Lower Rates to Boost Iran’s Economy
By Mahdi Goodarzi & Mojde Rezaee
Of the major challenges with which Iranian manufacturing companies are struggling is the liquidity lack. This comes mostly from banks’ lack of a rating system to properly distribute banking resources in addition to high interest rates on bank deposits, which have raised financing costs.
Considering the still under-developed role of Iran’s capital and debt markets in financing, producers seeking for facilities largely refer to banks. Unfortunately, not only have banks’ troubled balance sheets lowered their ability to grant facilities, they have also been placed in an unhealthy competition to absorb money just to meet their previously made commitments to depositors. The final result has been nothing but higher interest rates on deposits, burdening banks with even more commitments. The rise in interest rates has eventually increased facilities’ prices. Expensive facilities, when Iran’s economy seems to have just kicked recession and showed signs of growth, will threaten the remained active companies’ survival.
The continuous decline in inflation rate over President Rouhani’s first tenure has reached the real interest rate up to 10%. Just like low real rates that demotivate people to keep their money in bank accounts, high positive interest rates will also scare those demanding for investment facilities. To encourage investment and increase production, the Central Bank of Iran has obligated banks to offer annual 10% and 15% return on short-term and long-term deposits, respectively, started from September 2nd. The current article is to briefly discuss how this ruling is going to influence Iran’s economic conditions.
At the first glance, this policy (of course if implemented by all banks) might seem to have no immediate effect on manufacturers’ expenses, since the interest rate and consequently, the lending rate will come down way slowly. The gradual lowering of this rate, on the plus side, will prevent sudden decisions by depositors to enter durable goods markets.
Statistics have been demonstrating an ascending trend in short-term deposits’ growth with the long-term deposits registering near to zero growth rate largely because of changes in depositors’ expectations about the future of inflation and banking interest rates; this has decreased banking operation volume and their lending power. The 10-day period between announcing the directive and its implementation day, however, allowed the system to absorb new funds (although with higher than approved rate) or change its deposits combination from short-term nature to long-term, saving them from higher liquidity risks beside finding access to more funds to be granted.
To feel the positive effects of lowering the interest rate in the country, the freed capitals from bank deposits must be optimally directed towards the production field as below; otherwise it may add fuel to the fire of speculation in other sectors:
- Prioritizing small-to-medium sized enterprises in granting facilities;
- Developing the capital and debt markets to play a more active role in absorbing funds; and
- Designing different and efficient instruments, including investment funds in general and project funds in particular.
- Reducing investment costs, lowering the interest rate will bring prosperity to production, raise companies’ profit and help materialize their development plans; this will increase companies’ worth, adding to their share prices and boosting the stock market eventually;
- With costs declining, largely if intensified with setting import tariffs that support local production, prices will start to come down and demand will grow; products will then, be able to compete with imported goods;
- Lowering the interest rate and therefore, the lending rate will blow a fresh breath to half-closed manufacturing companies, helping the country kick recession; and
- Lowering such rates will boost production, enhancing growth and the country’s GDP; it will gradually empower the country’s local currency that can lower/control inflation in the long run, in addition to guaranteeing the employment.
Lowering the interest rate and subsequently, the lending rate might also come at an expense for the banking system:
- With the decline in deposits and banks’ resources, which might first happen due to capital flight from banks, banks’ economic activities will fall, resulting in lower profit. Experts, however, assume that as long as the real interest rate is positive, banks will not face a heavy migration of funds.
- Lowering the lending rate is expected to result in demand growth for facilities due to their rather cheaper price; this might end in budgeting banks’ resources which might, itself, raise the probability of rentier activities, decreasing quantity and quality of loans. It is worth mentioning that currently, banks are not capable of granting loads of loans; this requires boosting banks’ financial resources, which might be done first by raising their capital adequacy and then, by the government settling its debt to the banking system. Noteworthy to say, banks’ postponed demands originate, to a large extent, from high interest rates on facilities in the first place.
- If freed but not directed towards production, the flood of capital might cause speculations in parallel markets like forex, gold and housing, increasing inflation; in this case, this plan will not only fail to pull Iran’s economy out of recession, but also will ruin the government great accomplishment of curbing the inflation rate.
Being all said, it appears that the policy to lower the interest rate has upsides, including decreasing banks’ liquidity risk and lowering companies’ expenses; it has been implemented in a way that is anticipated to impose no heavy shock on the economy and other markets. Keeping deposits interest rate balanced, in line with the inflation, will encourage depositing, adding to the volume of facilities available at banks, which itself will make possible granting cheaper loans and bring about economic prosperity to the country.
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