Why High Inflation may Return to Iran

As a solution to the looming crisis, some economists suggest that policymakers should avoid excessive lending to the government. Reza Boustani, an economic analyst with the CBI, noted in an editorial published by leading economic newspaper Donya-e Eqtesad on Feb. 16 that the excessive borrowing of the government and commercial banks from the Central Bank will definitely lead to an increase in the money supply. He warned that in the medium term, when the CBI will want to change policy and cut off the money supply, it will fail to make the government repay its debt.

On the contrary, lending to commercial banks could be much safer, he wrote, arguing that banks can provide high-quality collateral in exchange for the loans they receive, enabling the CBI to control the money supply and thereby the level of prices just the way it plans. Boustani’s suggestion seems to be reasonable as banks have already excessively invested in non-banking assets, including land and property, during late 2012 and early 2013 when housing prices increased rapidly. Those assets can now be used as collateral with the Central Bank.

Among other steps policymakers have taken in the past year to help boost lending are the lowering of interbank lending rates from 29% early in the current Iranian fiscal year to 18.5-19%, and also the cutting of the reserve requirement ratio from 13% to 10%. These developments as well as the recent lowering of interest rates, coupled with the sanctions relief and the expansionary policy adopted in the second half of the fiscal year, may ultimately lead to a sudden increase of cash in the economy. Given the vulnerability of the Iranian economy to high inflation, policymakers must thus be on alert and plan ahead to neutralize possible harm to investors and industry alike.

(Picture: Central Bank Governor, Vaiollah Seif)

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