Iraq's central bank devalues currency by nearly 23% as anger mounts

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Iraq's central bank devalues currency by nearly 23% as anger mounts

The country's economic distortions have been exacerbated by the twin shocks of the Covid-19 pandemic and lower oil revenue

Faced with the twin shocks of dwindling oil revenues and the impact of the Covid-19 pandemic, Iraq’s central bank devalued the national currency by nearly 23 per cent against the US dollar on Saturday, the first time the peg to the greenback has been adjusted since 2015.

The Central Bank of Iraq set the exchange rate at 1,450 dinars per dollar, from a peg of 1,182 dinars, when selling to the finance ministry, according to a statement late Saturday. The dinar will be sold to the public at 1,470 and to other banks at 1,460.

“The structural distortions in the Iraqi economy are the ones that impoverished the public finances and restricted the ability of reform sought by the government and the Ministry of Finance,” the [You must be registered and logged in to see this link.] carried by the Iraqi News Agency.

“It is not a coincidence that the financial situation is this bad, nor is it the result of the current year or the previous year," the central bank said.

"Unfortunately [it is] rooted for more than a decade-and-a-half in economic policies with political thinking and the priorities of politicians taking precedent over economic thought and the priorities of development, and the principles of the relationship between economic policy on the one hand and fiscal and monetary policies on the other hand.”

“Fiscal policy lagged behind in performing its roles, and monetary policy was preoccupied with repairing the outputs of confused fiscal policy,” the regulator said.

Under the country’s provisional budget, 150 trillion dinars ($103 billion) are allocated to spending against 92tn dinars in revenue leaving the government with a wide deficit. Last month, the World Bank said millions of Iraqis could be forced into poverty due to the twin shocks of the pandemic and the collapse of oil prices. Even in its "benign scenario”, around 5.5 million Iraqis could be pushed into poverty, the Washington-based lender said.

Opec’s second-largest producer depends on oil revenue to meet 90 per cent of government expenditure, including $5bn spent on monthly salaries for public servants. Iraq’s economy before the devaluation was forecast to shrink 12.1 per cent this year, the third-steepest contraction in the Arab world after Lebanon and Libya, according to the International Monetary Fund.
[You must be registered and logged in to see this image.] Iraq government spending structure
A currency devaluation raises the local currency value of US dollar-denominated oil revenues and boosts budget oil revenue, Fitch Ratings said last month. A 20 per cent devaluation increases the value of oil revenue in 2021 in local currency terms by around 6 per cent of gross domestic product, it said.

The weaker dinar means inflation in the country will rise as the cost of imports will increase.

"This could stoke social unrest and place upward pressure on government spending, potentially offsetting the beneficial effect on public finances," Fitch said. "The risks to political stability from a large devaluation would be particularly acute, given the weak governance metrics – the lowest of any Fitch-rated sovereign."

A big burden for the government is the bill for public servants, which is equivalent to 25 per cent of GDP. Monetary financing from the central bank increased to 28.5tn dinars by end-August, from 14.1tn dinars at end-May, according to Fitch.

The pandemic coupled with lower oil prices and a decline in revenues forced the finance ministry to borrow from banks in order to pay salaries and meet other needs, widening the deficit. But having exhausted its domestic borrowing capacity it was left with little manoeuvring space.

"The subordination of the economic and financial policy to the aspirations of politicians led to Iraq's recent financial management models, and limited the administration's role to distributing oil resources and life-sustaining requirements such as salaries and operational requirements," the central bank said.

"The ministry of finance did not take up its leading role and position in economic affairs ... because of all these conditions, the central bank had no choice but to intervene on more than one occasion, to support public finances and save critical public spending requirements," it said. "But that does not mean that these interventions remain open without controls or ending."

The central bank said it understood the "difficulties" facing the structural reforms the government was trying to undertake but this does not prevent the monetary authority from taking effective steps to carry out reforms.
[You must be registered and logged in to see this image.] Iraq revenue and deficit
The legislative authority "will have an important role" in supporting the central bank’s direction to adjust the foreign currency exchange rate, the regulator said.

"Failure to take such a decision may force us to take difficult decisions that may put Iraq in a situation similar to what neighbouring countries have been exposed to," the central bank said.

Lebanon is facing its worst economic crisis since 1943 that led its currency to lose 80 per cent of its value in the black market against the dollar and caused inflation to spike to 137 per cent. A foreign currency crunch in the country led to capital controls that have prevented depositors from withdrawing their money.

Iraq's central bank said the depreciation of the dinar will only take place once and will not be repeated, adding that it will defend and stabilise the exchange rate with its foreign reserves.

The exchange rate had become "a major obstacle" to growth and the development of the local economy, the central bank said, which prompted it to respond to the requirements of financing the budget at an exchange rate that provides sufficient resources to cover the government's needs.

[You must be registered and logged in to see this link.], the ministry of finance said the decision to devalue the currency is "political decision of the Iraqi leadership" which has the support of political, parliamentary and economic actors that were engaged in lengthy discussions with government that led to this measure.

The country’s finance minister, Ali Allawi, defended the move as a "preemtive step to avoid [financial] problems" and described the new rate as "reasonable."

In an interview with the state TV on Saturday, Mr Allawi called the devaluation as "reformative step" to stimulate economy and private sector as domestic producers can’t compete with lower-cost imports now.

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I seems like a small step forward.....but a huge leap backwards.....only time will tell. I've been on this train ride from the beginning, all I can say is what a long strange trip its been.

1.45 makes sense as it is more in line with Iraq's neighbors. 1450 to 1 would just be permanent sanctions and that just doesn't sound right to me.