economic convictions, President Ahmadinejad began his tenure in 2005 by following a populist and welfare-oriented economic policy, promising to “put the oil money on everyone’s table.” His economic agenda included: (a) an expansionist fiscal policy aimed at “eradicating poverty;” (b) a distinctly overvalued rial to reduce imports’ cost; (c) a mandatory low interest rates policy to minimize capital costs of business; and (d) the use of bank loans, bond issues, and sale of state enterprise to finance budget deficits – instead of tax hikes or more efficient tax collection.
The expansionist binge began with: (i) extensive and poorly supervised loans to the so-called “quick-return projects” in order to increase employment; (ii) an immense nationwide housing project (Maskan-e-Mehr) to increase home ownership; (iii) hundreds of half-baked local development projects to satisfy the crowds who greeted the president in his countrywide tours; and (iv) a “subsidies reform program” involving monthly cash payments to nearly the entire population to make up for higher energy and bread prices. As a result, the national budget rose from IR1,590 trillion in 2005 to IR5,100 trillion in 2011 – or more than three times in seven years. With annual budget deficits running at more than 4% of GDP each year, total liquidity rose from IR921 trillion in 2005 to IR3,720 trillion in 2011, or nearly fourfold.
Protracted budget deficits and liquidity expansion during 2005-11 caused the average officialcost of living index to rise by nearly 17% a year – with the most conservative privateestimate showing 22%. During the same period, Iran’s main trading partners had price increases of 2-4% a year. By a simple calculation, the difference between Iran’s cumulated inflation during the seven-year period compared with those of its trade partners would have warranted some 90% devaluation of the Iranian rial. In actuality, the exchange rate only rose from $1=IR9,025 in 2005 to $1=IR10,445 before the December crash, or a total correction of less than 16%. Thus, the government not only ignored the facts; it also violated the clear mandates of both the Fourth and Fifth Economic Development Plans, requiring annual adjustments of the rial’s exchange rate in line with the differences between domestic and foreign inflation rates. Curiously enough, in December 2010, while announcing his subsidies reform program, President Ahmadinejad asked the head of the CBI to come up with a new and “realistic” exchange rate in view of Iran’s “ample foreign exchange reserves” – an order which some of his aides at the time interpreted to mean revaluing the rial towards $1=IR5,000!
The same incongruous treatment greeted the government’s regulations of bank interest rates. During the first six years of the Ahmadinejad administration, the authorized interest rate on short term savings deposits frequently trailed the annual inflation rate, eroding the net value of the depositors’ wealth. The maximum interest rate (called “profit share” to comply with Islamic principles) payable by commercial banks on short term (less than five years) deposits during 2005-10 averaged 13% per annum, while the corresponding inflation rate registered 17-22%. In the highly inflationary year 2008, the negative spread reached 10%. As a result, there was a steady decline in the growth of savings deposits during the entire period. Despite these warning signs, however, and even ignoring the mandates of the Fifth Economic Development Plan (2010-15), requiring periodic adjustments of the deposit rates in line with the inflation rate, the Council on Money and Credit, chaired by the president, refused to budge. Even when faced with continued turmoil in the exchange market in early January 2012, the Council (in the absence of the president) allowed interest rates paid on savings deposits to be left at the individual bank’s discretion (in order to divert liquidity from gold and dollars markets). The decision was vetoed once the president returned from a foreign trip. It was only after strong public pressures that on 25 January 2012 the president finally approved the rate adjustments.
President Ahmadinejad’s third gamble with the teetering economy was to fight a virulent and cumulative inflation with the wrong weapon. Instead of controlling consumer prices through conventional means, eg balancing the budget, raising interest rates, reducing bank borrowings, controlling liquidity, or raising factor efficiency, he chose the easy way. Blessed by the best six years of oil export receipts from Iran’s 106-year-old oil industry, he opened the imports’ floodgate. Iran’s revenues during the first six years of the Ahmadinejad administration reached $560bn, compared to only $433bn by all the eight previous governments since the 1979 revolution. In the same six years, imports amounted to $330bn – three times those of the Khatami and Rafsanjani administrations. Yet, during the same six-year period, the government debt to the banking system rose from IR113 trillion to IR403 trillion – or four times. The pernicious policy of trying to fight domestic inflation through cheap imports required the rial to be kept highly overvalued.
Sanctions As Catalyst
The Islamic Republic’s nuclear development program has been the third factor in the exchange rate drama. Widespread suspicion in the West regarding the ultimate objective of Iran’s uranium enrichment activities initially led the United Nations Security Council to issue four consecutive sanctions resolutions. And the move was subsequently followed by the US, the European Union and others.
Thus, the original “targeted” and “smart” penalties gradually morphed into the current “crippling” restrictions. They currently consist of stiff and extensive restrictions on travel, trade, banking, finance, shipping, insurance, investment, and transfers of nuclear technology involving hundreds of individuals, businesses, and agencies associated with the Tehran government.
Their sole objective has been to dissuade Iran from pursuing its nuclear program – a program which Tehran claims to be for purely civilian energy research and production, but the “sanctioneers” suspect it to involve certain military objectives and possibly even nuclear weapons ambitions.
Although the current sanctions have not targeted the exchange rate in any direct way, their indirect impact on the rate’s movement has been notable. While the rial’s equilibrium exchange rate was due for a substantial correction and for a long time, the plunge would not have occurred without a catalyst. The currency could still have remained out of equilibrium for a while thanks to rising oil export earnings. The trigger for the precipitous plunge was supplied by the news of forthcoming new crippling American and European sanctions in early December 2011 – particularly the oil embargo. The exchange market was visibly rattled. And, on 31 December, when US President Barack Obama signed into law the new (and unprecedented) sanctions involving Iran’s central bank, the exchange dam burst, and the downward movement began.
In the same vein, while negative interest rates on bank deposits were not unique to the Ahmadinejad administration, and never a lever for a game change, two specific factors related to sanctions heralded a dynamic change. The first was a shift in the investment climate, shaken by the threatening sanctions. Prior to 2010, when there was relative political calm, the real estate market was flourishing, and rising liquidity would flow into land, apartment building, and the Tehran Stock Exchange. With the news of ominous times ahead, the funds started to invade the gold and foreign exchange markets as far safer and better havens. The second factor was a bewildering and untimely decision by the Council on Money and Credit, aimed at compensating the effects of sanctions, to lower short term interest rates from 16% in 2008 and 13% in 2009, down to11% in 2010 and 10% in 2011, at the very time that consumer prices had begun to rise from 12% towards 22%!
Dr Jahangir Amuzegar is a distinguished economist, former member of the
Executive Board of the International Monetary Fund and periodic contributor to the Iran Times. This article first published in the Middle East Economic Survey (MEES).