Monetary and Capital Market Exclusive, March 2004

Monetary and Capital Market in Iran

Credit Operations and Corporate Activities

	The low efficiency in the official monetary market have caused the wide gap between the lending rates of official banking systems and the free markets and consequently resulted in economical rents.
Dr. Hussein Assadi, Managing Director of Iran Foreign Investment Company

The main objective in modification of the “Financial Markets” is, of course, to better facilitate finances in corporate environments. However, it is unfortunate that, so far, the performance of these markets have been based on trial and error and also in many instances resulted in financing the government expenditures. Statistical limitations related to information on corporate finance methods, especially in the industrial sector has prevented an accurate analysis on the conditions and efficiency of the country’s financial market.

The low efficiency in the official monetary market have caused the wide gap between the lending rates of official banking systems and the free markets (even sometimes the official interest gained through well controlled official credit institutions) and consequently resulted in economical rents. At times, due to the many constraints in obtaining loan and credit facilities through the official channels, corporations tend to go through unofficial and free markets to obtain their financing needs, which cause the prevalence of “dated” checks and development of “interest free funds”.  Even the private banks have not been able to bring competition into the country’s monetary markets because they have focused on services and the volume of their operations is small.

On the other hand, one can refer to the unwillingness of banks for paying obligatory facilities to the industrial sector, which could be clearly understood due to the significant differences between the bank performances with their respective approved budget. Meanwhile, high interest rates have, at times, led to default of bank loan installments.

At the same time, the capital market, as another pillar of corporate finance is facing problems. This small market utilizes almost a single tool, limited in term of geographical coverage and is more or less state-run that have not had any significant effect on the country’s economic development process. Although small companies face more acute credit problems compared to big companies, the conditions in the capital market, however, are such that small and medium companies mainly rely on monetary markets for finance.

Furthermore private companies cannot take much advantage of stock market facilities because corporate bonds are a new phenomena in Iran. At the same time, attention to problems of monetary market has led to major efforts, by the government, for removing existing problems. For example, attention to articles 94 and 95 of the Third Plan Law for inauguration of an electronic stock market, the establishment of regional bourses in the country as well as the establishment of a commodity bourse are to name just a few.

Of course, there have been proposals for creating an inter-bank competitive environment, increasing the number of financial audit institutes and independent underwriters with a higher authority to create a more transparent market and also for giving ways to establishment of an independent Security Commission supervising the issuance of bonds in order to eliminate information asymmetry considering the possible existence of moral hazard and stock market disability for dealing with such issues.

Nonetheless, solving institutional problems for solidifying the government’s ruling role and reducing its control over the financial markets need more effort. The overlap between country’s budgetary and the monetary systems, legal role to supervise the credit operations of banks without monitoring corporate activities of such institutions and issues arising from the conflicts of  interests, more acutely felt, with the case of the Central Bank of Iran; which has simultaneous presence in current structure of the four ruling bodies overseeing the stock market, which has always led to the dominance of the banking systems compared to the capital market, are among the most important instances with regards to segmentation between “monetary” and  “capital” markets.

Academically speaking, disintegration of monetary and capital markets and the relationship between short-term and long-term interests depend on supply and demand of short-term bonds (which are dealt in the monetary market) and long-term bonds (which are dealt in the capital market). The interest rates on such bonds with set maturity date are determined through supply and demand of the same type of bonds; with no effect on the other types.

At present, some observers believe that creating competition between monetary and capital markets can reduce interest rates because the capital market must work as the most competitive section of the economy; even though segmentation of financial from monetary policies is obvious according to economic principles. However, we must note that to make decisions about segmentation or even integration of the financial market, care should be taken not to allow repeated presence of the government to go beyond large-scale supervision and lawmaking in such a way that despite all efforts made to reduce the government’s role in the country’s financial market, the market would be again obliged to obey the government and competition in the stock exchange should not depend on the government’s interpretation. Therefore, the government’s presence in the capital market must be similar to presence of securities commission in other countries and it should play the role of a regulatory body. Of course, when forming a supervisory body independent of the Central Bank, various points including crisis management should be taken into consideration. Because changes in the interest rate would be ensued with changes in family expenses and wealth as well as the inflation rate and investment decisions and can, therefore, affect monetary policies.

Global experiences in this field are varied. During the past two decades, theories related to corporate finances and corporate governance were closely intertwined with theories related to financial brokerage and financial structures. Most eyes were riveted on information asymmetry in financial markets and costs of monitoring and where as the importance of the different methods; that is, the indirect finance method (publishing bonds) and the direct finance method through banks vary greatly in accordance with every country’s economic regulations, the role of banks is still prominent. Recent experiences in developing financial structures led to a standstill in the process of separating markets and each of the monetary and capital markets assumed their roles in corporate finance in a consolidated manner. Banks and other financial institutions are increasingly being merged. In addition, banks guide many investment funds and are mingled with insurance groups within the framework of holding companies. In other words, they are among major partners to and players in stocks and securities markets. In fact, reactions of various countries to division or unification of financial markets have varied according to the importance attached to macroeconomic issues and priority of such indices as inflation, employment or increase in investments. On the whole, presence of banks in the Iranian capital market could be studied in view of their state-run nature as opposed to the private culture governing international banks.

At present, externality and attachment to markets, industries and in general, global economy has been stressed as one of the most basic tools for development and as a large-scale priority of the country in large-scale decision-makings including the 20-year outlook document and the general outlines of the Fourth Economic Development Plan as well as the country’s industrial development strategy. In this regard, the role of foreign Iranian investment companies in creating and boosting contacts between domestic financial market with regard to capital and monetary operations and changes (especially technological) in the global economy, its achievements and attraction of foreign capital has become more important. Presence on the international markets through foreign investments would be followed by positive external effects the most important of which would be access to technical know-how, information as well as transfer of technology to the country, especially to domestic financial markets. Obviously, the facilitating role of taking part in such activities cannot be denied.

Meanwhile, to develop exports in the future and obtain competitive power to develop markets, the current trend of foreign investments should be protected and increased; so that, in addition to realization of the above goals, the country’s economic presence in target markets would be consolidated. Also, serious attention to investing surplus oil revenues in international markets would lead to diversification of the country’s forex revenues while creating added value to it which would lay new grounds for attraction of foreign investments within the framework of new cooperation and establishment of an atmosphere of trust toward the country. Comparative study of successful experiences by other countries also shows that establishing such external organizations is essential for establishing contacts between domestic economic requirements of various countries and the international economy. For example, the goal of foreign investments by the government in Kuwait is earning forex revenues through oil exports just as is the case with experiences regarding expansion of export markets through foreign investments. Experiences in Norway indicate that financial shocks resulting from budget deficit could be controlled through investing surplus oil revenues.

Iran Foreign Investments Company: Growth of global trade, especially foreign investment in the mid-1970s, along with increasing oil revenues in Iran during that period, encouraged the Iranian government to invest as much as one billion dollars in other countries through surplus oil revenues. Following the victory of the Islamic Revolution and due to problems resulting from eight years of imposed war, the government lost the opportunity to pay attention to previous foreign investments or find new opportunities. After the end of the war, however, and during the reconstruction period the way was paved for the establishment of a new company known as ‘Iran Foreign Investments Company’ through a review of former economic policies, so that, activities related to scattered investments made by the government outside Iran could be conducted under a single management. On this basis, most of the government’s investments in other countries were officially transferred to the said company and its executive operations started in March 1998. The goal of Iran Foreign Investments Company, based on its articles of association is investment and joint cooperation with legal and real entities in the field of justifiable production as well as industrial, mineral, commercial, financial and service activities outside the country and economic management of such investments. At present, most investments by the company are made in steel production, mining, banking and forming investment baskets through cooperating with creditable world-class capital management companies. Such investments have expanded in various geographical domains including Europe, Middle East, North Africa, Brazil and Central Asian nations.

Today, Iran Foreign Investments Company is trying to review its assets’ portfolio. The preferred fields for future investments by the company include financial services such as bank, insurance, bourse and establishment of investment baskets, high-tech IT industries as well as power plant projects and petrochemical industries. At present, the majority of medium-term investments by the company include investment and partnership in joint ventures or purchasing potentially profitable stocks.