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Iran Report 2 Monetary Predicament Final Review-2

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Iran Report 2 Monetary Predicament Final Review-2 A Monetary Crisis Understanding the Role the Money Supply has played in Iran’s Economic Downturn ECONOMIC RISK SERIES NO.3 | MAY 2019 1 1 ECONOMIC RISK SERIES NO.3 | MAY 2019 EXECUTIVE SUMMARY • Iran’s weakening currency and inflation are just symptoms of a much greater structural problem: the abnormally high growth of the money supply, which has tripled over the last few years. • The rial’s freefall has given rise to speculation, with investors and citizens alike rushing to buy up safe assets like gold, real estate, cars, stocks and foreign currency. • Iran’s nominal economy is growing at a much faster rate than its real economy. This has harmed future investment, as money is being left in dormant long- term deposits, where growth is guaranteed due to high interest rates. • Iran’s banking system is a ticking time bomb, with a high level of non-performing loans. The government has been bailing out cash-strapped banks in an effort to avert a crisis. However, this short-term solution can only postpone the inevitable. • Iran’s nominal economy cannot continue on this path. An overhaul of the banking system, including the rollout of new currency, more independence for the central bank of Iran (CBI) and greater adherence to international financial norms, is the only solution. Yet, US policies have directly endangered such reforms. Who are we? Castlereagh Associates is a research and analysis company, providing clients with key insights to support their decision-making and enable them to build more competitive and resilient businesses on national, regional and global levels. Copyright © 2019 Castlereagh Associates- All Rights Reserved. Credits: Copyright © Shutterstock A MONETARY CRISIS Money Supply Growth (Year-on-Year, as a %) 50 45 40 35 30 25 20 15 10 5 0 April-May May-June2017 2017June-July 2017 April-May May-June2018 2018June-July 2018 March-April 2017 July-August 2017 March-April 2018 July-August 2018 January-FebruaryFebruary-March 2018 2018 August-SeptemberSeptember-October October-November2017 2017 2017 August-SeptemberSeptember-October 2018 2018 November-December 2017 December 2017-January 2018 Money Supply Growth: Figure 1. Money Supply Growth Rate March 2017-October 2018 Source: Donya-e-Eqtesad 3 3 ECONOMIC RISK SERIES NO.3 | MAY 2019 The Rush for Safer Assets: Figure 2. Tehran Stock Exchange from July 2018 to April 2019 Source: Tehran Stock Exchange Website Housing Price Increases in Tehran (Year-on-Year, as a %) 100 90 80 70 60 50 40 30 20 10 0 April-MayMay-June 2017 June-July 2017 2017 April-MayMay-June 2018 June-July 2018 2018 March-April 2017 July-August 2017 March-April 2018 July-August 2018 January-FebruaryFebruary-March 2018 2018 August-SeptemberSeptember-OctoberOctober-November 2017 2017 2017 August-SeptemberSeptember-OctoberOctober-November 2018 2018 2018 November-December 2017 November-December 2018 December 2017-January 2018 December 2018-January 2019 Figure 3. Housing price increases in Tehran year-on-year Source: Donya-e-Eqtesad 4 4 ECONOMIC RISK SERIES NO.3 | MAY 2019 Bahar Azadi Gold Coin Prices (in Toman) 6000000 5000000 4000000 3000000 2000000 1000000 0 Jul-18 Mar-18 Apr-18 May-18 Jun-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 Figure 4. Price of one Bahar Azadi Gold Coin in Toman (1000 Toman = IRR10,000) Source: Donya-e-Eqtesad Price of 8.13g of Gold (Month-on-Month, in Bahar Azadi) 40 30 20 10 0 Jul-18 Mar-18 Apr-18 May-18 Jun-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 -10 -20 Bahar Azadi International Gold Price (same weigth as Bahar Azadi) Figure 5. Month-on-Month cost of Bahar Azadi Coins, measured against the International Gold Price Source: Bonbast.com and BullionByPost.com 5 5 ECONOMIC RISK SERIES NO.3 | MAY 2019 Money supply growth is the principal driver of high inflation in Iran. As Figure 1 illustrates, Iran’s money supply has grown substantially in recent years. While this trend is not new – the money supply has multiplied by a factor of 1100 over 30 years – it has accelerated to an abnormal rate under presidents Mahmoud Ahmadinejad and Hassan Rouhani. For the last decade and a half, money growth has more or less surpassed economic growth, meaning that the nominal economy has consistently expanded at a rate much higher than the real economy. Understandably, this has had a substantial inflationary impact on the economy. Most government policies have failed to curb the rise in the money supply, which grew by 24% each year, on average, between 1989 and 20171. The main drivers behind the rapid expansion of Iran’s nominal economy are linked to CBI policies, the investment basket and the unbalanced relationship between loans and deposits. There are at least five direct channels through which money growth occurs: 1 ISNA, 9/09/18, “The Volume of Money in Iran Has Tripled” 6 6 ECONOMIC RISK SERIES NO.3 | MAY 2019 In March 2018-April In addition to outdated investment laws and an underdeveloped bond market, 2019 the value of Iran’s banking system has many weaknesses. Strong interest rates and a gold increased by high non-performing loan percentage means most banks in Iran are high-risk 230% ventures. The level of risk and, therefore, high costs of banking forces lenders to shift their investment baskets away from productive investments and into liquidity. For instance, while the global reserve ratio for bank assets In March 2017- held by the central bank is 10%, this figure can go as high as 30% in Iran. January 2019: Those banks required to hold 30% of their assets in the CBI often borrow housing prices in from other banks to pursue their business, thus increasing the money Tehran increased by supply. 115% Currency devaluation has led to a speculative rush into non- productive assets. Source: Donya-e- Eqtesad In today’s Iran, holding one’s wealth in the local currency is seen as high risk. In an effort to shield themselves from the rial’s continued devaluation, Iranians are rushing to buy alternative assets. Although this does not impact the high percentage of money held in the form of deposits, a large number of bank clients have used their capital to purchase more profitable assets, especially since the CBI dropped deposit interest rates from 20% to 14% a few years ago. Such assets are usually less liquid and include gold, cars, real estate and company shares. Despite a bearish global market, gold prices in Iran have soared by 230% since March 2018 while property prices in the capital have ramped up by 115% since March 2017. Tehran’s Stock Exchange has witnessed phenomenal growth during the speculative rush on assets. Between early June 2018 and mid-April 2019 its market capitalisation more than doubled, from 95,000 points to 200,000 points. The introduction of the Integrated System for Hard Currency Transactions, or NIMA, which allows exporters sell their hard currencies to importers at a rate higher than the official rate, raised expectations from investors as well as the value of public companies operating internationally. 7 7 ECONOMIC RISK SERIES NO.3 | MAY 2019 The Investment Sphere: The share of Investment in GDP (%) 35 30 25 20 15 10 5 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Iran Turkey Figure 6. The Share of Investment in GDP, Turkey and Iran, 2004-2017. Source: Donya-e-Eqtesad, which gathered data from the CBI and Turkey Statistics Centre Between 2004 and 2017, a period which saw the imposition of secondary sanctions, declining expectations for the future negatively impacted investment levels and gave rise to short termism. Investment’s share of GDP decreased from 32% to 20% during this period. In 2017 real estate’s share in gross investment stood at 36%, significantly above that of industry and mining, at 19.8%, and agriculture, at 4.4%. In 2003-17, construction’s share in overall investment stood at a whopping 63%, against 37% in machinery only. With speculating on cars, gold or real estate seen as more profitable than investing in more productive projects, such as factories, future growth, individual income and the state’s tax extraction power is condemned to stagnation or even decline. The government’s introduction of policies to attract investment is key to rebalancing the economy. Currently, 80% of Iran’s money supply is held in non-productive, long-term deposits instead of only 28% for the EU. Left on their own, these deposits will only help increase Iran’s money supply and exacerbate the monetary crisis. 8 8 ECONOMIC RISK SERIES NO.3 | MAY 2019 The Banking System: The high number of banking institutions in Iran increases its vulnerability to a banking crisis. Iran has roughly 35 licensed financial institutions and a In 2018 plethora of non-regulated ones, which proliferated during Ahmadinejad’s $6bn* presidency. Unregulated lenders are one of the main drivers behind the tripling of the money supply: by offering potential clients attractive deposit was spent on rescuing bankrupt banks. rates up to 24% and multiplied credit offerings, they have disregarded the regulated balance between assets and liabilities or their clients’ solvability. *highest estimate Additionally, unregulated banks have provided special interest groups with loans they do not feel obliged to repay, since they are either part of the state Source: Donya-e- or close to influential circles.2 Eqtesad As a result, non-performing loans reached 15% of overall loans in 2013, a level that was reduced to 11% in 2016 due to actions taken by Valiollah Seif, the former CBI head.
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