Will Deposit Rate Cuts Help Iran’s Capital Market?

The intrinsic quality of capital is that it cannot afford to stop growing, as the whole process of economic reproduction is conditioned on capital accumulation.

The system depends on investors to nourish it and investors depend on the system to provide them with reliable means of capital growth—an existential interdependence.

It is no wonder, then, that there is always a battle for finding and capitalizing on the next lucrative investment opportunity. When things are good, the best of these opportunities usually manifest themselves in stocks, as growing companies compete for leading the economy and investors bet their money on them, with each risk upping the gains.

But the current convoluted situation of the Iranian economy is steering things in a different direction.

One would expect risk to pay, but the opposite stands true in Iran. Safe, low-risk options are much more attractive in terms of their returns. In fact, a large chunk of the country’s liquidity is safely parked in banks, slowly accumulating on rates reaching up to 20% and above while barely making an ounce of difference in the production sector.

It would be unfair to blame the investors. Evolution in Iran’s economic climate has turned most risk-lovers into conservative risk-averse beings.

Now, the government has recently come up with a plan to put things in order. It includes forcing the lenders to cut their deposit rates, which officials expect will enable the trapped liquidity to flow into other sectors, capital market included.

The new measure was implemented just a few days ago and the markets are still adjusting, yet capital market analysts seem skeptical it will change anything, at least in the short term.

Enforcing an Already-Made Decision

The Central Bank of Iran has announced that all banks and credit institutions have to set their annual and fixed interest rates at 15% and 10% respectively. All deposits made after this motion went into effect last Saturday were affected and non-compliers were warned of penalization.

Deposit rates were already cut back in June. Long-term deposit rates went from 18% to 15% with short-term rates set at approximately 10%. Many lenders failed to comply with that however, with rates reaching 22%-plus when hidden fees were accounted for. The CBI’s last week directive was mostly meant to enforce the already-made decision.

Markets and analysts have been all abuzz since Saturday, trying to forecast where capital would go, if it fled the now seemingly less attractive money market.

Interestingly, the officials’ remarks on this issue were on two different poles.

“Reducing deposit rates to 15% will not cause liquidity to flow into other markets, as none is still capable of outperforming such returns,” said CBI Governor Valiollah Seif.

Shapour Mohammadi, the head of Securities and Exchange Organization, believes the exact opposite, however.

“The reduced deposit rates will cause financial markets to become increasingly attractive and competitive,” he said.

Both seem to have a point. Seif is tacitly pointing at the general stagnation of the economy and that solving it requires something other than limiting the banks.

Mohammadi, on the other hand, is counting on CBI’s authority to bring the lenders in line and eventually make investment in other sectors, especially stocks, attractive.

In short, both are counting on the other to do their job ideally, and it’s not happening.

Banks made the most out of CBI’s deadline and renewed most of their clients’ contracts with the previous rates, effectively sealing money in their vaults for one more year. The capital market’s regulators, for their part, have yet to come up with a scheme to make the market more attractive.

Sidestepping officials’ theorizing, Financial Tribune reached out to market analysts to see if the deposit rate cuts have had any impact on the capital market so far.

Improvement in Medium Term 

Griffon Capital’s head of Asset Management research, Ali Hashemi, believes that there are a few prerequisites for the rate cuts to notably impact the equities market. In fact, the TEDPIX hit a new 18-month high in August, driven by strong corporate earnings, and hardly based on expectations of rate cuts.

High real interest rates have adversely affected stock market liquidity and valuations and created a large, liquid competing investment opportunity: high real returns from fixed income.

“There are no signs [of new capital] in the market yet, although one can be more optimistic in the medium term,” Ali Hashemi told Financial Tribune via telephone.

He added that real interest rates have fallen notably since Q1 2017.

The latest bonds issued by the government have been traded with YTMs well below 20%. This is positive for equities, especially if they (and bank deposit rates) remain below 20%.

However, the nature of bank depositors who are “inherently scared of stocks” means one should not expect meaningful flow from banks' vaults to the stock market. The only money that may find its way to equities in the medium term is the one already exposed to the capital markets through debt instruments, said Hashemi.

The money market in Iran is vast and mature, and Iranian bankers have a proven track record in skirting around CBI’s orders. Accordingly, lowering interest rates in this environment is complex and challenging. The CBI-mandated directive will help the condition, but it has to be supported by other structural reforms and more cohesive policies.

However, a senior market analyst at Bazar Saham Brokerage holds that it was wrong in the first place to bet on the cash in the money market for rejuvenating the capital market.

“There are different moneys in different markets: some go into equities, some banks and some into fixed-income securities. And they are owned by different types of investors. There’s really no overlap between them,” said Ali Nikoogoftar.

As an instance of a small-time risk-averse investor, the analyst pointed to an unnamed client who drew about $155,000 out of a bank deposit after rate cuts and invested it in Sakhab bonds, saying that “I will only risk to the extent of securing a monthly fixed income.”

Sakhab is one of the many types of debt securities issued by the government meant to clear its debts to contractors. It matures in a year and is priced at 1 million rials ($25.7) per bond.

“What the CBI did (cutting deposit rates) effectively preserved the previous condition (high deposit rates) for at least another year. So, there’s really no wandering money out there to land somewhere now, and no one with high capital at hand got surprised.”

Nikoogoftar believes that CBI’s measures have not changed the low-risk return rate in the economy and the tide will not turn for the capital market unless the economy improves as a whole.