Tyranny of numbers

Iran’s Inflation showing signs of moderating

Posted in Inequality, Macroeconomy, Poverty, Sanctions, Subsidy reform by Djavad on January 10, 2013

The Central Bank of Iran has just released the Consumer Price Index for the month of Azar (ending on November 20, 2012), and it shows a much smaller increase in prices than the previous two months.  The index rose by about 4.5% per month during the last two months (equal to 70% annually), but its pace moderated in Azar, rising by 2.5%.  This is still a sizable increase (about 35% annually), but it may be a sign that the large devaluation of the rial during the last week of September has run its course and consumers maybe back in the territory that, unfortunately, they have come to regard as normal: prices rising by about 20% per year.  This is, of course, conditional on no new shocks happening to the exchange rate or the money supply in the near future.

But such moderation in inflation, if it happens, will not keep the inflation rate for the year (1391 = 2012/2013) to below 30%.  If in the next three months prices continue to rise at the same rate as they have in Azar, the inflation for the year will stay below the 40%, but not by much.  This is a bit higher than the inflation rate that I assumed in my previous post, but below the record set in 1995, when prices rose by 50% (and a whopping 144% annual rate in the month of Bahman).  The 1995 inflationary period also started with a botched devaluation and as followed by two years of zero economic growth.  The prospects for this year of high inflation are worse because sanctions are preventing the supply side (both imports and domestic production) from moderating increases in prices, so it is harder now to control inflation than in 1995, and for the same reason the cost in terms of unemployment will be higher.

Sanctions are only part of the reason for high inflation; domestic policy is the other.  Two policies in particular have contributed to inflation: subsidy reform and maskan mehr (a low cost housing program).  Both have entailed borrowing from the Central Bank, which expands liquidity and fuels inflation, because they were not self-financing.  Subsidy reform was inflationary because it was undoing decades of price controls, but it did not have to be deficit expanding if the cash payments were in line with the money from higher energy prices.  These are the signature programs that will likely define Mr. Ahmadinejad presidency, so he may not be willing to scale them back in the last six months of his last term.  But if he prefers his legacy to be also about leaving a stable economy behind, there steps he can take.

The hole in the subsidy reform, some $15 billion, is easier to fill than the larger one left open by the low-cost housing program.  To fill this hole all the government has to do is raise energy prices while keeping the total cash transfers to consumers constant.  It can do this the easy way, by keeping the transfers at their current level of 450,000 rial per person per month, or he can do it the hard way, by limiting payments to the poorer two-thirds of the population only, which would allow individual transfers to go up to 600,000 rials.  Either way, the government would be able to bring into balance the money it collects from energy consumers and what it pays back to households as cash payments.  At this point the parliament is steadfast against continuation of the subsidy reform in any form or shape, but it may reconsider if the President were willing to offer a balanced plan that would not entail borrowing from the Central Bank.

Bringing the low-cost housing program out of the red is another matter because the collection part is all but over.  Buyers of these units have prepaid a small sum (about 120 million rials) as down payment and are expecting to pay about twice that before they can move in.  These amounts may have been enough a year or two ago when they signed their contracts, but will not cover the cost of their homes now.   They may not easily fork over the extra money that would keep the building contractors busy and prevent the government debt to the Central Bank from ballooning further.

But if anyone can persuade the would-be owners of these low-cost units that paying more for them is not the usual balancing of the budget on the back of the poor, it is Iran’s populist president.  Perhaps implementing a more progressive second phase of the subsidy reform while asking for more contributions for completed housing units from the lower-middle class would convince them that in re-configuring these programs he has their interests at heart.

11 Responses

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  1. Baddu said, on February 7, 2013 at 3:26 pm

    Dear Dr. Salehi,
    Would you be kind enough to comment on my above post of January 14.

    • Djavad said, on February 11, 2013 at 5:46 pm

      Sorry, I did not get to your comment. High amortization rates (or high depreciation allowance) allows companies to write off capital costs at a faster rate so they are willing to invest. They are like subsidies to capital. You say that in Iran the cost of capital is determined by a low value of rial so in fact they are being penalized. Now, if they buy a new plane, they are allowed to write off depreciation at a much higher rate, which should bring their tax obligations down. If I understand you correctly, the problem here is that prices are also based on these costs, because they are subject to government regulation. So, they are penalized twice. Prices for domestic airlines will in the end be determined by a combination of subsidies and price controls. All these have little to do with inflation because the latter is the general price level and depends on liquidity in the whole economy. I hope this helps (I know little about accounting!).

      • Baddu said, on February 16, 2013 at 8:54 pm

        In fact, the legal accounting procedure in Iran, by not accommodating for inflation, subsidizes prices and profits (dividends and taxes) by depleting the capital. So it seems to me that this should have the effect of reducing the current inflation rate by some margin and accumulating these margins to release them later with a vengeance. I would like to know if this is a correct analysis of the effects of this ruinous company practice on the macro economy – look at my IranAir example. Thanks in advance for your guidance.

      • Djavad said, on February 17, 2013 at 8:08 am

        I think legal accounting has limited effect on prices in competitive markets. You are assuming that prices depend on sunk costs, which is not generally true (only with administered prices).

  2. Rd. said, on January 18, 2013 at 9:44 am

    Dear Dr. Salehi,

    what are your thoughts on petro rials?


    • Djavad said, on January 18, 2013 at 1:15 pm

      I had a quick look and the article in Asia Times makes no sense to me (especially its last paragraph). Iranian rial is doing fine and is well accepted (in Iran and Afghanistan!) and its only problem is that the government is using it –issuing rials — too much to solve its social and economic problems (like the supply of low-cost housing). The government does not have to promise delivery of energy to people; it can just raise the interest rate on its bonds.

  3. Baddu said, on January 12, 2013 at 7:24 pm

    Dear Dr. Salehi,
    As you may well know Iranian accounting regulations require that companies calculate their costs by alowing for amortization costs at the fixed value paid for cpital goods based on the currency rates at the time investment took place. With inflation running at an average yearly rate of 20% or so, this would artificially reduce the price of goods produced and sold in this contry, at the cost of depleting the companies assets to the point of eventual bankruptcy. Look at Iranair which has amortized its planes based on 70 rials to the dollar – basis of calculation at the time of investment.
    My qustion is that do we have such a thing as a free dinner here? Or the prices would have to eventually compensate for this longterm miscalculation through some explosion?

    • Djavad said, on January 13, 2013 at 11:11 am

      You pose an interesting question. In general, prices are not affected by how the capital of companies are valued. In a competitive environment, which to some extent is the case in Iran, prices depend on variable costs (more precisely on the marginal cost) rather than on the average total cost, which includes the cost of capital. However, when there are price controls, this amy not be true. If price ceilings are based on the average total cost, yes, as you said, it will cause a serious problem. But as far as I know, price controls are determined by previous prices, so the original cost of capital may not figure in those prices. The problem here is quite simple: irrespective of how you price fixed capital, if you control prices as costs rise, companies will lose money!

      • Baddu said, on January 14, 2013 at 1:56 pm

        Since all companies are subject to the same – ‘cost reducing’ – accounting proceedure, the goods they all produce ‘cost’ low, so they all sell low. For example when an Airbus 300 is on the books at Rls 3,500,000,000 (=70 x $50,000,000), Iranair or MahanAir or Aseman would sell tickets based on amortizing this amount on 35,000 flights the plane makes during its 28 years of service. This would be Rls 100,000 per flight and at 250 seats sold on average per flight amounts to Rls 400 per ticket. Now replacing the plane will require $50,000,000 x 28,000 = Rls 1,400,000,000,000. So, even if the airliner could borrow the funds to replace the old plane, its amortization component of the ticket cost would be 4000 times higher than before or Rls 1,600,000 per ticket! This would not be hyper-inflationary but would be a mighty adjustment. Your take on this please.

  4. Amir said, on January 11, 2013 at 12:10 pm

    Dear Professor
    Could you please comment on this blog?!


    • Djavad said, on January 11, 2013 at 2:54 pm

      The story behind this post –hyperinflation — has never made sense to me. I have no idea where the money supply numbers for these graphs come from

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