Inflation in Iran: Flying back towards double-digit rates

In early April of this year, the Central Bank of the Islamic Republic announced that the country's inflation rate in 2016 had decreased to nine (9) percent, and thus, according to the same institution, "Iran has joined the ranks of countries with single-digit inflation rates after twenty-six years."

The announcement of a reduction in Iran's inflation rate from 40 percent in 2013 to below 10 percent in 2016 became one of Hassan Rouhani's most important trump cards in his election campaign for a second term in office.

Unstable achievement

Despite this announcement, a significant portion of the expert community, relying on a series of worrying signs, warned that the return of inflation to below 10 percent might not be long-term. In early May, when the Central Bank announced that the inflation rate had increased from 9 percent to 9.5 percent in the first month of the year, it became clear that concerns about the fragility of the process of this indicator reaching single digits were not unfounded.

The justification of this concern was confirmed once again by the announcement of the Central Bank of the Islamic Republic of Iran on June 4 of this year. In this announcement, we read that the country's inflation rate in May increased to 9.8 percent based on the annual trend (twelve months ending in May 2017 compared to the twelve months ending in May 2016).

In the current situation, it can be said with certainty that the single-digit inflation rate in Iran, after a very long period, is not a sustainable process, and this index will most likely return to above ten percent in June or July.

Before addressing the high probability of Iran rejoining the group of countries with double-digit inflation, it seems necessary to emphasize two points:

1) Iran's inflation rate, even at a range of eight to nine percent, is still very high compared to the majority of countries in the world.

According to World Bank statistics, the average inflation rate in the world in 2016 was 1.6 percent. In the same year, this index was recorded at 1.3 percent in the United States, 0.2 percent in the Eurozone, and 1.3 percent in East Asia. Even in the Middle East and North Africa region, which is the basis for comparing Iran's economic indicators, the inflation rate was 2.9 percent. This comparison shows that the use of the phrase "among countries with single-digit inflation rates" by the Central Bank is not very accurate, because in the current world conditions, there is a big gap between nine percent inflation and two percent inflation, although both of these are naturally in the single-digit inflation category. In other words, Iran still has a long way to go in the fight against inflation.

2) Nevertheless, there is no doubt that the achievements of the Hassan Rouhani government in the fight against inflation cannot be ignored. Various factors, from greater discipline in managing costs and revenues to the reduction of the back-breaking pressures caused by sanctions following the conclusion of the "JCPOA" and the government's loosening of control over the foreign exchange market and the reduction of inflationary expectations, played a major role in the transition of the consumer price index from the forty percent range to below ten percent. If these factors had not worked together, the possibility of Iran's inflation rate reaching several hundred percent would have been quite serious.

Of course, in several groups of goods that are most consumed by the people, the inflation rate is still at a high level, including the food and beverage group, whose prices increased by about eighteen percent in May of this year compared to the same month last year, and healthcare, which increased by more than sixteen percent. But overall, this feeling among the people that the rate of inflation has slowed down certainly worked in Hassan Rouhani's favor in the recent presidential election campaign.

Structural roots of inflation

Despite the success of the Hassan Rouhani government in significantly reducing the inflation rate, its deep roots remain intact. In fact, inflation springs from within the country's economic structures, and controlling it in a sustainable manner requires fundamental changes to these structures.

Severe fluctuations in oil revenues, currency shocks, weak productivity and high production costs, an increase in the index of imported goods, soaring government spending and budget deficits, expansionary fiscal policies, and a disproportionate increase in liquidity... all contribute to inflation.

Meanwhile, the disproportionate increase in liquidity plays a key role in fueling inflationary tensions. Liquidity, in very simple terms, includes cash in the hands of the public as well as bank deposits that can be quickly and easily converted into cash. The increase in liquidity must be proportional to the growth of goods and services available in a country. If the growth rate of liquidity is faster than the growth rate of goods and services available in a country, the inflation rate will naturally increase.

A government that is constantly running a budget deficit prints money to meet its needs (in technocratic parlance, it “borrows from the central bank”) and increases the volume of liquidity out of proportion to the volume of goods and services in circulation. Towards the end of Mahmoud Ahmadinejad’s second administration, about twelve billion tomans were being added to the country’s liquidity every hour. This was one of the most important factors in the high inflation that gripped the country for years.

The bank-centric nature of the Iranian economy, or the heavy burden placed on the banking system (Central Bank and banks) in financing, is one of the most important factors in the disproportionate increase in liquidity and the rise in inflation. In a country with a healthy economy, both the government and the private sector meet the majority of their financial needs through the capital market and foreign sources. In Iran, a very large part of the responsibility for meeting the financial needs of the government, quasi-state companies, and the private sector has been placed on the banking system and ultimately the Central Bank. The Central Bank, due to its lack of independence, cannot resist these “obligations.”

According to statistics from the Central Bank of the Islamic Republic of Iran, “In February 2016, the amount of banks’ debt to the Central Bank increased by thirty-five percent compared to the same period in 2015. Also, according to these statistics, the amount of government debt to the Central Bank increased by 28 percent during this period” (Deniya Eqtesad, April 11, 2017). Such pressure on the banking system naturally contributes to a disproportionate expansion of the monetary base. In other words, the Iranian economy continues to be plagued by very rapid liquidity growth, while real GDP growth (excluding oil) has been at a low level during the aforementioned period.

In these circumstances, reforming the country's banking system, ensuring the independence of the Central Bank, and providing the necessary conditions for expanding the capital market, including the debt market, should be at the top of the 12th government's priorities.

In agreement with a large part of the Islamic Republic's expert circles, the International Monetary Fund, while confirming that Iran's inflation rate will reach double digits again in the near future, predicts this index to be 11.2 percent this solar year and 11 percent next year.

It is safe to say that if the government fails to maintain the exchange rate at its current very slow pace, the inflation rate will increase more than the IMF says. Containing the exchange rate at the current level also depends on various factors, including the global oil market and pressure from economic and expert circles who say that preventing the natural growth of the exchange rate is contrary to economic fundamentals and will lead to another surge in the dollar price in the country's foreign exchange market in the not-too-distant future.

Source: Radio Farda