Iraqi Dinar: navigating currency volatility and black market activity
Shafaq News/ The Iraqi dinar has been plagued by persistent exchange rate volatility in recent years. This instability is characterized by sharp appreciations of the US dollar followed by sluggish depreciation, creating uncertainty for businesses and consumers.
Further complicating matters is a significant discrepancy between the official exchange rate set by the Central Bank of Iraq (CBI) and the rate prevailing in the parallel or black market. Many exchange shops blatantly disregard CBI directives, contributing to a wider "spread" between the official and market rates.
Some economists propose a bold strategy to address these twin challenges—volatility and the black market premium—by introducing currency "flotation." This would essentially remove the CBI's peg to the dollar, allowing the dinar's exchange rate to be determined by market forces. While initial depreciation can be painful in the short term, proponents argue that establishing greater exchange rate stability will have long-term benefits.
As of mid-May, the CBI sets the official cash selling rate at 1,305 dinars per dollar, while the rate for international remittances is slightly higher at 1,310 dinars. Local media reports suggest the black market rate hovers around 1,450 dinars per dollar, with historical highs reaching 1,600 dinars.
Iraqi authorities have implemented a series of control measures in response to these issues. These include restrictions on foreign exchange transactions, a mandate for all domestic commercial transactions to be conducted in dinars, and stricter scrutiny of international remittances. However, the effectiveness of these controls remains to be determined.
Some Iraqi economic analysts, fearing excessive volatility, express reservations about full-fledged dinar flotation. Others propose a more nuanced approach, advocating for a "managed float" system that allows for some degree of market flexibility while maintaining a degree of CBI control.
Is Currency Floating A Viable Option For The Iraqi Economy?
Mudher Saleh, the Prime Minister's Financial Advisor, believes that currency floating could be better suited for the Iraqi economy, primarily due to its reliance on oil exports and the dominance of foreign currency reserves. In an interview with al-Hurra TV, he explained that "the economic vision of floating the Iraqi dinar to eliminate the gap between the official and parallel rates might be feasible in an economy where the free market alone dictates the movement of the balance of payments, not in an economy dominated by the rentier government sector, which generates foreign currency reserves."
Saleh explained that the CBI is the only party that can manage the supply and demand for foreign currency in the domestic market. Calls for floating essentially imply "adopting the exchange rate prevailing in the parallel market to achieve the goal of stability and balance in the official exchange rate itself at a new exchange rate point reached by the market at the end of the hypothetical floating policy and a return to stability again."
Under a floating scenario, the CBI would relinquish its position as the primary provider of foreign currency, ceding control to free market forces with limited foreign currency holdings. Saleh warned that these forces carry "an uncontrolled package of inflationary expectations, referred to in economic literature as 'inflationary expectations-generating forces,'" granting dominance to a "limited number of speculators" who possess finite amounts of foreign currency, facing an "open demand for foreign currency from the market" that exceeds supply by "more than ten times, at least in our estimation."
Saleh described this policy as "uncontrolled," as the absence of a central government supply of foreign currency would prevent the establishment of any exchange rate equilibrium that floating aims to achieve, except through "a significant depreciation of the exchange rate as long as inflationary expectations-generating forces control it in a highly monopolized rentier economy."
He cautioned against the unpredictable nature of exchange rate movements in an "incomplete market" from a production standpoint in compensating for the required supply of goods and services. "No one will know what the new exchange rate resulting from floating will be," which will be accompanied by "a prior wave of inflationary expectations" whose direction is difficult to control, potentially prompting monetary policymakers to "intervene with excessive foreign reserves and unjustified squandering of foreign currency to impose stability."
Iraq's oil reserves, estimated at 145 billion barrels, are among the largest in the world, according to the World Bank. Oil Minister Hayan Abdul Ghani recently announced that the country aims to surpass 160 billion barrels.
The Iraqi Dinar: To Float or Not to Float
"Iraq cannot float its exchange rate," says Abdul Rahman Al-Mashhadani, a professor of international economic relations, describing pro-floating advocates as "inexperienced."
A study by World Bank experts in recent years recommended "raising the exchange rate." Still, Al-Mashhadani emphasizes that such recommendations should be taken with caution, as the IMF is primarily concerned with economic development. Meanwhile, monetary policy recommendations should be followed by the IMF, not the World Bank.
In its latest review, the IMF praised the CBI's efforts in tightening monetary policy and strengthening its liquidity management framework.
Al-Mashhadani explained that floating the dinar would lead to "a spiral of high inflation rates," disproportionately affecting marginalized groups. He argues that such a decision cannot be made solely on the basis of monetary policy but must also consider the burdens it would place on citizens.
The professor highlighted to Al-Hurra that the experiences of other Arab countries do not necessarily translate to the Iraqi economy and warns that floating the dinar could result in an exchange rate of 5,000 dinars to the dollar, as the CBI "loses control over exchange rates and leaves them to float."
He feared floating the dinar could lead to "social problems" as "wages erode significantly," potentially pushing new population segments into poverty. While a small group of traders, politicians, and businessmen might benefit from the instability, Al-Mashhadani maintained that floating the dinar would ultimately mean "handing over control of exchange rates to the parallel market."
He added that floating the dinar would not be enough to achieve the desired monetary stability. Instead, the CBI would need to "print more local currency to meet market demand," and the government would need to increase salaries and social assistance packages.
Saleh, the Iraqi government advisor, attributed the "gap" in dinar-dollar exchange rates between the official and parallel markets to "external factors imposed by the Compliance Platform and administrative control restrictions on external transfer movements." He assured that this issue was unrelated to a central bank reserve shortage.
Saleh pointed out that Iraq's foreign currency reserves are at their highest level in history, covering imports for 16 months, compared to the global benchmark of three months.
According to a previous Agence France-Presse report, dollar remittances through official channels have increased significantly in Iraq as the country continues its financial sector reforms in line with international standards.
In late 2022, the Iraqi banking sector adopted the SWIFT electronic transfer system to improve dollar usage monitoring, ensure compliance with US sanctions on Tehran, and curb the growth of the informal economy.
Saleh acknowledged that the adopted financial standards had encouraged the emergence of a parallel currency market, attracting those seeking dollars outside official channels.
He also highlighted a distortion in the support prices of certain goods "on the part of fiscal policy," stating that this support often benefits the rich and poor equally without discrimination. Saleh characterized this as an additional, unrecorded real income, a legacy of the consumerist welfare state of the rentier economy.
Saleh said, "It is unreasonable that 90 percent of Iraq's population still receives food subsidies provided by the state as an extension of the 1990s economic blockade era, despite the changing living standards, lifestyles, the growing number of affluent people, and the expansion of the middle class."
