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Iran interest rate cut sparks panic selling

· President's shock order defies expert advice
· Bank shares plummet amid rampant inflation

Robert Tait in Tehran
Friday May 25, 2007
The Guardian

Iran's financial system suffered a fresh jolt yesterday with panic selling on the stock market after the president, Mahmoud Ahmadinejad, abruptly ordered banks to cut interest rates sharply, despite surging inflation.

The order, which Mr Ahmadinejad issued by telephone during a visit to Belarus and which flew in the face of expert advice - has triggered warnings of a financial crisis and spiralling corruption amid fears of a capital flight from the country's lending institutions.

Mr Ahmadinejad's decree forced all state-owned and private banks to slash borrowing rates to 12%. Inflation is officially 15% but is generally believed to be much higher. State banks had been offering rates of 14%, while those in the private sector ranged from 17% to 28%.

The decision caused panic in the Tehran stock exchange, with private banks losing much of their share value overnight. Shareholders in one bank, Karafarin, queued on Wednesday to sell their stock when previously there had been 1.2 million applicants to buy its shares.

There was speculation yesterday that the move could force the resignation of the economy minister, Davoud Danesh-Ja'afari, who was not consulted.

Interest rates are normally set by the head of the central bank, who is nominally politically independent. The Hammihan newspaper carried a picture of a disconsolate-looking Mr Danesh-Ja'afari holding his head in his hand under the headline: Shock on the Tehran bourse.

The rate cut was imposed at the same time as Mr Ahmadinejad raised the price of petrol by 1p to 5p a litre. That caused anger among motorists, who expected a new rationing system to be introduced on Tuesday. The government has postponed rationing until next month, citing difficulties in introducing the necessary technology to filling stations.

The interest rate move theoretically helps the less-well-off, for whom Mr Ahmadinejad has pledged support with cheaper loans. But economists say cutting rates below inflation will scare investors into withdrawing their savings, thereby creating a black market in high interest loans. They also warn of higher inflation as investors redirect their money into property and push up house prices.

"Mr Ahmadinejad's argument is that the lower the interest rate, the more access people will have to money," said one analyst. "But you can't command interest rates down. They have to match inflation. To cut rates, the government has to balance its budget better."

Another economist, Saeed Leylaz, claimed the move was a reward to powerful groups who had supported Mr Ahmadinejad. "I believe the president knows the consequence of this decision but he doesn't care about the future."

"There are groups which helped put Mr Ahmadinejad into office and in my opinion, he is paying them back. In the last two years, the value of (outstanding) debts has reached US$11bn, compared with $3.5bn in the previous 100 years. Mr Ahmadinejad ordered the banks to pay these accelerated loans to the special groups. If you cut interest rates, it means they have less to pay back. You can imagine how disastrous this is to the banking system."