Iran is facing double-digit inflation, high consumer prices, rising unemployment, and anemic economic growth, according to a new report by Jahangir Amuzegar, a former executive board member of the International Monetary Fund. But not all of Iran’s economic problems are caused by sanctions. Many are self-induced and rooted in President Mahmoud Ahmadinejad’s attempts to curb inflation during his first term from 2005 to 2009. The government tried to control rising costs by holding the exchange rate, interest rates and basic energy prices in check. But that short-term fix led to long-term problems, such as worsening Iran’s dependence on oil, hampering companies’ ability compete internationally, and cutting industrial production capacity by up to 40 percent, concludes Amuzegar, who was finance minister in 1963. The following are excerpts from the report, with a link to the full text at the end.
Self-Inflicted Wounds
Of the thorny economic problems which Iran is going to face in the coming year, independent of sanctions, almost all are self-induced. They are rooted in a wrong-headed populist strategy of combating endemic inflation by hoodoo remedies. Faced with protracted double-digit price rises caused by perennial budget deficits and excess spending, President Ahmadinejad decided early in his administration to combat this demand-caused economic disequilibrium by focusing on the supply side. Thus, instead of trying to raise revenues or reduce wasteful expenditures, he chose a crowd-pleasing, short-term economic policy of controlling costs - with scant regard for its harmful long-term implications. To keep household and business expenses in check, the government proceeded to hold three vital cost factors -- the exchange rate, interest rates and the basic energy prices— in check through government diktats. The outcome has been a near disaster in all three areas.
The short-sighted policy of keeping the exchange rate artificially overvalued in order to hold import costs down led to a number of troublesome consequences such as: (a) reducing domestic producers’ ability to compete with foreign suppliers; (b) bringing down domestic production capacity of import-competing industries by some 30-40%; (c) idling thousands of workers with each additional billion dollar of imports; (d) worsening Iran’s non-oil trade balance; and (d) giving a hefty subsidy to foreign farmers and manufacturers The over-valued exchange rate also resulted in increased national dependence on the world economy (even for essential food items). Thus, with the imposition of new tough sanctions on Iran’s oil exports and its central bank operations announced in late 2011, the long dormant pressure on the rial blew up and the current era of exchange instability ensued.
The government’s extensive interest rate regulation must take its share of the blame. Holding interest rates on saving deposits below the inflation rate and keeping bank charges on commercial and investment loans below free-market levels in the bazaar have inflicted immeasurable damage to the economy. Low (and negative) returns on deposits have discouraged savings and parsimony, stifled productive investments had led savers to move their funds from bank accounts to such other outlets as real estate, precious metals and US dollars. Losing savings deposits has led the banks to steadily borrow from the CBI for their voluntary as well as state-mandated loans. Government dictated loans to favored, but money-losing, projects have been a main cause of the banks’ non-performing assets. Sizeable differences between mandated bank interest rates and the rates prevailing in the bazaar, combined with the small penalty for late repayments of loans, have induced some well-connected businessmen to borrow money from the state banks at rates in the low 20s, lend the borrowed sum in the bazaar at percent rates in the 30s, and postpone repayments of the loans for years at an annual penalty of only 6%! Poor and unprofessional assessments of borrowers’ proposed projects and the concentration of bank loans on a few selected mega borrowers have been other causes of the banking system’s problems. Nearly 80% of the total bank loans are now reportedly in the hands of less than 12% of active businessman. In the absence of real banking system reforms in the coming year, the situation is likely to get worse - particularly if the sanctions are not removed.
Finally, keeping energy prices artificially down for years has resulted in profligate energy consumption, the continuation of energy inefficiencies, the rise of energy-intensive industries vulnerable to external shocks, a growing need for energy imports, intolerable air pollution and a clear rise in energy smuggling to neighboring countries.
The government’s extensive interest rate regulation must take its share of the blame. Holding interest rates on saving deposits below the inflation rate and keeping bank charges on commercial and investment loans below free-market levels in the bazaar have inflicted immeasurable damage to the economy. Low (and negative) returns on deposits have discouraged savings and parsimony, stifled productive investments had led savers to move their funds from bank accounts to such other outlets as real estate, precious metals and US dollars. Losing savings deposits has led the banks to steadily borrow from the CBI for their voluntary as well as state-mandated loans. Government dictated loans to favored, but money-losing, projects have been a main cause of the banks’ non-performing assets. Sizeable differences between mandated bank interest rates and the rates prevailing in the bazaar, combined with the small penalty for late repayments of loans, have induced some well-connected businessmen to borrow money from the state banks at rates in the low 20s, lend the borrowed sum in the bazaar at percent rates in the 30s, and postpone repayments of the loans for years at an annual penalty of only 6%! Poor and unprofessional assessments of borrowers’ proposed projects and the concentration of bank loans on a few selected mega borrowers have been other causes of the banking system’s problems. Nearly 80% of the total bank loans are now reportedly in the hands of less than 12% of active businessman. In the absence of real banking system reforms in the coming year, the situation is likely to get worse - particularly if the sanctions are not removed.
Finally, keeping energy prices artificially down for years has resulted in profligate energy consumption, the continuation of energy inefficiencies, the rise of energy-intensive industries vulnerable to external shocks, a growing need for energy imports, intolerable air pollution and a clear rise in energy smuggling to neighboring countries.
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