Policy reversal on interest rates in Iran: Is it enough to revive the rial?

After weeks of wrangling, on Wednesday, January 25, President Ahmadinejad has consented to the request from his Central Bank to sharply raise interest rates (officially referred to in Iran as “the rate of profit of banks”), from 12.5% on one-year deposits to over 21% and higher.   The argument for increasing deposit rates is simple macroeconomics: when interest rates are below the rate of inflation, as they have been in Iran for the last two years, people will try to protect their savings by shifting their money to other liquid assets, such as foreign currency and gold.  According to some reports, this theory was put to a quick test when the price of dollar and gold dropped on the same day that the hike in deposit rates was announced.  At the same time, the Central Bank has announced that it will unify the exchange rates at 12,260 rials per dollar, which is an official devaluation of less than 10%.    But, as welcome as these pragmatic steps are, they may not be enough.  Higher interest rates will do some good, but are unlikely to lower the market exchange rate to the new official rate.  These are complicated times in Iran and simple macroeconomics may not apply.

The policy change on bank deposit rates is significant, both because of its magnitude — banks are free to offer deposit rates as high as they want — and because of the lesson it entails.  When President Ahmadinejad took office in 2005, he promised to lower both the interest rate and the exchange rate.  Seven years later, he has to live with higher rates for both.  The lesson to be learned from this fiasco is that a bit of economic logic can go a long way.  Ideologists inside and outside the government who view markets with suspicion and confuse understanding and respecting how markets work with defending neo-liberal and free-market policies, do themselves and the nation disservice.   In this particular case, the simple logic of markets says that you cannot control both the rate of interest and the exchange rate: if depositors cannot at least maintain the value of their money while it sits at the bank, among other things, they will turn to foreign currency, putting pressure on the exchange rate.

How have Iranian banks been rewarding depositors lately? If you put 100 rials in the bank ten years ago, today you would have 370 rials, which is worth only 91 rials because of inflation.  The real rate of interest on one-year bank deposits (nominal interest rate minus the rate of inflation) has been negative in 7 out of the last 10 years.  Real rates have averaged -1.7% per year for the period, and, significantly, reached minus 10% in 2011 (see the graph below).

It is not clear that the sharp negative turn in interest rates is responsible for the sudden collapse of the rial this month.  As inflation picked up in 2007, causing real interest rates to plummet, money first moved into real estate, which was already hot because of the oil boom, causing a housing bubble.  When the bubble burst, in 2008, people started looking for other stores of value, mainly gold and the dollar, pushing up their prices gradually.  The higher deposit rates will solve this part of the problem because they will attract money away from these risky and volatile assets into banks, but the larger problem, the sudden increase in the prices of gold and foreign exchange, is harder to solve.   This is because, in times of a crisis such as Iran finds itself in, bank deposits are not good substitutes for gold and foreign cash.

As I noted in my previous post, the latest crisis is caused in large part by the harsh US and EU sanctions that prevent not just ordinary traders but also Iran’s Central Bank from moving money around.  If sanctions worsen, as most people seem to expect, money in the local bank is of little use for paying for critical imports or for education or medical care abroad, no matter what the interest rate.  It is quite telling that the run on the rial started when the US sanctions against Iran’s Central Bank passed the Congress with near unanimity last December.  Once sanctions become law they are very hard to remove (the sanctions against Iraq were only removed in 2009).

An Iranian official said recently that the sanctions are good for Iran.  I am not sure if using the international financial system for  political reasons, as the US and EU have done, is good for anyone.  But we know of one good thing that the sanctions have done already — encourage more sound economic policy in Iran.

The fall of the Iranian rial: too much of a good thing?

In Tehran’s volatile currency market the rial fell to its lowest level ever today (January 2, 2012), the US dollar closing above 17,000 rials.  The devaluation of the rial that started at a gradual pace over a year ago, and was largely expected and welcomed by economists, accelerated, going from less than 11,000 to around 15,000 rial per dollar in a matter of weeks.  The additional fall in rial of about 10% in the last two days raises the question if the correction has gone too far.  To answer this question one needs to have some idea of what is the right rate of exchange for Iran’s currency, something that you are unlikely to find in standard economics textbooks.  There are two reasons why the market clearing price is not a good guide to the value of the rial: sanctions and oil.

Anniversary blues for subsidy reform

The anniversary of the subsidy reform, on December 20, 2011, arrived with fireworks, but not the kind the government had hoped for.  In a day that President Ahmadinejad was addressing a conference of the first anniversary of the subsidy reform in Tehran, the rial fell by more than 5%, breaching the psychological 15,000 rials per dollar barrier.  These two events are more than coincidentally connected.  The rial has been weakened by the inflation unleashed by the subsidy reform, a cost of the reform that was both foreseen and justified.  At the same time, the precipitous devaluation of the rial adds to uncertainty and macroeconomic instability that can undermine the subsidy reform.  The real benefit from the reform derives from reduced demand for energy, which can only happen if households and firms are willing to change their behavior and invest in energy saving equipment, which in turn requires confidence that the post-reform energy prices will not be washed up in some cycle of inflation and devaluation.  Remember, unsubsidized energy prices are equal their world prices multiplied by the exchange rate.  With 15,000 rials to the dollar, gasoline (at 4000 or 7000 rials per liter) is 50% cheaper than it was a year ago when the new price was set, and is once again subsidized.  

Iran’s place in the world distribution of income: an update

My post by the same title a year ago that featured a graph developed by Branko Milanovic was the second most visited post on this blog last year (after one on Iran’s energy subsidies), receiving 912 views.  So when I learned last week that he has been working on an update of his analysis of the world distribution of income, I requested an updated graph.   Branko was the keynote speaker at an Economic Research Forum conference that I attended in Cairo, where he was introduced as “Mr. Inequality”. His new results show that Iran’s position in the world distribution of income improved between 2005 and 2008, something that should surprise no one since during this period Iran was the recipient of about $200 billion worth of transfer from the rest of the world as oil income.

Taking the surprise out of Iran’s low unemployment rate

The fact that after a long hiatus the Statistical Center of Iran (SCI) has decided to publish the results of its quarterly Labor Force Survey should be welcome news but instead it has been met with controversy and disbelief.  The new report for summer 1390 (2011) shows a surprisingly low unemployment rate of 11.1%, down from 13.6% the same quarter a year ago.  In the absence of data on the Gross Domestic Product (GDP) from the Central Bank in the last 3 years, analysts were hoping to find answers to questions about the economy’s health from unemployment data, but instead they were disappointed.  Many reports, including one interview with a former SCI deputy director, dismissed the data as cooked.  A closer look shows they are right to be skeptical of the lower unemployment rate, but not to question the survey’s veracity.  Based on the published report I argue that the actual rate of unemployment maybe as much as 40% higher than what has been officially reported.

The trouble with rial

Iran’s currency, the rial, is about to change if not disappear altogether.  Iran’s Central Bank is seriously considering taking 4 zeros out of the embattled currency, and even changing its name, perhaps to something Persian sounding like parsi.  Neither of these two actions, if they come to pass, deal with the real trouble with rial. I am all for taking the zeros out, and could go along with the name change if that would help people forget that the new rial is the old rial 160 times less valuable (compared to 1977).

Affirmative action for Iranian men — to help women!

A recent news item posted on Alef’s site (in Persian) with the provocative title, “33 harmful effects of  increase in women’s enrollment in universities,”   reported the opinions of “experts” and politicians, including some members of the parliament, on the consequences of the rising presence of women in universities.  Expressing concern about the imminent “takeover” of universities by women, and suggesting the need for affirmative action for men,  is not new (I wrote a short article on this subject more than three years ago).  What is new is the claim that it is not good for women.  Affirmative action for men to help women!

Egypt: between populism and subsidy reform

Cairo, June 14, 2011

This is my first trip to Cairo since the uprising that toppled the Mubarak regime.  The airport was unusually quiet and all Mubarak pictures are gone, but otherwise there are few signs of a country that has just experienced its most dramatic social upheaval since the 1952 revolution. Egyptians like to think of the uprisings as Revolution (“al thawrah”) which in Arabic signifies deeper social change than “enghelab,” the word Iranians use for revolution.  But what has transpired in Egypt’s first six months of “revolution” pales in comparison to Iran’s 1979 Islamic Revolution.  There have been no executions or mass exodus of the rich, and not even an overhaul of the high echelons of the bureaucracy, as happened in Iran. Egypt’s judicial system has taken the lead in calling the members of the ancien regime to account. So far it is moving cautiously; only 45 individuals are currently in jail or standing trial for their alleged crimes, including Mubarak and his two sons.  If the judiciary can satisfy popular demands for justice, Egypt has a good chance for a soft landing on this side of the uprisings, and its judicial system may emerge as a strong pillar of its future democracy. If it fails to do so, revolutionary justice may take over and all bets would be off about democracy and restoring the economy to its previously robust growth path. No one seems certain how Egypt’s revolution will end.  As de Tocqueville has said, “in a revolution, as in a novel, the most difficult part to invent is the end.”

Getting More from Less: Merging Ministries in Iran

The recent decision by the government to merge several ministries has ignited a fresh round of dispute between President Ahmadinejad and his conservative critics, but the controversy has been all about whether the president has the authority to merge ministries and very little has been said about the actual merits of the proposed mergers.  It now seems clear that the Guardian Council and the Parliament will have their say on the merger (see this report in Persian), but in the highly politicized environment in Tehran, I doubt that the merits of the proposed reorganizations will get the attention they deserve.  The stated objective — to cut down the size of the government — is unlikely to be realized beyond cutting the size of the cabinet.  I am not aware of any downsizing dividend from the “dissolution” of the Management and Planning Organization two years ago.  (Incidentally, that decision was made in a similar manner to these mergers, but at the time it was the reformers who questioned the government’s authority to change the line up of the ministries.)  As far as I know, MPO’s bureaucracy is still in place.

The poor and the middle class

A recent article on Tehran Bureau’s website portrayed urban Iran as “a sea of poverty”. This stark description was based on the calculations made by three Iranian researchers that showed as many as 55% of urban Iranians were below a poverty line set at 58,035 rials per person per day (more on the methodology of the paper later). For an unpublished study that was relegated to the poster sessions of a conference in Tehran it has been hugely successful, getting quoted in dozens of Persian and English language websites. The reason is not the study’s novelty of techniques or approach, which is standard, but is its extravagant claim about Iran’s poverty rate, which appeals to those who think the news portends political change. Although I have seen even higher claims of poverty rates for Iran (as high as 90%), those did not make it to the prestigious TB, which is part of the PBS/Frontline website. So I decided to write a reply to set the record straight.