Liquidity growth in Iranian economy
started at 20 percent, then it reached 25 percent, and later even 30
percent was accepted as ordinary.
Picture of Iranís Oil-Dependent Economy
Dr. Masoud Nili,
To review Iranís economy at present and
its outlook, many factors which have undergone considerable changes should be
taken into consideration.
Seven factors are more important than
others and taking account of them as a group is more important than studying
every one of them individually.
The first factor is the approved budget
for the current Iranian calendar year (started March 21, 2006) as the most
important economic phenomenon which has been followed and implemented within
frame of governmentís decisions. In better words, it encompasses governmentís
programs from January 2006 up to the end of the Iranian year, 1385 (March 20,
2007). The first external policies of the government were reflected in budget
supplement for the past Iranian year (ended March 20, 2006) and another part
of them has been manifested in the current yearís Budget Act. The second
factor is changes in liquidity and its effect on the domestic economy. The
third factor is related to new policies on performance of banks and forceful
determination of profit rate of bank deposits.
The fourth factor is nuclear policies
and their effect on Iranís economy with the fifth factor being energy price
and situation of energy consumption.
Governmentís policy in stabilizing
prices is the sixth factor while the seventh factor is foreign exchange rate
and its determination.
Perhaps, we better compare todayís
conditions with the situation in 1974-77 because current conditions are very
similar to conditions of those years. Before 1974, Iranís oil revenue stood at
1.5-2 billion dollars a year, which increased to 10 billion dollars in 1974
and to 20 billion dollars in 1977.
Therefore, the country was faced with
rapid growth in oil revenues and Iranís oil earning quintupled in two years
and increased ten times in less than four years. In reaction to revenue hike,
governmentís budget increased by 3 percent, but further rise in budget in the
following years was less steep. Historical experiences show that developments
in relation to increase in foreign exchange resources are usually bigger than
developments under those conditions. For this reason, it is generally believed
that Iranís budget in 2006 is the most expansionary budget during all
In 1998, average oil price stood at 10.8
dollars per barrel and oil revenues grew fourfold in about 7 years. Meanwhile,
state budget in 1998 was less than 71,000 billion rials, but Iranís budget for
2006 has been estimated at 600,000 billion rials; that is, while oil revenues
have quadrupled over a 7-year period, state budget has increased eightfold
during the same period.
The effects of liquidity growth
resulting from budget supplement of 2005 and Budget Act of 2006 along
with such a high growth rate for liquidity will be very detrimental to
Before 2002, government spent an average
of 15 billion dollars in foreign exchange. The figure increased to 21 billion
dollars in 2003, to 30 billion dollars in 2004, and to 36 billion dollars in
2005. It seems that the figure will reach 45 billion dollars in 2006, which is
indicative of serious budgetary dependence on petrodollars.
The Third Economic Development Plan
aimed at reducing governmentís dependence on oil revenues to less than 12
billion dollars, but it actually soared to more than 40 billion dollars in
2006. Therefore, the governmentís budget experienced such a great leap in 14
months from January 2005 to march 2006, when the government was determined to
offer Majlis with a budget supplement. Considering this reality, one can
conclude that the country witnessed one of its biggest financial developments
in the Iranian year, 1385.
Although the government justifies
increased size of government under the aegis of increase in developmental
budget, it should be noted that every rial of developmental budget in later
years should be considered at a higher rate than one rial in current budgets
and, for example, if a hospital is built through developmental budget,
expenses on physicians, nurses, staff and other parts of the hospital would be
supplied through current budgets. On the other hand, if developmental budget
grows 70 percent, but production of cement and iron beams, which are needed to
implement developmental projects, only increases 10 percent, demand for such
goods will increase and lead to higher prices and runaway inflation. When
price of capital goods increases, it will reduce investment by the private
Like physicians who are
attentive to blood pressure and temperature of their patients, the first thing
which is focus of attention in economy is volume of liquidity. Average growth
of liquidity in the world is about 13.5-14 percent, but corresponding figure
in Iran is, unfortunately, very high and it has even crossed the red line
during the past three years. However, the inflation rate has not yet moved
proportionate to such growth in liquidity and this has prevented
decision-makers to think of a solution.
Liquidity growth in Iranian economy
started at 20 percent, then it reached 25 percent, and later even 30 percent
was accepted as ordinary. Liquidity growth rate reached 36 percent in 2005
with the volume of cash hitting 900,000 billion rials. Once experts were
worried about a 40-percent growth in liquidity, but now it has reached 50
percent and is expected to exceed 50 percent in the current year with the main
reason being proposed budget supplement according to which 8-9 billion dollars
of foreign exchange was liquidated into rial. Conversion of that foreign
exchange to rials will have a great effect on growth of liquidity, part of
which will be belatedly experienced in 2006. Therefore, the effects of
liquidity growth resulting from budget supplement of 2005 and Budget Act of
2006 along with such a high growth rate for liquidity will be very detrimental
to Iranís economy.
Under this situation, we get close to
Saudi Arabiaís conditions. The difference is that liquidity growth rate in
Saudi Arabia is very high, but inflation is near zero. The reason for low
inflation is lack of industries which has made Saudi Arabia vulnerable to
imported inflation. Since imported inflation is not higher than 2 percent,
excessive inflation growth does not happen in Saudi Arabia.
Perhaps we better liken
decisions made by the new government and Majlis and the current situation of
the banking system to tsunami. For many years, profit rate has been a central
discussion by the Central Bank of Iran and the banking system. In all those
years, debates always focused on three major rates: profit rate, foreign
exchange rate, and energy price, which have taken a converging course over the
past years. Those debates are still in full force. Advocates of lower profits
rates believe high profit rate to be the main reason behind lack of
competitiveness in the country and compared Iranís profit rate to
corresponding figures in such industrial countries as the United States,
Europe and China where profit rate is below 10 percent. Undoubtedly, lowering
profit rate of bank deposits will not encourage people to deposit in banks,
but reducing profit rate of bank facilities will increase demand for loans and
those facilities and increased demand will, in turn, lead to establishment of
parallel markets and make those markets even bigger.
Proponents of the plan remind difference
between profit rate of facilities and deposits and currently mention their
problems, but they think that by putting pressure on banks and lowering profit
rate of bank facilities, the banking system will be improved.
Banking system is the most competitive
industry in the world; that is, if one bank fails to perform efficiency, its
share will be immediately taken up by another bank while the reverse is true
here. In Iran, people are dependent on banks and when they form long lines in
front of banks before working hours begin, it shows that banks will have no
problem with regard to customers and their work is guaranteed. Meanwhile,
state-run banks are seriously dependent on rules and regulation and inefficacy
is inherent to governmental banks.
Banking system is the
most competitive industry in the world; that is, if one bank fails to
perform efficiency, its share will be immediately taken up by another
bank while the reverse is true here.
When profit rate of bank facilities is
reduced, demands for those facilities will increase in parallel and the bank
should report to applicants on its performance and should increase the number
of its branches and staff to be capable of handling increased demand.
Therefore, the idea that reducing profit rate of bank facilities will not harm
depositors is not true. Iranian economy is based on economic rents and if we
wanted to mention two major characteristics of such an economy, they would be
firstly, oil and, secondly, banking system.
The different between value of money
which is taken from bank and its value in the market, is high and that
difference leads to rent seeking. If we coupled this factor with growth in
budget and liquidity, which are the most important reasons for increasing
inflation, rent margin will increase and this is the main breeding ground for
administrative corruption in the country, which adds to number of those
seeking economic rents.
Iranian nation still remembers the story
of low-priced dollars which were apparently used to implement developmental
projects. They still see unfinished barns along the roads which should have
been completed many years ago.
This is what is called a populist
approach to the issue. People can be attracted under such conditions in the
short term because they think it will lead to expansion of justice. However,
when government spends a lot due to increase in oil revenues, people will not
pay attention to large-scale consequences of that spending. In fact, we can
continue to attribute inflation to a group of inconsiderate people and,
inflation remains a strange phenomenon just as is the case with the Iranian
economy. At the same time, inflation has been eradicated in the world and
there is no inflation in advanced economies. For example, Turkey which was
grappling with an 80-percent inflation rate for years will have one-digit
inflation in 2006 or South American countries which were suffering from
several-thousand-percent inflation rates are now experienced one-percent
inflation rates. Only five countries remain with high inflation rates and Iran
is one of those countries. Unfortunately, most people think that the
government is treating price hike in a physical and punitive manner.
We will import 7-7.5
billion dollars worth of energy most of which will pertain to gasoline.
Nowhere in the world, has a government bought 6-7 billion dollars gasoline
because most of their needed gasoline is produced inside their respective
countries. The whole foreign exchange revenues of Iran reached about 7 billion
dollars in 1988, part of which was spent on weapons and the rest, which
amounted to about 3 billion dollars, was spent on importing gasoline. Our
current gasoline imports are tantamount to all foreign exchange revenues of
those years. Some have proposed that new refineries should be built inside the
country, which is not very different from purchasing gasoline, because Iranian
oil refineries have low production capacities and, in that case, a large part
of oil will be used inside the country to produce gasoline instead of being
exported. In this way, countryís oil revenues will take a nosedive.
Oil exporting countries are
generally vulnerable to Dutch Disease. It means, when we are faced with
plentiful resources, selling those resources will affect foreign exchange rate
inside the country by reducing it. This will increase inflation and price of
imported goods falls in the face of rising price of exports. Finally, we reach
a point where we are currently standing: that is, we import oranges from Egypt
and foreign chocolates which can be even consumed by low-income strata. As a
result, domestic producers lose their profits. This situation will lead to
where Saudi Arabia has already reached; that is, a point where domestic
production of no commodity is economically justifiable.
At present, there are 12
economic indexes to be controlled by the Central Bank of Iran of which
11 indexes are in critical conditions and only one index has resisted in
the face of calamity and that index is proportion of liquidity to
Central Bank of Iranís reserves.
unification of foreign exchange rate, domestic production became economical.
However, this will only last for a short time after which domestic production
will not be economical anymore, goods are imported in lower prices, domestic
industry is stifled and housing and service sectors prosper. Therefore, such
growth is like a balloon, which has been inflated asymmetrically, showing a
State-run companies have
been barred from changing price of their produced commodities, but inflation
is still rising. The government accounts for the lionís share of domestic
economy and gross domestic product is dependent on the state-run sector.
Governmental companies are not able to
invest through such a price control mechanism. For this reason, they resort to
banks and take loans, which will deprive the private sector from bank
facilities and drive them to the brink of bankruptcy.
I showed through a research last year
that foreign exchange rate can be kept constant against growing liquidity up
to a certain time, but it will get out of control sooner or later. At present,
there are 12 economic indexes to be controlled by the Central Bank of Iran of
which 11 indexes are in critical conditions and only one index has resisted in
the face of calamity and that index is proportion of liquidity to Central Bank
of Iranís reserves. Since Central Bank of Iranís reserves is enormous, nobody
is purchasing foreign exchange. This will be to the opposite of past years
when everybody was buying foreign exchange and when Iran accepted UN
resolution 598, foreign exchange rate fell by half in less than an hour and
many economic activists had a heart attack. In case of new sanctions, the
situation will become unsafe and increased inflation and liquidity will get
the country close to crisis.
Therefore, sanctions should not be
looked upon as merely mechanical changes. The spring which has been compressed
for many years, will be suddenly released. At present, 12 levers have been
employed in the country, which are moving against one another. We are moving
toward challenge in our diplomacy, but our annual budget is being directed
toward abundance of resources. As long as wages and salaries are increasing,
on the one hand, while limitations are being imposed in other fields, on the
other hand, problems will not be harnessed. In case of new sanctions, higher
inflation and increased foreign exchange rate will be inevitable.