Central Bank of Iran Sets 22% Inflation Target

EghtesadOnline: The Central Bank of Iran says based on “realistic assumptions and scenarios” it will set the inflation target at 22% during the current fiscal year that ends in March 2021.

News ID: ۷۵۰۱۰۸

27 May 2020

The announcement came in the follow-up to an earlier statement by CBI Governor Abdolnasser Hemmati that the bank will use multiple policy instruments to implement “inflation targeting”.

Taking stock of factors impacting inflation in the past five decades and the inadequacy of past inflation-taming efforts, the CBI said plans are in place for a change in approach to reduce the galloping inflation.

“Since the 1970s, Iran’s economy has been grappling with instability conspicuous in double-digit inflation for five decades,” the statement on CBI’s website said

“Perpetuation of such conditions has resulted in poor balance sheets, particularly in the government’s annual budgets, which in turn has given rise to colossal liquidity”.

The CBI said another inflation shock emerged in 2018 due to expectations about increase in currency prices and “speculative attacks” in the forex market triggered by the new US sanctions after Donald Trump walked  away from the landmark Iran nuclear deal and unleashed his hostile “maximum pressure” policy against Tehran.

“The situation was exacerbated by the steep decline in oil exports, pressure on Iran’s ties to international banking and difficulties in importing raw materials and intermediate goods that disrupted economic activities”.

The regulator said it has been partly successful in neutralizing the impact of sanctions over the past two years by limiting the space for avaricious speculators and controlling factors that push up inflation.

Role of Policy Instruments

The CBI statement added that its leverage to control inflation was limited in the past half century blaming inadequate modern monetary policy instruments.

Now is the opportune time, the CBI said, for a change of attitude toward managing inflation given the expansion of instruments for managing the money market, a bigger role of private enterprise and change in approach toward plugging budget deficits.

Elaborating on modern monetary instruments, the regulator said grounds are now paved for setting a reasonable inflation target.

It particularly stressed the role of open market operation, the interest rate corridor, trading government bonds in the interbank market and using bonds as collateral to borrow from the central bank.

The OMO and an interest rate corridor (IRC) are the main components of the CBI’s new monetary policy that started operations in January.

OMO is a financial instrument through which central banks buy and sell securities to expand or reduce money supply. The mechanism allows central banks to buy government bonds to increase the money base (cash reserves) and by extension curb inter-banking lending rates.  Selling government bonds reduces the base money and raises interbank rates.

In addition, within this framework, banks can hold bonds as collateral to borrow from the CBI.

Under the IRC framework, the CBI sets the floor and ceiling of policy rates and lets other money market rates, such as interbank rate, move within this setup.

Defending the inflation targeting policy, the CBI said “the inflation target is a means for guiding CBI monetary policy”.

“Within this framework, targeted inflation will function as a compass that guides policymakers,” the CBI said, adding that the CBI will regulate interest rates in the defined framework by trading bonds via the interbank market and making changes to the floor and ceiling of the IRC.

CBI holds the opinion that the inflation rate will be of the descending order in the current fiscal year and the target is based on “realistic assumptions and scenarios”.

CBI data show that inflation was 41.2% in the last fiscal year (March 2019-20). The figure is expected to drop in the current fiscal year as forecast by the International Monetary Fund.

The IMF has forecast slight improvement in Iran’s economic indicators in 2020, estimating that consumer prices would drop to 34.2% in 2020 and 33.5% in 2021.

Skepticism

There are reservations hat the CBI target may not be feasible at least in the short-term in light of the fact that none of factors affecting consumer prices are stable.

Criticizing the CBI’s policy, Vahid Shaqaqi, a university instructor, says the regulator should first identify and stabilize key variables affecting inflation before setting inflation targets.

“Volatility in the currency market, stability in the capital market, improving non-oil trade balance, managing budget deficits and controlling monetary base are among such variables,” he was quoted as saying by ILNA.

Shaqaqi said none of the above variables are in a stable condition, which makes targeting inflation more difficult.

Pointing to an inflation target of 22% as announced by the CBI, the economist said “even reaching 30% inflation would be rather difficult, demand serious economic reforms and comprehensive plans that is not likely to in the short-term”.