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Touch and Go on Single-Digit Inflation

Touch and Go on  Single-Digit InflationTouch and Go on  Single-Digit Inflation

Inflation has ravaged Iran’s economy for as long as memory can go. With a centrally managed economy, the government’s fiscal policies have taken center stage and in the absence of an independent central bank, government spending has been the main source of inflation.

As windfall petrodollars poured into government coffers, capital expenditures soared. But following crude oil slumps, governments suddenly found themselves with many grand projects and lower income, so they borrowed from the central bank; in other words, money was printed which, in turn, gave rise to Inflation. The past decade has been a testament to this wretched cycle.

The Central Bank of Iran’s job during this period was to minimize the damage brought about by decisions the government made regarding banks and budget. There was no control of money supply, let alone inflation targeting.

In the end, policymakers tried to control the effects of monetary expansion by pegging foreign exchange rates, capping lending rates and controlling energy prices, along with those of the most essential goods.

Double-digit inflation is mainly structural. However, for the first time, structural changes are underway, albeit slowly.

The administration has moved to give the central bank more autonomy. Though it is now getting it to expand money supply to boost economic activity, the general trend is one of more power and responsibility for the central bank.

With contractionary policies, the bank has managed to curb inflation from a year-on-year peak of 45.1% in 2012 to 15.6% in June 2015. The easing of sanctions against Iran as a result of negotiations with the West, along with a prolonged slump in global commodity prices, have borne part of the burden of restraining inflation during this period.

The target and the government’s promise has been single-digit inflation. Touching it now seems at hand.

Year-on-year Consumer Price Index for Mehr—the Iranian month ending 22 October—rose 10.8%. Producer prices—considered by many as a predictor of inflation’s direction—rose less than 10% for two months in a row. The Producer Price Index increased by 8.5% in Mehr, having grown by 9.3% in the previous month of Shahrivar.

With the slump in commodities persisting due to weak growth from China and trouble in Europe, and stifled market activity in Iran, producer prices are likely to rise at an even slower pace. This makes it safer to say year-on-year inflation will fall to a single-digit territory in the coming months.

Top government officials are saying it will happen as soon as next month, meaning consumer prices will rise less than 10% in Azar (the month ending December 21).

However inflation, which averaged 14.8% during the 12 months to Mehr, is unlikely to fall to a single digit and stay there anytime soon. The government has abandoned contractionary policies that helped bring inflation down in the past two years, as economic growth started to roll back toward recession.

This month, it unveiled expansionary policies to stimulate consumer demand. Reserve ratio—money deposited by banks with the central bank—will be cut by three percentage points for healthy banks, releasing an estimated $7 billion plus to banks. The central bank will also extend loans to buyers of Iranian cars and durable goods at an at least eight-percentage-point-discount to normal lending rates.

Though the government’s plan is a somewhat controlled move, there are doubts about how much its impact on consumer prices can be controlled. Furthermore, the structural drivers of inflation are still in place. Add that to the much anticipated wave of foreign investment expected to boost Iran’s economy once sanctions against its nuclear program are lifted and there is a recipe for inflation.

The administration’s efforts have borne much fruit. Policies and structures are being changed for the better. Not far from now, we will have an independent central bank fighting to keep the economy from overheating.

For now, we can revel in touching single-digit inflation. In the long run, however, it is as professor Gianluca Benigno of London School of Economics told the Financial Tribune: “I think in general for a developing economy like Iran, that is just opening up, it is not that easy to have a stable low single-digit inflation, as exchange rate fluctuations and imports and exports will have significant impact on the economy.”

Financialtribune.com