CBI Expects Higher Inflation

EghtesadOnline: In a report on macroeconomic variables, the Central Bank of Iran said soaring foreign exchange rates could buck the declining trend of inflation in the coming months.

News ID: ۷۵۱۲۸۵

18 October 2020

Tracking inflation in the past few months, the CBI said consumer prices increased in May to July due to declining government revenue that spurred inflation expectation and rattled most markets.

While inflation growth slowed in the past two months, the central bank predicts that steep volatility in financial markets has the potential to undermine the trend and result in a new bout of inflation.

In a press release published on its website, the CBI said “external factors” emanating from the US economic sanctions States had the biggest negative impact on consumer prices

Steep rise in forex rates in the past few months has been a strong driving force behind inflation growth. The US dollar rate more than doubled from the beginning of the current fiscal year in March, rising from around 160,000 rials to more than 320,000 rials now.

“Soaring forex rates, upsurge in international commodity prices and the high and rising home prices are among factors that threaten prices in the months to come,” the CBI said.

The CBI governor, Abdolnasser Hemmati, in a note on his social media account again singled out the unilateral US restrictions as the primary external factor hurting monetary variables in Iran and the economy at large.

“There is no doubt that the most importing factor affecting the economy is external -- namely the omnipresent and oppressive sanctions against our country,” he wrote.

In 2018 the US imposed tough economic sanctions after Donald Trump walked away from the landmark Iran nuclear deal and unleashed his hostile “maximum pressure” policy against Tehran.

Sowing Chaos

The openly hostile penalties have further deepened turmoil in the market as forex rates have jumped to historic highs. The US Treasury Department on Thursday imposed fresh sanctions against 18 Iranian banks aiming to totally cut off the country from the world's financial system and choking off the already shrunk government revenues.

Among other things, the sanctions have resulted in a sharp decline in government revenue and, by extension, drilled bigger holes in the budget that have made access to foreign currency for import difficult if not impossible. As a result exporters also face huge challenges in repatriating their earnings home.

As per the CBI report, broad money supply reached 17.1% during the first six months of current fiscal year (ending Sept. 21). On an annualized basis, the money supply has grown 36.2%.

Likewise, the monetary base increased by 5.4% in the first half of the year, indicating 5.7 percentage points decline compared to 11.1% in H1 of last fiscal. The decline is related largely to the government’s suspending borrowing from the CBI and approaching the bond market to fund budget deficits.

The CBI said steep price rises in various markets is threatening the lower inflation target announced earlier by the regulator.

Earlier in May, the central bank set the inflation target at ±22% for the fiscal year that ends in March 2021, a highly ambitious target seen by many as unfeasible unless the government in Tehran finds a way to control inflation expectations among the public.

The average goods and services Consumer Price Index in the 12-month period ending Sept. 21, increased by 26% compared with the corresponding period last year, according to data released by the Statistical Center of Iran.

Coping Mechanism

The CBI in the press release announced new measures to control variables affecting price inflation.  Holding regular bond auctions to raise funds for budgetary needs, supplying currency for imports, rewriting rules governing the legal reserve of banks and regulating interest rates at interbank market are among the latest measures.

The government launched a series of bond auctions in May to sell Islamic bonds to banks and investment companies plus investors in the stock market. Bond sales via weekly bond auctions so far have contributed 710.19 trillion rials ($2.1 billion) to the budget deficit.

Last month the CBI increased banks' reserve requirement ratio to 10-13%, after it was cut in March, to support businesses impacted by Covid-19.

The ratio was reduced after the deadly coronavirus spread earlier this year to help provide banks enough resources for supporting businesses in need.

An estimated 750 trillion rials ($2.2b) was paid to struggling businesses impacted by the deadly virus. The loans were mainly given to SMEs hit hard by the pandemic.

Despite the chronic shortage in currency resources, the CBI said $15 billion was secured for importing basic goods since the beginning of the year.

The central bank also noted that interbank interest rates have increased steadily in recent months after dropping by as low as 10% in June.

Average interest rate in the interbank market reached 14.8% in the fifth month of the fiscal year (August 21). It further increased by 17.2% on average next month.

The CBI raised the lower bound of interest rate corridor (IRC) in the interbank market to 14% in August.  The upper bound now is 22%.

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