Hemmati Signals Interest Rate Cuts

According to Fars News Agency, Hemmati made the announcement this week in a talk with reporters and said the move marks a major shift in CBI monetary policy. 

"Our goal is to change the liquidity structure. The main reasons for the rise in money supply are (high) deposit interests and the multiplier effect. We must reduce (the two variants) and increase the monetary base." 

Elaborating his point further, he said, “There is little money in the hands of the people and if we can make this change we can boost production." 

The multiplier effect refers to the disproportionate rise in final income emanating from injection of spending. In other words, capital infusion, whether it be at the government or corporate level, should have a snowball effect on economic activity, according to Financial Tribune.

The latest CBI report shows liquidity reached 17,645 trillion rials ($127.8 billion) in the fiscal month to Nov.22, up 22.1% compared to the same month last year.  

The report published on the CBI website indicates that the money supply increased by 15.3% compared to the end of the last fiscal (March 2018-19).

In 2013 the CBI embarked on an initiative to rewrite the money supply structure through a coordinated plan with the Budget and Plan Organization, presidential economic advisor and the Ministry of Economic Affairs and Finance. 

The bank pursued the plan to control the monetary base amid conditions that the production sector had high demand for cash after a jump in currency rates. However the bank never succeeded in curbing the monetary base due to regular withdrawals from the National Development Fund of Iran (the sovereign wealth fund) and mounting debt of the banks to the CBI.  

This led to an increase in interest rates way above the rate of inflation, and in 2016 the gap between interest rate and the inflation rate reached the historic high of 11%. 

It is likely that the CBI would try to curb lending and deposit rates through the much touted Open Market Operation.

Hemmati said this week that the CBI would launch the OMR in the current fiscal (March 2019-20) as part of its latest effort to regulate the monetary market. He said the plan is on the agenda of the Money and Credit Council – a top decision-making body. 

In OMO the CBI determines a range for [interbank] interest rates and allows banks to operate within the specified range.   

OMO is a financial instrument through which central banks buy and sell securities in the open market to expand or reduce the supply of money. 

Within the OMO, the CBI buys government bonds to increase the money base (cash reserves), thereby reducing inter-banking lending rates. On the other hand, selling government bonds decreases the base money and raises interbank rates. 

The initiative is seen as part of the current fiscal budget law. As per the law, “in order to implement monetary policy and control interest rates and inflation, the CBI will launch the OMO and trade in Islamic bonds issued by the government. Banks can hold the bonds as collateral to borrow from the CBI.”