Float the dinar is the solution to save foreign exchange reserves

Float the dinar is the solution to save foreign exchange reserves

May 15, 2017

In recent years, officials, economists, and even ordinary citizens have used the alarm to warn against a drop in Iraq's hard currency reserves.
The last statement on this matter was to the Governor of the Central Bank of Iraq and the agency on the relations, which confirmed three months ago that the balance of foreign reserves amounts to 49 billion dollars. The foreign currency balance has fallen by more than a third from a record high of $ 77 billion in mid-2014. This clearly indicates that there is a serious structural imbalance in the balance of payments that can not be resolved by easy administrative decisions, especially as indicators suggest a continued depletion of foreign exchange reserves in Iraq at the near and medium levels.
All this threatens to increase pressure on the national currency and cast further doubt on the country's ability to finance imports and necessary investments.
Everyone agrees on the reasons for the sharp drop in foreign reserves, mainly composed of US and European treasury bonds, as well as cash balances in the currencies of the dollar, the euro, the pound and the gold bullion. It is no different that the decisive factor behind this crisis is the collapse of oil prices since June 2014. Prices recovered relatively late in 2016 after OPEC and Russia decided to cut production rates, but the return of black gold prices to their previous levels remains a distant dream as the supply surplus persists for the foreseeable future. Hence, it is not permissible to rely on an imminent and imminent rise in prices.
However, another reason for the problem lies in lower interest rates at the global level, which also means that the CBI earns less money on US and European bonds and on foreign exchange reserves in foreign banks, which account for the lion's share of Iraq's foreign reserves.
Against the near-consensus on the reasons, there are significant differences in the proposed solutions to the crisis of the collapse of foreign exchange reserves. Most of the members of the Economic Committee in the House of Representatives and many of those interested in economic affairs focus on combating money laundering and what they call "smuggling" of hard currency and the black market and criticizing the currency auction of the Central Bank and even demanding the suspension on the grounds of suspicion of corruption in the sale of dollars to private banks and banking companies.
Some also proposed charging for foreign currency conversion. Some even go so far as to call for a monopoly on hard currency by the state and to prohibit the treatment of citizens and private companies.
Combating money-laundering, smuggling and potential corruption remains an important and pressing issue regardless of the size of the currency reserve. In this regard, there are laws that the Central Bank and other state bodies must strictly enforce. But the legitimacy of these measures does not justify the call to impose arbitrary administrative restrictions on dealing in hard currency and look at the dollar and the euro as a saved fortunes can not touch. The demand for state monopoly on hard currency is, to say the least, an essential feature of totalitarian regimes.
Hitler and Stalin entered the history of economics as the first to apply this monopoly as a permanent principle of economic policy. This principle then became a dominant policy in socialist countries and in developing countries that followed the strategy of public sector dominance. Like Saddam Hussein, the tyrant has "masterminded" the control of hard currency in the country until it has already become the preserve of him and his family and close associates.
The result of this sterile policy was not limited to the recovery of the black market, the collapse of the Iraqi dinar and the deepening of imbalances in the distribution of income, but also to the emergence of harmful social phenomena and behaviors. There is no doubt that many Iraqis remember how some foreigners and Iraqi expatriates acted during the siege as if they were "kings" simply because they had a few hundred dollars.
In short, it can be said that resorting to administrative procedures to impose arbitrary restrictions on dealing in hard currencies and their conversion and other "easy" measures will not solve the problem of depletion of foreign exchange reserves, but will lead to the adverse results of the decline in confidence in the national currency and the speculation and black market and direct damage to the interests of Citizens and restrictions on their freedom of travel, treatment, study abroad and others.
The solution to the problem of serious decline in the reserves of foreign currency requires primarily economic measures and not administrative, especially the implementation of difficult reforms in the area of exchange rate and the activation of customs tax. It is quite clear that after 2014, the value of the Iraqi dinar against the dollar has been overstated under the new circumstances resulting from continued low oil prices.
However, the central bank did not move and only reduced the value of the Iraqi dinar in late 2015 by a small percentage did not exceed 2%. A slight reduction not commensurate with the financial and economic variables of the country.
It is clear that the central bank adheres to the fixed exchange rate policy and pegs the dinar to the dollar. If this policy is necessary and justified after 2003 and has succeeded in establishing the necessary monetary stability for the development process, clinging to it infinitely does not benefit the Iraqi economy in the long term. The central bank's reluctance to adopt exchange rate flexibility appears to reflect concerns about the potential political and social costs of devaluing the dinar against other currencies and the expected rise in the prices of imported goods.
On the other hand, this hesitation confirms the fears of circumventing the constitutional independence of the Central Bank and its increasing dependence on the government, especially after the ousting of the former leadership of the bank headed by Sinan Shabibi on the basis of accusations of fabricated and malicious corruption.
But this situation will not serve to maintain monetary stability, which requires now to take decisive and bold actions, foremost of which is a clear reduction in the dinar exchange rate. Such a step could "trap" more than one bird with one stone: first, reduce demand for hard currency and imported goods; secondly, improve the competitiveness of domestic production; and thirdly, raise state budget revenues and thereby reduce the fiscal deficit.
This is confirmed by the experiences of several countries, including Russia and Egypt. In 2014, Russia was in a very difficult position due to the collapse of oil prices and the imposition of economic sanctions by the West. But expectations of the collapse of the Russian economy have not materialized. Thanks mainly to a certain correlation between the Russian ruble exchange rate and world oil prices.
This has left the ruble more than half its value against the dollar in 2015, but at the same time it has stabilized the price of ruble oil, thus preventing the collapse of state revenues. This would not have been possible had the Russian central bank not floated the ruble in November 2014.
A similar positive experience provided by Egypt, which also in late 2016 floated the pound. Despite the controversy surrounding the impact on the life of the Egyptian citizen, this was the difficult decision to record successive rises in Egypt's foreign exchange reserves.
It will be said, of course, that the conditions of Russia and Egypt differ from Iraq, and this is self-evident and does not delay, because the circumstances of each country differ from another country, but this does not prevent the benefit of the experiences of other countries, especially that Russia, like Iraq, energy.
The situation in the Iraqi economy forces the central bank to move and adopt a flexible policy in the exchange rate in preparation for floating the dinar against other currencies in the medium term.
Managed Floating, which allows the central bank to intervene to prevent sharp and dangerous fluctuations in the dinar exchange rate, can be used here.
The attempt to solve the problem of the decline of Iraq's foreign exchange reserves by "easy" decisions will mean only perpetuation and adventure to generate other crises.
Dr.. Najeeb Al Obeidi
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What's the difference in hard peg and fixed float?  Hopefully not much

Readytogo wrote:What's the difference in hard peg and fixed float?  Hopefully not much

What is the difference between a fixed and a floating exchange rate?
A fixed exchange rate denotes a nominal exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies. By contrast, a floating exchange rate is determined in foreign exchange markets depending on demand and supply, and it generally fluctuates constantly.
A fixed exchange rate regime reduces the transaction costs implied by exchange rate uncertainty, which might discourage international trade and investment, and provides a credible anchor for low-inflationary monetary policy. On the other hand, autonomous monetary policy is lost in this regime, since the central bank must keep intervening in the foreign exchange market to maintain the exchange rate at the officially set level. Autonomous monetary policy is thus a big advantage of a floating exchange rate. If the domestic economy slips into recession, it is autonomous monetary policy that enables the central bank to boost demand, thus 'smoothing" the business cycle, i.e. reducing the impact of economic shocks on domestic output and employment. Both types of exchange rate regime have their pros and cons, and the choice of the right regime may differ for different countries depending on their particular conditions. In practice there is a range of exchange rate regimes lying between these two extreme variants, thus providing a certain compromise between stability and flexibility.

Managed float regime is the current [You must be registered and logged in to see this link.] environment in which [You must be registered and logged in to see this link.] fluctuate from day to day, but [You must be registered and logged in to see this link.] attempt to influence their [You must be registered and logged in to see this link.] exchange rates by buying and selling [You must be registered and logged in to see this link.]. It is also known as a dirty float.
In an increasingly integrated world economy, the currency rates impact any given country's economy through the [You must be registered and logged in to see this link.]. In this aspect, almost all currencies are managed since [You must be registered and logged in to see this link.] or [You must be registered and logged in to see this link.] intervene to influence the value of their currencies. According to the [You must be registered and logged in to see this link.], as of 2014, 82 countries and regions used a managed float, or 43% of all countries, constituting a plurality amongst exchange rate regime types.^{[size=11][You must be registered and logged in to see this link.]}

[size=44]HARD CURRENCY PEGS

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International Finance For Dummies

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Dollarization and currency boards are among the examples of hard pegs, which severely limit the possibility of an autonomous (independent) monetary policy in a country. Therefore, sometimes the exchange rate that stems from a hard peg is referred to as a fixed exchange rate, as in the case of a metallic standard.
In the case of dollarization, a country adopts a foreign currency to be circulated in its economy as the medium of exchange. A currency board backs the money supply or domestic currency liabilities with foreign currency or foreign currency–denominated assets to support the pegged rate.

[size=30]DOLLARIZATION[/size]

Dollarization is a general term that describes a country’s act of giving up its domestic currency and adopting another country’s currency to be used in all transactions. Despite the name, the replacing foreign currency doesn’t have to be the dollar.
Consider some historical examples for dollarization. One of the smallest European countries, Monaco, adopted the French franc in the 19th century and currently uses the euro, after France adopted the euro in 1999. Also, the U.S. dollar is the legal tender in Panama since the early 20th century.
Clearly, eliminating a country’s own money and, therefore, monetary policy is a radical step. After the domestic currency in circulation is replaced by a foreign currency, the country cannot have an autonomous monetary and exchange rate policy. Suppose that a country adopts the dollar.
Because this country doesn’t have its own money and its own central bank, it has to accept the monetary policy of the U.S., conducted by the Federal Reserve Bank (the Fed). Clearly, the monetary policy–making division of the Fed, the Federal Open Market Committee (FOMC), conducts its monetary policy in consideration of the economic outcomes in the U.S.; the dollarized country’s economic situation doesn’t matter to the Fed.
Therefore, the dollarized country loses its ability to address its domestic economic problems. In all countries, central banks have similar responsibilities: issuing currency, protecting the purchasing power of the currency or promoting price stability, implementing monetary policy to address business cycles (contractions and expansions), and regulating financial markets.
The central bank of a dollarized country is able to regulate the country’s financial markets and promote price stability by adopting a lower-inflation country’s currency.
The dollarized country’s central bank loses something else as well. In addition to the aforementioned responsibilities, all central banks act as a lender of last resort. In times of crisis, especially financial crisis, central banks inject liquidity into financial markets.[/size]

“Iraq pursues a policy of a de facto peg to the U.S. Dollar, and therefore monetary policy is constrained in tackling the current shock.

“The Central Bank of Iraq (CBI) had kept the Dinar steady through January 2009.

“In 2014, the nominal exchange rate in the official market remained stable against the U.S. Dollar at 1,166 IQD/1 USD, but the rate in the parallel market increased.

“The CBI has recently taken steps to simplify foreign exchange market regulations, but has not eliminated all existing exchange restrictions and the multiple currency practice.

“With the peg, fiscal policy carries the burden of macroeconomic stabilization, but in this case does not have the space to do so.“