The rise in government borrowing through the sale of bonds does not have a worrying effect on inflation and the nominal interest rate in a stable economy with an inflation rate of 2% and zero interest rate.
However, the impact of such borrowings and debts in an unstable economy like Iran’s with an inflation rate of 50% and an interest rate of 20-30% can be alarming given the inflationary expectations, Ali Cheshomi, an economist, wrote for the Persian-language daily Donya-e-Eqtesad.
A translation of the text follows:
The annual budget deficit leads to the accumulation of government debt. Thanks to oil revenues, the concept and calculation of the Iranian government’s budget deficit is complicated. Non-oil budget deficit is the best criterion to analyze budget deficit, i.e., to calculate the difference between government revenues (including taxes) and its expenditures. The deficit can be bridged through the sale of oil, net government debt and the transfer of shares and government assets.
Up until 2017-18, oil revenues were used to tackle the biggest part of the government’s budget deficit. Total budget deficit stood at 1,190 trillion rials in 2017-18, of which 1,020 trillion rials were addressed via oil revenues and 40 trillion rials via the sale of governmental companies’ shares; the net sum of government borrowing was only 120 trillion rials secured through the sale of bonds.
The net ratio of bond sale to the government’s total spending was 4% in that year, which increased to 14% in 2019-20. The sale of government bonds stood at 440 trillion rials in 2017-18; 740 trillion rials in 2018-19; 960 trillion rials in 2019-20; 1,910 trillion rials in 2020-21; and 2,180 trillion rials in 2021-22. The ratio of the sale of these bonds to the total operating and capital expenditure of the government was 36% in 2020-21 and 25% in 2021-22. The government’s bond sale will reach 3,000 trillion rials in 2022-23, if the government earns 1,900 trillion rials from oil sale and exports.
There is no denying the fact that the inflationary effects of financing the budget deficit through the sale of bonds are much less than direct borrowing from the central bank and the expansion of monetary base. However, the inflationary and real effects of such financing will be destructive for Iran’s unstable economy. The sale of such a huge sum of bonds will reduce the prices of bonds in the secondary market and increase the interest rate and eventually drive up costs for producers.
As the central bank finances government bonds indirectly through interbank and open market operations in recent years, the debt of the government and banks to the central bank would increase, as well as money supply. Their inflationary effects would also increase via monetary base, as it was the case in recent months.
Another adverse effect of bond sales in an economy with double-digit interest rate is the rise in the government’s interest cost. This interest cost is traceable in Murabahah bonds — an Islamic financing structure in which the seller provides the cost and profit margin of a commodity — and similar bonds, which is hidden in the Islamic treasury (discounted bonds).
All in all, the increase in the sale of bonds will raise the interest rate and the government’s overt and covert interest cost, which will exacerbate the budget deficit.
