Is Financial Market Instability in Iran on the Horizon?

Hadi Qavami, the Vice President of the Budget Commission of the Parliament, in an interview with the House of the Nation news agency, referred to the recent unrest and rising prices of currency and gold, stating: "The fluctuations and changes in currency prices have several reasons, the first of which is the decrease in oil prices, as the budget anticipated $50 per barrel, but it is currently selling for about $43, resulting in a shortfall of about $7 to $8 per barrel." This official added: "The Vice President of the Planning, Budget, and Calculations Commission of the Islamic Consultative Assembly stated that it is predicted that by the end of the year, there will be a budget shortfall of about 37 trillion tomans, adding that this budget deficit is mainly due to the decrease in oil prices, and when less oil is sold, the inflow of currency decreases and the price of currency increases." It is explained that, thus, with the decrease in the government's foreign currency revenues and the increase in the budget deficit, the government's ability to control the value of international currencies in the market and stabilize their prices becomes more limited. What are the reasons for the increase in the budget deficit? Of course, the amount mentioned by the Vice President of the Budget Commission only includes the government's apparent budget deficit and does not cover the hidden budget deficit. A combination of various causes explains this shortfall. First, although this budget was more realistic than previous budgets, it was simultaneously drafted with optimism. It seems that the government was optimistic about the success of nuclear negotiations and the release of Iran's foreign assets. However, some economic experts had warned against this optimism during the budget drafting. Furthermore, while it cannot be denied that the decline in the price of exported crude oil and consequently the reduction in government revenues is one of the factors increasing the budget deficit, the fundamental cause must also be sought in the rent-seeking structure of the government's budget. Other sources of the budget deficit of the twelfth government are the legacy of the previous government, namely cash subsidies, Mehr housing, and the debts of the government to the Central Bank. A significant portion of the government's budget consists of payments to rent-seeking and political entities that do not create value in the economic sphere. Additionally, many state and quasi-state institutions that have a share in the budget are inefficient and knowingly or unknowingly waste part of the budget. How does the government hide the budget deficit? Hadi Qavami, Vice President of the Budget Commission, states that the exchange rate adjustment and its sale in the market generate income for the government. He stated: "In the budget for the year 95, the exchange rate was set at 2,950 tomans, but the government actually sold it at 3,300 tomans, meaning that about 6 to 7 trillion tomans were obtained from the exchange rate adjustment and the difference in currency prices." He added: "The government covers some of its budget deficits through currency adjustment, and in the year 96, the exchange rate was determined in the budget at 3,300 tomans, but it has now reached 3,880 tomans, which may even reach 4,000 tomans." However, selling expensive currency in the market is not the only way to cover the budget deficit, as borrowing from the Central Bank and also from commercial banks are other methods the government uses to cover the budget shortfall. The increase in liquidity is one manifestation of this accumulated and massive debt of the government to the Central Bank and is a source of many economic challenges in Iran, such as inflation and unemployment. Overall, liquidity has grown this year, and it is unlikely to continue, which is not a positive sign. The growth of liquidity must always be balanced with the growth of the real sector of the economy; otherwise, inflationary waves or unrest in financial markets will manifest themselves. Yesterday, the government could artificially keep the rial price high by injecting currency into the market; currently, the government's maneuverability to supply currency is limited due to the budget deficit and reduced foreign currency revenues. In the current conditions of the country, although liquidity is growing, at the same time, due to the decrease in the speed of money circulation, all inflation in the market for goods and services has not been reflected in prices. One sign of this decrease in the speed of money circulation is the statistics provided by the Central Bank President, according to which nearly 45% of banking resources are frozen, with 15% related to banks' claims against the government. Statistics related to transactions of capital goods such as housing and cars also indicate a decrease in money circulation. The impact of declining interest rates and the migration of idle liquidity to financial markets While the government's budget deficit and reduced foreign currency revenues limit the government's ability to inject and supply currency to the market and control the prices of international currencies, other developments in the currency market are underway that are further inflaming the currency market. The most important development is the migration of bank deposits from banks and their conversion into idle liquidity in the currency market, leading to increased demand for it. It is explained that with the recent decrease in bank interest rates, non-liquid components of liquidity are converted into liquid components and flow into other financial markets that are easily accessible and can be profitable in the short term—namely, the currency and gold markets—because most Iranian savers are still not accustomed to investing in the stock market. Investment in the housing and real estate market also requires excessive liquidity and, secondly, foreign currencies are not quickly convertible into rials. Therefore, the most liquid and accessible market for investment is first the currency market and second the gold market. Such investments do not have complicated procedures, and investors have their investments at their disposal without worry. It is natural that Iran's high inflation compared to the international average, especially in the US and Europe, creates conditions for the depreciation of the rial and the increase in the value of international currencies. However, besides this, there are other reasons that justify the increase in currency prices. The flood of idle liquidity, which was previously trapped in banks, will also increase pressure on the currency market and push international currency prices higher. First, if until yesterday the government could artificially keep the rial price high by injecting currency into the market, currently, the government's maneuverability to supply currency is limited due to the budget deficit and reduced foreign currency revenues. In this context, the flood of idle liquidity, which was previously trapped in banks, will also increase pressure on the currency market and push international currency prices higher. Thus, the groundwork for turbulence in financial markets will be prepared. It remains to be seen whether the government can neutralize this turbulence by employing short-term policies or whether Iran's financial markets will once again experience unrest as in the past.