The Potential Asset Bubble In Iran That Not Many Are Talking About And The Way Out Of It
Iran, of late, has been mired in afflictions — from facing sanctions by the US to the coronavirus pandemic and now, to the potential asset bubble in its stock market.
All of these factors together give a very scary proposition due to their debilitating effects — socially, politically and economically. It is imperative to thus know how this asset bubble came about and what the government can do to save face (that is, if it accepts the existence of the bubble).
What is an asset bubble
Like in any decent article related to asset bubbles, one should first be acquainted with its definition and its applicability.
Essentially, it refers to the large deviation of the value of a financial asset from its ‘correct’ or ‘fundamental’ value. Broadly speaking, the ‘fundamental’ asset price is equal to the net present value of the cash flows which the owner of the asset is entitled to receive.
The financial assets in question in Iran’s case are stocks — an eerie allusion to the Great Depression, among others.
How can we say that Iran is, in fact, facing an asset bubble
The Tehran Stock Exchange has seen gains of 225% in the last year. Listing some 1,000 companies, it has had a market cap of about $210 billion as of May 2020. The Benchmark of TSE also climbed more than 365,000 points and gained 71% during 25 trading sessions since the beginning of the current fiscal year (March 20).
Now you might ask that if the stock market is booming, then the economy of Iran must consequently be in good shape. Not necessarily, since only an indicator of public sentiment and not the ground reality.
Iran has been showing a winding real economy for quite some time. Its GDP contracted by 7.6% in the first 9 months of 2019/20 (Apr-Dec 2019) largely due to a 37% decline in the oil sector. Iran’s Unemployment Rate is forecasted to be 16.327 % in Dec 2020 as reported by the International Monetary Fund. Furthermore, the onset of the pandemic has left its citizens struggling with poverty and health, as cases currently rise above 130,000.
Several economists have expressed growing fears about this brewing asset bubble.
But why are people investing in the stock market of all places
Now here comes the interesting part.
The sanctions imposed by the US on Iran over its nuclear programme, prevents Iranians from engaging in much of world trade, let alone investing in it. They thus have to turn to the domestic markets. The pandemic, stirring the sudden need for self sufficiency, adds to this blockage.
However, due to the exorbitant inflation rates, everything from the housing market to gold has become too expensive to invest in and people receive low returns on their deposits with the banks, as the profits aren’t able to compete with the inflation rate.
Thus, the stock market is the only remaining avenue to profitably funnel one’s money into. The Tehran Stock Exchange’s daily gains stand at a whopping 5% which is highly appealing, especially to the ordinary folks.
Certain rational investors are aware of the bubble, yet decide to buy in for a while and then sell at the top. The crash will only occur when speculators run out of money to keep buying.
This leads to a paradoxical cycle as depicted below :
The government’s role
Interestingly, the Iranian government is actually encouraging this form of financial growth and is eager to privatise state owned firms. It has listed an exchange-traded fund with its shares in banks and financial institutions and has said it plans to do the same for government stake in mining, steel and petrochemicals firms, as well as privatising other state-owned firms and two soccer clubs.
Along with this, the trade of justice shares on the TSE and other capital markets is set to begin on May 26th. Justice shares are the shares of government companies that were allocated to about 49 million Iranians hailing from low income backgrounds, about a decade ago. These were earlier not tradable, the owners receiving small dividends for the past two years, and are now said to double their worth of 30,000 trillion Iranian rials in the stock market.
This move not only helps raise the much needed revenue for the government through consequent higher valuation of its PSUs, but also puts more money into the poor’s pockets, instilling their faith in the economy and furthering the falsely positive sentiment driving stock market growth to an asset bubble. These temporary gains reflect nothing but the Iranian government’s shortsightedness.
As people from all backgrounds line up in front of stock exchanges to combat their paucity of funds, the belief that current trends have become the new normal and will continue to last, and even grow, is catching on.
What is the way out of this and what will happen if nothing is done
The circumstances of this particular asset bubble are very peculiar. In the past, asset bubbles have generally existed singly. However, this one is coupled with a worldwide pandemic which has brought a halt to both demand and supply fronts. So, while it is important to minimise the high valuations of the asset bubble, the government has to also stimulate the economy and raise the demand and supply in the economy.
Identification of the cause of the asset bubble helps in formulating policies to combat it. Thus, building upon the information above, it is imperative that the government opens up other avenues of investment to direct funds from the stock market elsewhere. A key move would be to try and get the US to remove its sanctions so as to allow international trade. This leakage will help break the inflationary cycle. Appealing to the UN might help Iran’s case.
Meanwhile, the government needs to shed its extreme privatisation attitude and maintain reserves to back them up against the inevitable market crash.
An increase in tax rates will not only increase the state revenue, but will also act as an indicator of the possible reversal of the stock market boom to the general public.
For stimulating the pandemic hit economy, an economic package — with majority of it being monetary rather than fiscal — might do the trick (monetary aspect including policies like reducing repo rate for increasing liquidity and fiscal aspect including those like higher government expenditure on infrastructure).
The monetary focused package will stop the fiscal deficit from burgeoning beyond the centre’s capacity. At the same time, it will fuel the banks, increasing liquidity up to the point where companies can actually increase their production and profits, creating more jobs and demand. The equilibrium will be forced to shift upwards.
Iran could also take a loan from the IMF which it would use to provide direct transfers to companies that need it while ensuring no additional investment in the stock market using this money. This could be even useful if the sanctions aren’t lifted.
Thus, the simultaneous rise of the fundamental value and fall of the stock value will allow a certain stabilisation of the market and will reduce inflation.
According to Economist Hyman P. Minsky , The five steps in the lifecycle of a bubble are displacement, boom, euphoria, profit-taking, and panic. Iran is currently graduating from euphoria to the profit taking stage and will soon be in the panic stage if Iran is not careful enough.
The citizens will end up combatting massive unemployment, poverty, hunger, inflation and illness. Several will face morbidity and death due to their inability to afford healthcare which will also be scarce due to lack of government funds and imports.
As throughout history, Iran will once again face riots against the political regime and its inability to avert impending crisis.
Iran currently stands in a fragile position, like a cave about to collapse from the pressures of the boulders above. And only time will tell whether this cave will crumble or will go on to see a glimmer of light from outside.