Iran's CB Looking at Euro CDs

EghtesadOnline: The Central Bank of Iran said it is planning to launch euro-denominated certificate of deposit to reduce the volume of rials held by the public and downsize the money supply, the bank’s governor said.

News ID: ۷۵۰۳۴۴

29 June 2020

In a note in his social media account Sunday, Abdolnasser Hemmati said that the euro-denominated CDs will bear fixed interest rates that will be sold to buyers at the going rates.

“With adequate reserves of euro banknotes, the CBI will be committed to reimburse the CDs in euro on the maturity date,” he wrote.

A certificate of deposit is a product offered by banks and credit institutions that provides an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period of time.

Hemmati said the CBI will soon send the proposal to the Money and Credit Council, the top banking and monetary policymaking body in Iran, for approval.

The move is in line with a series of CBI efforts to curb the ballooning liquidity and lessen the inflation rate toward the declared 22% target.

In a recent report the central bank said money supply reached 24,721.5 trillion rials ($131 billion) when the fiscal year ended on March 19.

It grew by 5,893.5 trillion rials ($31.5 billion) in the past three months – a 31.3% jump and one of the highest in the past five decades.

The huge of money supply has caused serious concern in many quarters about its impact on consumer prices, compelling the CBI to clarify the root causes of the unseen growth.

In a recent press release the regulator blamed borrowing from the National Development Fund of Iran, the country’s sovereign wealth fund, new US sanctions on oil exports and other key economic sectors for the monumental growth in liquidity.

Inflation Target

CBI’s report was more than enough to question Hemmati’s bold decision to set inflation target at 22%.

Taking stock of the complex situation in Iran’s financial markets, economists and market pundits insist that it is unreasonable to set a fixed inflation rate in an economy where financial market indicators fluctuate at tremendous speed.

They argue that there should be adequate compatibility between inflationary expectations and the CBI inflation target.

The CBI last month set the inflation target at 22% for the current fiscal year that ends in March 2021 and said it “will use all monetary policy instruments at its disposal to achieve this goal”, and that the target is “based on realistic assumptions.”

CBI data show that inflation was 41.2% in the last fiscal year and is expected to drop this year as forecast  by the International Monetary Fund.

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

The CBI says its leverage to control inflation was limited in the past half century due largely to inadequate monetary policy instruments.

So far it has announced several aspects of the monetary policy to realize the inflation target, including open market operation and the interest rate corridor (IRC).

Hemmati said Sunday that the CBI will continue taking “stabilization measures” vis-a-vis financial markets. “The current monetary policy frameworks allow the use of  monetary instruments when necessary to reach the inflation goal.”

In one of its latest moves, the regulator increased the cap on interest rates for interbank deposits to 12%, up from the previous 10%. The decision, it said, was made to narrow the interest rate spread in the IRC.

OMO and IRC are the main components of the CBI’s new monetary policy announced 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.