The Central Bank of Iran says it will revise its policy interest rate in the interbank market if it discerns that inflation expectations are rising.
In a report analyzing macroeconomic variables in the last calendar month (ended July 21), the CBI said “at present it does not see the urgency [or need] to change the policy interest rate”.
The policy interest rate is an interest rate that the monetary authority sets to influence the evolution of the main monetary variables in the economy (consumer prices, forex rate, credit expansion, among others).
Taking stock of economic variables last month, the CBI said that inflation expectation declined slightly, and by extension “the negative real interest rate dropped” last month.
Real interest rate is an interest rate that is adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor.
“If the spike in asset prices signals rise in inflation expectations, and the descending order in the interbank interest rate is maintained [then] changes in the interest rate corridor [IRC] may be required,” the CBI said.
IRC is a system for guiding short-term market interest rates towards the central bank’s target/policy rate. Under the IRC structure, the CBI sets the floor and ceiling of policy rates and lets other money market rates, such as interbank rate, move within this setup.
The interbank deposit rate (the lower bound of IRC) presently is 14%. The upper bound is 22%. Interest rates have been declining in the interbank market in recent months reaching 18.08 last week.
Major asset markets, such as the bourse and currency market, are highly sensitive to interbank interest rates. Lower rates make investment in such markets rewarding while higher rates have the opposite effect.
Decline in Inflation Expectation
Pointing to changes in the composition of broad money supply in the previous calendar month, the CBI said that in the 12 months ending July 21, the share of money (M1) declined to 34.9%, down from 61.7% in March.
M1 is composed of physical currency and coins, demand deposits, travelers' checks, other checkable deposits and negotiable order of withdrawal (NOW) accounts.
CBI said curtailing M1 growth means that customers’ deposits are parked longer in banks and long-term deposit is gaining traction.
Without providing details, the regulator said broad money supply rose 9.9% in the four months since the beginning of the fiscal year, down 0.9 percentage points compared to the 10.8% in the corresponding period last year.
This is while the monetary base is expanding at the tremendous speed due mainly to the government’s fiscal indiscipline. It rose by 12.8% in the four months, up 10 percentage points compared with its growth in the same period last year.
The CBI ascribed the substantial expansion of monetary base to the former government’s move to borrow for discretionary spending from the CBI.
Apart from the discretionary spending, the CBI also blamed the monetary base growth on discretionary payments for the guaranteed purchase of wheat – a long-standing state policy implemented by successive governments.
As per the report, the CBI paid 33.4 trillion rials in discretionary funds to the Organizations Targeted Subsidies to be transferred to the Government Trading Corporation of Iran for buying wheat from local farmers.
Despite notable growth in the monetary base, the CBI said “it had partly managed to neutralize the impact of the government’s borrowing on the money supply by regular implementation of open market operations.”
The CBI has prevented unbridled expansion of money in the interbank market by implementing reverse repurchase agreement (reverse repo) in the past four months to collect excess liquidity of banks in the interbank market.
In a review of the asset markets, the regulator said prices rose in the housing, stock and currency sectors in the preceding month. Data show the rising trend has continued into the current month.
