I am in the process of preparing a book on the Political Economy of Iran under Ahamdinejad. I do not know when this project will be finished but I will do my best to complete it sooner rather than later. To give you some idea of what I will be writing in this, I post one of the chapters here. Please feel free to share your criticisms with me. I am a very " small" person, but am " big enough" to take criticisms.
p.s.When I cut and past, I loose all the footnotes. Anyone interested to receive a copy of this post with all the footnotes, please drop me an email to: email@example.com
and I will be happy to send you a copy.
Economic management: Ahmadinejad’s style
Until recently, hardly any day will have passed without the index of Tehran Stock Exchange [hereafter, TSE] setting a new record . Some commentators have even claimed that the movements of this index show that economic sanctions had no meaningful impact on the Iranian economy . It has also been claimed that despite all these sanctions, risks have declined in Iran and the economy has had a very healthy growth rate. The main purpose of this chapter is to show that given the prevailing overall economic conditions in Iran, this record breaking behaviour is seriously dangerous and risky and is not sustainable. It is further claimed that what we witness in Iran has all the hallmark of a financial bubble and like all other bubbles it would burst soon. But how can such a dire prediction be justified?
- A brief background
Let us begin with a very basic and well known principle of a capitalist economy. In a modern capitalist economy, price system plays a vital role in helping economic agents to make decisions. When a price changes, it gives signals and economic agents respond to these signals and make decisions which determine how resources will be allocated in the system. For this system to produce the expected outcomes, a number of preconditions must be met:
- Prices must be real so that this signalling reflects the true costs [the main justification for removing subsidies].
- Not only the prices must be reflecting the true costs, markets must be competitive too. If there are factors, economic or otherwise, reducing the level of competition in the system, efficiency will suffer and that will not be beneficial to the overall working of the economic system.
- Last but not least, for this system to work well, the state must minimise its intervention in economic decision making and most if not all these decisions must be made in the private sector [ the main justification for privatisation and in Iran, for the re-interpretation of Article 44 of the Constitution]
It goes without saying that if any of these conditions are absent, price system will fail in its main function, i.e. signalling, and in the absence of right signals economic agents will not be as efficient as they can. For instance, if the basis of pricing is production costs, i.e. firms have the power and authority of using production costs to set prices, in a non-competitive environment, there will be no incentive to try to reduce them as these extra costs will be effectively passed on to consumers who in a non-competitive environment have little option but to pay or refrain from consumption altogether. Either way, this will not be useful for the overall management of the economy. On the other hand, when these conditions are met, main questions, such as: What goods/services should be produced? How much? And how? All these questions will be answered via this signalling process. Observing these signals, economic agents will then decide what production should increase and which areas should face a contraction. When this happens, we are told that resources allocation and private and social welfare will be both maximised. In a modern capitalist economy, one of the most important markets is the stock exchange where shares of the listed companies are bought and sold. On the basis of what we have briefly described above, the Stock Exchange Index is a signalling device for the overall state of the economy. If the markets are sufficiently transparent, then, this index should be a very useful yardstick to assess the overall economic condition. Leaving a lot of details out, the potential buyers of shares, would wish to buy a particular share because it pays a relatively higher yields than others. When this happens, there will be more demand for that share, and hence, its price goes up further and in turn, given its weight in the Index, contributes to increase the overall index. This is not the only incentive for the purchase of shares and another motive could be the potential capital gains in the medium and long term. Suppose a buyer A buys 100 shares of a company B at £1 each and five years down the line, the market price of these shares are £5. £4 per share or £400 for 100 shares in our example is capital gains that could be realised if the owner of these shares so wish. Once again, if the Stock markets are to perform these functions properly:
- They should be free from state manipulation and should be independent from the government.
- There should be a variety of institutions to monitor and assess the quality of information provided, and to make sure that there will be no insider trading and similar illegal activities.
- Markets must be competitive to ensure that signalling would reflect the true state of the economic fundamentals. In short, these prices go up and down reflecting the true state of the underlying economic conditions.
As before, if in relation to the stock markets, any of these pre-conditions are absent, the signalling could not and should not be trusted.
On the basis of our discussion so far, when the index keeps rising in an economy, a potential conclusion may be that the economy is doing fine. Listed firms- usually the largest ones in that economy- are profitable and share buyers are picking up these signals, and respond in a way that their higher demand is pushing the prices of these shares up. So far so good. Let us now return to our case study of Iran.
- Breaking records in a collapsing economy: The case of Iran
In the remainder of this chapter, we shall argue that in the case of Iran, a corruption riddled economy, the real sector, i.e. the productive sector, is suffering from a very serious recession. The state that lacks a properly functioning fiscal system uses its control over the Central Bank to increase liquidity as a means of financing its activities. Parts of this massive liquidity fuels inflationary pressure which in turn intensifies the deep rooted recession in the real sector. Some of this extra liquidity goes to real estate, creating a housing bubble or going into stock exchange fuelling a financial bubble. What we witness in Iran, in contrast to what many believe, is not a healthy economy that is giving signals to economic agents but rather the expansion and extension of these bubbles. Let us explore some of these issues further.
First of all, not only TSE is not an independent institution, but most of listed firms who are active in this market are in fact state owned or are owned by quasi state organisations, such as Islamic Guards. Fro Instance, we know that 10% of capitalisation of this market belongs to Iran’s Telecommunication which was recently ‘purchased’ by the economic arm of the Islamic Guards. Furthermore, we also know that as from the beginning of 2008 the way that TSE index was calculated has changed and the current index shows price variations and also what is referred to as “cash productivity”. According to the Boursnews “ given this change, if during the period under examination, the prices remain constant, but listed firms give higher dividends, the overall index will move up. The second and more fundamental problem is the current index is in fact a mixture of the old and new indices that has been mixed for the first time in the world. What has been done in Iran is very similar to adding a measure of length [metre] to a measure of weight [kilogramme] despite the fact we know that this should not be done.” So this mixing, not only is unique to Iran, it is also totally meaningless and perhaps even misleading. We further know that some of the largest companies in the country, such as, Mobarakeh Steel, Kharq Petrochemical, Iran Khodrou, Sipa, Telecommunication, all listed companies have distributed profits among their shareholders, hence helping to inflate the index. While shareholders will be happy with this, in contrast to what is claimed by the government, this distribution of earnings is clearly an indication of the absence of opportunities for productive investment and expansion in the economy. The environment for investment is not right, and hence, the boards of these companies decided to take this root. Boursnews has even claimed that “Telecommunication has distributed illusionary profits among its shareholders so that one of its main shareholders, Consorsium Touse-e Etemad Mobin (the economic arm of theIslamic Guards that bought Telecommunication) could pay off an instalment of its debt to the government for this purchase. It goes on further to add that “Our economy faces a serious problem and despite all the noises that government ministers make, the economy and our main firms face numerous serious challenges that it is not at all clear how would they be sorted out”.
Contradictory statements made by government ministers support the warnings issued by Bousnews. The minister for industrial affairs, Mr Mehrabian , and his statements confirm this view. While offering an inflated view by giving impressive data of the health of these industries, at the same time, he declares that “a special centre will be set up to deal with all the problems of the industries and mining in this country”. This centre was proposed by Ahmadinejad, approved by the cabinet and consists of deputy ministers of industrial affairs, labour, economic affairs, energy as well as representatives from social security, Central Bank and commercial banking sector. Decisions made by this centre, when approved by the minister “will be binding for all sections” of the government. One of the main functions of this centre is to organise the completion of many unfinished projects. To put it differently, if there is no crisis as the minister claims, then why this centre was set up and at the same time, if the crisis is real, then, the record breaking behaviour of TSE index has nothing to do with economic health and economic fundamentals! Let us add also that last year, it was revealed by the same Mr Mehrabian that 6700 companies who were unable to service their debts were given extra time and yet, the minister claimed that “there is no crisis”. During the same press conference, Mr Mehrabian added that a new list is in progress of other companies who are unable to service their debts. Since then, all indications show that the situation if anything has become worse. At one level, the imports into Iran increased, meaning that these troubled Iranian companies have possibly lost a further share of the domestic market, to the extent that without government direct financial help they are unable to pay the wages of their employees. Furthermore, government interference into the money market- the arbitrary reduction of interest rate, biased distribution of credits and loans in favour of newly setup firms that despite their interesting titles, were a complete failure- meant that there was little credit left to be offered to established firms in the real sector. In addition, even if there was no shortage on the supply side, arbitrary reduction of the interest rate lefts banks with little motive to lend out at a rate set by the government below the inflation rate. Instead of offering loans, banks prefer to enter into a kind of partnership contracts with clients which are much more expensive than interest charges on loans. In relation to addressing the causes of recession of domestic firms, the government has taken a very confusing position. While it blames it on international crisis, at the same time claims that Iran is a “rose garden” in a global jungle which is on fire! On the other hand, according to one estimate, the banking sector in Iran has about 50.000 billion tomans “toxic” debts, that is outstanding debts that have not been settled upon maturity. The government has instructed these banks, mostly state owned, to give the borrowers an extra year to pay and this extension while might be helpful to the borrowers, is potentially capable of intensifying the crisis in the banking sector further. One point is certain, this delay seems to have created an Iranian style “credit crunch”, that is, the banking sector can not offer too much credits to those who needed them most.
The corporate financial crisis started at the big firms and then moved to others. Iran khodro, the largest car maker in the Middle East, is said to owe between 6000-10.000 billion tomans, and for the first time in its 45 years existence, it made a loss last year. At the same time, the largest debtor in the economy is the government. While the balance sheets of these firms may look fine, lack of payment by the government has created a very serious shortage of liquidity for many of these firms. For instance, in the energy sector, government debt to firms engaged in this sector has exceeded 5000 billion tomans, creating a crisis for many firms at various stages of production. It is most likely that last summer, frequent cuts of electricity may have been caused by this factor. It is estimated that these cuts cost the economy billions of dollars. Whatever the official views of ministers in Iran, as the crisis in the energy sector- frequent cuts- created a serious crisis for many producing units in cement making, steel factories and a few other industries. We also know that another special committee was set up to address these problems. The cost of electricity shortage for the mining industries, cement making, and steel factories is huge. In the steel industries it is estimated that around 10% of final output is lost due to power cuts . In the second largest car producer in the country, Sipa, on one of such occasion, the production line altogether was suspended for several hours. The deputy minister for Industrial Affairs has publicly stated that “the main problem in the industrial sector of Iran is a shortage of liquidity and circulation capital”. In his view, this could be reversed, but no policy was offered to address these shortages. Like other ministers, he has also blamed the banking sector for not providing sufficient credits for industries but nothing was said about an imposed interest rate which is below the inflation rate and further, to another anomaly that banks are obliged to offer credits to governments designated firms.
Let us add that the crisis in the economy is not limited to cases referred to thus far. It is much wider and deeper than what is being admitted, if at all, by government. Given the spread of the crisis, this record breaking behaviour of the TSE index has all the characteristics of a serious and dangerous bubble that is taking shape. According to Khoshchehreh a former member of parliament and an Economics professor at Tehran University “in the current situation, employment situation and the number of unemployed reached a dangerously critical point” . We also know that there is a recession in the housing market that could very easily spread to other sectors. During 2009, house building in Greater Tehran has fallen by 48% . In the energy sector, especially electricity production and distribution, “as little has been done to address its financial crisis, the intensification of the crisis is almost unavoidable”. With the closure of firms, “there is likely to be destructive waves of redundancies and also several projects would have to stop with potentially serious implications for the rest of the economy that could not be compensated” . Despite the fact that the TSE index keeps setting new records daily, but “productive activities in the country have never been this poor” . According to the chief executive of Iran’s Chamber of Commerce, “ about 50% of companies scattered all over the country have either closed or are at the verge of closure” and “ most of productive firms operate at 30% of their productive capacities” . The chief of textile industry association believes that “textile industries move toward total recession” . Nehavandian who has recently been elected as the head of Tehran Chamber of Commerce responded to the growth in the number of bouncing cheques and said “this is a clear indication that the economy is not in a good shape” . He added “a reduction in capital and an erosion of social confidence are two major problems facing the economy. The fact that the number of bouncing cheques is constantly rising, is a clear indication that the economy is not performing well”. In support of this warning let us add that in the period of 2002-2009, while Iran revenues from oil increased significantly, investment as a proportion of national income has declined” . As to specific industries, we know that domestic furniture market is almost totally under the control of foreign imports, and about 70% of domestic demand has been taken away from domestic producers . If domestic demand was rising and extra demand was being met by foreign supply, this would not have been an indication of a serious crisis, but this is not the case in Iran. Foreign supplies are replacing domestic production and this process is reflected in rising unemployment. For instance, the official data show that in 2009, unemployment rate has increased by 1.5% and we also know that in 21 out of 30 provinces the rate has increased. Lorestan with 19% has the highest unemployment rate followed by the province of Hamadan where unemployment rate jumped to 18% . In other chapters we would discuss the crisis in sugar industries in full, and here we would just remind our readers that there is a gap of 0.5 million tons a year between domestic production and consumption of sugar. In the period of 2006-2008, more than 5 million tons of sugar were imported into the country. As a result domestic production has fallen from 1.3 million tons to less than 0.5 million tons, another factor fuelling unemployment in Iran. In the past two years, the production of beet root declined by 74% and there was a 75% fall in the production of sugar . Despite all these disturbing developments, the industrial affairs minister claims that by the end of the year- 2010- investment in industries in Iran will increase five folds, but every other indicator clearly show how serious the situation is and no such massive rise in investment is taking place.
In relation to largest automaker in the Middle East, Iran Khodrou, we are told that “the largest manufacturing firm in Iran has such a drastic financial problem that every now and then rumour has it that it has gone bankrupt” . In 2009, the company had to sell some of its fixed assets in order to distribute promised dividends to its share holders. According to a report in Tehran daily Etemad, for 2010, the managers of Iran Khodrou plan to tell the shareholders that company’s made no profit in 2008-2009, and in fact, made a loss of 120 billion tomans. In relation to Iralco- an aluminium producer controlling 50% of domestic market- and like many others have recently been bought by the economic arm of the Islamic Guards- there is a similar problem and its financial position is very weak. Eisa Rezaee, the general manager of Mehr Eqtesad-e Iranian [another proxy firm owned by the Islamic Guards] pointed out, “up to the end of 2008, the prediction was a dividend of 400 tomans per share will be paid, but in actual fact, the loss per share was 323 tomans and overall the company made a loss of 56 billion tomans. In addition, Iralco had a debt of 400 billion tomans to banks, 30 billion tomans to electricity firms and 12 billion tomans other debts” . We are not sure how, but, these were taken out of the balance sheet of Iralco and were not reflected there. Over the summer- 2010- while the TSE index was breaking all records, we know that in the Industrial Estate Abbas Abad in Pakdasht, where 1800 small and large factories are accommodated, “frequent power cuts” created a “highly critical situation”. In a report on this, we read that “sometimes at the middle of a process, there is power cut, and this happens when semi processed materials are to be moved between various stages. Not only our equipments are damaged but semi processed materials are spoiled too. In many cases, they could not be used or re-used”. In money term, the costs of power cuts are “several hundreds of million tomans per hour”. In addition to moulding- which suffered major losses, we know that “Glass, petrochemical, plastic, shoes, plates and cutlery makers” who are stationed in these industrial estates in Greater Tehran “have suffered very serious unrecoverable losses as a result” to the extent that “many of them are now working at 50% and less of their full potential” . Given this brief description of the economy, we argue that the movements of TSE index have little to do with economic fundamentals and with the health of the economy. We shall return to this issue and examine it further by looking at Iran’s Industrial sector in greater details.