Domestic Economy

Bumpy Road to Single-Digit Inflation

Bumpy Road to Single-Digit Inflation Bumpy Road to Single-Digit Inflation

With annual inflation rates falling below their long-term trend, economists are speculating whether it is possible to further reduce inflation to a single-digit rate and if so, what measures that would require.

Policymakers and economists chose the 25th Annual Conference on Monetary and Exchange Rate Policies, which was held May 31 and June 1 in Tehran, as an appropriate platform for debate.

Calling the shots, Ali Tayyebnia, minister of economy and financial affairs, claimed that “inflation has already reached its core [rate] and maintaining fiscal and monetary discipline won’t be enough to reduce it further.”

The theoretical framework behind the idea of a core rate of inflation was first laid out by Robert Gordon in a 1975 article. For Gordon, core inflation is its stable, long-term rate for a particular unemployment rate. Calculations of core inflation exclude products with volatile prices, like food or energy.

Nothing was more agreed upon at the conference than that core inflation in Iran is determined not so much by technical factors like the unemployment rate, as by political incentives and obstacles.  

Since the 1979 Islamic Revolution, inflation in Iran has averaged 19.5 percent. If periods of extraordinary high rates of above 30 percent are left out of this picture, average inflation falls to around 17 percent, which is still two percentage points above the current rate of around 15 percent.

Autarkic economic policies during Iraq-Iran War helped to keep inflation down until a sudden drop by over 50 percent in oil prices in 1986 caused inflation to peak just short of 30 percent.

After the war, inflation was successfully brought down by the Hashemi Rafsanjani administration to below the 10-percent mark as trade was opened up and oil revenues were used to increase imports. The value of imports shot up between 1989 and 1992 from $13 billion to $31 billion. Privatization of state assets was also started in earnest.

However, a rapidly growing pile of foreign debt made the government hastily turn around the liberalization plan during its First Five-Year Economic Development Plan (1991-96). This backtracking not only caused imports to plummet back to $19.3 billion in 1994, but also fueled inflation, which hit an all-time high of 49.4 percent in 1995.  

A combination of gradual and professional liberalization with stable oil prices helped Mohammad Khatami’s government keep the inflation rate consistently below its long-term average in the late 1990s and early 2000s.

Low and stable inflation rates were undone by Mahmoud Ahmadinejad’s administration with its stress on populist economic redistribution policies.  Money printing by the Central Bank of Iran was used to finance ever-expanding subsidies as well as a controversial social housing scheme known as Maskan-e Mehr. These expenditures were backed up by increasing global oil prices, which peaked in 2008. Expanding oil revenues could keep down the tide of inflation temporarily, but when oil prices dropped in 2009 and anti-Iran sanctions (over the country’s nuclear energy program) were tightened by the EU and US between 2010 and 2012, inflation shot up once again.

Since the coming to power of President Hassan Rouhani in the summer of 2013, contractionary policies and relatively prudent fiscal policy has been the line of action.

  Reform Only Way Forward

The conference saw panel discussions and speeches by 14 Iranian and six foreign experts. One of the more influential international attendants was Martin Cerisola, assistant director for the Middle East and Central Asia Department at the IMF. Cerisola stressed the importance of managing inflation expectations, which he argued can only be achieved once inflation is stabilized.

He also pointed to the need for the CBI and the government to cooperate on the same directives. Indeed, this theme was echoed by other participants too, many of whom believed central bank independence would be an important step towards lowering volatility.  

In an article for Donya-e Eqtesad newspaper, Seyyed Ali Madanizadeh, an assistant professor at the Management and Economics Department at Sharif University of Technology, argues that the only way “clear monetary policies” are pursued is when the principle of core inflation becomes “institutionalized” across government institutions.

However, the government has so far been ignoring deeper scrutiny and tough reform for fear of a financial meltdown and bankruptcies of financial institutions. The academic believes this fear has stimulated private banks to borrow excessively from the CBI. He noted that “[private] banks interact in the same way with the CBI as the government does,” using the CBI as a free credit tap.

He stresses that the pile of over 380 trillion-rial debt of private banks to CBI in the last Iranian year (ended March 20, 2015) is but one consequence of the failure of the government and CBI to tackle the issue of banks with the excuse that they are too big to fail.

Teymur Rahmani, the University of Tehran economist who rightly predicted two years ago that inflation would fall soon and significantly, believes that central bank independence is crucial. For him, this independency would mean that the government stop tapping credit from the CBI, Parliament stop interfering with the CBI’s day-to-day running and the CBI should have the final say and full responsibility over inflation.

Many participants also stressed that price-setting by the government implies dangerous intervention in the free market and is the cause of high inflation.  

  Political Unity Needed

Nevertheless, reducing inflation is a costly political project. Rahmani points out that Rouhani’s monetary squeeze is the main reason why GDP is still lower than three years ago.

Consecutive governments have felt little pressure to lower inflation further when rates were between 10 and 20 percent. Instead, only when inflation spiked above 25 percent has the government taken an active interest in reducing it.  

Madanizadeh and Rahmani believe reform will only be enacted when a consensus and solidarity is reached across the entire political specter behind the aim of changing the legal, political and institutional structure.

Madanizadeh uses the example of Turkey, which faced a severe financial crisis in 2001 and registered inflation of 74 percent. A political drive to solve inflation led to the approval of 19 bills in just five months to reform the country’s financial structure. As a result, inflation was halved in 2002, falling further to 20 percent in 2003, 12 percent in 2004 and 6 percent in 2005.   

The government should also adhere to some policy subscriptions. It should use economic methods for measuring the profitability of semi-state business activities. If these ventures are unproductive, they should either be privatized appropriately or be reduced in size. Participants in the conference also concluded that government subsidies should not be allowed to grow uncontrolled. Instead, strict supervision and prudence should be applied to the government budget.

Seyyed Mehdi Barakchian, a researcher at the Presidential Office, also pointed out if sanctions are removed, oil revenues might be channeled into expanding the monetary base of the economy. Instead, Iran should follow the model set by other oil-exporting countries in safely transferring the trade surplus to a sovereign wealth fund where it can be stored for future generations and used for national and international investment opportunities.

Legal and banking reforms are other factors that could bring inflation rates down even further. Yadollah Eni Ashari, a legal specialist, believes legislation leaves a lot of room for illegal credit institutions to flourish.

CBI official Peyman Qorbani stressed that banking reform is on its way and a bill will soon be offered to parliament. He believes that tackling inflation is only a secondary priority. More important are “monetary stability, stability in foreign investment and credit account.”