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September 2017, No. 85


Banking

Interest Rate Cuts, Forex and Inflation


The suitable workings of managing currency fluctuations to maintain financial stability and economic growth and the health of the banking system were among other major talking points.


The 27th annual Conference on Monetary and Foreign Exchange Policies was held in Tehran on July 1-2 with a focus on financial stability.

Discussing the Central Bank of Iran’s role in maintaining financial stability, the institutional and operational structure of capital and bond markets, credit crunch and the role of financial stability in curbing inflation with the goal of attaining sustained economic growth were the objectives of this conference.

The event also focused on the effects of imbalance in budget and quasi-fiscal activities on financial stability in which the effects of these categories will be measured against the balance sheets of the banks and CBI.

Factors exerting an influence over the convergence and divergence of rates in financial markets, ways of creating convergence between rates in financial markets, price wars and their effects on banks’ risks were also reviewed.

The suitable workings of managing currency fluctuations to maintain financial stability and economic growth and the health of the banking system were among other major talking points.

The role of the banking system’s international ties in managing the foreign exchange market and the longstanding issue of unifying the dual foreign exchange rates were also discussed in the confab. 

High Bank Rates: A Challenge to Investment, Production

On the first day of the conference, First Vice President Eshaq Jahangiri, Minister of Economic Affairs and Finance Ali Tayebnia, CBI Governor Valiollah Seif, CBI Deputy Governor Akbar Komijani, and Head of the Management and Planning Organization Mohammad Baqer Nobakht delivered keynote speeches.

Jahangiri referred to the administration of President Hassan Rouhani’s general tendency of keeping away from reducing rates through official directives, and noted that the current rates present challenges to investments, production, and macroeconomic endeavors.

After a round of negotiations and meetings last year between the CEOs of private and state-owned banks and a subsequent decree by the Money and Credit Council, a top financial decision-making body, bank interest and deposit rates were officially set at 15% and 18% respectively.

However, a number of factors, including a shortage of capital and credit crunch in the banking system, have caused the real interest rates currently offered by a number of banks to be around 20%. The interbank rates are also in the same ballpark even though, as Jahangiri pointed out, they have been brought down from the 30% witnessed at the beginning of the government’s tenure in Aug 2013.

Echoing the President, who recently announced that banking reforms will play a central role in his agenda for the second term in office, the first vice president said reforming the ailing sector is “one of the key policies” that could help the country overcome its significant hurdles.

A problematic 11% general unemployment rate and, more importantly, a troubling 25% unemployment rate among young graduates, coupled with the low purchasing power of people, were identified as major problems by the official.

“Iran will need to generate one million jobs a year to live up to the task,” he said, noting that women should be a main focus for the jobs.

According to Jahangiri, unifying the country’s dual exchange rates, a plan which was supposed to be implemented last year but has been delayed, because conditions for a stable and lasting rate unification are yet to be provided, will be followed up as a “high priority” in the next administration.

He said the government has been successful in stabilizing macroeconomic indices despite the fall in the oil revenues, stressing, the success was the result of policies for financial and monetary discipline, management of liquidity and controlling inflationary expectations.

Jahangiri said the 11th government managed to hand over financial and monetary stability to the 12th government, and this in his words was a “big achievement.”

More on government achievements in the banking sector, he said inter-banking interest rate was lowered up to 17 percent from about 30 percent when the 11th government took over. “Of course the rate has gone a bit higher but it is expected to be lowered. Such a bank rate will make investment, production and economic activities more difficult because growth will be expected to take place when bank rates are lowered in tandem. In the final days of the 11th government, the officials in charge need to and intend to make a precise assessment of the policies adopted in the period.”

The top government official said some policies for single parity rate system will be transferred to the next government and it would definitely be pursued in the next government.

“All officials and organs have the duty to move in line with the policies of the Economy of Resistance,” he said, adding that appropriate investment is needed for better economic conditions. “Over recent years, investment in Iran has been highly negative, following a falling trend and is not yet in a favorable condition.”

To address unemployment problem, foreign investment should be absorbed, while attending to non-oil exports and export of goods and services, commented Jahangiri.

Elsewhere in his remarks, the VP thanked bank directors and managers for their invaluable efforts and said the banking system has afforded a great deal of help and assistance to the small- and medium-sized institutions. He called for banking reforms and said it is the key to overcome challenges facing the country.

Since about two years ago, there have been efforts to provide legislation on amendment of the banking system so that Iranian banks will operate on international standards in dealing with the overdue debts and capitals and build links with the international banks.  

A Source of Eroding Stability


“Iran will need to generate one million jobs a year to live up to the task,” Jahangiri said, noting that women should be a main focus for the jobs.


The economy minister referred to the high interest rates as a “significant obstacle to growth of investments and employment and a source of eroding stability”.

“The real rates, which are in no way proportional to the inflation rate of around 10%, have increased the costs of production units and lowered the competitive power of domestic production while lowering people’s capability of repaying loans, which itself reduces the profitability of lenders,” he said.

Tayebnia underscored the importance of reducing the unruly interest rates for causing a boom in the beleaguered housing sector, stressing that getting the sector out of recession will not be possible without rate cuts.      

Owing to the significance of rate cuts which, if unachieved, could dash all hopes of sustained growth and job creation, the official pitched the idea of creating a specialized committee “in the foreseeable future”.  

The minister spoke of the advantages of the government’s plan to increase the capital of state-owned banks and improve their capital adequacy ratio, saying their total capital of 110 trillion rials ($2.93 billion) four years ago increased to 590 trillion rials ($15.73 billion) last year.

Furthermore, “100 trillion rials ($2.66 billion) of construction resources were supposed to be allocated for capital increase of banks as part of the current annual budget, which was not approved by the Parliament”.

He urged all official bodies to prioritize bank capital increase because investing in the banking system has the biggest impact on economic growth.

He further provided statistics on the average GDP growth of Iran in the past 40 years, which he put at 2.3% and called inadequate. 

Interest Rate Monitoring Body

Tayebnia also said Iran has been successful in establishing brokerage relationship with more than 240 foreign banks. He said the conference has turned into an effective institution for debate and dialogue on the most important economic issues of the country.
He stressed that for the current Iranian calendar year of 1396 (2017-18), which is the initial year of the Sixth Five-Year Economic Development Plan, the average economic growth rate of eight percent, one-digit unemployment rate and one-digit inflation rate have been targeted.

He noted that last year, the government had managed to eliminate the inflationary and deflationary crises hitting the country since the years 2012 and 2013.

The minister said as far as short-term measures are concerned, the last Iranian year 1395 (2016-17) marked the year of non-inflationary vibrancy with an economic growth rate of 12.5 percent and an inflation rate of nine percent. Major portion of the economic growth rate was caused by an increase in oil production and export, he added.

“However, without oil economic growth reached 2.9%, 5.4% and 5.6% in the second to fourth quarters of the year from minus 1.8 percent in the first month of the year.”

Looking into the long-term plans, it should be said that low level of growth, harsh fluctuations, and tiny share of productivity in growth have turned into a serious problem for the economy, said the minister, adding that the average growth rate of 2.3 percent cannot address social demands and prepare the ground for elimination of poverty. “So, we will have no way but jump to higher levels and sustainable economic growth so as to end economic vulnerability and make it resistant, while eliminating unemployment.”
Tayebnia said maintaining economic stability and tranquility is the most important factor for achieving economic growth. “Public trust in government has been the most important achievement of the 11th government.

All should join hands to safeguard the achievement.” Elsewhere in his address, Tayebnia said one more key measure taken by government over recent years has been lifting restrictions facing the banking system. This was achieved following implementation of the Joint Comprehensive Plan of Action (Iran Nuclear Deal) and lifting of the sanctions, which led to establishment of banking relations, including establishment of brokerage relationship and facilitation of banking exchanges, he added.
He reiterated that at the time of sanctions, only 30 small and risky banks cooperated with Iran but today, more than 240 banks have brokerage relations and in the near future, relations will be established with more banks.

He also hailed government success in banking domain such as controlling inflation expectations, controlling forex market, ensuring falling inflation rate and higher economic growth rate.

The minister proposed creation of a financial monitoring body to ensure proper implementation of the policies and their evaluation in order to resolve the problems in the way of cutting interest rates. 

Uncertified Credit Institutions under Fire

The CBI governor made a jab at uncertified credit institutions that have grabbed many headlines recently, as many angry depositors demand their capital back from a number of these discredited entities.

Seif said their activities in the past few years have forced lenders to initiate “an unprincipled competition over bank interest rates”, which was exacerbated by the entry of bonds published by the government to clear its debts and subsequently affected their profitability and capital adequacy.

According to him, the banking system allocated a total of 570 trillion rials ($15.2 billion) during the first two months of the current fiscal year that began on March 21, registering a 16.4% rise compared with the same period of last year.

About 70% of the loans were in the form of working capital, he added.

Seif also referred to statistics released by the Central Bank, according to which a 12.5% GDP growth was achieved last year, mostly owing to a boost in oil and derivatives exports.

“The non-oil sector has also improved immensely, upgrading its negative total GDP growth in the first quarter of last year to a positive 3.9%, 5.4% and 5.6% in the next quarters respectively,” he said. 

Islamic Banking on the Rise  

Seif told the conferees Iran has the largest financial system based on Islamic, or Sharia law. He said Islamic banking assets are now being used by 2 billion people and Iran’s Islamic banking assets account for over 37% of world’s total.

Iran’s Islamic banking assets are $482 billion, according to Dubai government data from 2014. That’s more than in Saudi Arabia, Malaysia and the United Arab Emirates combined.

“The Islamic Republic is among the few countries that have adopted Islamic banking principles and now some non-Muslim individuals are embracing usury free banking on moral grounds,” he said.

The CBI chief noted that a long-term vision for the promotion of Islamic banking is in the making to make Iran a hub of Islamic finance. He also highlighted the need for upgrading the codes of conduct governing the Iranian banking system in line with international standards.

Current Iranian banking laws were first ratified in 1983 and remained unchanged throughout the years. But two recent bills–one concerning banking laws and the other central banking regulation – is pending the lawmakers’ approval. The bills call for major changes in the banking laws and ensure a stronger and effective regulatory role for the CBI. 

Technical Mechanisms to Cut Rates

Komijani outlined technical mechanisms in three axes for reducing interest rates. According to him, “influence of the debt market on the money market”, “inappropriate expansion of investment funds,” and “high interest rates set by auto manufacturers’ bonds”, have caused interest rates stickiness. Commenting on organizing investment funds, he said the major part of these resources are received in the form of deposit, but a small share of the resources flow into the market and over 70% of them return to the banks. In this regard it has been decided that the proportion of investment in the money market and the capital market of these funds stand at 70% and 30% respectively and in the next stage in order to prevent fluctuations in the balance sheets of the banks stand at 60% and 40%.

Pointing out that the high participation interest rate by automakers is another reason for the bank interest rate to stand high, he stressed that with regard to the approvals of the Money and Credit Council, the interest the automakers can pay to their customers is about 3% higher than the interest set for the banking system. Meanwhile, the withdrawal interest rate should be for a period of one year and the automakers should abide by the specified formula. Komijani noted that if the automakers act otherwise they would be deprived of the facilities they are supposed to receive or have received from the banking system.

Elsewhere he said Iran’s inflation rate is expected to reach 12.2 percent, with its economic growth standing at 4.6 percent and its liquidity rate at 20.2 percent in the current Iranian calendar year of 1396 (to end on March 20, 2018). He said a look at chronology of economic growth in Iran in the 2012-2016 period shows that it stood at 12.5 percent in 1395 (2016-17) and the economic growth rate minus oil has been following a positive trend since the first quarter of the year.
The main reason for growth in Gross Domestic Product (GDP) was growth in oil, he added.

“Due to international sanctions, we failed to fully utilize the capacity available by oil but due to achievements gained by the sector, we managed to take moves forward,” he added.

He said the country gained good growth in the industry and mining sector: It showed growth rate of 6.9 percent from minus 4.6 percent.

He also put growth in the agricultural sector at 4.2 percent and hoped the trend will continue this year too. 

Banking Sector Indispensable to 8% Growth

Head of the Management and Planning Organization said Iran is aiming for an average annual growth of 8% over the course of the next five years and to achieve this ambitious goal, the banking sector needs to extend 1.8 quadrillion rials ($ 57.6 billion ) in credits to private firms. Mohammad Baqer Nobakht added that the country’s growth target and its commitment to turn itself into a regional power hub by 2021 are simply a “must” and not some “option.”

“Financing through the money market takes center stage here and banks as the most important finical intermediaries should be able to provide 24% of the  resources to businesses in need,” he said in the opening remarks to the conference.  

Achieving 8% growth is a tall order for the country emerging from nearly a decade of punitive sanctions over its nuclear program. While it has succeeded to regain most of its share in the global oil market, the Islamic Republic is still facing challenges to attract foreign investment in other sectors and dispel the fears of major international banks in doing business with it.

Nobakht, a trusted ally of President Rouhani, referred to dismal growth rates of the past including the minus 6.8% rate when Rouhani took the helm of the government in mid-2013 with 380 trillion rials ($12.1 billion) of debt to the banking system alone.  While in the three months ending March 20, 2015 the country secured a 2.9% growth, and 4.4% growth for the first quarter of the current fiscal year (started March 20), most of other periods have been marked by lackluster performance. The government has set its eyes on 5% growth this financial year.  

Part of the growth target will have to come from investment at about 15.4%, according to Nobakht. This would require 7.2 quadrillion rials ($230.5 billion) in annual investment. Given the critical status of banks and the heavy reliance of the country on the banking system for funding, domestic and foreign investment would provide a breath of fresh air to the economy.

As part of the Sixth Five-Year Economic Development Plan (2016-21), the government wants to engineer 8% growth, by supplementing banks’ business lending with 370 trillion rials ($11.8 billion).  

As part of its plans to revive the economy, the government has also identified some 7,500 struggling production units, singling them out for 160 trillion rials ($5.1 billion) in new loans.

Nobakht said the 2,000-page plan blueprint is the most carefully-devised blueprint for its practicality and efficiency. “Some of its articles have even been clarified down to the operation level.” The sixth plan is now being reviewed in Parliament.

Alluding to this year’s theme of the Islamic Banking Conference, “Interaction of Usury Free Banking and International Banking”, Nobakht acknowledged that long-time isolation had widened the gap between the accounting and banking standards and those of global banks, calling for officials and experts to end this disparity. 

IFRS Adoption, Risk Management of Banks

Due to the importance of conforming banks’ balance sheets to International Financial Reporting Standards and establishing risk management departments, the second and final day of the conference focused on these two issues.

International and domestic banking experts elaborated on ways of reforming the risk management systems of banks and the necessity of their compliance to IFRS to connect to the international banking system.

The Central Bank of Iran first released the IFRS-based balance sheet templates in February and seriously pursued the complete implementation of IFRS and other international banking requirements such as Basel Accords to improve financial transparency and the international operations of Iranian banks.

 

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