Impact of Fiat Money

EghtesadOnline: Expansion of monetary growth has again been blamed on the Central Bank of Iran’s obligation to purchase forex from the National Development Fund of Iran and settle the payment in rials, an “ill-advised method” the CBI governor says is tantamount to over borrowing from the bank at a time when NDFI currency resources at best are inaccessible.

News ID: ۷۵۰۵۷۹

01 August 2020

In a note on his social media account, Abdolnasser Hemmati wrote the CBI buying currency from the NDFI to fund budget deficits at the time of tough economic and banking sanctions is like “funding the budget via [expanding] monetary base”.

“This method in the short-term is tantamount to borrowing from the central bank,” he wrote, adding that “the CBI communicated its (frank) opinion about the possible adverse impact of this method of budget financing”.

It merits mention that the government has often approached the NDFI, the crisis lender and sovereign wealth fund, for financial help as its own revenues were not adequate to cope with multiple crisis, such as the ongoing coronavirus pandemic.

NDFI, which is independent of the government, technically holds a portion of oil and gas revenue for future generations.

Buying NDFI currency is a rather superficial move when in actuality its resources are not accessible due to banking and economic sanctions that make money transfer almost impossible.

As per procedures, the CBI has to pay to the government the rial equivalent of the foreign currency and receive the forex in lieu. However, since Iran’s currency reserves are blocked overseas and there is no possibility of unfreezing it in the foreseeable future, the CBI has to print money to pay to the government. This effectively means running the CBI printing machines fulltime and expanding the monetary base.

It is for this reason that Hemmati says such method is “tantamount to borrowing from the central bank”, at least in the short-term and until the government finds a way to unfreeze its foreign assets and use them to back the rial payment.

In sum, unless there are tangible currency reserves to back printing money it would be like fiat money.

Monetary Base Growth

The CBI’s latest report on monetary data shows that growth in broad money supply picked up in one year, rising 34.2% by the end of the calendar month to June 21 compared to the same period last year.

Broad money reached 26,571.7 trillion rials ($115 billion),  growing 7.5% in three months from the beginning of the fiscal year in mid-March.

As per published data, the monetary base grew to 3,834.7 trillion rials ($16 billion) by June 21, indicating 8.8% growth since the beginning of fiscal year.

The senior banker expressed the hope that expansion of monetary base could be contained because the government has changed it approach to secure funds for budgetary needs.

He referred to the bond offers in the debt market and selling government shares in state-owned companies as more appropriate methods for fixing the budget deficits.

Hemmati said in judging the CBI’s performance, the broader economic landscape and systemic economic shocks should be considered. Judgment should be “based on the CBI’s prerogative and the degree of its independence”.

He recalled that recent consumer price inflation is not merely attributable to growth in money supply and the monetary base as “rising inflation expectation emanating from non-monetary variables, and performance of other markets have had a distinct role.”

He was alluding the monumental surge in share prices in the past several months that had spillover effects in other financial markets, namely currency and gold.