Nigeria’s experience further highlights the negative consequences of maintaining a multiple exchange rate regime. The persistent gap between official and market rates reduced incentives for the repatriation of export revenues and pushed the economy toward speculative activities. The resulting spread—reaching up to 40 percent—undermined economic incentives and distorted resource allocation. The World Bank has warned that such conditions steer the economy toward import dependence and speculative behavior, while wasting foreign exchange resources and increasing vulnerability to oil price shocks (World Bank, 2013: 249–250).

The Historical Evolution of Preferential Exchange Rates in Iran

The multiple exchange rate policy in Iran has deep historical roots, predating the 1979 Islamic Revolution and becoming increasingly complex and institutionalized in subsequent decades. Prior to the revolution, Iran’s exchange rate system was largely fixed and pegged to the U.S. dollar. Nevertheless, even during that period, episodes of balance-of-payments pressure occasionally produced a dual exchange rate structure, whereby the government allocated preferential rates for essential imports while other transactions occurred at higher or market-based rates. This situation intensified following the surge in oil revenues during the 1970s and the rapid expansion of imports. While the policy ensured the short-term availability of basic goods, it gradually fostered black markets, smuggling, and rent distribution.

Following the revolution and the outbreak of the Iran–Iraq war, the Iranian economy faced two major shocks: large-scale capital flight—estimated at USD 30–40 billion—and a sharp decline in oil revenues. In response, the government formally introduced a multiple exchange rate system to manage scarce foreign exchange reserves and prioritize imports. At the peak of this period, multiple exchange rates coexisted, including official rates for essential imports such as food and medicine, export rates, sector-specific preferential rates, and a free market rate. However, the negative consequences—black markets, smuggling, and rent-seeking—soon became evident, making the 1980s Iran’s first major experience with systemic economic pressure arising from exchange rate differentials (Bonato, 2007: 15–16; Guillaume et al., 2011: 10–15).

During the 1990s and early 2000s, following the end of the war and the onset of reconstruction, efforts were made to unify exchange rates and restore greater transparency. In 1993, rising oil revenues enabled the government to partially reduce exchange rate multiplicity. The peak of these efforts occurred in March 2003, when the government fully unified the exchange rate, shifting to a market-based system that accounted for over 90 percent of foreign exchange transactions. This brief period demonstrated that Iran’s economy could function under a unified and transparent exchange rate regime, though the success was fragile and highly dependent on oil revenues. With changing international conditions, the nuclear dossier, and subsequent sanctions, this equilibrium gradually eroded (IMF, 2004: 5–9).

From the early 2010s onward (post-2011), declining oil revenues and restricted access to the global financial system rapidly depleted Iran’s foreign exchange reserves. In response, the government reverted to extensive exchange controls. In January 2013, an official fixed rate of 12,260 rials per U.S. dollar was announced, while the market rate diverged sharply. Imports were classified into ten priority groups, with only essential goods such as food and medicine receiving access to the official rate. These policies culminated in April 2018 with the introduction of a preferential rate for essential imports, creating a three-tier system: the official rate (4,200 tomans), the NIMA rate (approximately 11,000 tomans), and the free market rate (around 13,000 tomans).

Mounting fiscal pressure—amounting to billions of dollars in hidden subsidies annually—and escalating corruption ultimately compelled the government to initiate reform. From 2021 onward, a gradual phase-out of the 4,200-toman preferential rate began, and in May 2022 this rate was removed for many goods, though the multiple exchange rate system persisted (Majlis Research Center, 2019: 16–19).
By January 2026, extensive administrative controls and the allocation of foreign exchange at a preferential rate of 28,500 tomans were also abandoned. While this effectively eliminated preferential exchange rates for most imports, the government once again relied on direct cash transfers to households to offset inflationary effects. However, delays in compensation, inadequate adjustment to inflation, and structural weaknesses in targeting mechanisms intensified livelihood pressures, thereby eroding many of the potential benefits of reform while amplifying its social costs.

Economic and Social Consequences of Removing Preferential Exchange Rates

This historical trajectory illustrates how a temporary crisis-management tool gradually became a structural and problematic feature of the economy, generating significant economic and social costs borne primarily by vulnerable groups.

The most immediate impact was an inflationary shock. With the removal of artificially cheap exchange rates, the cost of imported essential goods rose sharply. Economic studies show that such inflation is highly regressive, as food expenditures constitute a much larger share of consumption among low-income households. At a time when Iran’s overall inflation exceeded 40 percent, this additional shock pushed many households toward absolute poverty. The World Bank had previously warned that sluggish economic growth combined with price shocks could expose approximately 2.5 million people in Iran to the risk of falling below the poverty line (World Bank, 2025).

A second consequence was the heavy burden imposed on production and employment. Iran’s productive sector—particularly small and medium-sized enterprises—had long relied on preferential exchange rates for imported intermediate inputs. The abrupt removal of this support sharply increased production costs, triggering bankruptcies, output reductions, and layoffs in sectors such as food processing and livestock. In the long term, this weakened domestic production capacity and increased import dependence, creating a vicious cycle in which a reform intended to promote self-sufficiency instead heightened economic vulnerability (Center for Development and Futures Studies, 2021: 2–6).

Social consequences extended beyond economic indicators. The reform intensified perceptions of injustice and deepened public dissatisfaction, as the costs of correcting an inequitable system were once again borne by ordinary citizens—particularly the middle and lower classes. Such livelihood shocks, when accompanied by perceptions of unequal burden-sharing, can erode social capital, reduce public trust, and weaken societal resilience (Salem et al., 2022: 132–135).

Despite severe criticism and short-term costs, the removal of preferential exchange rates carries strong macroeconomic justifications within a comprehensive structural reform framework. The fiscal burden of hidden subsidies—amounting to billions of dollars annually—was unsustainable, particularly under sanctions. Eliminating these subsidies frees resources for productive investment, technological development, and strengthening health and education systems. Moreover, narrowing exchange rate gaps weakens rent-seeking networks, enhances transparency, improves resource allocation, and facilitates Iran’s integration into the global economy. From the perspective of institutions such as the IMF and World Bank, complex multiple exchange rate systems signal market distortions, governance weaknesses, and limited investor confidence (IMF, 2023: 12–16; World Bank, 2013: 5–7).

Conclusion

Iran’s experience with the removal of preferential exchange rates offers a sobering lesson about the costs of delaying structural reforms. A policy initially introduced as a temporary response to sanctions gradually deepened the crisis it sought to manage. While its removal was necessary, inadequate compensatory mechanisms and adverse economic conditions imposed heavy burdens on vulnerable groups. This case underscores that economic reforms cannot succeed in a political and social vacuum: meaningful change requires strong political will, institutional capacity, and informed public participation. The removal of preferential exchange rates is therefore not the end of the reform process, but the beginning of a more challenging phase of deep economic transformation in Iran.

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