On August 3, the presidency of Ebrahim Raisi will enter its third year. Despite numerous promises and the full support of all branches of government for the president, the inflation is speeding ahead at full force.
Less than two weeks after Ehsan Khandouzi, the minister of economy, assured the country that, with the growth in liquidity slowing down, the inflation rate will subside in the coming months, statistics on monetary and banking variables poured cold water on the minister’s wishful thinking.
The Other Side of the Coin
In his press conference, Khandouzi announced that, in the past month, the point-to-point increase in liquidity has been 29 percent. If the annual growth in liquidity slows down to less than 30 percent, it could potentially lead to the cooling down of inflation.
In the summer and fall of 2021, the point-to-point growth in liquidity was hovering over 40 percent and a return to a long-term average of less than 30 percent is something that the government’s custodians of the economy have repeatedly promised. February 2021 was the last time when the rate of increase of liquidity was inferior to 30 percent (29.96 percent).
Iranian statesmen and policymakers are loath to talk about the other side of the coin: the changes in the monetary base, which is the total amount of money created by the central bank, including the total currency circulating in the public, the currency that is physically held in the vaults of commercial banks and the commercial banks' reserves held in the Central Bank. For months, liquidity and the monetary base have gone in opposite directions in Iran, meaning that the increase in liquidity has slowed down at the same rate as the increase in the monetary base.
Detailed statistics on monetary variables in the month of Esfand (February 20 to March 20) poured cold water on Khandouzi’s optimism about the future of inflation in Iran.
According to data provided by Iran’s Central Bank, the point-to-point increase in the monetary base through that month reached 42.2 percent (860 trillion toman).
The “Money Multiplier” Puzzle
Even though data about monetary and banking variables for the past months have not yet been published, the silence of the economy minister about this other side of the coin shows that these trends continued during the spring.
These movements in opposite directions and the divergence between liquidity and monetary base can be explained by a variable called “money multiplier” (also known as money supply multiplier or monetary multiplier), which reflects the relation between the monetary base and liquidity. Money multiplier is the ratio of commercial bank money to central bank money. It shows how much money commercial banks are able to supply for each unit of the central bank’s money.
In the past months, Iran’s Central Bank imposed quantitative restrictions on banks and their balance sheets, reducing the monetary multiplier and, as a result, preventing the liquidity from increasing at the same rate as the monetary base or the printing of money.
The inflation rate’s continuous increase, the jump in foreign currency prices and the growth in production costs have increased the need of businesses for raising funds and especially working capital. But due to restrictions imposed on commercial banks to control liquidity and also various kinds of credits that the government has the duty to provide, the commercial banking system is not able to fulfill the demand for loans and this can lead to a deep economic recession.
On the other hand, although the government and the central bank have done everything to control the banks’ balance sheet, the government’s own budget remains unbalanced, and this is inflationary by nature.
Reports by the Central Bank show that the monetary multiplier decreased from over 8 in 2021 to 7.37. This decrease can clearly explain the divergence in the growth of liquidity and the monetary base.
Banks Are Increasingly Indebted
Why did the monetary base grow at such a breakneck speed and what broke the point-to-point growth of this variable?
By examining the evolution of the monetary base’s components, we can see that the 167-percent increase in the banks’ debt to the central bank at the end of the last Iranian calendar year compared to the previous year has had the strongest effect on the growth of the monetary base. This debt increased to more than 391 trillion tomans which, by itself, is close to 41 percent of the growth of the monetary base in that year.
The other component, the net value of the central bank’s foreign financial claims, had a 19.1 share of the monetary base’s growth in the last Iranian year. However, during the same period, the bank’s net value of financial claims on the government sector, with a -18.6 share, had a negative effect on the growth of the monetary base.
The transfer of all the government’s main and subsidiary accounts to a single treasury account with the central bank and the increase of the government deposits in that bank has been the main factor in turning the central bank’s claims on banks through loans, a component of the monetary base, into a negative value.
But this transfer of government’s deposits and accounts from commercial banks to the central bank has forced the banks to respond to these transfers and the shortage of liquidity by using other channels to compensate for the shortage, primarily by taking loans from the central bank. This can be clearly observed at the top of the central bank’s claims on the commercial banking system.
At the same time, considering that the government’s budget has remained unbalanced, it seems very likely that this deficit has been transferred to the monetary base through the commercial banking channel and through quasi-financial operations. In other words, the government is securing its financial needs through commercial banks and the obligatory loans that banks must provide for projects – such as the National Housing Projects, the Project to Rejuvenate the Population, Guaranteed Purchase of Wheat and Loans for Self-Employment. In turn, commercial banks have been given a free hand in using the resources of the central bank.
The toxic relationship between commercial banks and the central bank and the inability of the central bank to correctly and comprehensively play its regulatory and supervisory role of the banking system have also played a role in the accumulation of this debt.
Inflation and Disagreements
More important, however, is the disagreement between government officials and a number of economic experts over the fate of inflation in Iran. Officials insist that the slowdown in the growth of liquidity plays a decisive role in controlling inflation. Meanwhile, critics of the performance of the central bank and the government say that the current situation is fragile. They argue that the divergence between the growth of liquidity and the monetary base will soon turn into convergence and, with the cash that the central bank continues to print, inflation will have the necessary fuel to rise.
In response to these pessimistic analyses, the central bank’s Deputy Governor Mohammad Shirijian has said: “It is true that the monetary base has increased, but the central bank has not deposited any money in the surplus reserve accounts of the banks in the central bank. In other words, this money has not been injected into the economy and the worries that this increase in the monetary base would lead to an increase in liquidity in the coming months are unjustified.”
Worries Over (Ready) Money
However, data on monetary and banking variables for the last Iranian calendar year that has been published by the central bank have led to yet another wave of worries over inflation because these statistics show that the share of ready money or cash in liquidity has continued to increase.
In the last month of that year, the share of money in liquidity reached 25.7 percent, compared to slightly over 20 percent a year earlier. The increase in the share of money in liquidity has continued off and on since late 2021.
If we add the share of non-stable banking deposits to the share of cash in liquidity, we can see that only 40 percent of Iran’s total liquidity is in long-term banking deposits and around 60 percent of liquidity is kept in an unstable situation that can quickly be turned into cash in circulation. This situation has the potential to be inflationary but it is also a strong indication that people expect the inflation to continue to climb.
In explaining the continuous increase in the share of cash and not-stable deposits in recent years, the analyses fall into two groups. Some analysts believe that this change is the result of inflation that has forced people to keep liquidity in hand for paying daily expenses so they can cope with increased prices. According to others, the change in the composition of liquidity is due to the continuous expectations of inflation and fluctuations in various markets.
While government officials offer an optimistic picture of the future of inflation and base their claim on the slowdown in the growth of liquidity, their optimistic predictions are threatened by the possibility that this slowdown will not last, the monetary base will continue to grow, the share of ready money will grow and bank deposits will increasingly turn into short-term deposits. What makes this prospect even more terrifying is the dark shadow that the government’s continuous budget deficit has cast over the Iranian economy.