Will Low Rates Help Rescue Manufactures?

Finance Desk
Will Low Rates Help Rescue Manufactures?
Will Low Rates Help Rescue Manufactures?

When banks announced last month they would cut deposit rates by three percentage points, most market observers hailed the long-anticipated move, not least because it was a decision made by lenders themselves–and not by another decree from the regulator.

The fact that the inflation has fallen from a whopping 40% in 2013 to single digits after decades made a rate cut inevitable. However, what was conspicuous by its absence from the banks' move was the reduction in lending rates hovering at 22-20% -- reportedly among the highest in the world.

This provided the critics with new fodder to attack the ailing banking sector and its performance over the years that leaves much to be desired. Banks decision to lower deposit rates is geared to serve their own narrow interests, the critics say. The fact that they left loan interest rates unchanged is an indication that helping the struggling private businesses is the last thing on their minds, they claim.

However, those familiar with Iranian lenders' dire conditions know the reason for their reluctance to offer cheaper loans. The lenders themselves are in deep trouble, burdened by $25 billion of sour loans, undermined by botched investment schemes and isolated by years of sanctions. They are obviously ill-prepared to ramp up lending while sick banks long ago choked off credit to companies.

While pressure on banks to lend more may seem a convenient short-term strategy to bail out struggling SMEs, in the long-run it will prove to be a replay of past mistakes–ignoring the writing on the wall that demands meaningful reforms for improving the business landscape.

The Parrot that Ceased to Be

Appeals for credit to the moribund production sector and the struggling SMEs are both legitimate and well-intentioned. The manufacturing sector has rarely been in a worst state than it is now: 60% of the country's SMEs are facing closure according to Ali Yazadani, managing director of Iran Small Industries and Industrial Parks Organization. Some 1,502 manufacturing units have been foreclosed by the lenders, 25% of which have shut down and the remainder are punching well below their weight.

The private sector is concerned about its future. Without immediate help many SMEs will go under and that is something the government is desperately trying to avoid. But pumping cash into inefficient units willy nilly risks a return to earlier palliative policies and a surge in bad loans.

While it makes sense to salvage industries that have hit upon hard times due to the recession or any other reason, forcing beleaguered banks to lend beyond their capacity will only precipitate a banking crisis. The government, however, is planning to allocate 160 trillion rials ($5.1 billion) to help 7,500 semi-closed production units. The Ministry of Industries, Mining and Trade has announced that by July 22 the struggling manufacturing can approach banks for up to $970,000 in new credits.

Do Away With the Excesses  

Although it is not yet clear how the latest scheme will be implemented, policymakers should ensure that it helps not harm. While caring for short-term needs, the government should look within itself to find the nub of the problem. For years economists have warned about the drawbacks of a state-dominated economy throttling growth. Add to that a Kafkaesque bureaucracy and a litany of unwanted and unhelpful regulations choking free enterprise. Knowing that as long as the bureaucracy remains unfriendly to entrepreneurship, bailing out the apparently inefficient and underperforming units will hardly solve the problem.

The bureaucratic labyrinth is what allows banks to circumvent regulations and offer interest rates higher that the regulator has decreed (in response to the inaction of banks, the Money and Credit Council recently ordered banks to lower their lending rates.)

If the specter of rigid state control does not permanently disconnect with the centralized economy, the prospects for attracting foreign investment will look bleaker.

Last month Arj Company, the country's oldest home appliance manufacturer, announced that it was on the brink of bankruptcy. The sad story of Arj, which has become the poster child of a state-dominated economy, should serve as an important lesson. Despite the fact the company had been overtaken by Bank Melli Iran, the state-owned lender, it was deemed a failed and inefficient entity.

Market forces are and can be brutally honest, but in the end that is the only sensible way forward.