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.
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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
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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
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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
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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
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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.
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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.
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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. Thus, the banking sector remains in dire need of reform, especially now that most Iranian banks are sanctioned by the US and bank runs are a prime motivator of public demonstrations, as seen in the December 2017 protests. Some analysts believe that it would cost around $200bn to overhaul the banking sector and that mergers are likely to continue for the foreseeable future.3
A notable acquisition occurred on the 10th November 2018, with private lender Bank Mellat’s takeover of the scandal-ridden Sarmaye Bank. Used as a payment channel by the oil ministry during the imposition of multilateral sanctions in the 2000s, Sarmaye Bank’s main shareholders pillaged its assets and put at risk the pensions of 900,000 teachers. Another five debt- ridden banks and credit institutions were later acquired by the state-owned Bank Sepah in March 2019. Most of the failing lenders were affiliated with parts of the armed forces: Bank Ansar, Bank Ghavamin, Hekmat Mehr Eqtesad, Hekmat Iranian Bank and the Financial Institute of Kosar. Representing 18% of Iran’s banking assets and 24m clients, the banks’ merger with Bank Sepah have made the latter Iran’s largest financial institution – second only to Bank Melli, another publicly held bank.
The rescue of politically linked financial institutions does not augur well for Iran’s economy, as it indicates a willingness by the state to prioritise special groups’ interests and political stability over the country’s financial soundness. The policy, which is supported by the Minister of Economic
2 Sedaye Bank, 19/03/19, “Reform of the Banking System and Adherence to FATF Rules’. 3 MEES, 01/06/18, “Iran’s Banking Sector: Dark Days Loom”. 9 9
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Affairs and Finance Farhad Dejpasand, has negative implications for state finances. Former head of the Judiciary Sadeq Amoli Larijani said that in 2018 the government borrowed as much as IRR300,000bn (between $2bn and $6bn depending on the exchange rate) to salvage bankrupt banks.
Future Monetary Reforms:
The CBI wants to The solution to Iran’s economic crisis lies in the nominal economy. President remove Rouhani can at least be praised for trying to overhaul the banking system, four 0s even if his economic policy blunders and the rescue of politically connected from the IRR. banks will cast a shadow on his legacy. A series of reforms currently before Parliament have the potential to greatly benefit the economy.4 The prospects for their passage into law are boosted by the current non- confrontational relationship between the government and Parliament, mostly helped by Rouhani’s pact with ex-conservative Parliament Speaker Ali Larijani. In fact, Ali Larijani has veered towards the moderates and backed most of government policies, especially on the economy. Although Larijani will probably tone down his support for Rouhani, as shown in his recent regret for passing FATF laws, his initial motive for backing the President was to garner support from reformists and moderates, considering that his political family of conservatives has sought to distance itself from the Larijani family altogether. Indeed, Ali Larijani’s brothers have been mired in corruption scandals that have been particularly pointed at by conservatives.
Legislation in the pipeline
• One piece of legislation currently being reviewed by the Parliament’s economic commission concerns the regulation of bank deposits. If passed, the bill would ensure that money put into banks serves a productive purpose. It also calls for a new monitoring system for the CBI and the application of more stringent fines for those who default on their loans.
• Another piece of legislation being considered is an 80-article bill which aims to overhaul the CBI’s legal framework, increase its independence, review its duties and authority, and revisit its role in supervising banks’ risks, Islamic loans and price controls.
4 Bourse Press, 22/04/19, “The most Important Reforms of the CBI and the latest about the Legislation on Islamic Banking”. 10 10
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• As discussed in our first report, Iran’s multi-tiered currency system is faulty on many levels and has done the economy more harm than good. According to Al Monitor, Mohammad Bagher Nobakht, head of the Planning and Budget Organisation has admitted that the system is not working. This indicates that the currency system could soon be overhauled and the official exchange rate devalued.
• A more controversial raft of legislation in the works is that needed for Iran’s admission to the Financial Action Task Force (FATF). While most of the laws necessary for compliance with the FATF have been passed by Parliament, the Expediency Council has refused to sign the Counter-Financing of Terrorism bill as well as the UN Convention against Transnational Organised Crime. The US’s designation of the Islamic Revolutionary Guard Corps (IRGC) – the backbone of Iran’s military – as a foreign terrorist organisation, makes any further progress on this front highly unlikely. Passing such laws would mean that the Iranian state would have to sanction parts of its own military whilst tacitly accepting that millions of Iranian men who served their military service with the IRGC will be considered terrorists on a world stage. Expediency Council member Ayatollah Mojtahed Shabestari made it clear that Washington’s latest move precluded it from signing the bill. Although Iranian government officials and parliamentarians are in favour of the bills, many fear compliance would involve repressing the IRGC’s economic might. As a result of the deadlock, the FATF is likely to put Iran back on its blacklist in June 2019, which would lead to increased scrutiny of Iranian financial institutions and even self- sanctioning.
• Last but not least, the CBI has presented Parliament with a plan to redenominate the currency, by dropping four zeros from the rial and adopting the toman as the national currency. This would mean that 1 toman would equal IRR10, instead of 1000 toman equaling IRR10,000 for the same value. Redenominating the currency would decrease inflation only if the aforementioned reforms are properly applied. By itself, the move should reduce the cost and complexity of accounting and printing.
While the legislative pipeline might have been a positive sign for Iran’s future a few months ago, recent US policy moves have put all attempts at reform in jeopardy. If the end of US waivers results in a drastic plunge in oil revenues as expected, the government will have little choice but to increase borrowing 11 11
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from the CBI, exacerbating the problems with the nominal economy. According to the economist Masoud Nili, money supply growth in 2019 could equal that of the 2011-18 period, which in itself was a high point in Iran’s economic history.
Finally, one has to consider the role of foreign governments in Iran’s economic crisis. Much hope has been placed on the special purpose vehicles designed by the EU. The Instrument in Support of Trade Exchanges (INSTEX), which was registered in late January 2019, was designed to act as a payment channel for food, medicine and agricultural goods between Iran and European countries. However, Iran cannot rely on this limited financial pipeline for its economic development. The Islamic Republic has already been ousted from SWIFT – the Society for Worldwide Interbank Financial Telecommunication. Being put back on FATF’s list is likely to put an end to INSTEX, as it would be increasingly difficult for Europe to justify economic ties to Iran, even for humanitarian purposes. Moreover, the country in which it is registered – France – does not garner much trust among Iranian officials, as it is seen as the EU’s strictest member and a close ally of Abu Dhabi and Saudi Arabia, Tehran’s enemies in the region.
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