In response to the current slump in economic activity, the government has embarked on subsidizing consumption of durable goods and cars, along with easing monetary policy, by cutting bank reserve requirements.
It is doing this to stimulate consumer spending and increase demand for Iranian goods, whose manufacturers, especially automakers, have seen inventories rise as a result of tumbling sales.
“Conditions are such that there is no solution apart from a short-term reversible easing of monetary policy,” wrote presidential advisor, Masoud Nili, in a note published by many Iranian news outlets.
The government says sanctions bar exports, so an increase in exports is off the cards. Domestic consumption’s share of GDP (50%) is more than three times that of exports (15%). So, stimulating domestic consumption is the wiser policy and the only option left. Consumer demand must be stimulated to get the economy going.
Central Bank of Iran Governor Valiollah Seif admitted to the plan’s inflationary effects a week after it was unveiled.
Opposing monetary expansion in Iran’s current circumstances, economist Mohammad Tabibian said domestic production and employment problems should be solved by addressing the supply side of the economy.
“The current [close to 15%] inflation shows there is unmet demand,” he said. Instead, the government is stimulating consumption using credit, fiscal spending and monetary aid to exporters.
“Injecting money will create a short-term real effect and long-term inflationary consequences,” the economist wrote in Donya-e-Eqtesad.
Part of the target behind the government’s short-term stimulus plan is reviving stock market activity.
“That can never be done by injecting money into the equity market,” Tabibian believes, saying its failings come from underlying economics.
“Economic development can lead to growth in the stock market but boosting equity markets does not lead to economic expansion; rather it distorts financial markets.”
The economist also questioned the execution of the plan. As an example, he cites the case of auto manufacturers who had griped about having over 100,000 unsold cars in their warehouses.
Car buyers were saying the ask price was too high for the poor quality offered. So now the government has given both parties a big rent.
The CBI lent 80% of a car’s price as loans to buyers at 16% in a four-year repayment scheme. The two big automakers, IKCO and SAIPA, sold nearly half a year’s production in the first six days of the plan. It added up to 110,000. The central bank called it quits and stopped the financing when the ceiling was reached.
Tabibian reckons the total rent given to automakers and the lucky car buyers is worth 1.4 to 2.4 trillion rials ($40 to $70 million at market exchange rate). This is if you account for the four-year repayments and the 20% to 23% deposits earn in banks. The actual figure is higher if you consider lending rates that hit 28%.
“The fact that people bought cars at a cheaper price shows they got their word though. So did the manufacturers, who sold their cars at their ask price. But both these cost the public in the form of inflation, environmental costs and continuation of inefficiency,” he said.
Not Fully Monetized
Tabibian said Iran has not completely gone past an agricultural economy, which faces water shortage.
“Other sectors are like inflatable castles. If you don’t blow in them with oil money, they quickly show signs of deflation. Iran’s economy, as far as the public sector is concerned, is not a fully monetized economy,” he said.
Unlike advanced economies, which defend the value of their currency and its stability, monetary policy has been an afterthought in Iran. The government spent windfall oil revenues and borrowed from the central bank whenever crude prices fell. Meanwhile, the central bank’s role has been one of damage containment.
Acts like rationing foreign exchange supply and drafting foreign exchange budgets distort the value of the rial as Iran’s common unit of value. The government should be able to plan its expenses in rials and let departments buy their needed foreign exchange from markets. Drafting part of the budget in foreign exchange—usually dollars but lately euro as well—and giving some goods or industries foreign exchange rations distorts the rial’s value.
The preferential treatment of industries and individuals also creates rent, corruption and bolsters one industry with cash at the expense of draining others.
“Say you give two companies 100 rials, but give the second company permission to exchange 50 rials to a foreign currency at a cheap rate. Then the two 100 rials are not equal in value. The second company’s 100-rial budget is worth more. Thus, the meaning of 100 rials becomes flawed,” Tabibian said.
Another example is the government giving essential foodstuff like rice, cooking oil and sugar to its employees as some kind of aid or support. But due to the government’s size in the economy—after years of bungled privatization some 60% of the economy remains centrally planned—this action also distorts the price of goods and in turn the rial’s.
One of the worst cases is municipalities repaying contractors by getting them to build extra floors that would otherwise be illegal to build. This method, called selling “density permits” has been widely used to raise money by municipalities. This means the receiver is allowed to breach city regulations and build more on a plot of land.
A similar example is the government’s “debt repayment” schemes in which it has ceded control of defunct state companies as repayment of its debt.
Disrupting the Value Chain
Some government actions are disrupting the value chain, Tabibian believes.
Subsidizing gas feedstock for petrochemical producers transfers part of the gas sector’s profits to petrochemical companies and their shareholders. All because of a bureaucratic decision.
It’s the same story with the government’s purchase of agricultural products, transferring the profits of value created by farmers to the wider public. The hefty profits the construction sector is known for is because the government caps steel and cement prices regardless of market demand.
“Iran’s currency needs to become a credible and transparent unit of value. The pricing process for goods should be sorted out and value creators should receive their fair share from their work,” he said.
This is a first step, but it’s a prerequisite for sustainable economic growth.
Iran must do away with laws, “that in spite of the good intentions of the regulators, are against production, investment and entrepreneurship”, Tabibian concluded.
