Post By Oldwazhisname
September 2015 Status of Iraq –
Are Conditions Conducive For An RV Event? Part 4 of 4
Although many infrastructure projects are underway, Iraq remains in deep housing crisis, with the war-ravaged country likely to complete only 5 percent of the 2.5 million homes it needs to build by 2016 to keep up with demand, the Minister for Construction and Housing said in September 2013.
The needs for basic services infrastructure continues to go unmet, in part due to budget and corruption issues. Huge economic possibilities exist if this segment can be properly unleashed.
What About All Of the Supposed Deposits of Undiscovered Gold?
When I first got involved in buying IQD, I heard about an untold amount of wealth available to Iraq from undiscovered and unmined gold deposits under neighborhoods in Bagdad. It was supposedly accidentally found by US soldiers during the early days of the Invasion.
I went about enough research into this matter to give a strong opinion that this is most probably total fiction, probably fabricated to advance the storyline of why the IQD would see a significant rise in value. I read reports of symposiums put on by the Iraq Minister of Mining whatever, and while he talked tangently about gold to be mined (Iraq is a big country), his excitement was centered on phosphates, quartz, salt and Sulphur.
Historically, 50 to 60 percent of Iraq’s arable land has been under cultivation. Because of ethnic politics, valuable farmland in Kurdish territory has not contributed to the national economy, and inconsistent agricultural policies under Saddam Hussein discouraged domestic market production.
Despite its abundant land and water resources, Iraq is a net food importer. Under the UN Oil for Food program, Iraq imported large quantities of grains, meat, poultry, and dairy products.
The government abolished its farm collectivization program in 1981, allowing a greater role for private enterprise in agriculture. Rightly so, this important segment of the Iraqi economy has huge upside if the Government will support its development.
The international Oil-for-Food program (1997–2003) further reduced farm production by supplying artificially priced foreign foodstuffs. The Invasion of 2003 did little damage to Iraqi agriculture; because of favorable weather conditions, in that year grain production was 22 percent higher than in 2002.
Although growth continued in 2004, experts predicted that Iraq will be an importer of agricultural products for the foreseeable future.
Long-term plans call for investment in agricultural machinery and materials and more prolific crop varieties—improvements that did not reach Iraq’s farmers under the Hussein regime. In 2004 the main agricultural crops were wheat, barley, corn, rice, vegetables, dates, and cotton, and the main livestock outputs were cattle and sheep.
Favorability Index – The Economy Of Iraq
Using a scale of “1” to “5” (with “1” being very favorable and a “5” being very unfavorable) to assign a current estimate of the conditions relating to Iran’s overall economic situation that would support a revaluation event, I would assign a current rating of “4” (“unfavorable”) and deteriorating.
As it stands, Iraq is a “one trick pony” with oil being its primary source of revenues and the depressed global oil prices is outside of its control, aside from producing more.
The 2016 Budget will soon be proposed and what the GOI comes up with to generate enough revenues to support the country will be revealing. Failure to address this issue satisfactorily will have a direct negative impact on the value of the dinar, I can nearly guarantee that.
To the extent that an estimated 25% of the Governments budget is being spent on the ISIL problem, a near-term resolution of the ISIL problem will significantly help but not totally alleviate this issue. Rescue will come from a combination of a rise in oil prices and the diversification and development of the Iraqi economy.
The Prognosis For An Increase In The Value Of The IQD
The totality of the above discussion should allow a reasonable reader to come to conclusions about the overall prospects for an increase in the value of the IQD, at least looking back from something of a historical perspective and an accurate read on current conditions.
IMO, the prospects have been dim for several years and the current prospects still look quite difficult, albeit maybe improving. But no doubt, there is a long ways to go for the conditions to seem ripe for a favorable event.
If my assessment seems overly harsh, consider the recent bond ratings assigned by internationally respected bond rating agencies during Iraq’s efforts to float international bonds. Standard & Poor’s credit rating for Iraq stands at B- Fitch’s credit rating for Iraq is B-.
In general, a credit rating is used by sovereign wealth funds, pension funds and other investors to gauge the credit worthiness of Iraq thus having a big impact on the country’s borrowing costs. Pathetically weak countries like Belarus, Congo and Ghana have been assigned this same level of rating. Actually, I could find only the countries of Greece and Valenzuela, both know to have already defaulted on recent debt, to have a lower rating.
What Determines the Value of a Country’s Currency Value When It’s On a Pegged Value?
My challenge is going to be to try to state this topic in a relatively simple manner, while making it relevant to Iraq and the IQD. Gurus both make it too complex with talk of “reducing the note count”, while others convey that moving the value of the IQD can be done at a whim without a whole cascade of fallout issues to worry about.
Manipulating the value of a country’s is often a balancing act between several opposing objectives (as an example, when China recently decided that by devaluation or manipulation of its currency’s value, it can help spur a better balance of trade by making their products more competitive but it comes at the cost of greater in-country inflation).
Let me begin with the “short term” determinants of the value of currency.
There are two primary ways for deciding it. The first is the exact monetary regime that Iraq has been using and it calls for some authority (in our case, the Central Bank of Iraq, the “CBI” ) to peg the currency to some commodity or some other currency. In Iraq’s case this has been the USD.
This is referred to as ‘fixed exchange rate” or a “peg” (as if the value of the IQD is nailed to the value of the USD, i.e. when the USD moves in value, so does the IQD).
While it is pretty rare today, it used to be that most of the Word’s currencies for the last five hundred years were “pegged” or fixed to gold; after the Second World War, when USA emerged as the dominant economy, many countries have chosen to peg their currency to the dollar, as is the case of Iraq.
In this situation, the CBI has declared an exchange rate of 1166 IQD equal to $1 USD and it must be willing to either buy or sell its currency for gold or any foreign currency at the declared rate.
The other way is a floating exchange rate. Iraq does not currently use this method. Here, no central authority “decides” the value of the currency. There are open markets where the currency is allowed to trade and the value of the currency is whatever is decided by these markets.
Typically, a market consists of a large number of “market makers” – people who are willing to buy AND sell currency at some (slightly different) rates. The difference between their buy and sell rates is what they earn as profits – compensation for creating the markets.
Typically these will increase the “value of currency” if they have net positive demand (i.e. more people buy the currency than those who sell it) and vice versa. This adjustment keeps happening continuously allowing others to gauge the value of the currency.
In Dinarland, there is great debate as to what Iraq will do to effect a RV of its currency. Some guru’s like Kaperoni are adamant that a float of some sorts is what will happen.
Other Gurus have stated specifically that there will be some initial adjustments to new peg rates of anywhere from between $0.10 to $4.20/IQD and higher. IMO, there is no clearly stated and consistently applied method for such an event (which if you think about it, is a problem for the RV scenario, in and of itself).
In the medium run, the value of currency is determined, by two main factors – balance of trade and inflation rate.
Roughly speaking, balance of trade refers to difference between exports and imports. If exports are higher, then more people will demand the currency and hence it will appreciate (or increase in value) and vice versa.
Iraq from 2009 through 2012 enjoyed a significant surplus situation and we saw the CBI’s reserves begin to rapidly increase. It was a cause for a lot of enthusiasm in Dinarland. In order to drive home this point, we sometimes forget that we saw several upward revaluations of the IQD during this time.
Conversely, with the collapse of global oil prices and the cost of fighting ISIL having significant detrimental effects of a deficit balance of trade and a huge deficit in the Iraq government’s budget, we are increasingly of late getting comments that a devaluation of the IQD is being considered (see article below by an American economist).
Very modest inflation is common in most of the World’s stable economies. However, Inflation is basically a decrease in the value of currency. Thus, as things become more expensive, the currency becomes less valuable or depreciates.
Typically, inflation is a local phenomenon (i.e. it changes the value of the currency within the country) while balance of trade is a foreign phenomenon (i.e. it changes the value of the currency relative to other currencies).
This is the exact situation we have seen in-country, where the Street Rate of the IQD is significantly worse than the international rate being defended by the CBI. There cannot long exist a great disparity between in-country street rates and international official exchange rates.
As we move forward, it will be important to not only keep track of the deficit trade problem caused by diminished revenues from foreign trade, but it will be important to track the internal inflation that could be caused by taxes and tariffs that will reduce the purchasing power of goods and services inside Iraq when a 7-20% tax that didn’t previously exist is now applied in the marketplace.
I will add that it is my opinion that the double whammy of the falling value of the street rate of the IQD caused by limiting the supply of USD through the auctions and the application of the Taxes and Tariffs Law earlier, caused the GOI to suspend collection of most taxes several months back.
In the long run, the value of currency is determined by one single factor: whether the rate of printing (or creating) the currency is higher or lower than the rate of increase in demand for it.
The demand for currency would typically grow with the real growth rate of the country. We saw this significantly happen between 2003 and 2009, when Iraq was making huge strides in getting its act together.
If the central bank were to print more than that rate, then the money supply would increase. It would lead to higher inflation. People within the country would import more and export less thus leading to an unfavorable balance of trade. These would increase the supply of the currency, thus forcing the market makers to decrease the price leading to depreciation.
On the other hand, if the printing of money is LESS than the rate at which economy expands, we would see deflation. Prices would fall and people could “make money” just by holding onto it. This is a rare phenomenon because governments typically prefer to print money and use it for their ends rather than allow deflation.
In the case of us in Dinarland, the speculation has been (because there is no clear proof this is happening) that the CBI is reducing the money supply by removing IQD from the marketplace. This is one of the narratives that actually could ultimately lead to a meaningful improvement in the value of the IQD compared to other currencies
The Historical Value Of the IQD
Money is not an organic creature but its value keeps changing with the society and its economic conditions. One IQD in 1931 is not the same as one IQD today, both in terms of appearance and purchasing power.
There is a lot of confusion and misinformation floating around in Dinarland about what the historical value of the IQD had been, why it has changed and the reasons why it will revalue. Hopefully, the insights in the section will put to rest the many false stories about the historical value of the IQD.
The IQD was introduced in 1931 and the IQD was originally pegged to the British Pound. The value of one IQD was equal $4.86 USD between 1942 and 1949 and (because of devaluation changes to its underlying peg, the Pound) the value equaled $2.80 USD between 1949 and 1971.
As a gesture of independence in 1959, Iraq uncoupled the IQD officially from the British Pound. However, the IQD remained at equality with the Pound until the unit of the British Pound devalued for the second time.
Soon after the inflation of the US Dollar in 1973, the IQD revalued to $3.39 USD. The value of IQD remained the same until the Iran-Iraq War. Iraq in 1982 devalued the IQD by 5% equating it to $3.22 USD.
In early 1988, the official exchange rate of the IQD continued to equate to $3.22 USD, but, the levels of Iraq’s cost of living was rapidly rising (inflation) by 25-50%/year starting in 1985, such that by 1988, the street rate of the IQD was half the official rate of exchange per USD.
After the Gulf War in 1991, because of UN sanctions, the formerly used version of the IQD (called “the Swiss Dinar”) was used no more. A new “Saddam Note” set of currency units was created.
Because of the sanctions by the United States and the over-printing these new currency units by the government, the IQD devalued rapidly, and by late 1995, the value of 3,000 IQD equaled $1.00 USD.
Between October 2003 and January 2004, the Coalition Provisional Authority issued new Iraqi dinar coins and notes (the ones we now hold), with the notes printed using modern anti-forgery techniques, to “create a single unified currency that is used throughout all of Iraq and will also make money more convenient to use in people’s everyday lives”.
Old Saddam-era banknotes were exchanged for new at a one-to-one rate, except for the Swiss dinars, which were exchanged at a rate of 150 new dinars for one Swiss dinar. (This event pegged the value of the IQD as 3,703 IQD equal to $1.00 USD.)
I want to point out that this last paragraph is straight from CBI’s website and if you follow the above train of the changes to the value of the IQD, you will see no room for the Guru myth that George W. Bush destroyed the value of the IQD (and so goes all of the false narrative of the US can once again turn on the value of the IQD back on. You see, the value of the IQD was already destroyed before George W. Bush ever showed up on the scene).
In August 2005, the IQD exchange rate had improved to 1,470 IQD equal to $1.00 USD. The value had steadily improved until it reached a value of 1,170 IQD by 2008.
In October 2012, Dr. Shabibi, Governor of the CBI, announced changing the per to 1,166, the last official announcement of any change to the official pegged rate of the IQD.
Let’s Hear From An American Think Tank Economic Professor About Iraq’ Current Economic Situation And How Current Affairs are Affecting the prognosis For a RV
Finally, I have included excerpts from an excellent (but dour) article put out in January 2015 by Frank R. Gunter, a Professor of Economics at Lehigh University and a Senior Fellow at the Foreign Policy Research Institute.
His study is based on discussions at the November 2014 Iraq Economics, Development, and Policy program at the American University of Sharjah in the United Arab Emirates. I include it, in part because it ties in nicely with the above analysis but it also touches on the valuation prospects for the IQD.
“The combination of the ISIS insurgency and low oil prices are producing an economic shock unprecedented in Iraq’s troubled history.
The ongoing conflict will require a sharp rise in security expenditures at the same time that government oil export revenues are collapsing, forcing the government into deficit spending.
This deficit spending, combined with a loss in reserves from the Central Bank of Iraq, calls into question the much-vaunted stability of the Iraqi dinar.
Dollar Flows in Iraq
The flow of dinars and dollars within Iraq is critical to dealing with the ongoing crisis and yet little understood even within the country. The figure below illustrates the pattern of these flows. As is well known, the primary source of government revenues – over 95% – is from oil exports.
For over a decade, the dollars earned from these exports have been paid into the Development Fund for Iraq (DFI), which is held by the Federal Reserve Bank of New York. The primary reason for having oil export payments paid to the DFI rather than directly to Iraq’s Ministry of Finance (MoF) is to avoid confiscation of these funds by foreign courts in settlement of Saddam-era lawsuits.
Upon request, dollars from Iraq’s oil exports are transferred from the DFI to the MoF. At this point, a divergence occurs. Over half – about 60% in 2013 – of the dollars flow out again to the rest of the world as payments for government imports, debt service, and miscellaneous transactions.
The remaining dollars are sold to the Central Bank of Iraq (CBI) for dinars at a rate of 1166 Iraqi Dinars per US Dollar. The MoF then uses these dinars to pay for the Government of Iraq (GoI) expenditures in the Iraq economy such as salaries, pensions, social safety net, security, etc. The dollars accumulated by the CBI through these dinar sales are, of course, the nation’s international reserves.
However, many of these dollars immediately flow out again. The CBI holds daily auctions to provide dollars to the Iraq economy. Financial institutions buy dollars from the CBI in order to provide them to individuals and organizations that want dollars as a more secure savings asset, to facilitate domestic transactions, to purchase legal and illegal imports, and for capital flight.
This demand for dollars is quite large. For example, during the first 14 auction days of December 2014, CBI dollar sales totaled $2.25 billion.
Those Iraq individuals or organizations that are forbidden by the CBI to directly access the currency auction must purchase dollars at a premium in the parallel currency market. On December 18, 2014, the exchange rate in the parallel market was 1199 Iraqi Dinars per US Dollar – about 3% higher than at the CBI auction.
In every year but one over the last decade, the inflow of dollars to the CBI from the MoF exceeded the outflow of dollars through currency auctions resulting in an increase in the country’s international reserves.
For example, in 2013 the MoF sold about $55 billion to the CBI while about $53 billion flowed out again through the currency auctions resulting in about a $2 billion increase in international reserves. The large increase in international reserves since 2004 has been the major support for the country’s enviable exchange rate stability. However, the results for 2014 were grim.
Because of political disputes, Iraq never passed a 2014 budget. Instead, government expenditures in 2014 were based on an arguably unconstitutional extrapolation of the 2013 budget. And the Government of Iraq (GoI) has continuously delayed even a partial accounting of 2014 revenues and expenditures.
However, recent data from the International Monetary Fund support the view that Iraq’s fiscal and monetary situation is deteriorating. At the same time that oil export earnings are declining, GoI security-related dollar imports have increased dramatically.
One effect has been on fiscal reserves held at the DFI, which have fallen from almost $18 billion at the end of 2012, and $6.5 billion at the end of 2013, to about $4 billion at the end of November 2014 (IMF Press Release 14/560, 9 December 2014). Equally worrisome is the drop in the country’s international reserves.
From $77 billion at the end of 2013, the international reserves held by the CBI fell to about $67 billion at the end of November 2014. This is only the second year-over-year fall in international reserves in the last decade. In the absence of reliable data from the GoI, there are two possibilities.
Either there has been a decrease in MoF sales of dollars to the CBI and/or a substantial increase in dollar auction sales to financial institutions. However, through November 2014, auction sales of dollars by the CBI have totaled about $47.4 billion, which is roughly in line with 2013 dollar sales.
Therefore, the cause of the drop in Iraq’s international reserves is more likely a result of the collapse in oil export revenues combined with increasing security-related dollar expenditures by the Iraqi government and, possibly, accelerating capital flight.
Thus in 2015, Iraq not only faces a fiscal crisis from falling oil export revenues but also a monetary crisis because of the loss of international reserves. The fiscal crisis might be best understood by distinguishing between the “break even” price of oil and the “crisis” price of oil.
Break Even and Crisis Prices
Despite the fact that the country’s 2015 fiscal year starts this month (January), the crucial assumptions underlying the budget are uncertain. Over the last several months, no sooner has the GoI announced a planning price for oil for the 2015 budget then world prices have fallen below this level.
The most recent announcement on December 25th was for a $102.5 billion budget based on an annual average oil price of $60 per barrel resulting in a large deficit (Gulf Research Center, December 25, 2014).
Expenditures of $102.5 billion in 2015 means that the GoI expects to spend almost $22 billion less than its actual expenditures in 2013! Where will the cuts occur? The drop in oil prices to similar levels in 2009 provides insight into both the reactions of the GoI and the effects on the Iraqi economy.
In 2009, as total revenues decreased by about 33%, salary and pension expenditures increased by about the same percentage. This necessitated sharp cuts in the other major expenditure categories, safety net transfers and public investment, in order to reduce expenditures.
The remaining deficit was financed through the sale of GoI treasury bills and the MoF “clawing back” unspent government funds from the state owned banks. The economic effects of the draconian cuts in public investment were severe and long-lasting.
Since public investment accounts for over 90% of Iraq’s fixed capital formation, the cuts in the investment budget caused most economic development activities to grind to a stop.
Work on improving roads, increasing electricity generation, opening schools and clinics, increasing access to clean water, and so on was abandoned until oil prices finally recovered in 2010.
And when the projects were eventually restarted, it was often discovered that previous work had to be completely redone due to looting, vandalism, environmental damage, or planned revisions. By some estimates, it was not until 2011 that public investment returned to the levels achieved at the end of 2008.
Assuming oil exports of about 3.3 million barrels per day, Iraq needs an oil price of about $80 a barrel in order to break-even and to be able to pay for its sharply reduced 2015 expenditures without running a budget deficit.
An oil price this high would provide sufficient revenues to pay not only for current expenditures and security costs but also for essential infrastructure investment. Since world oil prices are already less than $60, it is extremely unlikely that Iraq will be able to break-even in 2015. But at what price of oil will the required reductions in GoI expenditures become politically destabilizing?
That depends on the crisis price of oil.
The crisis price is the lowest oil price that will allow the GoI to pay salaries and pensions, purchase the necessary supplies for the police and army, maintain a minimum social safety net, pay interest on its debts, pay war reparations, and continue the absolute minimum infrastructure maintenance and construction to allow a steady increase in the volume of oil exports.
If the world price of oil falls below the crisis price for an extended period of time and other revenue sources are not available, then the necessary expenditure cuts can be expected to be politically destabilizing. In 2009, this crisis price was an estimated $50 a barrel.
Therefore, while the world price of oil in 2009 was below Iraq’s break-even price, it was above the crisis price.
However, in 2015, the crisis price of oil is expected to be much higher. Not only has there been a steady increase in government salaries and pensions since 2009, but also the GoI expects to sharply increase its security expenditures to fight ISIS. As a result, the 2015 crisis price of oil is an estimated $70 a barrel.
Since world oil prices are expected to remain below the crisis price in 2015, the GoI faces a difficult challenge – either find another source of revenue, borrow the needed funds, or make politically unacceptable cuts in salaries or pensions. The latter option can be expected to lead to widespread political protests by government employees and retirees as well as threats of a government shutdown.
If world oil prices average $60 per barrel in 2015 (currently at under $50), then the GoI needs at least an additional $12 billion to fund its minimal crisis budget and an additional $12 billion – $24 billion in total – to rise to the break-even point.
While its international and domestic options to raise these funds are limited, the GoI has a high probability of funding its crisis budget. However, the GoI faces a much lower probability of being able to fund its 2015 break-even budget.
Options for international lending are limited. Government to government loans from the United States and other countries involved in the current war on ISIS are likely to face strong opposition in Washington and other world capitals. It will be argued – with an element of truth – that Iraq’s budget problems are mostly self-inflicted, the result of GoI mismanagement and corruption.
In addition, it will be pointed out that the U.S. and other states have already forgiven 80% or more of their Iraqi debt and that these countries have spending needs at home. Iraq’s regional neighbors such as the UAE and Kuwait – who generally did not participate in the loan forgiveness program – are facing their own budget challenges resulting from the collapse in oil prices.
However, it is likely that the GoI will be able to borrow several billion dollars. In addition, it appears that Kuwait has agreed to a one-year suspension of war reparations.
These reparations were imposed under an agreement with the UN, where Iraq agreed to pay Kuwait 5% of its gross earnings from oil exports to compensate for the damages incurred during the Iraq invasion of Kuwait in 1990. With a world price of $60 a barrel, a one-year’s suspension will free up about $3.6 billion.
There are at least five other sources of funds to meet the fiscal deficit. First, the GoI can readily access the funds held at the Development Fund on Iraq that were an estimated $4 billion at the end of November 2014.
Second, in 2009, the GoI was able to transfer about $7.7 billion from state-owned banks back to the MoF. These funds represented amounts that had been budgeted but not yet spent. In view of the constraints on spending in 2014, it is unlikely that more than several billion can be clawed back from state-owned banks in 2015.
Third, the GoI could attempt to borrow domestically although the amount raised would probably be less than $1 billion. While there have been several bond issues since 2003, demand for such instruments is limited especially since there is no liquid secondary market for government debt.
Fourth, although the country has an income tax system, tax revenues in previous years have been de minimis. It is unlikely that increasing the tax rate will raise substantial revenues in 2015.
Finally, and most controversially, it has been proposed that the MoF obtain part of the country’s $67 billion in international reserves by encouraging/forcing the CBI to buy dollar denominated bonds from the MoF.
Until a few years ago, it was believed that the CBI could resist such GoI pressure to monetize its debt, but former Prime Minister Nouri al-Maliki was able to remove the head of the CBI without the approval of the National Council of Representatives and replace him with a Maliki loyalist. This event severely undermined the perceived independence of the CBI.
Adding together these various sources of funds, the GoI should be able to raise or borrow enough to pay not only for its crisis budget in 2015 but also move part of the way towards its break-even budget.
However, if sub-$60 per barrel oil prices continue into 2016, then the GoI will face an even wider budget gap while having exhausted its borrowing options. It may be impossible for the GoI to even pay for its crisis budget in 2016. But a more immediate challenge than the future price of oil is the increasing stress in early 2015 on the Iraqi exchange rate.
Exchange Rate Options
A great source of pride for the CBI has been its ability to maintain a relatively stable exchange rate despite intense conflict in 2006-7. In fact, the CBI actually allowed a 20% appreciation of the dinar during this period. However, as discussed above, CBI reserves are falling as a result of lower dollar sales to the CBI by the MoF combined with large auctions of dollars by the CBI to financial institutions.
In addition, there is the possibility that the GoI will attempt to relieve its current fiscal crisis by encouraging or forcing the CBI to buy GoI dollar denominated bonds. This would replace liquid assets in the CBI accounts with illiquid assets, GoI bonds.
If either or both of these events occur, then there will be a loss of confidence in the ability of the CBI to maintain the current exchange rate of 1166 Iraqi Dinars per US Dollar.
Anticipating a depreciation of the dinar, speculation against this currency can be expected to increase. The CBI and GoI have few options to curb this speculation and prevent a loss of the nominal anchor of the Iraqi economy – its stable exchange rate.
One possibility is to further restrict access to the daily currency auctions. (And this is exactly what subsequent to this article happened. The GOI at the time it approved the 2015 Budget, mandated that there be a cap on auctions of $75 million/day.
The street rate of the IQD immediately floated to an approximate 6.3 % devaluation in purchasing power.) This was the primary policy response when the exchange rate came under attack in February 2012.
Buyers of dollars were required to be registered and provide documentation for the precise purpose of the dollar purchases. Further restricting access can be expected to lead to a widening gap between the official exchange rate of 1166 Iraqi Dinars per US Dollar and the rate in the parallel currency market.
An expansion of a dual exchange rate system can be expected to increase corruption as institutions use their political influence to gain access to the more favorable currency auction rates.
In addition, by restricting access to dollars for less favored groups – primarily in the private sector – it can be expected that there will be a further slowdown in the growth of the country’s non-oil economy, exacerbating the economic crisis.
A more cynical or possibly realistic policy response to the loss of the country’s international reserves would be a sharp pre-emptive depreciation of the Iraqi dinar. This would not only lead to an increase in import prices and a decrease in the prices of non-oil exports boosting domestic production but also reduce – at least temporarily – speculative pressure on the dinar.
The experience of countries in similar situations over the last several decades show that if the depreciation option is chosen, then it is better is to depreciate sooner rather than later and by a larger rather than smaller amount.
One view is that the GoI should immediately announce a return to the pre-2006 exchange rate of about 1470 Iraqi Dinars per US Dollar – roughly a 25% depreciation. However, with a new government, it is unlikely that there will be an aggressive dinar depreciation.
Typically, governments wait until a crisis brought about by a substantial loss of reserves occurs before depreciating their currency. And there is the fear that without fundamental changes in the Iraqi economy, any depreciation will only be the first of many.
A more long-term solution to the country’s loss of reserves and accompanying exchange rate crisis would be a return to using a currency board such as the one that provided Iraq with a stable exchange rate during
the tumultuous period of 1930-49. Unlike the CBI, the former Iraq currency board guaranteed full dollar convertibility of dinar notes and coins only.
This immunized the currency board from the speculative attacks that are often the downfall of fixed exchange rates such as Iraq’s. However, the adoption of an orthodox currency board can be expected to face serious political opposition since it would reduce the GoI’s ability to divert financial resources in order to favor particular economic sectors or to benefit friends of government officials.
Iraq’s Perfect Storm
The combination of falling world oil prices and the ISIS conflict has resulted in the most serious fiscal and exchange rate challenges since the 2003 invasion. It is tempting for the new government of Prime Minister Haidar al-Abadi to seek only limited modifications of fiscal and exchange rate policies so as not to run the risk of further destabilizing an already complex situation.
And if low – sub-$100 a barrel – oil prices are a temporary phenomenon with higher oil prices returning in 2016, then this limited strategy should work.
However, if deceased oil demand from the BRIC countries combined with an increased oil supply driven by both the fracking revolution in the United States and Saudi Arabian attempts to rein in the world oil market, then Iraq may face several years of oil prices substantially below $100 a barrel.
It should be noted that, even after adjusting for inflation, the world recently experienced two decades, 1985-2005, of sub-$60 a barrel oil. A future of low oil prices will require difficult and, to a great extent, irrevocable decisions about both fiscal and exchange rate policies. Rich countries with long histories of stable government can afford to make stupid decisions. Iraq cannot. “
After wading through a nearly 30 page report, some of you will want to hear my conclusions.
I am no different than many of you reading this, wanting some level of a favorable RV event to occur, preferably yesterday.
However, I have a career dedicated to underwriting risk, judging conditions and estimating whether a good or bad outcome is likely. One of the tenants of underwriting is that past behavior is a very good predictor of what the future will bring, certainly until conditions improve.
Based upon the above, it is difficult to see how things will change anytime soon. If anything, there is great potential for things to get worse, even a worst case scenario where the fundamental remaining positives of Iraq are completely wiped out through some sort of adverse regime change.
I think we came very close to that happening twice in the last four years: once with Maliki nearly becoming a dictator and again with Iraq nearly being overrun by ISIL.
Although both have seen positive steps toward successful resolution, we are far from a certainty of either resolution. Further, Iraq is clearly high centered in sectarian issues and not able to move forward on any meaningful resolution of the unification/reconciliation/reform issues.
The collapse of the global price of crude oil and the significant cost to fight ISIL have Iraq in a very difficult place. No, I don’t see an increase anytime soon and think the possibility to devalue the IQD along the lines of what Dr. Frank Gunter says above is very reasonable on the near term horizon.
oldwazhisname : Some of you are familiar with prior posts of mine where I attempt to give to the community certain insights that are being discussed.
I try to share authoritatively only when I have the expertise in what is being discussed and when I can contribute meanigful information to further the discussion.
I haven't been so active for the past several months because what is happening in Iraq seems to be generally stalled out for any kind of RV event and we have seen a number of events that appear threatening to our hoped for event.
For the past few weeks, I have been putting together a completely honest narrative about what has happened and what is currently happening in Iraq that is fundamental to the RV process.
In making this effort and to keep it pure from the hype of Dinarland speculation, I tried to get this information from outside sources: US government analysis articles, economic perspectives from industry sources, accurate historical narratives provided by military/diplomatic participants, etc. I hope it proves helpful to the community.