Curbing inflation or exit from stagnation?

Fariba Rasouli: Members of the government's economic coordination committee has been recently appointed by Iran's Vice President. The task of the team is to make macroeconomic policies and tackle the current economic issues. Hassan Dargahi is on the committee and talks about government policies towards exit from recession in his interview with "Tejarat-E-Farda".



Last month the 11th administration published a report about roots of stagnation. For the first time it was the written word and the government invited comments from academia and experts, this was followed by an economic stimulus package in order to provide solutions for a non-inflationary stag-exit throughout the years of 2014 and 2015. It seems that experts and economists achieved a consensus on the government economic policies, what is your total assessment of the package and the current situation?
Let me start with the content of the package, as you mentioned for the first time the government published a written report and invited comments from experts. In order to achieve a consensus on policies towards exit from stagnation, first of all, roots of the current economic downturn need to be addressed. For this purpose prior to unveiling its economic stimulus package the administration published an analytical report about roots of the current recession. Our economy was in urgent need of that measure. There were no declared economic policies since President Rouhani took office. During the past twelve months important progress has been made though; stemming the rapid rise of inflation, shifting towards stability and the implementation of the 2nd phase of Subsidy Reform Plan and transition out of Mahmoud Ahmadinejad era's reckless policies into a phase of moderation which is far from over. The country was in desperate need of exit from stagnation and recession and the government's short-term plans to deal with recession within the next two years would pave the way for long-term economic reforms within the framework of the Iran's Sixth Development Plan.

You mentioned that there are signs indicating that the inflation is being tamed. How did the government settle that issue? What are the prudent policies to be formulated towards a non-inflationary stag-exit?
It is an important question. Curbing the unleashed surge of inflation is quite an achievement. Point-to-point inflation was 45% last year as Iran was preparing to hold the Presidential election and it has dropped to 14.5%. Currently inflation has fallen to 25% with the annual change in CPI. The question arises as to whether it was achieved by government's economic policies or its political performance. Has the administration's reconciliatory approach had an impact upon stabilizing the economy? By accepting the first scenario we assume that without the policy of détente and with current economic sanctions the government would be able to accomplish its objectives and move towards single-digit inflation in 2016. Under the second scenario international relations and sanctions would have a profound impact on economic and fiscal policies of the government. In my assumption the government has done a great job stemming the rise of inflation by taking measures such as shaping disciplinary monetary policies, nonetheless foreign relations and its reconciliatory approach was a contributing factor. Oil and banking sanctions of 2012 detonated a currency crisis in Iran and after a decade of injecting petrodollars our national currency collapsed. This led to expectations of inflation and its sharp rise. Shortly after the 2013 election the Iranian rial began to gain against foreign currencies, the point is that political optimism, banking on the success of nuclear negotiations and negative shock in demand side of the economy caused by recession, were the key factors behind the stability in exchange rate. One year after Presidential election, the administration headed by President Rouhani has adopted contractionary policies which could deepen the recession. Surprisingly the liquidity growth has increased by 3% (from 25% in last June), this would confirm the second scenario and indicates the significant role of government's political performance in achieving its economic goals. In collaboration with Central Bank the current administration has not increased the monetary base and promoted fiscal responsibility and discipline. In order to keep this downwards trend and meet the objective of single-digit inflation in 2016, liquidity growth and size of monetary base must be scrutinized by the Central Bank in a two-year period. Besides implementing the government's economic stimulus package policies, optimism and predictability play a crucial role. Indecisiveness and ambiguity result in hike in prices one more time. The government's political achievements must be preserved by taking wise economic measures.

Criticisms have been leveled at government's focus on inflation while our economy is suffering from recession. What are the measures to be taken in order to stimulate the economy and recover from recession?
Let me rephrase your question. "In order to exit from stagnation, is it enough to tackle the inflation?" the answer is "no". Government and the Central Bank need to pay attention to production gap. It's not possible to reach sustainable growth in high inflation countries. High rate of inflation is directly related to fluctuations and economic uncertainty. During the past forty years Iran has always suffered from two-digit inflation. This is a sign of macroeconomic instability which makes it so hard to make long-term decisions about investments.
As I mentioned earlier curbing inflation is considered as a prerequisite to exit from stagnation on the other hand, production gap shouldn't be neglected. That's the paradoxical complexity of stagnation which must be tackled by policy makers. According to economic theories and models the objective of stemming the rise of inflation must be achieved in the mid-term in order to prevent the recession from deepening. The question is that what is our current rate of inflation? In a low inflation economy further decline might lead to recession however, in a high inflation economy like ours the inflation must be targeted in a short period and lowered to a threshold. Keeping the lid on inflation is what must be done and then setting the objective of single-digit inflation. In this way the government pursues these two policies at the same time, there is no prioritization, stimulating the supply side of the economy and curbing inflation are followed simultaneously.

What is that threshold? Some experts believe that it stands at 20% to 25% for the current year.
As I said stability and certainty must be ensured on the other hand, stimulating supply side of the economy needs to be taken into account by the Central Bank. This is called "flexible inflation targeting" in which the target set by the central banks is flexible. On the contrary, strict inflation targeting is set, when the central banks concentrate on maintaining and achieving inflation, close to their target. As you know this is done by adopting monetary policies. Iran's Central Bank is facing this question; "Is it possible to reach 20% inflation rate by the end of 2014 and then 15% by the end of 2015 and a single-digit rate in 2016?" The current year inflation is a determining factor as to meeting those objectives. High inflation is not in favor of domestic production and any expansionary monetary policy and shock in demand side of the economy must be neutralized by stimulating supply. This stresses the importance of government policies towards "non-inflationary" exit from recession.

You mentioned bringing down the level of inflation as a necessary but not sufficient condition for exit from stagnation. What's your reason for that?
Actually the question is; how would lowering the level of inflation affect domestic production? Low inflation results in stability and economic predictability. According to macroeconomic theories decline in inflation and expected inflation leads to decline in nominal price of raw materials and consequently rise in domestic production. Nonetheless such mechanism doesn't work in our inflexible production system. Price of raw materials is not affected by the level of inflation in Iran.

What are the factors of production?
There are four determining factors or rates which include: fuel price, interest rate, wages and exchange rate. These rates are regulated by the government in Iran and are usually upwards. Lowering the rate of inflation doesn't lead to decline in price of production factors with the exception of interest rate. We hope that Central Bank adjusts the nominal interest rate in order to reduce the costs of production and proper orientation of existing resources. By implementing the Subsidy Reform Plan annual increase of energy carriers' price is expected in the country. In order to compensate the inflation of previous years wages are annually increased. On exchange rate it seems that CBI is pursuing the policy of establishment of a single-tier regime close to free market rate and further decline in the rates wouldn't be reasonable. As you can see our difficult economic situation poses a dilemma for policy makers and the supply curve doesn't shift towards increase in quantity of production.

What is the solution for GDP boost?
There two measures to be taken In order to overcome the obstacles in the way of domestic production and stimulating supply side of the economy: Firstly , injection of resources and secondly enhancement of productivity. Iran's oil revenues have dropped dramatically and the crucial importance of non-oil exports has been emphasized in the recent economic stimulus package. That's the only option to strengthen our economy. We need to seize the opportunity; even in case of reconciliation and lifting the current sanctions, our oil revenues spending policies necessitate an overhaul.
On the other hand, productivity plays a crucial role in shifting the supply curve to the right and increasing the quantity of production. Enabling business environment has been emphasized in the package. As proclaimed in the government's package financial resources must be channeled to productive manufacturing units. Government debts to banks and contractors must be paid off. Financing projects through innovative financial instruments and reforms of the capital markets are much-needed.

How can entities obtain working capital resources?
Provision of working capital and liquidity for business entities seems to be grinding to a halt. Despite liquidity growth entities face the issues of working capital. Some believe that injection sums of liquidity would resolve the issue, with our current banking system structure it will bring nothing buy another inferno of inflation. Where is the bottleneck? It's mainly rooted in incoherent relations between the financial sector and the industry. Recession and economic uncertainty, non-performing loans, bad assets and unfinished projects provide fertile ground for corruption. Banks prefer to invest in fixed assets and their own non-bank subsidiaries as a result banks have been diverted from their real function as financial intermediaries and got involved in side activities, therefore, proper allocation of resources, improvement of business environment and an overhaul in banking and financial system prove their significance once more.

Financing SMEs through money market and larger enterprises through capital market has been emphasized in the government's rescue package…
Actually that's the government's direction in order to facilitate the provision of working capital for SMEs this might take more than two years though.

As our last question; what makes the package vulnerable?
"Execution and supervision" are causes for concern. Implementation of the policies in full would demonstrate the government's determination to rebuild the economy and gives political credibility to the government's pledge. The other thing is the crucial importance of coordination between the policies of the package and monetary and fiscal policies within the next two years, financial indiscipline would pose obstacles in the way of economic growth and exit from stagnation. Government budget balance and stability in exchange rate are of crucial importance. The President regards the size of monetary base as a "red line" which is unprecedented nevertheless, due to problems and difficulties in repatriating oil revenues withdrawals from National Development Fund of Iran and printing money are matters of concern. Inflationary expectations which induce changes in aggregate demand would be another matter to be discussed. In order to keep the lid on inflation foreign policy and relations with international community must be taking into consideration. Unpredictable future of the economy and indecisiveness would direct the monster of liquidity to unproductive investments including the currency exchange market. In that case, conditions would be ripe for inflation inferno. Central Bank's contingency plans to stabilize the currency market are also seen as essential.