Economy + Policy E1:R3
◢ As inflations reaches all-time lows, money supply continues to rise, but CBI governor Seif remains confident that the economy is not overheating
◢ Parliament has blocked a critical budget amendment devised by the Rouhani administration to pay government debts and address the country's credit crunch
Rising Money Supply Threatens Markets
Valliollah Seif, the governor of the Central Bank of Iran (CBI), announced in March that the money supply had risen 30% in the last fiscal year (1394), reaching IRR 10.1 trillion. This rate of growth was even higher than the 22.3% seen in the previous year.
Seif's comments, and more recent indicators, have raised concerns that Iran's economy could be seeing some overheating effects in which the expansionary monetary policy may risk undoing some of the recent progress to lower the inflation rate.
On the other hand, some observers think that the money supply is unlikely to expand much further. A large amount of capital remains locked in the banking system, and the government can't afford to pump money into the economy much longer as it faces its own mounting debts. Moreover, the rise in the money supply is can be attributed to the multiplier effect rather than a key change in the monetary base.
In the Iranian calendar year 1394, the monteary base grew by 19% to reach IRR 1.57 quadrillion, while the money supply grew by 30%. In the same period, the money multiplier rose from 5.97 to 6.46.
The concern is that falling interest rates seem to have had an effect on deposits. Resources are being moved from long-term to short-term deposits. CBI governor Seif has discounted the concern over the uptick in short term deposits, pointing out that Iranians maintained their deposits even when the real interest rate in Iran was negative. Currently, inflation is below 10%, while the deposit rate ceiling is 15%. In previous years, inflation was 30% while the deposit rate ceiling was 25%. Yet, Iranians continued to keep their funds in banks.
Government debt and toxic loans have hampered lending by Iranian banks in recent years. The Rouhani administration is keen to get small and medium sized enterprises (SMEs) to lead the country's economic recovery. To encourage new entrepreneurial activity, the administration has tasked banks to allocate IRR 160 trillion to 7500 SMEs which have been identified as underperforming companies. The loans are meant to enable capital investments that can help boost production capacity. The decline in the interest rate has made such financing packages much more affordable for SMEs in Iran, which may encourage business leaders to seek growth.
Part of the drive to support SMEs is about finding rapid ways to reduce stubborn unemployment in Iran. While the country is waiting for major post-sanctions development projects to break ground, it will take time for new factories and infrastructure development projects to generate jobs. In the near term, supporting more nimble SMEs is the most sensible way to increase demand in the labor markets.
Crucial Budget Amendments Rejected
A planned amendment to the 1395 Budget Bill, which aimed to improve the government’s ability to pay debts to companies and contractors, has been rejected.
The debts of governments to companies and contractors, most particularly banks, have locked a huge part of the liquidity which has exacerbated the recession and limited the government's ability to pursue expansionary monetary policy. The clauses 19 and 20 of the budget bill of the year 1395 (March 21, 2016 – March 20, 2017) were among its most controversial parts and were originally left out of the approved budget. The recently submitted amendments sought to have these clauses approved, but in a move that surprised many analysts the amendments were rejected.
The amendments were intended to authorize the government to use 50,000 billion tomans from the surplus foreign exchange account of the Central Bank of Iran against the outstanding debts. In turn, these repayments would be used by state-owned banks to increase availible capital for lending.
The Economic Commission rejected the amendment based on the argument that selling foreign currency to raise the required funds for recapitalization of banks would strengthen the rial, while also increasing inflation by bringing new liquidity into the market. Iran's Deputy Minister for Economic Affairs Shapour Mohammadi has criticized this logic, says changing the foreign currency exchange rate is only a simple accounting operation and does not change the monetary base. The argument did not win over the parliamentary committee however. What seems to be happening is that opponents of president Hassan Rouhani are using the historical concern around rising inflation to argue against this important and long anticipated recapitalization of banks. Inflation has falling drastically, and the Rouhani administration can risk increasing liquidity in an attempt to alleviate the country's credit crunch and support lending, but parliament is not taking this view. The consequence of the rejection of the amendment could be profound. If financing does not become availible to potential homeowners and entrepreneurs, it could mean that the economic stagnates and undershoots is target of 5% growth this year.
Elimination of Transactional Currency Exchange Rate
Given the fact that Iran’s currency exchange rate has been stabilized at IRR 35,000 recently and there are growing signs that the country will implement a single foreign exchange system, the predicted exchange rate is between IRR 34,000 to 35,000. The long mooted policy is already being enacted in defacto means in some corners of the economy.
Iran’s Deputy Minister of Industry has said each day the Central Bank receives a list of goods which should no longer be given the official foreign exchange rate. He added that the Ministry of Industry does not prioritize any group when it comes to allocation of the official FOREX rate. He also said now that the elimination of those receiving official foreign exchange is picking up steam, even importers are making no objections, and, for this reason, it seems that the government is implementing its policy in a proper way until more complex legislative and regulatory means can be used.