Hemmati Defends Currency Control Policy

EghtesadOnline: Governor of the Central Bank of Iran says the bank has had at its disposal few policy options to address problems that have plagued the economy for years and came to the surface after the US imposed new sanctions in late 2018.

News ID: ۷۴۹۴۶۲

18 January 2020

Abdolnasser Hemmati, who was addressing the annual CBI general assembly on Thursday, pointed to measures for controlling the currency market as the most viable solution the government had in the summer of 2019 -- a time of heightened stagflation, according to Financial Tribune.

“At the outset of the rising currency rates and the subsequent inflation last year [fiscal 2018-19], which coincided with the economy entering recession, the central bank had no alternative but to control the currency market,” the CBI website quoted him as saying.

He reckoned the weaknesses of the contractionary policies proposed by some economists as an alternative at the time, noting that the contractionary policy would involve significant rise in interest rates and steep decline in the base money.

Base money, or monetary base, is the total amount of bank notes and coins circulating in the economy.

“When it comes to coping with stagflation, the best macroeconomic theories shun the workability and certainty of contractionary proposals to raise interest rates,” he said.

It was crystal clear for the CBI that raising interest rates could make a bad situation worse as it would both deepen the recession and give rise to the already stressed balance sheets of banks, Hemmati said, adding that “this would have only postponed the problem”.

To tackle the issue, the CBI focused on the currency market given its role in and contribution to pushing up inflationary expectation. Hemmati said the approach to control currency rates was a well-thought innovative that had been rarely tried.

Taking stock of the positive sides of the CBI’s currency policy, he said bank authorities were looking for a policy that first could curb speculative activities, and second did not require regular injections of currency reserves that would undermine national forex reserves.

Such a policy should also pave the way for repatriating overseas earnings by exporters of non-oil goods and at the same time provide the currency needs of importers of essential goods and machinery needed by manufactures.

Additionally, the policy would be immune to steep fluctuations in currency rates emanating from political tensions, check capital flight and encourage people to offer their household foreign currency.

Steps the CBI took to implement such policies include direct participation in the currency market, setting limits on rial transactions and developing a secondary forex market to meet the currency needs of businesses.

US President Donald Trump in May 2018 abandoned the nuclear deal Iran had signed with world powers in 2015 and announced new economic sanctions regime against Tehran, described as the "toughest ever" against any country in recent memory.

The first negative effect of the sanctions was on the currency market when foreign currency prices surged to unprecedented highs in the summer of 2018 and the rial depreciated more than 60%. Currency market volatilities soon extended to all other markets causing the prices of goods and services to soar.

CBI is now of the opinion that the economy is showing signs of recovery, thanks partly to its measures. The most obvious sign of the recovery is the rebounding rial, which government authorities say has appreciated 40% against the dollar.

There also are indications, the CBI says, that tability has returned to consumer prices and the key manufacturing sector.

Banking Reforms

Apart from currency policies, the CBI has stepped up efforts to reform the flawed banking sector, but the reform process has been gradual and done carefully to avoid worsening the recession.

“The CBI was cognizant of a lack of legal, social, political, and theoretical grounds for resolving issues pertaining to banks’ balance sheets. It sought to gradually increase supervision on banks to control their risky behavior, ” Hemmati said.

He pointed to the merger of five military-affiliated banks and credit institutions, change in the composition of the board of directors of stressed banks and increasing disciplinary measures against poor-performing lenders.

OMO Unveiled

On the sidelines of the general assembly, which was attended by the President Hassan Rouhani, the platform for trading government bonds within Open Market Operation was unveiled.

The CBI announced the inauguration of OMO last week as part of its monetary policy to curb inflation, control interest rates in the interbank market and harness the ballooning liquidity.

Lenders can manage their need for liquidity or offer their surplus liquidity in the interbank market within the new CBI monetary framework.

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

OMO provides central banks with the capability to buy government bonds in order to increase the money base (cash reserves) and by extension curb inter-banking lending rates.  In the same vein, selling government bonds reduces the base money and raises interbank rates.

In the OMO framework banks can hold bonds as collateral to borrow from the CBI. Speaking to state TV on Thursday, Hemmati said OMO is a popular monetary policy in the world that has replaced conventional, but ineffective and limited, methods that involved controlling liquidity and monetary base.

Given that the previous measures had failed to produce the desired results, the CBI has pinned hope in monetary policy to help curb inflationary effects of the liquidity unseen in the domestics banking industry.

In the budget plan for the next fiscal year (March 2020-21) the CBI is allowed to collateralize banks’ debts over a gradual process in a way that at least 50% of banks and credit institutions’ debts to the CBI are collateralized by debt bonds issued by the treasury.