Economy + Policy E1:R6

Economy + Policy E1:R6

Key Developments

Iran's parliament has approved a budget amendment design to help the government pay-off long standing debt, now at IRR 6 quadrillion.

◢ Concerns linger that the amendment, which had been rejected four times, will create inflationary pressure by expanding the money supply. 


Budget Amendment Approved

In a key act of cooperation between the Rouhani administration and the new parliament, a budget amendment has been approved. 

For years, the administration has faced hefty debts to banks and contractors. According to the Minister of Economic Affairs and Finance Ali Tayebnia, the government has total debt of IRR 6 quadrillion (USD 193 billion), of which IRR 1.1 quadrillion is to banks. The money supply is hovering around IRR 10 quadrillion.

As the banking system plays a central role in financing public projects in Iran, frozen resources have created major credit problems for the government in the recent past, especially when coupled with low oil prices. This has pushed the administration to find new methods to clear its debts.

The government has proposed using arbitrage by revaluing the Central Bank of Iran's foreign currency assets, taking advantage of the fact that since 2012 the rial has lost considerable value. This will provide the government a way to pay a larger proportion of outstanding debt with its current resources. 

The proposal had been rejected for times, before recently being approved by the Parliament's budget and planning committee before passing in a vote on the floor. Under the Note 35 of the Budget Law, the administration will be allowed to pay up to IRR 45 trillion of the banks’ debt to the Central Bank of Iran through the arbitrage process. However, the note must be executed under the following conditions:

  • Any increase in monetary base through the arbitrage process is forbidden.
  • The clearance of debt is only possible after the Audit Organization confirms the amount and the debt.
  • Any increase in government debt to banks is forbidden by the end of this year.
  • The government does not need to pay interests if it pays the principal of the loans. 
  • The government must make quarterly reports to the Supreme Audit Court, Parliamentary Budget and Planning Committee, and Economic Committee, while the court is the body in charge of supervision.
  • The Ministry of Economic Affairs and Finance is in charge of executing Article 103 of the National Audit Law approved in 1366. That means the ministry has to register the used resources in the statements related to the Budget Law.
  • This not should be executed based on a bylaw suggested by the economy Ministry, Management and Planning Organization and the CBI and approved by the cabinet members. Under the approval, the parliamentary economic committee has identified the share of each bank from the unreleased resources.

Critics Worry About Rising Inflation

Critics argue that the government’s proposal will cause the money supply to increase drastically, as the arbitrage process would increase the monetary base in the form of the government’s and banks’ debt to the CBI as well as net foreign assets. As assets are reevaluated, net foreign assets will increase in rial terms, and as a result, the CBI will need to print money based on the reevaluated assets. Usually, the inflation rate increases more rapidly if it is to increase as a result of a rise in the monetary base, rather as a result of a change in the multiplier ratio. Opposition MPs have made a condition that they would agree to the amendment if the government guarantees that the monetary base will remain unchanged.

The government has already made a proposal to clear it debts though the same mechanism under Paragraph B of Article 26 of the Monetary and Banking Act, which was approved in 1351 (March 21, 1972 – March 20, 1973.) Under the article, the government is allowed to go through the arbitrage process only if the CBI has a single FX rate system in place. As the FX system is currently managed as a floating system under Paragraph J of Article 81 of the 5th Five-Year Development Plan, the government is not legally allowed to use the arbitrage mechanism to pay its debt to the CBI. Critics argue that if the government proposal passes through parliament, it would create a precedent for future administrations to use the same method to use CBI resources, a policy that could increase inflation and decrease the nominal value of the national currency.

Critics also argue that it would not be reasonable for parliament to allow the government sell the same dollars it had sold to the CBI 50 years ago, asking for the difference. This trend could end up creating a vicious cycle in which the government borrow from banks and lets banks borrow form the CBI.

Proponents See No Alternatives

Proponents of arbitrage suggest that inflation is unlikely as there would be offsetting changes in the monetary basis across three key components: net CBI assets, bank debt to the CHI, and government debt to CBI. As net CBI assets increase as a result of the arbitrage process, debt will decrease such that the net effect will be close to zero. Proponents also argue that arbitrage is an accounting operation and will not effect inflation. Given that oil prices remain low, proponents of arbitrage view it as the government’s only way to clear its debt.

Along with the proposal to employ arbitrage, the government has also suggested that it will endeavor to significantly increase capital adequacy in Iranian banks. Average capital adequacy rates of Iranian banks currently stand at 4%, lower than the Basel I regulations. Banks following Basel III regulations are required to have a capital adequacy rate of about 18%.

Likely Outcome

Despite what proponents of arbitrage argue about the offsetting changes in the monetary base, we believe an inflationary impact is very likely in the event of the government going forward with the proposal. 

Even if the monetary base remains unaffected by the arbitrage process, it could increase as the banks, inject the newly received funds into the economy. Banks are under pressure to put capital to work, and a new spate of loans to businesses and households will increase the multiplier ratio, boosting the money supply. 

However, we do not believe that an increase in the monetary base and money supply will be as significant as critics claim. Given a likely increase in inflation and decrease in interest rates that is the dominant macroeconomic trend, capital is expected to shift from savings to other markets, reducing the amount of quasi money and the multiplier ratio. 

Financial Markets E1:R7

Financial Markets E1:R7