CBI Holding the Key to Iran’s Economy Stability
In a healthy economy, the central bank seeks the goal of optimum inflation rate through monetary and foreign currency policies. The Central Bank of Iran, however, aims at maintaining the local currency value, balancing payments, facilitating trades and boosting the country’s economic growth. With our monetary policies lacking the required instruments, the policymaker is left with the foreign currency exchange rates anchoring the inflation rate and inflationary expectations; this is why the administration, in cooperation with the CBI, attempts to fix this nominal value, not considering the balance of national payments and inflation rate fluctuations, despite knowing that our nation inflation is higher than international references and the impossibility of selling the country’s currency reserves in the long term.
Forex rate repression and its consequent jump have taken place in Iran’s economy before in frequent occasions; the long-run sales of currency reserves will reach a critical state at some point and the huge gap between domestic and foreign inflation plus the CBI sudden noninterfering policies will inevitably result in a shock. The last example of the forex shock happened over the winter of the current year.
What Happened in the Market?
When the CBI obliged banks to lower interest rate on deposits by decree in early September 2017, some expected a rise in “deposits flight” to parallel markets like forex and gold. Furthermore, the injection of more than IRR 51,000 bn of the CBI resources for repaying the principal and interest on depositors’ claims at un-regulated financial institutes plus the liquidity soar compared with the economic growth resulted in money supply piling up among people.
Nevertheless, officials in the CBI and the government believed that FX rate would descend in February 2018 in line with the decline in seasonal demand. The US president demanding changes in the JCPOA as a pre-condition for suspending sanctions, however, caused concerns in the country and therefore, fluctuations in the currency rates.
Under such circumstances, the CBI announced the implementation of its “rescue package” to stabilize the forex and gold markets. Dragging the USD/IRR down to a significant extent, this package included three solutions:
- Issuance of certificate of deposit (Denominated in IRR) with 1 year of maturity and an annual 20% yield;
- Issuance of certificate of deposits (Denominated in IRR) backed by USD with 1 and 2 years of maturity and 4%-4.5% annual yield; and
- 6-month pre-sales of “Bahar Azadi” gold coin at IRR 14,000,000 and 1-year pre-sales at IRR 13,000,000.
Post Rescue Package Time
The CBI rescue package managed to reduce fluctuations in the market and put an end to the soaring rise of the foreign exchange rate, especially USD/IRR. However, it hit much criticism, a part of which will be explained below:
Most economists and banking experts accused the CBI of lacking a long-term strategy in its policies for controlling the currency market and while it decided to issue certificates of deposits with 20% return, it had lowered the interest rate on banking deposits earlier. Furthermore, they believe that this package is blind to the roots of the recent fluctuations, which are still active and might bring about another chaos in the market sooner or later.
Referring to non-taking the preventive actions in this regard, some assumed that the CBI delay in executing the “rescue package” has not only resulted in the loss of the country’s forex resources, imposing much cost on economic practitioners by adding to the uncertainty, it also burned the public trust in the government and the CBI, whose compensation will take much time.
From another angle, some have raised concerns over what will happen after the 2-week period, which might push the interest rate in the country upward, adding to production costs and depriving companies of their competitiveness, hindering economic growth and causing an economic recession.
There are also some who believe that the current package, despite the short-term excitement causing in the public, will only compress the inflation spring more, which will definitely go off after the CBI runs out of power to maintain stability in the next year. In fact, the only viable option is to gradually increase the USD/IRR rate according to the simplest form of PPP theory.
FX Rate Effect on the Capital and Debt Market
In order to prevent money supply parade in the FX market, the Central Bank of Iran issued 1-year 20% return certificates of deposits. This affected the expected yield on investment, dragging down debt securities’ prices and increasing their return. In addition to the higher level of risk due to interest rate rise banks have to deal with, it imposed a significant loss on previous buyers of such securities as well.
In this regard, Fixed-Income Investment Funds can be mentioned as one of the victims of such fluctuations over the debt market rates. Most of them had turned their bank deposits into debt securities complying with the “not so far long ago directive” of the CBI and the SEO; as the result, bank deposits, with the highest volume in funds’ portfolios (more than 70%), were replaced with investments in debt securities and equity. The significant hike in the debt market rates, hand in hand with the decreased value of such funds’ AUM, raised their unit redemption rate significantly.
What is the Solution?
The destructive cycle of “FX rate jump-repression” mainly originates from the chronic inflation in Iran’s economy, which itself comes from lack of a proper and effective monetary policy framework, CBI non-independence, the banking system’s structural problems plus lack of financial and budgetary discipline (specifically in the Plan and Budget Organization), which calls for more attention to their uproot in the first place. In this regard, separating FX and monetary policies is of utmost importance, which intensified with a framework to target desirable inflation rate will bring about higher economic growth.
Considering President Rouhani government’s accomplishment in fixating 1-digit inflation rate in the country, taking steps towards the CBI independence is a must for keeping such an accomplishment. But this is only one face of the coin. The other face will be the implementation of structural reforms, specifically in the financing and the banking system to improve the country’s long-term economic growth, which will not be possible without an independent central bank.
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