A Critical Overview of Economic Mechanisms

EghtesadOnline: Iran’s economy is on the brink of experiencing a crisis, if not already. What got us here? Farhad Nili, the representative of the Central Bank of Iran to the World Bank, believes that four main mechanisms, namely massive imbalances, people’s overexpectations, external pressures and the system of governance, have led the economy to its present state.

News ID: ۷۴۵۹۹۲

10 September 2018

A gist of his interview with the Persian weekly Tejarat-e Farda follows:

Fundamental Imbalances:

Saddest Part of Iran’s Economy

The first mechanism, the saddest part of our economy, is a collection of fundamental, established imbalances within the economy, including water crisis, air pollution, government’s financial system, banking system and pension funds.

The imbalance between the volume of water consumption and water reservoirs in the country has a long history. The historical problem of water shortage cannot be blamed on the incumbent or the former government. It is a chronic condition that has worsened over time, particularly in central and eastern parts of the country.

The second serious imbalance in our country is that of air pollution. Emissions of pollutants in Iranian cities outpace those of nature’s air purification process.

Although the banking system’s imbalance is not as old as water and air pollution, it seems to be escalating at a faster pace. The disproportionate revenues and expenditures, or assets and liabilities, have become embedded in the country’s banking system; neither the Central Bank of Iran nor the Economy Ministry can resolve this problem single-handedly.

The Central Bank of Iran’s latest budgetary report shows Iran’s budget deficit came in bigger than expected in the first quarter of the current year (March 21-June 21) to reach 290.1 trillion rials (about $2.3 billion).

The shortfall for the period was larger than the budget law’s forecast of 82.2 trillion rials ($668.29 million). The deficit is 66% more compared to the preceding year’s corresponding period.

Overall revenues during the three months amounted to 99.7 trillion rials ($810 million), indicating a decline of 45.1% year-on-year, while spending hit 389.7 trillion rials ($3.1 billion) to register a 9.4% growth YOY.

Similar imbalances apply to the government’s financial system and pension funds. An economy should either be capable of generating income from within, or it needs to earn resources from outside through investment or by taking out loans to cover its expenses.

In the absence of these two resources, an imbalanced economy has to create money. It has been a long time since Iranian governments have resorted to the latter option.

To cover the widening budget deficit during the period under review, the government issued 57.3% more bonds worth 290.1 trillion rials ($6.59 billion) in the first fiscal quarter (started March 21) compared with the corresponding period of last year.

For more than four decades, the money supply has annually grown by 25% on average. This trend has become one of the established orders of the Iranian economy. The constant increase in money supply is because the economy fails to create added value in its real sectors to get balanced. It prefers to create money in the nominal sector. That is why the greater part of creating money comes to pass in the final quarter of the year, the time the fiscal imbalances should be addressed.

Latest data released by the Central Bank of Iran show the total volume of money supply reached 15.3 quadrillion rials (over $124 billion) by the end of the previous fiscal year on March 20, 2018.

The figure was indicative of a year-on-year growth of 22.1%, as it stood at 12.53 quadrillion rials (more than $101 billion) at the end of the year before. Although this hike is high, it actually shows a decline in pace when compared with the past two years when the money supply had registered an annual rise of 23.2% and 30% respectively.

High Expectations

Iranian people’s expectations outweigh the potential of the economy for various reasons. As said before, the 25% rise in money supply suggests that each year the purchasing power grows by 25% compared with the year before. This is while only 4% more goods and services are produced every year in the economy.

So the prices must go up by 21% in the long term in order for the economy to balance out. It is not possible for people to buy more than the goods produced or stored in warehouses in the medium term.

As a result, the gap between the growth of money supply and the increase in added value should turn to the rise in prices (or inflation).

The truth is Iranian people’s expectations do not match the country’s per capita income. Iranian people do not compare themselves with Vietnam, Philippines, Jordan, Malaysia, Indonesia, China and Poland.

Instead, they compare themselves with European countries, the European portion of Turkey, and the privileged areas of Kuala Lumpur and Jakarta. They believe that Iran is an oil-rich country so they should enjoy more material welfare, whereas the imbalances mentioned earlier don’t allow the government to fulfill these expectations. The impact of these expectations has aggravated the imbalances.

Global Interdependency and One-Way Governance

The intensity of the third mechanism, external pressures, hinges on our diplomacy and the picture we have presented of ourselves to the world. Iran does not have a strategic partner in the world. It is not a member of an international club or group. That’s because, for a period of time, we wrongly defined independence as lack of dependency on other countries, while a dynamic independency requires mutual dependency.

You need to make people depend on you as much as you depend on them in order to tie their destiny to yours.

By adopting a smart, honest and fair approach, the fourth mechanism, the system of governance should foster collaboration with people. People don’t like monologues. They prefer to have dialogue with the policymakers. They want to inquire and demand answers.

Unfortunately, the signals being sent by the system of governance are not good. A state faction repeats the same remarks regardless of the time and date we are in.

The system needs to show that it is aware of the changes: changes in money supply, water, environment, among others.

That the money supply grows regardless of political changes offers a good lessons to us. It shows different governments with different political alignment take office but the policies they pursue have no effect on money supply.

The whole thing suggests that despite the conflict of political ideas, governments do not really have a comprehensive action plan to tackle the problems.

The second lesson is that replacement of people won’t work because the structure stays put. Replacing people serves no purpose, as the outcome of a dysfunctional structure would remain the same. What got us here won’t get us there.

(Farhad Nili holds a PhD degree in economics from University of York, the UK.)