Stop playing with fire!

Against the advice of the Iranian Money and Credit Council, President Ahmadinejad has decided to reduce the interest rate. While further details are not yet available, but it seems likely that the rate would fall by another 2%. It should be said that this further reduction is happening against rising inflation rate. That in turn, would imply that the real rate of interest would move further into negative. There would be a number of implications:
- The saving rate is likely to fall further.
- If saving and depositing in a bank is not rewarding enough, this is likely to fuel transactions in real estate and lands. Hence further rises in the price of houses are most likely. An already critical situation would become more critical.
- It would also encourage capital flight, i.e. those who have surplus money would decide to take their money out of the economy altogether.
- On the positive side, however, borrowing becomes more attractive. Some argue that this could encourage investment in the economy. I do not share this view. I think that the main underlying reason for insufficient investment in the economy, is high political risk and that is unlikely to be changed be this fall.
In short, this playing with fire, while causing damages to the supply side of the credit market in Iran, is unlikely to encourage investment.
One can only hope and pray, that the fragile financial system of the IRI would not collape altogether.
My link does not work, you can read about Ahmadinejad's decision at:
http://www.farsnews.com/newstext.php?nn=8602050405