Two of the main risks involved in investment are exchange rate risk and inflation risk. As defined in Chinese literature risk is a combination of danger and opportunity, also exchange rate risk and inflation risk provide both opportunities and threats for investors and companies, and therefore should be examined separately. In recent years, Iranian economy experienced double digit inflation and big depreciation in Rial. The major part of consumption in Iran (both capital and non-capital consumption) is influenced by the increase in the exchange rate, which results in an increase in the cost of goods sold and therefore in final price of products. On the other hand, depreciation in Rial and increase in inflation rate will have an impact on financial costs of companies. As a result, investors face both systematic and non-systematic risks. However, there are no instruments in Iranian financial markets for investors to cover these risks. So foreign investors should seek investment opportunities that can gain enough returns (in Rial) in order to cover these risks and earn suitable foreign exchange returns. In the table below, examining of this issue has been shown:
During the past years, the exchange rate experienced intense volatilities in Iran. In the following table the changes in the exchange rate during the recent years has been shown:
*note: all the years in this report are Iranian calendar years (20th March yearend)
According to the above data, growth rate of Dollar/Rial in Iran within the period of 1368 until the end of 1394 has been equal to 13.8 percent and from 1376 until the end of 1394 has been 11.6 percent, and finally from 1384 until the end of 1394 was equal to 14.4 percent. Now considering the policies that were adopted by the eleventh Iranian government and the reduced inflation and resemblance of this period to the period of 1376 until 1384, we can assess the growth rate of Dollar for the next few years to be at 8.3 percent. Â This is an acceptable rate due to the anticipated reduction in the inflation rate to under 10 percent levels as well as the purchasing power parity. Considering these rates we examine the investment opportunities that result from changes in the exchange rate:
Sukuk: Government bonds, Murabahah, Ijarah, etc. are various types of Sukuk that are available in the Iranian capital market. These securities have different rates of return and are guaranteed by banks. Presently, the rates for these securities are at 20 percent and 21 percent and their returns are paid on monthly or every three months basis, thus their effective rates reach to levels above 21 percent. Considering this rate, the foreign investor can gain a return of 11.7% assuming that Rial depreciate by 8.3 percent annually.Â Even if we suppose a 14.4 percent reduction in the value of Rial, a return of 5.7 percent will be obtained by investors which is an acceptable rate globally. These securities are exempt from taxation. Considering the returns pointed out, presently the above mentioned securities are assessed as suitable opportunities for foreign investments and it is expected that the arrival of these investors will result in reduction in these rates of return. On the other hand, the inflation rate is on a declining trend, which makes the investment in these securities more attractive for investors, thus gradually declines their rate of return. It is noteworthy that considering the bank guarantee for repayment of the interest and the face value, the interest on these securities can be viewed as risk free rate of return.
Investment in company shares: The stock price of companies that are present in the Iranian capital market are influenced from various aspects by the exchange rate and reduction in the inflation rate:
- According to the issues explained in the previous section, the return of these securities is expected to decline which, in turn can lead to a decrease in the rates of return expected by the investors and therefore lead to an increase in the price of stocks:
This can be interpreted otherwise: a decline in the rates of Sukuk and government bonds can lead to an increase in the market P/E which eventually results in an increase in stock prices. This part of the exchange risk is desirable and can be an opportunity for investors. This increase in the stock price in the capital market is systematic and will continue so long as the rate of return of the securities maintains its declining trend.
- One of the financing methods for companies is obtaining loans and issuing government bonds (in Sukuk form in Iran), and presently the financing cost in Iran via this method is 25%. As mentioned earlier, Sukuk rates are expected to decline and therefore reduce the financial costs of companies. On the other hand, companies can obtain loan from other countries, which bearing in mind the mentioned rates regarding the changes in exchange rates in Iran, can also lead to significant reduction in financing costs. This can raise the profitability of those companies that have used loans and issuing of securities as means of financing. Now we have to examine which company has obtained higher loans, and as a result of the reduced interest rate will experience a larger increase in its profitability. Higher profitability will lead to higher share prices, which is interpreted as the nonsystematic risk of the exchange rate.
- Reduction in the inflation rate and changes in the exchange rate, will affect the sales and cost of goods sold of companies. In this case as well, companies should be examined separately in order to identify the intensity of the effect of the above mentioned elements. Some companies will face lower profitability while other will have the exact opposite experience, thus will have different effects on their stock prices.
Considering the cases mentioned above, investors should study the systematic as well as non-systematic aspects of inflation and exchange rate risks in Iran prior to making any decision regarding investment opportunities and strategies.