Is Iran on the right track to managing inflation?

To make the economy stable and predictable, the government needs to put an end to its borrowing habit and cut spending in a significant way, economists believe.

al-monitor Iranian President Hassan Rouhani arrives for the closing statement at the Asian-African Conference in Jakarta, April 23, 2015.  Photo by REUTERS/Darren Whiteside.

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sanctions, iranian economy, inflation, hassan rouhani, central bank, business & finance, business, banking

Jun 11, 2015

To achieve sustainable growth and bridge gaps in employment and living standards, efforts must be directed toward the attainment of a single-digit inflation rate, an elusive target, according to Iran’s authorities and prominent economists who spoke at the 25th Annual Conference on Monetary and Exchange Rate Policies in Tehran on May 31-June 1.

President Hassan Rouhani and his pragmatic economic team feel proud these days of taming inflation to about 15%. However, the officials admit that they will have a long, challenging way ahead to bring general price level of goods and services down further, as they will need to consider "totally different" tools from those so far used to curb 40% inflation of October 2013.

“Inflation has already reached its 'hard core' and maintaining fiscal and monetary discipline won’t be enough to keep it down,” Ali Tayebnia, the minister of economic affairs and finance, said in an address to the two-day event dubbed "Stable Single-Digit Inflation: Policy and Institutional Requirements."

“A 5% inflation rate is ideal for our economy if we want to be among the top 100 nations having single-digit inflation,” the minister added.

Since 1973 the annual inflation rate has been 18.9% on average, with a 49.4% rate having been registered as the highest level in the fiscal year to March 20, 1995, when the economy grew 1.8% under Hashemi Rafsanjani's presidency. The central bank data shows the country has been gripped by chronic double-digit inflation for four decades, though inflation slipped below 10% in fiscal years 1975-76, 1985-86 and 1990-91.

Akbar Komijani, a Central Bank of Iran (CBI) deputy governor who was among the speakers June 1, said the regulator will have to focus on “structural inflation,” which is not caused merely by the excess of demand over supply but built into the economy because of the government's monetary policy.

Komijani believes that an increase in investment expenditure and the expansion of money supply to finance is the major factor responsible for inflation in a developing country like Iran.

But despite the challenges the government will have to face to bring down inflation, Komijani expressed confidence that the policymakers “will bring inflation down to at least 14%” over the course of the rest of this year (ending March 19, 2016).

But even if economic sanctions are eased, the main problem will persist. The government itself has been the root cause of the high inflation as the monetary policymaker has always been influenced by politics. Whenever the budget runs at a deficit, as it has for years, administrations have the right to borrow from the CBI and, in recent years, from commercial banks — a policy that, if it continues, would be a major obstacle in achieving the central bank's ambitious objective.

Shahid Beheshti University's Hassan Dargahi said macroeconomic policies in Iran have been politicized and are not scientifically managed. "This is why the efforts to stabilize the economy have always failed,” Dargahi said in his address to the event that hosted hundreds of economic and financial experts, with 14 Iranian and six foreign nationals attending as speakers.

Dargahi, who holds a doctorate in economics, believes fiscal and budgetary policies have been constantly pressing monetary policy and calls for independence of the central bank as a breakthrough to liberate hosted monetary policymaker. He also complained about the lack of an integrated approach toward the money, finance and foreign exchange markets, suggesting that a special headquarters must be created to achieve “low and stable” inflation.

In Iran, almost all experts acknowledge that to make the economy stable and predictable, the government needs to put an end to its borrowing habit and cut spending in a significant way, a painful treatment that requires structural reforms in key spending areas and the banking industry.

The budget deficit has been a major source of inflation in Iran over the past half-century. Since the 1960s, administrations have encroached excessively on CBI’s resources. The trend was accelerated after the 1979 revolution in an effort to fill the gap in the budget caused by post-revolution unrest, the eight-year Iran-Iraq War and macroeconomic mismanagement.

In the 2000s, excessive borrowing eventually made the parliament to bar the administration from accessing CBI resources. However, the limitation only propelled the government to shift to commercial banks insofar as the banking system has been put on the verge of financial collapse.

Now with the government debt to banks reaching $34 billion (at the official exchange rate), toxic loans approaching the same figure and the sanctions being still in place, Iranian lenders seem to have been left with one option: borrowing from the central bank at a very high interest rate of 34% just to survive.

Pierpaolo Benigno, a professor of economics at Italy’s LUISS Guido Carli, told Al-Monitor at the banking event that “the best way the government can help bring inflation down is to stop borrowing” from the banking system. That will let the exhausted banks take a breath. As another effective tool, Benigno pointed to the interest rates. He wondered why Iran is cutting deposit rates if it's serious in achieving single-digit inflation.

Masood Nili, a top presidential economic adviser and a key speaker at the conference, shared the same idea of what the government behavior could look like, saying the government must pay for the “imbalance” it already created in the economy, referring to its too much spending and too much borrowing.

In an interview with an economic quarterly published by the Monetary and Banking Research Institute, the economist said he sees banking reforms as the “second most important issue” to be addressed after the nuclear dispute with the West is resolved. "If we want to address recession and inflation, we need to find an immediate solution to the banking crisis; since recession will occur once banks fail to provide financing for manufacturing and inflation will increase when lenders continue borrowing from the central bank."

Nili said the “only solution” to the inflation problem is the creation of a vibrant and efficient “debt market,” where government liabilities can be traded.