Economy, Business And Markets

Fighting Economic Reality

Fighting Economic Reality Fighting Economic Reality

The central bank’s capping of interest rates will increase rent-seeking and corruption, and also waste the banking system’s resources, as seen several times in the past, a prominent economist told Eghtesad News website.

The central bank is forcing banks to borrow and lend at lower rates in hopes of increasing business lending, but “capping rates will have the opposite effect and will not help the economy grow,” Mousa Ghaninejad contended in his interview.

Interest rate decisions are made by the Money and Credit Council – a body inside the central bank but heavily controlled by the government. The council decided last month to lower the cap on deposit interest rates to 20 percent for the longest maturity which is one year, and the cap on lending rates to 24 percent.

The council cited keeping interest rates at a reasonable distance from inflation as the main reason for lowering the interest rate ceilings. It argued that since inflationary pressures on Iran’s economy have eased from a year-on-year peak of 35 percent in 2013 to 15 percent in 2014, interest rates should also fall.

Banks agreed to offer the new rates, but already there are reports of breaches. Many economists and market analysts say lowering interest rates is not feasible because of the high cost of money. For example, Shahr Bank puts the cost of money at 28 percent, sources close to the bank told the Financial Tribune.

Interest rates are in part determined by inflationary expectations in the market not what happened in the past. “Current or past inflation is one thing, but the businessman’s expectations is entirely another thing,” said Ghaninejad.

A command view of the economy is prevalent among Iranian policymakers, a view Ghaninejad strongly opposes. “Market realities cannot change for the better with directives,” the veteran economist said. “Such methods will only backfire. Sadly, time and again, policymakers of various stripes have tried to tell investors or stop market reaction to their policies. All of this has ultimately cost the public their savings and wellbeing.”

Economic growth hawks in Iran have been pushing lower borrowing costs in order to boost business activity. Some economists contend that this will increase inflationary pressures. Inflation’s fall was facilitated by a number of factors including the appreciation of the Iranian rial, the decline in global prices for key staples, and the easing of international sanctions. An influx of cash, if materialized, could reverse its declining trend.

Ghaninejad, however, points to another pitfall of the policy. “Yes, lower interest rates do reduce the cost of borrowing for companies that gain access to loans, as banking resources remain scarce lower borrowing costs would also increase demand for cheap loans and trigger a race among potential borrowers.”

He said large, inefficient government-owned or quasi state companies would be the winners of such a race, as they would use their economic and political influence to take out their rivals. “They also usually don’t repay the loans, increasing the already high amount of non-performing loans.” Ultimately, “the public will suffer the most from the decision,” said the economics professor.

Firstly, lower deposit rates means lower return on personal savings – which have already been eradicated by the past few years’ economic crisis. Secondly, the economy will go into a deeper recession due to waste of resources. Thirdly, as a long term consequence, inflationary pressures could increase as misuse of financial resources will weigh on the banks, pushing them to resort to borrowing from central bank, which would have to print more money.

“This is a basic economic principle that when you cap prices, you will create excess demand,” said Ghaninejad. The excess demand will create hordes of people asking for resources and “you will have no choice but to ration them.”

Policymakers should not fight realities; instead they should try to accept them and find logical solutions, Ghaninejad noted. “When money is scarce, interest rates climb. By lowering rates by force, you are ignoring economic facts, something that would eventually come back and affect you.”