Preconditions for Inflation Control

EghtesadOnline: It is possible to curb inflation by managing inflation expectations in the short run, but addressing the root of inflation and implementing structural reforms are crucial in the medium- and long-term.

News ID: ۷۸۶۹۱۷

30 August 2021

This was stated by Vahid Shaqaqi-Shahri, an economist and university professor, in a write-up for the Persian-language daily Kasbokar. Below is a translation of the full text:

When it comes to inflation, we need to consider two pressing issues. The first is the fundamental causes of inflation in the Iranian economy and the second is inflation expectations. Fundamental causes have specific roots and structural reforms are needed to address these causes. Resolving these issues might be time-consuming, therefore the government needs to take tough decisions. The second issue, i.e., inflation expectations, can trigger the first issue.

Fundamental causes are like a growing heap of straws and inflation expectations act as a spark or fire that burns this pile and causes economic distress.

For managing inflation expectations and resolving the fundamental causes of inflation, two timelines should be set: the government needs to reduce inflation expectations for the next three to four months or even up to the end of the current Iranian year (March 20, 2022). In the meantime, it should initiate structural reforms to address the causes of inflation in the medium- and long-term.

Fundamental causes include economic imbalances like budgetary, banking and foreign trade imbalances. Budget and trade deficits should be tackled. The budget deficit of fiscal 2021-22 is estimated to exceed 3,000-4,000 trillion rials.

Over the past few years, the government managed to cover part of this deficit by selling treasury bonds, tapping into the capital market and borrowing from the National Development Fund of Iran, the country’s sovereign wealth fund. It would be grueling to keep addressing the budget deficit via these channels (bonds and NDFI).

Financial imbalances of the banking system should be reduced and operational budgeting must entail structural reforms. Non-oil exports should improve and official imports must be curtailed. Unofficial imports and a serious fight against smuggling must be put on the agenda.

It is also important to consider the reduction of banks’ frozen assets. Ambiguities regarding the end of the Covid-19 crisis and Iran’s approach toward curtailing it, the capabilities of the government’s economic team, nuclear talks and sanctions against Iran’s economy as well as ambiguities about recent conflicts in the neighboring countries, particularly in Afghanistan, the issue of accepting international financial safeguards demanded by the inter-governmental watchdog, the Financial Action Task Force, are undefined variables of Iran’s economy.

These ambiguities need to be resolved in some way, as all these issues can act as a spark that results in economic kindling.