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January 2018, No. 86


Opinion

Government Is the Root Cause of Current Problems!


Fundamentally and logically, the banking system is based on loan agreement, but we wanted to devise a banking system excluding a loan agreement.



In our contemporary history, whenever oil revenues go down, the economic behavior of the government becomes more rational, and whenever oil revenues go up, government policies turn unreasonable.


The Iranian economy is currently faced with numerous problems, including budget deficit, complications in the banking system, unemployment crisis, and more serious and tangible problems. In your opinion, what are the roots of these problems and how has it approached the crisis point?

For a more precise explanation of the root causes of these problems, each one should be examined separately, although these problems are closely related and intertwined. One of the problems of the Iranian economy over long years has been the budget deficit. Of course, it should be noted that the budget deficit is not problematic per se and under all circumstances; for example, the United States and Europe, and developed economies in general, often face budget deficit, but they would not finance the deficit through issuance of bonds. That’s why the budget deficit in these countries would not escalate inflation.

In Iran too, the government suffered budget deficit in the 1960s. However, the adoption of appropriate financial policies, the issuance of bonds and taking loans from the international banking system prevented escalation of inflation. Until 1351-1352 (1972/3 – 1973/4), despite the fact that the government faced a budget deficit, the economy did not experience inflation. The problem of inflation started when oil rich revenues flowed into the economy, and the injection of money (read wrong monetary policies), triggered inflation. In the post-Islamic Revolution era too, the country was also affected by the budget deficit, but it did not have any proper financial means to prevent the deficit from turning into inflation.

As a result, the financial burden of the budget deficit was directly imposed on the banking system, which caused an increase in the monetary base and liquidity that led to chronic inflations. 

What are the roots of the banking problems?

The banking system in our country has long been coping with huge overdue payments, and an important part of the bank liquidities has been frozen. Toxic assets exist in the balance sheet of almost all state-owned and many private banks. It has somehow caused the banking system to be locked out and forced the banks to turn to the Ponzi Scheme to supply their liquidity.

In fact, the reason for this is the fact that banks become sources of fixed assets such as buildings, purchased branches or direct investment in long-term economic projects, all of which have very low liquidity power. Banks in the country now have a lot of assets that are not cash and have no liquidity capability. Now the banks by relying on the proverb “the best advice is found on the pillow” have resorted to the Ponzi Scheme to see how things will go about in the future and how much of their assets would be cashed or how much of their claims would be collected.

The root of this problem too lies in the wrong policies of the government. Our banking system has a fundamental problem which emanates from Usury-Free Banking Act of 1362 (19183/4). The law has generally excluded the loan agreement from the banking system, and the only loan agreement contained in this law is Qarz-al Hassana (interest-free loan) while this type of loan does not have the function of banking operations at all.

Fundamentally and logically, the banking system is based on loan agreement, but we wanted to devise a banking system excluding a loan agreement. This is a fundamental problem. Some believed that transaction contracts could take the place of loan agreements in the banking system. Back in the 2000s we had long debates with religious scholars who wanted to replace the loan agreement with solutions compatible with the Sharia. Interestingly, these scholars succeeded to a great extent by raising the transaction contracts. Although they had some shortcomings but they were functional more or less. With the execution of this scheme the performance of banks was relatively good in the first half of the 2000s.

With the coming to power of a populist government in two consecutive terms (that is the 9th and 10th governments from 2005 to 2013), government interventions in the banking system increased unreasonably. The government ordered a cut in interest rates in bank deposits and loans which made the banks to overlook the transaction contract policy. As a result, the little rationality that existed based on the market mechanism and economic logic was taken away from the banking system. The reason that the government was able to impose its irrational will on the entire banking system was the huge hard currency income from oil exports over these years, which was being injected into the national economy dauntlessly. As of 1385 (2006/07), the number of credit institutions set up outside the Central Bank system, and the number of private banks and credit institutions launched with CBI authorization, increased unprecedentedly. 

Why did banking in the economy become so attractive that everyone chose this job and wanted to become a banker?

The reason was that the government by adopting wrong monetary policies in fact opened a window for injecting cheap money through the CBI into the economy. Anyone who launched a bank or a credit institution could take this cheap money and easily turn it huge profits in the market. They also made big profits through speculative activities in land, construction and import markets. As a result, banking and the establishment of financial and credit institutions became attractive and abundant. In contrast, monitoring and controls were weakened and the result is the crisis we are facing today. Certain people received the money in the form of loans and facilities, and against their initial pledge and justifications schemes, they spent the money elsewhere, such as real estate and stock purchases and did not return the loans.

Since the cost of money for these people was low, they either did not pay the penalties the bank considered for them or even they did it would still be profitable for them not to return loan itself. Then, with the recession in the real estate market, a major portion of the assets were frozen. The main factor behind this crisis was a wrong policy, namely prescribed rates for the banking system. I am worried because the prescription approach vis-a-vis the banking system has again been placed on the agenda. That is to say they want to lower deposit and loan interest rates by issuing orders. Every time we keep distant from the economic logic and the market price mechanisms, we will eventually be penalized through the same market system. The penalties we pay for these crises today are the product of incorrect monetary policies of 2006 and beyond. 

You mean unemployment is also a result of the government’s wrong policies?

Yes; pay attention to the trend of the economic growth after the Revolution; it was about two to three percent a year on average. This rate was very dangerous for the Iranian society, which in those years (the 90s) had a very young population who would gradually enter the labor market in the coming decades. It is obvious that unemployment is caused when economic growth is slow and population growth is high. So the root of the problem of unemployment should be sought in the low economic growth. Why the economic growth was not high? Because our economy was heavily state-owned, it is the same today.

Only under conditions that the economy is truly free, liberalization takes place in the real sense of the word, and the business climate is suitable for investment, unemployment problem can be eased. Remember that the release of statistics that, for example, under what conditions the rate of participation is up and when it is down is more a matter of demography. But the problem of unemployment is an economic issue and its root cause is low economic growth rate. Our economic growth has always relied on oil and government investment in the capital-intensive industries, such as oil, gas and petrochemicals.

These industries do not generate employment. Employment is created in small and medium-sized enterprises and SMEs cannot be state-owned. Of course, in our country at one juncture even these enterprises were government owned but faded gradually. If the rate of job creation is supposed to rise gradually, conditions should be provided for SMEs to grow. This is possible only in the business environment. In the face of financial repression, pricing and market crackdown, it is clear that SMEs which do not have a strong political base cannot grow. This is the root of the unemployment problem.

Can we consider a role for ‘social justice’ in this process?

Social justice, which is often talked about, and many of its proponents do not know what it is, is merely limited to the issue of distribution in the economy. It promotes the outlook that the state should step forward and establish distributive justice under the theme of ‘social justice’. The first question is that what is to be distributed? There must definitely be something to distribute. The same thing we call the economy cake. If you manage to enlarge this cake, its distribution will be more successful. But if you fail to make the cake bigger, the distribution will be just distribution of poverty.

What happened in our country during the post Revolution period, and especially in the years of abundant oil revenues (2006-2012), which we describe as the period of populistic policies, was that the economy cake grew bigger, but the reason was merely oil revenues in foreign exchange. In other words, the economy cake became larger through imports, and the government was heavily in pursuit of distributive policies. They did not even hide this policy, and the distribution of cash subsidies is a proof of those policies.

They said they would bring the oil money to the tables of the families, by which they meant cash distribution or the ‘social justice’ they had in mind. But the result was that in the six to seven years that we had the highest foreign exchange revenues and the economic growth rate was just over four percent, the annual rate of job creation stood at almost zero. One of the reasons for the aggravation of the unemployment problem is this distributive justice. When you enlarge the economy cake by injecting imports and oil revenues and you want to distribute it, there would remain no room for production boom and job creation therefore, economic growth would go down. The same four-percent growth rate was entirely related to oil and oil-related industries. That is to say domestic output was practically paralyzed. In those years, many domestic producers, even small and medium ones, would prefer to order goods from China instead of manufacturing them in Iran because the exchange parity rate was very low and it was more profitable for them. They would import the goods to Iran by paying shipment costs and stick their own brands on them. They would make big profits after sending the commodities to the market. What exacerbated unemployment were these wrong policies. The question of social justice, with the false impact it left on economic policies in the field of distribution area, aggravated the unemployment crisis. 

Can the government, as the creator of these problems, now solve them?

Ethically, we cannot say that we do not have hope; we should be hopeful. Of course, there is this logic that I believe in; that if the government lessens its burdens, reduces its interventions; the people would be able to solve their own problems in a better fashion. But as long as the government seeks to solve the problems of the people, we cannot expect a better outcome.

It has been announced that the government will exercise certain policies to generate employment. For example, in order to help boost domestic production it would compel banks to provide small and medium-sized enterprises with loans. But the fact is that these polies will not solve the problems. These are the same wrong policies of the past that have just changed color. The government must pull itself out of the economic system. Because oil and gas is inevitably under the control of the government, the state cannot be completely left out of the economy, but economic logic must also be established in the same spheres

In our contemporary history, whenever oil revenues go down, the economic behavior of the government becomes more rational, and whenever oil revenues go up, government policies turn unreasonable. Today, if we see the government has taken more sensible policies it is because of the sharp decline in oil revenues. This is disappointing. How long should we repeat the failed experiments?

 

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  January 2018
No. 86