Jun 25, 2018

Turbulent developments in the past few months on the foreign exchange and gold markets in Iran and the government’s failure to manage runaway prices has compelled some economists to start using the term “bubble economy.”

The interrelationship among various markets within the country’s economy was explained in a June 14 Al-Monitor piece. In this article, however, we will focus on the root causes and complexities of behaviors by economic players. Regardless of whether these acts are driven by economic, psychological or political factors, they are damaging to the economy as a whole and compound the government's challenges in managing the economy. At the same time, it is clear that a continuation of the current conditions will increase the likelihood of an economic crisis with unprecedented social and political consequences. The current wave of strikes and demonstrations by traders and other economic actors is an example of how the problem will be amplified if the authorities do not develop proper responses.

It is not a secret that in the past few decades the country’s economy has continuously been undermined by internal factors such as mismanagement and corruption and external uncertainties such as sanctions, threat of war and regional insecurity. However, the intensity of the recent events supersedes the collapse of the Iranian rial in 2012, when a similar confluence of internal and external challenges was faced under the Mahmoud Ahmadinejad administration, including the threat of war over the collapse of the then nuclear negotiations. In trying to explain the price hikes, Iranian officials have also referred to “bubbles” extensively and have stated that the price developments could not be explained by economic fundamentals.

An economic bubble is usually generated if there is optimism about the future value of a specific commodity such as property, gold, oil, etc. However, in the case of Iran, the driving force for various bubbles in the economy is a confluence of different factors, including an anticipation of inflation, unsustainable financing practices and misguided government policies. The best description of the current situation is that the economy is in a state of limbo. Some may even argue that the whole country is in a state of limbo more than it was in 2012. This is very damaging and confuses the society at large, in particular economic players. The recent actions of the Central Bank of Iran (CBI) are a good indication why key stakeholders distrust the CBI and other relevant authorities. In response to the rial devaluation on the open market in March and April, the CBI announced the unification of exchange rates, clamped down on foreign exchange bureaus, but then failed to provide the needed hard currency to satisfy the market. In the meantime, a three-tiered exchange rate system is emerging — an embarrassing outcome, considering the process started as a path to unify the previous two-tiered system.

While economic analysis always focuses on visible markets, such as hard currency, gold or the stock exchange, the key shortcoming in the Iranian economy is the nonexistence of a proper capital market. This forces economic players to use financing approaches that are harmful to the economy as a whole. For example, property developers pre-sell their housing units and build in an anticipated inflation into their pre-sale price. The same approach happens in the automotive market with liquidity being absorbed by companies from nonbanking sources. Furthermore, an established method of financing internal trade is delayed payments by bank checks — sometimes postdated by 10-12 months — here again with a built-in inflation. These financing gaps are then hedged against through speculation in the hard-currency and gold markets. In the meantime, banking liquidity is being invested in other markets, pushing up prices. In other words, there is a chain of ill-structured interdependency among economic players that can collapse if the economy experiences high levels of volatility.