Age-old Inflation in Iran and its underlying constituents over approximately four decades
Written by Navid Kalhor
Iran’s economy has been undergoing decades of chronic inflation and at some specific intervals experienced hyperinflation (1995 & 2012) due to many structural and built-in economic complications and difficulties, impacted principally by windfalls of oil revenues in the course of OPEQ’s golden years in earlier years or at times of troublesome budget deficits afflicting different administrations in the past decades, remarkably high-rocketed when Rouhani’s predecessor was in charge of the country.
The average inflation in Iran generally hovered around 20% in the past 40 years. Taking into account the average growth in the general level of prices for goods and services in Iran and the major reasons behind losing purchasing power among general public, two factors are essentially deemed to explain the presence of this unwelcome phenomenon, burgeoning the monetary base across the economy.
High inflation in Iran can be explained on the hills of growth in foreign assets of Central Bank of Iran (CBI) during periods of insurmountable rise of oil prices worldwide and translation of them in large amounts into the national currency, rial, or, conversely, when the downfall in oil prices pressured the then presidents to turn to the Central Bank to borrow money in order to finance their spending on general and civil expenditures for their respective state –run organizations and cash payments for civil projects all over the country.
Although there was a law passed in the year 2000 hindering the encroaching of CBI’s assets by the government to tackle challenges faced during sliding oil prices, the financial predicament spread out across the economy in the wake of embargoes and the prevailing recession, plaguing almost all businesses in the country, left no way out for the Executive Power but to shift the channel of loan-taking to the state-run and commercial banks to make ends meet.
This dilemma led to Iran’s 10th placement among inflation-stricken countries in the world in the previous decade, bringing along two-digit inflation. Nevertheless, Iran only managed to keep one-digit inflation rate just four times in its CBI’s history. Regarding this, one occurred prior to revolution in 1979 in Iran and the next after this time line.
According to a study done by Islamic Parliament Research Center of Iran, there are seven distinct factors effecting the inflation rate categorically. These are classified into the following arrangement:
- Decree by the government on operating banks to pay loans by using state-owned resources
- Borrowing from National Development Fund of IR of Iran (NDFI)
- Borrowing from Banks
- Borrowing from Central Bank of Iran
- Decree on operating banks to accept illiquid collateral for loan seekers
- Currency policies
- Low independence of CBI
Borrowing from Central Bank of Iran and other operating banks
Above-mentioned points are inseparable ingredients to the inflationary pressures, underpinning its ballooning in the economy in the prior periods by unconventional administrative functions adopted by different administrations, according to the economic experts working on this agenda in the parliament of Iran. In their telling, different unorthodox policies and mandates by governments and the parliamentarians, themselves, hampered economic growth for the country and caused the action of containing employment rate insurmountable for the officials.
Budgetary and fiscal policies in the years ago were the primary negative contributing factors ending up in the rise in average prices of commodities and services, damaging economic stability and sustainable growth in order for different series of Development Plans—we are now in the sixth 5-year Development Plan (2016-2021) –also including the 20-year Perspective Document (ending in 2025) to reach their designated results outlined for them.
As we posited earlier in the text, the governments were prohibited to take out loans from CBI. But, saddeningly, the imposed mandate did not change the nature of liabilities of the governments at the time and made them to get heftily indebted to state-owned banks and other commercial ones, piling up an incredible amount of debts to the banking system amounting to 1,170,000 rials or $34bn currently speaking.
Now what can be noticed at macro-economic level and is an open secret to market practitioners is the triangular linkage between CBI, Banks, and the government in general concerning the matter. In other words, financial turmoil and prevalent lackluster at large in the economy can fundamentally be attributed to these three elements’ role slumping any dramatic promising movement to push for reasonable results in economic indicators.
This episode is notoriously enforced by the government and public sector’s large amount of indebtedness to the banking system by failing to pay off their due and, alas, delayed loans.
Consequently, this issue aggravated the lending bankers’ situation as the resulting outcome of granting facilities with back-to-back default by the borrower left no venue of refinancing for the banks but to beg for money from traditional provider of money, namely, Central Bank of Iran, albeit, forcing interbank rates to climb up since the big borrower never managed to pay back its owed dues, pushing up NPLs (Non-Performing Loans) in the balance sheets of the respective banks which has hit record high of $26bn, according to Tayyebnia, economy minister.
The event naturally enforces the base money growth and is a living testimony of the Central Bank’s non-dependence from the administrations’ decisions and the regulators’ incapability to have its own say and final verdict in urgent situations.
In economic literature, this is referred to as dominance of fiscal policies over the monetary ones, culminating in financial repression in the overall structure of economy.
Some instances in respect to misfortunes of fiscal repression are “obliging operating banks to offer loans to particular sponsored groups by the government, granting loans with less-than-market interest rates, rescheduling or forgiving due liabilities of the indebted clients and accepting certain type of assets as collateral” which can deteriorate and inversely influence creating an efficient and strong capital market, as there are sovereign guarantee backing loan takers to access cheap money with low interest rates rather than risking their money in markets such as stock exchanges, which involves accepting risks in proportion to the reward they might be looking for and in this vein halting full flourishing of the capital market.
Based on the findings reached on repercussions of imperatives imposed by the budget law between 2013/14-2015/16 by Islamic Parliament Research Center of Iran, it is has become evident that a considerable amount of obligations on the banks have been made during the aforesaid period and as a result of such instructions the monetary base climaxed by 31.8%, 13.2%, and 6%, respectively, nevertheless illustrating Rouhani’s administration being victorious in keeping in check its massive proportions and reducing its perilous side effects on economy.
Furthermore, the financial sponsorship provided in this manner for certain individuals and entities increases the probability of unsuccessful payments of these resources by the appliers, as they do not feel committed, wholeheartedly, to pay back the principal and relevant interest to the lender and thus, indirectly adding unduly to government debts.
Last but not least, when banks are instructed to do so, they will not consider risk management seriously and rate their clients in accordance with the required standards to figure out their capacity for repayment of the lent money.
In the light of budget draft proposed annually to the parliament of Iran by the presidents, what is frequently observed in the recent years, while the budget draft was in the process of being reviewed by the parliamentarians, is the annexation of different notes to the articles of the budget.
Borrowing from National Development Fund of IR of Iran (NDFI) and Currency Policies
According to article 84 of 5th Development Plan, share of NDFI from oil and gas revenues was designated to be 20% in 2011 and presumed to go up 3% every year. According to the objectives of the Fund, its resources are only allowed to be used in foreign currency terms and converting them to rial is categorically banned by the same law.
Thus, we can name two factors capable of enhancing inflation if the fund assets are employed in the wrong way. To be specific, they are:
- likely reduction in NDFI’s stake in oil and gas revenues, as presumed in the related law
- Using the Fund not in foreign currencies as specified and translating it to rial, in spite of its articles of association
Should governments make other arrangements for using the Fund’s petrodollars, it will positively put in extra pressure on monetary base on the back of increasing foreign assets of CBI and the aftermath of such destructive measure would be without doubt inflation.
Currency policies, in a lesser degree to NDFI, could play their own role on exacerbating inflationary pressures, provided that the independence of Central Bank is harmed by the relevant administrations in power.
Unluckily, the freedom to execute sound monetary policies by CBI was occasionally punctuated by the then incumbent state officials with printing and creating money without being substantially backed by strong international monies.
This way of creating fiat money while the Central Bank does not have access to its foreign assets due to, e.g., international sanctions on Iranian banking system, peaked up the inflation rate to record highs, never registered in the history of the country, which was more than 50% according to unofficial sources at the time. This was down to non-existence of a reliable metric being reported by the officials then.
This event surged the rial value of foreign assets of Central Bank, skyrocketing money supply and bringing about the resultant, inevitable inflation following such incautious and imprudent conduct.
In the end, the Parliament’s law makers and Executive Power’s policy makers should exercise their best practice in regard to macro-policies designated for expanding sustainable economic growth so much so that monetary and fiscal discipline never gives way to favoritism with certain individuals, groups or entities in the society and when it comes with budget deficits, every incumbent administration that happens to be governing the country’s incomes and expenses should exert its utmost effort and caution to take heed of basic age-old theories of economic schools just like everywhere else in the world to lead its citizens to an agreeable standard of living.
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