Tyranny of numbers

Last June, I wrote on this blog about the return of inflation in Iran, when inflation had jumped from an annual rate of 18 percent in April 2018 to 34 percent in May.  In more recent months, inflation has been running at an annual rate of 78 percent per month, twice the rate in May.  But, for the past two months, October and November, the monthly rate has declined.  Is this a sign that the current phase of high inflation, which started with the collapse of the rial, is about to end?   Containing inflation is critical if Iran is to convince its citizens that economic stability is returning and that the news of hyperinflation and economic collapse are exaggerated.One reason why inflation might be slowing is that its prime source, the declining value of the rial in the free market, has disappeared.  Since early October, the rial, which fell by two-thirds in the first six months of this Iranian year (April-October 2018), has remained stable, around 140,000 rials per USD.  (This week it was below 130,000.)

Why the rial has stopped falling is an important question.  It may be because of intimidation of traders and speculators (two men were executed this month for illegal trading in gold), or because the Central Bank is selling more dollars in the free market.  It is also possible that a new equilibrium has been reached, where  traders no longer see profit opportunities in holding foreign currency, perhaps because they expect the government to hold the line on the money supply. It is also possible that incomes have fallen enough to stifle demand for imports and for foreign currency.

For a closer look at the devaluation-inflation dynamic, let us examine two graphs, one of the free market exchange rate (figure 1) and another of inflation (figure 2).

Figure 1 shows two episodes of devaluation, in 2012 and 2018.  The most recent episode looks more dramatic than the first, but the two are similar in magnitude. In 2012, the rial lost about 63 percent of its value in little over a year, between December 2011 and February 2013, whereas in 2018 it lost 75 percent of its value during a similar period.

Figure 1. Free-market exchange rates (rials per dollar)

Source: The Central Bank of Iran and http://www.bonbast.com for latest months (accessed November 24, 2018).

As I explained in a recent piece on Lobelog.com, there are strong similarities between the two episodes of devaluation, mainly in their causes (sanctions) and prior overvaluation of the rial, but also in the magnitude of cost-push inflation they generated.  Will the similarities extend to the slow down in inflation that occurred in the months after the 2012 devaluation, shown in figure 2, and perhaps to loss of income and change in poverty?

Figure 2. Comparing high inflation episodes in 2012 and 2018 (annual rates, three-months moving averages)
Source: The Statistical Center of Iran.

To start with inflation, notice that it spiked following the October 2012 devaluation, but started to moderate as the months went by, by early 2013, just as the rial stopped losing value.   Would this scenario repeat itself in early 2019?  The lower monthly inflation rates for the past two months suggest that it might.  It certainly can if the government maintains tight control of the money supply and if wage increases are kept to below the rate of inflation.

The announcement this week that the budget for next year (starting March 21, 2019) envisions only a 20 percent increase in government wages, while prices will be at least 50 percent higher, and that there will be no wage increases between now the first of the Iranian year (March 21), suggests that the government intends to prevent a vicious circle of inflation-devaluation-inflation.  Further erosion in the value of the rial is to be expected, as inflation continues, but it is consistent with a slow-down of inflation below the current high level.

As for household incomes and poverty, inflation has already hit hard most Iranians in the pocketbook.  (Vice President and Head of Iran’s Atomic Energy Agency, Ali Akbar Salehi, was reported to have complained in an interview that his monthly salary had fallen from $3000 to $700!).  There is no way for the country to absorb the large negative aggregate shock imposed by sanctions —  loss of oil income and restricted trade — without a sizable decline in the average living standards.  Last time around, real consumer expenditures per person fell by about 6.5 percent, but this decrease was mostly in higher income groups, as seen in figure 3, which shows average consumption by quintile of per capita expenditures.

Figure 3. Average household expenditures per person per day  (2017/18 rials)

Source: Author’s calculations from Statistical Center of Iran micro data files.

In 2012-2013, the top quintile was hit the hardest (but the added pain was presumably the lowest), while the lowest quintile was able to maintain its consumption for a few years thanks to the universal cash transfer program. That program is operating differently now. Instead of the same amount of cash to everyone, there is a complex system of cash and in-kind transfers.  Oddly, the neo-liberal government of President Rouhani that argued strongly against cash transfers on grounds of its adverse incentives to work (“fostering beggars”), it is now giving money conditional on low income, which is sure to reduce the incentives of those near the threshold to work.