Expert warns “Iran’s economy is in a death spiral”

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Expert warns “Iran’s economy is in a death spiral”

Professor Hanke: “Assuming there won’t be any change in policy, then Iran’s economy is in a death spiral. The only question is when the Grim Reaper will arrive to mark the end”. (IranWire)
By Behrouz Mina
April 26, 2018
Steve H. Hanke is a professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore. He is a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute in Washington, D.C., a Senior Advisor at the Renmin University of China’s International Monetary Research Institute in Beijing, a Special Counselor to the Center for Financial Stability in New York, a contributing editor at Central Banking in London, and a contributor at Forbes. Hanke is also a member of the Charter Council of the Society of Economic Measurement and sits on the Euromoney Country Risk’s Experts Panel. He has also held senior appointments in the governments of many countries, including Argentina, Estonia, Lithuania, Indonesia, Bulgaria, Bosnia-Herzegovina, Ecuador, Albania, Kazakhstan, the United Arab Emirates, and former Yugoslavia. A well-known currency and commodity trader, Hanke played an important role in establishing new currency regimes in many of these countries.
Hanke is the author of many books, including Zimbabwe: Hyperinflation to Growth (2008), A Blueprint for a Safe, Sound Georgian Lari (2010), Juntas Monetarias para Paises en Desarollo (2015), and Currency Boards for Developing Countries: A Handbook (2015).
Professor Hanke spoke to IranWire about Iran’s currency crisis, the damage sanctions have on the country’s financial stability, and why external sanctions and internal mismanagement constitute a perfect Iranian storm.
Given your expertise on currency markets, what similarities do you see between events in Iran and Venezuela?
Well, looking at them from 30,000 feet, you can find similarities between these two countries, both internally and externally. On the external side, both countries are facing primary and secondary sanctions. Internally, both governments have created similar business environments. Both countries have fundamentally socialist economies. In Iran, the Iranian Revolutionary Guards Corps (IRGC) and religious foundations own significant shares across different sectors, and they actually run the economy. The true private sector accounts for a tiny part of Iran’s economy.
Both countries export oil. In Iran, government-owned and regime-controlled entities such as the National Iran Oil Company (NIOC) account for a huge part of the economy and its export revenues. Ninety percent of the currency exchange in the market is made possible by NIOC and oil revenues. A similar situation exists in Venezuela, where the economy depends on oil and nothing else is really produced. However, Iran’s economy is in worse shape than Venezuela’s. Iran’s economy has been subjected to mismanagement and corruption for far longer than Venezuela’s. Populist policies and extensive government interference in the economy started in 1999 when Chavez became President in Venezuela. In Iran, this has been ongoing since 1979. And corruption happens when a government meddles in the economy. Both countries are suffering from high levels of corruption because of their governments’ intrusions.
When it comes to currency, are they facing similar problems? Is the Iranian rial falling because of the government’s meddling?
The Iranian rial will be going down. It is a very vulnerable half-baked currency; it is exposed to both negative internal and international factors. Secondary sanctions are hitting it down considerably. In the meantime, the Iranian government continues on its path of mismanagement. There have not been any significant policy changes to improve Iran’s economy or business environment. These internal and external forces are causing the perfect storm.
Above all, Iranians do not trust the rial. They are smart. They have been dumping the rial for the past few months because they expect that the rial will not hold its value. They are buying dollars, hard currencies, gold, or even commodities. This has happened before, in 2013. However, it is hitting President Rouhani’s government for the first time. Rouhani’s challenges are formidable when we remember no one trusts Iranian banks either. There is simply no trust in the Central Bank or commercial banks. The entire money and banking system is totally dysfunctional. So the rial will continue to decline.
Do sanctions play a significant role here? Do you think President Trump’s threat to stop implementing the nuclear deal, known as the Joint Comprehensive Plan of Action (JCPOA) caused the Iranian currency to decline?
Everyone is afraid of doing business with Iran because they are afraid of getting caught up in either primary or secondary sanctions. The threat of abandoning the JCPOA creates chaos and increases the risk of doing business. This scares off everyone, even Europeans. They do not want to do business in Iran while there is a chance of getting hit by secondary sanctions by the United States. President Trump’s threat to pull out of the JCPOA has already caused problems for Iran’s economy. The economy is totally mismanaged and vulnerable.
But Iran’s private sector is not the target of most of these sanctions.
Even if the private sector was significant in Iran, these external challenges make everyone nervous. They know there will be problems in working with Iran. The threat of sanctions also has made Iranians nervous. That is why they want to convert their rials into something else, anything else. President Trump’s threat to tear up the nuclear deal affects foreign investment. Iran needs extensive investment, which must come from international sources. The depreciation rate of Iran’s capital stock is much higher than the investment rate. Iran’s capital stock is declining and declining sharply. In this regard, Iran’s economy is very similar to the USSR’s in its last years. Just look at how earthquakes destroy recently-constructed structures. All of these are built in a corrupt system by shady contractors. Iran’s capital stock has been neither improving nor increasing.
It seems as though President Rouhani’s government would like to see a bigger private sector in Iran. Don’t you agree?
Yes, Rouhani tried to help the private sector. But, his reforms have been too little, too late. However, he needs to initiate a big bang to reform the economy. The kind of reforms Iran needs require a big push. But conducting economic reforms in Iran is a dangerously political matter. The IRGC and religious foundations will oppose any drastic measures. This has made Rouhani very cautious. He is leaning toward major reforms, but you cannot just lean toward reforms when actual reforms are needed. He does nothing to implement reform. Iran’s economy needs a major revolution with a capital “R” to save itself. The state has always been too involved in the economy in Iran. It was the same during the Shah’s reign as well. Iran’s private sector was small then as well, but it was larger than what it is today. After the revolution, Iran’s private sector shrank. The state has been expanding its role in the economy ever since 1979.
Why do you say the current economic situation is the perfect storm?
For one thing, you can throw away the official estimation of the inflation rate. They say it is around 10 percent. It is not. I have estimated it personally based on the value of the rial and it is about 58 percent. This inflation is caused by and associated with the rial being weak and vulnerable.
So how do you see the future for Iran?
Assuming there won’t be any change in policy, then Iran’s economy is in a death spiral. The only question is when the Grim Reaper will arrive to mark the end. Iran’s economy is disintegrating, and it has been disintegrating since 1979. The process speeds up from time to time. Iranians already experienced hyperinflation in 2013, when the monthly inflation was more than 50 percent. The disintegration slowed down when President Rouhani was elected to office. But, the death spiral is speeding up again because nothing has changed internally and the external forces are conspiring to squeeze a weak and mismanaged economy. In Venezuela, the Grim Reaper could appear anytime now. Its annual inflation rate is currently close to 19,000 percent. The death spiral is much faster than in Iran and the end will arrive sooner.
How will what’s going on in Iran affect the Middle East and Iran’s neighbors?
Iran’s economy is too isolated for a disintegration to have any global or regional impact. Iranians will suffer the most. There might be some effects in the energy sector in the region, with Iran being an oil and natural gas exporter; however, Iran’s death spiral will not affect anybody other than Iranians themselves. Its economy is isolated and weak. When the Grim Reaper arrives, no one outside of Iran will notice. It will be like the end of the USSR.
Iran Wire