An Iranian economic/political figure, in a recent meeting of experts, warned against overemphasizing the issue of budget deficit as being the main cause of inflation. He said such an overstatement is “a geopolitical mistake and a big political lie; those who want to topple the government inflate this issue whereas the problem is corruption and the financial imbalances plaguing banks.”
In this article, I try to list the main contributors to banks’ financial imbalances and consequently the government’s budget deficit. Note that budget deficit refers to the additional annual expenditure of the government over its revenues, regardless of whether it has been specified in the annual budget [the document] or not.
Gholamreza Salami, the former head of the Iranian Association of Certified Public Accountants, prefaced his editorial in the Persian daily Donya-e-Eqtesad with this note. A translation of the text follows:
The government’s debts to the banking system currently account for 10% of the money supply and the banks’ debts to the Central Bank of Iran constitute 22% of the monetary base. Without doubt, budget deficit is the source of this huge debt.
Of course, state-owned banks have no option but to lend the Iranian government money and finance their own deficit by borrowing from the central bank. In other words, to contain the runaway inflation, the government has been legally prohibited from borrowing from the central bank and therefore it bypasses the law and finances its budget deficit by borrowing from banks and indirectly becomes indebted to the central bank. Therefore, it is crystal clear that a significant part of the banks’ imbalances is caused by the government’s budget deficit; this is not a political lie.
Another reason behind imbalances in state-owned banks and some private banks is their huge current and accumulated losses stemming from payment of interest on their lost resources [like paying interest to clear what is owed by passing bad checks]. In other words, banks have spent a fraction of the depositors’ funds to cover their huge accumulated losses instead of granting loans and earning profits, and so they have to borrow to pay the deposit interests.
To contain the runaway inflation, the government has been legally prohibited from borrowing from the central bank and therefore it bypasses the law and finances its budget deficit by borrowing from banks and indirectly becomes indebted to the central bank
Calculating the compound interest on the government debt is impossible; this is also legally true about debts from the non-governmental sector but banks receive compound interest from their debtors by extending the principal and interest for months and years. This approach is definitely not possible to apply to the government.
Since the lion’s share of state-owned banks’ accumulated losses followed the extension of debt relief by the government, another fraction of the imbalance in question has emanated from the government’s budget deficit [as the government is legally obliged to pay the costs imposed on banks by the debt relief to them through the budget mechanism].
Bonds issued to finance the government’s budget deficit, which is bought by the banks, either compulsorily or voluntarily, should also be added to the debts of the government to the banks. In doing so, the share of the budget deficit in the banks’ imbalances can be measured more accurately.
Of course, corruption [cheap loans granted to some entities] is to blame for a part of the banks’ imbalances as well. In the words of the aforementioned economic/political figure, even a freshman of economics and finance knows that when inflation hovers around 40-50%, granting loans with 18% interest and sometimes at lower rates gives an edge to “the superior genes” [a catchphrase referring to individuals related to those yielding influence and connected to positions of power], who welcome the forgivable 6% penalty on overdue debt payment and postpone the repayment of loans for years.
The Central Bank of Iran’s stipulation that banks cannot apply interest on overdue loan payments obliges them to allocate additional resources to cover these payables in their balance sheet. And when the volume of these payables snowball [which is multiple times the global average due to the rentier nature of the domestic loaning system], they have to pay compound interest to their depositors without receiving a penny from the payables in question. This is also a cause for imbalance.
This may not directly stem from the government’s budget deficit, but a closer look reveals that it is not so irrelevant after all. [The government is to blame] because besides its [faulty] policymaking and creation of such predicaments, the government, together with its subsidiaries and quasi-state enterprises, is considered the biggest debtor to the banking system.
Thanks to the difference between the inflation rate and the interest rate, banks, non-governmental banks in particular, have channeled part of their deposits to high-risk and sometimes insider investments. They have practically removed deposits from the cycle of banking operations.
Such investments are occasionally risky. In many cases, the banks’ conventional sources of income have decreased, but their obligations to pay interest to depositors have remained intact. This also results in banks’ imbalances.
