Economy, Business And Markets

Former Banker Warns of Liquidity Trap

Former Banker Warns of Liquidity TrapFormer Banker Warns of Liquidity Trap

Tahmasb Mazaheri, a former governor of the Central Bank of Iran has warned that a surge in liquidity over and above 10% would not be acceptable in the current fiscal year that started in March and urged the government to realize that printing money will do more harm than help.

According to data released by the CBI, the money stock has increased by 30% in the month ending March 19 at an annual rate to over 10 quadrillion rials ($327.3 billion at the official exchange rate); a formidable increase that becomes inexplicable given that inflation is now below 10%.

Some have termed this the “liquidity puzzle” and ask why the country doesn’t see decent economic growth even when liquidity is at record highs.

Mazaheri believes the government’s debt to the banking system and the mountain of bad loans are the main culprits. He, however, is cautiously hopeful saying that the current circumstances are not sustainable.

 “When the debts are cleared, liquidity will come into play. What the government needs to do is “to prevent the hyperinflation that this liquidity could create”, he told the ISNA.

The former economy minister said the government needs to function this year “in a way that liquidity will not increase by more than 10%,” adding that “I don’t expect [the liquidity] not to surge at all because it would not be unrealistic, but it is possible to cap it at 10%.”

 Inflationary Concerns

“That kind of increase in money stock would be proportionate to inflation.  Even with a 5% economic growth rate, we can contain inflation with this volume of liquidity and the government’s achievements won’t be wasted. But if the government fails to control liquidity and we are faced with a 20-30% rise in liquidity, then we will face runaway inflation.”

Iran expects economic growth of more than 5% in 2016 after emerging from years of isolation and punitive economic sanctions.

The economy is still struggling and growth is close to zero but many investors are betting that restoring Iran’s links with the world and attracting foreign capital and technology will trigger economic revival.

As to the options the government has to control the liquidity, Mazaheri said it would need to curb borrowing from the central bank and be careful not to raise the monetary base.

 Citing a rise in the monetary base as one of the reasons for an increase in liquidity and inflation, he said, “Every rial plucked from the resources of the CBI would mean a rise in the monetary base and a six-fold increase in liquidity.

The most important thing that needs to be done, he says, is for “the government, state companies and private and public-sector lenders to use CBI resources to the minimum. They must use it only when absolutely necessary and consider it a taboo.”