Business And Markets

CBI Reforms: A Road Not Taken

CBI Reforms:  A Road Not Taken
CBI Reforms:  A Road Not Taken

Resistance economy has become the face for change in Iran in recent years. In actuality it is taking steps to circumvent sanctions against the country. Under this pretense, the central bank is taking a shot at overhauling the banking system. They unveiled a plan with three main objectives last week. The intended changes are welcome. Yet, their methods of implementation and how they would measure success are not quite clear.

The bank is aiming to control inflation, stabilize the banking system and unify the foreign exchange regime while decreasing exchange rate fluctuations. Given the current economic conditions, the central bank of Iran will be hard pressed to push towards these changes successfully and without repercussions.

 Weeding Out Inflation

Iran is suffering from hyperinflation and just reducing money supply isn’t going to rein it in. The bank cannot raise interest rates either. Firstly, monetary policy, including the decisions on interest rate, is not set by the bank. It is made by the Money and Credit Council – a council within the CBI, largely controlled by the government. This makes monetary policy susceptible to political meddling. Secondly, any move to raise interests or contract money supply would create a backlash by manufacturers and economic growth hawks. They would argue that the bank is killing the economy with a credit crunch. Due to this pressure the MCC has actually lowered interest rates in the past year.

Thus, for controlling inflation, the onus falls on the administration. A large part of the inflation is the legacy of the profligate policies of the former government. A cutback in these policies and putting government finances in order will go a long way on curbing inflation. Another part of the inflation is a consequence of financial sanctions, which raise the costs of importing goods.

Though the criticism by manufacturers is somewhat justified, they stand to gain if the government moves to curb inflation. Yes, manufacturing does direly need financing and it lacks it.

 But the instability of the economic and political landscape alongside inflation does far more damage than anaemic financing. Growth in manufacturing comes from improved productivity and stable economic conditions, not necessarily from cheaper money.

Besides any increase in money under current conditions would only double up inflationary pressures. The inflation venom must first be taken out of the system. Then as the economy stabilizes a shot of financing will aid business growth.

 To Tame Bankers

The CBI’s secondary target is stabilizing the banking system – An arduous challenge in itself. Iran has eight state-run and 19 “privately owned” banks all of which have invested heavily in the ownership and management of commercial entities outside the banking sector.

The central bank, in conjunction with the ministry of economy are forcing banks to sell their non- banking operations in a three-year time frame and return to making profits through financial operations. Bankers contend that under the prevailing economic conditions, such operations are far from profitable because they are not allowed to offer their own interest rates.  

Yet, the more daunting crisis lies in the balance sheet of these commercial banks. A mixture of corruption, cronyism and recession has led many firms to default on their debts. Now, Iranian commercial banks hold between them over 870 trillion rials ($26.2 billion at market rate) of non-performing loans, according to the latest announcement by the CBI. The true amount is far greater as banks reschedule the due date on loans to make records healthier, economists and government officials contend.

“Nearly all government-owned commercial banks and some private banks are technically insolvent,” said Mousa Ghaninezhad, a prominent economist to the Financial Tribune.

Now, the CBI wants to tackle the corruption and slowly remove the toxic debt from the system. The governor has repeatedly said most of the bad debt is held by just over 500 individuals and that the bank will take action against them. So far no palpable step has been taken.

Untangling the banking system requires transparency. Part of the bank’s plan relies on it. The CBI should perform regular stress tests and publicly release their results. Also the bank needs the judiciary system’s full cooperation if it is to deal with corruption. The judicial process is a long and hard one in Iran and given the ambiguous laws, countering corruption may currently prove futile. In the end, a restructuring of debt seems unavoidable and yet its prospects seem improbable. Forcing a loss on depositors is the last thing on the administration’s mind.

 Liberalizing Forex Market

Last but not least comes the CBI’s elusive target to unify the foreign exchange regime. To do so, the bank must close the gap between ever increasing market rates and its officially offered rates. The government is trying to do this slowly, too slowly perhaps. The market rate for the dollar is rising by the day. The US currency is up by 15.1 percent versus the rial this year, while the official bank rate has only gone up 8.4 percent. Analysts are already saying the dollar is undervalued in the market.

But this whole currency issue raises a darker question. Are the officials really in favour of a free market? Iran’s currency market lacks depth, so the idea of a free floating currency is farfetched. But, reading on between the lines iterated by officials there is a desire to command the market. They still want to instruct, not regulate. Actions have consequences in the free market and although officials seem eager to control the ramifications of their deeds in the market, they show little signs of restraint whilst committing those actions.

If the CBI really wishes to stabilize the currency, it must introduce financial instruments while moving towards a managed float. Futures, options and swaps increase market depth. They also help manufacturers hedge against currency fluctuations. As for the valuation of the currency, given that the bank has always overvalued the rial in recent history, it should leave the market to its own devices and take up a more supervisory role.    

But all this is inconsequential given the central bank’s current state. It lacks independence and is too prone to political influence. Its foreign exchange reserves are depleted. It is also cut off from the international markets due to financial sanctions placed against it. So the bank has little room to manoeuvre in order to implement its financial reforms. Regrettably, much of the bank’s success in executing its plans relies on external elements and not the least on the eventual outcome of Iran’s nuclear negotiations with the West.