The Forum for Partners in Iran's Marketplace

January 2019, No. 90


Bomb of Liquidity & Bomb of Unemployed

The exchange rate variable, as is obvious from its title, is a “macro” variable and is not considered to be “inherent consistency.”

Dr. Masoud Nili, economist, answers questions on the economy from his critics. Excerpts: 

One of the most detrimental incidents that cause long-term and widespread damage is big leaps in exchange rates. The huge destructive role of these leaps is that it disturbs macroeconomic stability and imposes uncertainty on the economy. The great dimensions of these harmful effects have led a large part of the macroeconomic literature to focus on how to avoid these fluctuations. Accordingly, the prevention of unwanted jumps depends on the gradual and mild adjustment of the exchange rate within the framework of a “credible” macroeconomic program for regulated reduction of inflation that is coupled with cuts in inflationary expectations.

The exchange rate variable, as is obvious from its title, is a “macro” variable and is not considered to be “inherent consistency.” Politicians in our country have always and decisively adhered to this advice by some domestic economists who considered the exchange rate “acceleration of gravity” or “Pi”, and regarded this dream attainable. Both the groups, namely politicians and certain economists abhor two propositions of economics: One is the relationship between inflation and exchange rates, and another is the relationship between liquidity and inflation. The platform of these domestic economists is in line with the aspirations of most domestic politicians. These economists have even more interesting analyses. They believe that consumption of energy, water, commodities and many other items has nothing to do with their prices. But the high consumption of these items is rooted in the ambiguous factor called “institution” or “structure”, which is never said what it really is. One can only guess from this perspective that the price of these items, regardless of inflation, should remain constant as a measure called “non-manipulation of prices”. So here too the principle is for the prices to stay fixed.

One can only guess from this perspective that the price of these items, regardless of inflation, should remain constant as a measure called “non-manipulation of prices”.

Various studies on Iran’s economy show that its chronic inflation is due to the high growth of liquidity, as the largest institutional failure of the Iranian economy, which is rooted in largely fiscal deficits imposed by policy making institutions on producer firms, banks and the government which are ultimately provided by the Central Bank of Iran (CBI). Although these imposed deficits are done with goodwill on behalf of politicians to check rising prices, this action is the main cause of inflation and arousing incentives in state officials to put pressures on economic enterprises. When we do not address these mechanisms and do not use the theory of economics, the only factor that remains to explain about the unpleasant economic changes is the role of some economists influenced by structural adjustment policies, who themselves may be affected by the insinuations of international organizations and institutions.

The study of monetary base components in 2014 shows that the growth of bank debts to the CBI was the most important factor in the growth of the monetary base this year. Therefore, the most important challenge to control the monetary base and inflation in 2015 will be the banks’ debt to the CBI. In analyzing the factors affecting the achievements of 2014 and the upcoming issues in the next year, it can be concluded that what has already been effective in improving the economic performance, namely the absence of a new shock and macroeconomic stabilization, trade and foreign currency openings, and other measures are all categorized at the policy making level; however, the removal of the barriers that will stand in the way of national economy from now on will require institutional reform: Issues such as determining the fate of securities and creating markets for government debts, leverage exploitation from the development budget, quantitative and qualitative development of the capital market, structural reforms in the banking system, and creating a commitment in the government to adhere to financial and budgetary discipline, including priority institutional reforms. The continuation of economic success in 2015 is tied to these reforms. One can say that in 2015, inflation will hit the hard core, and economic growth will hit its hard shell, and continued success requires major steps taken by the government and the people.

In 2016, I raised the term super-challenges and the necessity of national discourse on how to solve them and introduced the problem of the banking system as one of these super-challenges. In addition, during the second conference on Iranian economy in December 2017, I showed that chronic inflation and how it is exposed is the main factor in adopting anti-growth policies in the Iranian economy; and I emphasized that the mechanisms that make it in the country’s economy continue to be active.

“The Iranian economy is currently facing two large time bombs: One is the high number of inactive people compared to active population, which is a very big proportion. The second is the liquidity bomb. These two time bombs are not set yet and do not show the time of explosion. Inactive Iranian population lives in the population of the working people, and short-term actions should be taken to ensure that they would not run out of patience. Therefore, contrary to the claims made, the issue of liquidity and its effects are not related to this year and after the effects of inflation, but rather it was accidentally rooted in a period in which inflation was declining towards becoming one digit.

Liquidity Growth & the Role of Private Banks

The creation of private banks was one of the policies of the Third Economic Development Plan. However, the policies of the plan did not concern the creation of private banks, but rather it included a series of policies that their implementation, even incompletely, made the best economic performance of the country over the past four decades. The reduction of the achievements of the Third Economic Development Plan, which was agreed by the vast majority of experts and decision makers of the country, and was elaborated and implemented with the efforts of a bunch of experts and economic decision makers, is far from fairness and expert judgment. During the years of the third plan, despite incomplete implementation, the economy of Iran experienced an average growth of 5.7 percent and an annual average inflation rate of 14 percent the result of which was improvement in welfare of households along with a unique improvement in income distribution.

However, study of the role of private banks and their current situation requires taking into account of the entire path for monetary and banking policy in the past years since the creation of private banks to the current situation. In fact, the discontinuity of the path and the connection of the starting point to the final point and the conclusion based on the fact that the conditions created at the end point are the disadvantages of the starting point is tantamount to inexpert simplification and inattention to the complexities and policies adopted in its mid-term since the formation of these banks after the third plan, up to date. This kind of argument about private banks is like someone considers marriage the cause of divorce. Because the starting point for divorce was marriage, without looking at the developments that have taken place in the middle period.

Private banks were launched after the third development plan aimed at creating competition in the banking industry and generating a transformation in the banking services. The entry of private banks in the early 2000s led to significant changes in the services provided to bank customers and cuts in the finished cost of money. Four banks were added to the banking network during 2004-2005, and the number of banks increased from 11 to 15. But during the time span 2005-2012, banks experienced a two-fold increase and their number rose to 30. Explaining the current state of the banking network cannot be done regardless of the developments that took place at this stage and the factors affecting banking by different sovereign institutions, which in a comprehensive way took ownership of the vast majority of the private banks and virtually changed the nature of their privatization.

As the banking system, with the arrival of private banks, was experiencing a new environment of competition, since 2005, with the change in the government approach to economic policy, setting controlled interest rates was intensified, and in fact, the mechanism for setting the price of monetary services which is the most important factor in shaping the motives of monetary and financial market activists were disturbed. This occurred at a time that due to a significant increase in oil revenues as well as government policies on housing development, the monetary base grew through a rise in net foreign assets of the CBI and banks’ debts to it. In fact, since 2005, the economy has witnessed a significant development at the level of monetary variables in proportion to the size of the economy (GDP) so that the ratio of the monetary base to the nominal GDP, which was going down during the years of the third plan implementation, changed course as of 2005 and assumed an upward trend.

Development of the nominal sector of the economy affected by these factors, along with the suppression of the bank deposit interest rates, have turned banking into a rentier activity, so that any entity or group whose financial scale was at the level of a project took advantage of the regulatory weakness of the CBI in monitoring banking activities and benefited from the significant gap between the deposit interest rates and the returns created in the economy caused by inflation or other factors and by access to liquidity profited from possessing money.

These conditions, coupled with the boom in the housing sector in this decade brought about by the Dutch disease and the government policies in the development of the housing sector made the banks turn to relationship-based loan granting and aggregate corporations and inject part of their resources into real estate disturbing the cash flow in the banking network. Along with these factors, the intensification of the economic sanctions in the late 2000s caused some firms not to be able to repay back their loans, and this caused an increase in involuntary default on the banking network, which aggravated the financial constraints. In fact, what makes the current situation in the banking system a reality is the set of events in the field of macroeconomic policies in the 2000s, the change in the nature and ownership of a large part of private banks, and the weakness of the supervisory authority plus external conditions.


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  January 2019
No. 90