A U-Turn in Rouhani Administration's Economic Policy
Oct, 2015
Vistar Business Monitor
Last Thursday night, President Hassan Rouhani attended a television program, elaborating on his administration’s performance in the past two years and revealing his new plans for the next couple of years in order to improve business environment.
In fact the administration has reached to the point that it should simultaneously address inflation, stimulate demand, and help provide financing to businesses through an efficient and active banking system.
To that end, the administration has considered measures to reduce the reserve requirement to 10 percent should banks take certain steps, make a balance between the deposit rate and the inflation rate, reduce lending rate to 26 percent, and inject 75 trillion rials into development projects that could have immediate impacts on the demand side and eventually on growth.
The recent remarks by the president can be interpreted as a U-turn in the administration economic policies. It seems that some 75 trillion rials in financial resources is to be poured into the treasury, raising the possibility of a higher inflation rate at least in the short run.
The administration aims to complete the development projects 80 percent of which has been completed. By referring to early-returned projects, the president was meant to give priority to the projects that are expected to be completed by the end of this fiscal year, creating more jobs.
When a government decided to inject money into development projects in a bid to stimulate the demand side, such a policy could fuel inflation in the short run, but in the long run once the project become operational inflation can be reduced again.
However the question is whether such a stimulus plan needed considering the fact that sanctions will be lifted soon? Sanctions relief coupled with inflow of old income will positively affect the demand side, therefore we believe there is no need for the government to try to stimulate demand. With the president vowing that sanctions will be lifted in the next two months one can expect that the oil output and its exports will increase. In a worst case scenario, it will take the government three months to receive the oil money. So, a five-month plan recently introduced by the administration to stimulate demand may not be a proper policy.
The administration must be warned that its new economic plan to stimulate demand could end up in higher inflation, which the government has managed to reduce since its inauguration. It seems that authorities have introduced the new plan only under rising pressure from rival groups. The administration appears to react against criticisms in a move to show that it has been planning to address the economic woes. As a result it has acted in a populistic way just to convince the public opinion.
The clear result of the new plan is that the administration has dramatically made a change in its economic approach, adopting an expansionary policy. This means that inflation will hover between 12 and 15 percent by the end of this fiscal year. Instead, the economy will partially exit recession. To provide the financing required for the unfinished development projects, the administration appears to have counted on the oil income India has paid.
However, there is still a way to avoid higher inflation. That is to use the money by selling treasury bonds and debt bonds instead of injecting fresh capital into the economy. The administration must start selling bonds to the public in a move to minimize the inflationary impacts of its new policy. Any other solution could fuel inflation.
However, treasury and debt bonds are the financial means repeatedly experienced in the developed countries. The administration is to spend more in a bid to stimulate demand, but it can do that in a way that is less inflationary. The administration can easily run the economy using its own budget on one condition that it cuts huge budget of certain parallel entities and stop them wasting resources.
There is another issue that the administration has to address; that is the rial’s rate against other currencies. While the interest rate remains high and inflation is decreasing, time is ripe for the government to unify the official and unofficial exchange rates, a move that could depreciate the rial, leading to more demand, higher exports, and better growth. However, the administration seems to be reluctant to use this effective tool.