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EghtesadOnline: In a report on the economy in the next March 2021-22 fiscal year, the Majlis Research Center said inflation will largely be the inability of the government performance in realizing its budget projections and the stabilizing monetary variables.

The research center of the parliament said the manner in which the government finances the budget deficit and controls the monetary base to regulate money supply are key long-term factors impacting inflation.  

High inflation expectations emanating either from budget deficits or increase in forex rates, as short-term causes affecting inflation, determines the speed at which "every single rial increase in monetary base leads to inflation". 

According to the MRC report posted on its website "When inflation expectations are high, long-term bank deposits shift to short-term accounts and money flows to the financial markets, durable goods and ultimately to consumer goods.

It criticized the current methods of budget deficit funding, namely selling bonds and often borrowing from the sovereign wealth fund, saying these will produce “chronic inflation particularly in the next fiscal year”. 

"Bonds sold this year will mature in the upcoming years, which will financially overburden the government. Thus, inflation this year would be carried over to the next." 

Pointing to the significant role of debt market in plugging the budget deficit holes this year, the research organization was not convinced that the government can draw on this method next year, saying that bond market capacity will be limited. 

Perennial budget deficits and the lack of sustainable resources to compensate deficit spending have pushed up inflation in recent years, it recalled. 

"Steep decline in oil revenue in the past two years has led to persistent deficit spending and there are no sustainable resources” to fill the gaps. 

The budget was in the red to the tune of 1,270 trillion rials ($5 billion) in the first seven months of current fiscal year (March 20-Oct 21). The government was able to make do by selling 900 trillion rials ($3.6b) in bonds, divesting shares in state-run companies worth 340 trillion rials ($1.36b) and borrowing 120 trillion rials ($480 million) in "discretionary spending"  from the Central Bank of Iran. 


Monetary Policy

The MRC partially blamed the CBI's monetary policy in giving rise to inflation expectations that resulted in acute volatility in financial markets in the past year. 

It pointed to the steep decline in interbank interest rates in the first few months of the current fiscal year that pulled down “real interest rates".   

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or investor.

Composition of money supply has changed due to decline in real interest rates, the MRC said, adding that the share of money (M1) increased and that of quasi-money (M2) diminished. 

MRC said the central bank regulates interbank interest rates and "could avoid the inflation-creating impact of money supply by increasing the rates at the appropriate time."   

Interbank interest started declining in November 2019 dropping from around 18% to 10% in June. Since then the rates soared to reach an average 14.8% in the fifth month of the fiscal year (August). It climbed further to 17.2% on average a month later and in October was an average 20%. 

Broad money supply reached 28,958.9 trillion rials ($115b) at the end of H1 up 36.2% compared to the same period last year. The share of money (M1) was 6,007 trillion rials ($24b) by Sept. 21 -- up 80.2% year-on-year. M1 increased 40.6% in H1. 

M1 refers to highly liquid assets, including physical currency and coins, demand deposits, traveler checks, other checkable deposits and negotiable order of withdrawal (NOW) accounts.

M1 contributed to 20.7% of the total money supply in H1 -- the highest in seven years. It was 17.3% at the end of the last fiscal year. On the flip side, the share of quasi-money or M2 in money supply declined from 82.7% in mid-March to 79.3% in H1. 

"Rising inflation expectation due to the ballooning money supply has strongly swayed the [peoples’] unwillingness to keep their money in banks.

As per CBI data, total sight deposits rose by 2,572.5 trillion rials ($10.2b) in the period ending Sept. 21 to 5,407.4 trillion rials ($21.6b) -- a whopping 90.7% annualized growth.  Sight deposits rose 47.7% in six months. 

This is while term deposits had a slower pace with 28% annual growth reaching 22,951.9 trillion rials ($92b) and term deposits posted 12.2% growth in H1. 

Steep volatility in financial markets is a consequence of the increase in sight deposits seen in the flood of liquidity in the stock market from March to August followed by the unsurprising exodus to the currency and gold markets. 


budget deficit money supply Inflationary