Interbank rates have been declining over 14 straight weeks reaching 21.09% on Thursday, the highest in one year.
The rate was 19.9% in late March before declining to 17.95% on July 8, the lowest in the present fiscal year. Ever since the rates began to rise steadily. Decline in the first few months of the year was linked largely to the liquidity surplus in the interbank market.
Market observers say the increase in rates is, among other things, indicative of the liquidity crunch in banks operating in the interbank market despite the central bank’s efforts to tame the uptrend with the help of expansionary policies.
Expansionary monetary policy works by expanding the money supply faster than usual or lowering short-term interest rates.
The policy has been implemented through open market operation as the CBI in the past several weeks tried to inject funds into banks via the repurchase agreement (repo) and the so-called “structured borrowing”, in which banks put up government bonds as collateral with the CBI to borrow.
Banks in critical need of funds borrow at 22% from the CBI, which is the upper bound of interest rate corridor (IRC). Lenders with surplus credit park money with the CBI at 14%, the lower bound of the IRC.
The regulator this week injected 241.2 trillion rials ($860 million) into seven banks in the interbank market via repo.
As a component of open market operations, repo is a form of short-term borrowing for dealers in government bonds. In case of a repo, a dealer sells government securities to buyers, usually with short-term maturities, and buys it back at the maturity date at a slightly higher price. The maturity date in Iran’s interbank market is usually seven days.
While the rising interbank rates are said to be going a long way in controlling the runaway inflation, experts say the high rates will undermine the production sector in the long-term and discourage investment in asset markets.
Stock Market Sensitivity
Increase in interbank rates tend to agitate investors in asset markets. The stock market in particular has proven to be highly sensitive to interbank rates and financial experts see a positive correlation between share prices and interbank rates. As such, lower rates make investment in shares attractive while higher rates have the opposite effect.
Market observers say the sharp decline in interbank rates in first quarter of last year sent a “positive signal to the stock market” and was the main cause behind the departure of liquidity from banks to the bourse.
As per data released by the Central Bank of Iran, the average rate dropped to 11.71% in May 2020 from 16.68% a month earlier. It declined to 9.72% in the month to June 22. This coincided with an unprecedented bullish trend in the stock market as the price bubble burst a month later.
Rates have moved upward since then reaching 14.79% in the month to July 22, rising to 19.97% and reaching 22.63% by mid-October before declining again.
Capital market officials have urged the central bank to regulate interbank rates and bond yields to levels that do not undermine the bourse.
