Iran Capital Market Awaits Reforms by New Government

The stock market was dealing with a great deal of ambiguities during the last days of the 10th government (the second term of former president, Mahmoud Ahmadinejad), as petrochemical feedstock prices were not determined, the battle over setting mining royalties was raging and the fate of Iran’s nuclear program was hanging in the balance.

The advent of the 11th government, with promises of economic stability and responsible fiscal policymaking, did not immediately resolve the market’s fundamental issues, but helped pop the price bubble and tread a new path.

President Hassan Rouhani’s prime achievement during the past four years was negotiating the nuclear deal with world powers to abolish the crippling economic sanctions imposed on Iran over its nuclear program. The implementation of the Joint Comprehensive Plan of Action and the optimism over foreign investment surge into the country triggered a good appetite for shares in Iran’s capital market and put the brakes on the nearly two-year long bear market.

Fast forward to late May and the stock market is welcoming Rouhani’s reelection with a solid growth. The market had its ups and downs during Rouhani’s first term, but economic stability was slowly taking shape. Galloping inflation was brought to heel, the economy started to grow and Iran’s trade balance tilted toward positive territory.

However, many other issues came to light, which was only natural considering that the total collapse of the economy was no longer the concern and things were closer to normal.

Tehran Stock Exchange’s primary index TEDPIX has lost a total of 2,218.4 points at a steady rate ever since May 24, a few days after the election results were announced. It is safe to say that the initial enthusiasm over continuation of “stability” has worn off and now it is time for the government to address the stock market’s fundamental concerns.

 Fixing the Banking System

The Iranian economy is traditionally reliant on the banking system for financing its activities, but the banks are struggling with empty coffers.

Years of rampant borrowing and spending by the 10th and 11th administrations left the government with a lot of debt to the banks and afflicted lenders with toxic assets.

Bankers needed to stay afloat, one way or another. One thing to do was offering high interest rates, predominantly above the cap set by the Central Bank of Iran in order to attract money.

And what did that accomplish? With a single-digit inflation rate and lack of liquidity in the market, the promise of risk-free high-interest profit would draw capital from all economic spheres to the money market and close the door behind it.

“You cannot expect the capital market to drive the economy until the banking system is reformed and the high 22-25% interest rates are curbed,” Vali Nadi Qomi, managing director of Novin Investment Bank, was quoted as saying by the Persian economic daily Donya-e-Eqtesad.

“As long as the banks are grappling with financial woes, the capital market will not be able to finance private large-cap firms, municipalities or governmental projects,” he said.

Interest rates on deposits have been officially set at 15% per annum by the Money and Credit Council.

Behnam Behzadfar, an official with the Securities and Exchange Brokers Association, believes that high interest rates have effectively sidelined actual producers from the economy, further exacerbating the current stagnation.

“[This] impedes economic growth by preventing the capital market from having a meaningful role in driving the economy,” he said.

The official noted that CBI has already taken measures to address the issue and its tangible effects are expected to be felt in a few years.

Merging banks and credit institutions with the aim of lowering operational costs and pushing lenders to adopt international accounting standards are among the initiatives.

 Unifying Forex Rates

Economists and market players have long called on the government to close the gap between the official and market foreign exchange rates and put an end to its interventionist practices aimed at propping up the rial.

Iran has been living with the dual exchange rate system for several years, which helped fuel corruption and hampered cross-border trade.

Those with ready access to the official rates, that are set lower than market rates, have been able to benefit from relatively cheap hard currency, while other individuals and businesses have had to pay a higher price in the open market. This has obviously led to complications in the stock market.

“Many of the exchange-listed industries currently export their products based on the free market rate, while they purchase some of their raw materials using the official rate. This fosters ambiguity and confusion in the market, which dampens investors’ sentiment,” says Mehdi Afzalian, a market analyst.

The currency market volatility in the final months of 2016, which saw the rial hitting record lows against the dollar (reaching 41,500 rials in late December), scuttled CBI’s plans to scrap the dual exchange rate regime by the yearend (March 20, 2017).

The rial was trading at 37,500 against the dollar on Wednesday, the Association of Bureaux de Change Operators’ website showed.