global investment house- kuwait – iran economic & strategic outlook – monetary policy
In 2004/05, attempts were made to implement monetary policy aimed at controlling inflation. Policies set in the fourth plan aimed at providing liquidity required for productive sectors in order to encourage investment and observing certain obligations such as prevention of monetary expansion incompatible with inflation and liquidity targets. Factors affecting liquidity growth and its constituents indicate that claims on non-public sector have had a marked effect on liquidity growth and net foreign assets ranked the second. In general, the Iranian monetary policy has been aimed at controlling inflation. Despite a target liquidity growth rate set forth in the development plans, a range of factors including the need to accommodate higher than expected economic growth and to finance the Iranian Rial, the liquidity grew by 34.3% in 2005/06.
According to the Fourth Development Plan (2005-2008), the government is bound to reconstruct and modernize the economic sectors by introducing the following reforms: the government should foster the creation and operation of small and medium size companies to develop networks, branches, chains, and creating necessary measures for enhancing their technical, engineering, research and development skills. It was also decided, as part of the plan, that the government should decrease bank’s interest rates in 2006. The government also issued Participation Papers in order to curb inflation. Under the Fourth Plan, extending directed credits in the form of sector or regional allocations shall be carried out either through subsidy payments or administered funds where banks are obliged to provide the facilities at a lower rate. Increase in the outstanding balance of directed credits shall be reduced by 20% p.a., and the government is also required to decrease its debt to the banking system. The average inflation and liquidity growth rates are set under the Fourth Plan at 9.9% and 20% per annum respectively.
The monetary base in fiscal year 2005/06 grew by 45.9% y-o-y to reach US$220,541.4mn and thereby achieving a CAGR of 22.6% over the period of 2002/03 to 2005/06. The main reason for the rise in the monetary base was the increase in the net foreign assets of the Central Bank of Iran (CBI) and the government’s withdrawal from the OSF and converting it to IR. Money supply (M2) increased at a y-o-y rate of 25.8% in 2005/06 to reach US$317,919.4mn as a result of an increase in quasi money which surged in 2005/06 by 39.3%. Demand deposits, also increased by 28% to contribute to the increase in M1. The size of liquidity (M2) increased at a rate 34.3% in 2005/06 to reach US$921,019.4mn, mainly driven by an increase in CBI’s net claims on the public sector (as a result of increase in public sector’s deposits with the CBI). The government indebtness to both the Central Bank of Iran and local banks, have decreased in the fiscal years 2004/05 and 2005/06 consecutively. One of the main monetary adjustments highlighted in the fourth plan was to decrease the government debt to banks. To that end, government indebtness to the CBI decreased by 4.4% and 9.5% in 2004/05 and 2005/06 respectively to reach US$101,254.9mn at the end of 2005/06. The government indebtness to local banks have also followed an upward trend to increase at a much higher pace in 2004/005 of 42.1%, however it then decreased by 6.1% in 2005/06.
Lending rates in 2005/06 charged by private banks and non-bank credit institutions decreased to 17% from a range of 23-28% in the previous year, while that charged by the public banks during the same year stood at 14%. The decrease of interest rates has resulted in an increase in the facilities extended by the banks to the private and the public sector.
It is worth mentioning that the Iranian Central Bank independence is still an issue that is being debated. The lack of total CBI independence is hampering its efforts to bring inflationary pressures under control, and other monetary policies.
In the years 1997-99, Iran had three exchange rates, namely official, export and import, as well as open market exchange rates. In 2000, CBI abolished the export rate and in 2002 according to the implementation of the exchange rates unification policy abolished the official rate. Moreover, the establishment of the inter-bank market and transition of all foreign exchange transactions to this market paved the way for collecting of all exchange applicants and suppliers in one market with all the transactions conducted through it. In recent years, Iran’s foreign exchange policies’ regulations have aimed at the facilitation and promotion of private sector’s economic contribution. These policies which were adopted according to the fourth development plan include exchange rate unification, regulation of the exchange rate market, protection of foreign trade and foreign investment. One of the adopted policies is that the Iranian foreign exchange regime is a managed floating exchange system and conduct foreign exchange regulations in fields of good trade, transactions of exchange services, and banking operations. In addition to that, Fourth Plan serves, through the introduction of the flexible exchange rate system, to promote Iranian exports.
Both, the inter-bank market exchange rate and the parallel market exchange rate depreciated in 2005/06 by 3.5% and 3.4% respectively. The IR was allowed to lose value against the US$ by the CBI to support the competitiveness of the non-oil exports in order to increase its share of government revenues, and to reduce its reliance on oil generated revenues.
Inflation in Iran, measured by the consumer price index (CPI), has been in double digits since 1991 and peaked approximately at 50% in 1995. Until recent years, monetary expansion due to financing the budget deficit, the depreciation of the market exchange rate, the removal of some subsidies, and the suppression of imports have all contributed to rising prices.
Inflation fell sharply in the year 2000 due to improved economic conditions and enhanced public confidence in the stability of the economy as well as the implementation of non-expansionary monetary and fiscal policies. In the year 2005/06, the inflationary pressures continued to decline aided by a decline in the prices of goods, services and housing, water, fuel, and power, etc. The consumer price index declined in 2005/06 to reach 12.1% from 15.2%. Housing, water, Fuel, and power price index fell in 2005/06 to reach 13.8% from 18.2% in 2004/05. The goods price index was also declined in 2005/06 to stand at 9.8% from 12.5% in the previous year.
The wholesale and the producer price indices also exhibited a downward trend during the fiscal year 2005/06. The wholesale price index decreased to reach 9.5% from 14.7% in the previous year. This was the result of decrease in the prices of domestically produced goods and exported goods. A substantial decline in the imported goods price also helped further push the wholesale price index downwards. Imported goods prices index decreased to reach 6.6% from its level in 2004/05 when it stood at 14.5%.
The producer price index declined in 2005/06 to reach 9.5%. The producer price index in all sectors declined in 2005/06, except for the mining sector where its producer price index increased to reach 16.5% in 2005/06. This is due to an increase in the activity of mining in Iran, the increased reliance on local mining firms rather than importing foreign experience, and hence, the need to import expensive heavy machinery which helped push the producer prices up. The inflation in agriculture, animal, husbandry, forestry, and fishing sector decreased in 2005/06. Manufacturing and services sectors producer price index also declined in 2005/06.
