Monday, 27 May 2013

Unpleasant arithmetics at the Central Bank of Iraq

In its conflict with the central bank, the Iraqi government got its economics wrong. Twice.

The last few weeks saw a further decline in the value of the Iraqi dinar. The gap between market and the official exchange rates reached its peak in the second week of May when the dollar was being sold for around 1290 dinars; 10% above the official rate of 1166 dinars to the dollar. This might be surprising since for several years prior to 2012, the Central Bank of Iraq (CBI) managed to maintain a narrow gap between the official and market rates using its daily currency auctions.

The story of how the Iraqi foreign exchange market went from stability to volatility in the space of 18 months can be divided into three episodes.

Episode 1 (Jan 2012 – May 2012): Two explanations for an emerging gap

In early 2012, The CBI and the government offered two different explanations for a newly-emerging gap emerged between official and market exchange rates. Mudher Salih, then the deputy governor of the CBI, attributed the gap to excess demand from the neighbouring Syria and Iran—which were facing foreign currency shortages due to sanctions. Meanwhile, Izzat Al-Shahbandar, an MP and an aide to PM Maliki, blamed the stringent measures of the CBI, which hindered the foreign currency supply, for the emergence of the gap. Shahbandar claimed that prior to 2012, the CBI sold $200 million on average in its daily auctions, but that figure fell to $100 million in 2012.

Contrary to Shahbandar’s claims however, CBI’s data (summarised in the table below) show that the amount of dollars sold had in fact increased in the period from January to May 2012 relative to previous years. The data leaves little doubt which of the two explanations is more plausible - the only question mark is about the source of Shahbandar's figures.

Episode 2 (May 2012 – Oct 2012): The CBI increases supply and gets its governor sacked

To meet the excess demand, the CBI significantly increased its supply of dollars, successfully bringing the market price down to within 3% of the official rate in early October (see the chart below). At that point, an arrest warrant was issued against its governor, Sinan Al-Shabibi, over allegations of “of financial irregularities” related to the currency auctions. A more detailed report by the Board of Supreme Audit (BSA) concluded that the CBI’s loose control over the auctions encouraged smuggling of the dollar out of the country and money laundering.

The change in tone is notable: in October, the CBI was being accused of leniency in running its currency auctions, having been (falsely) accused of stringency in May!

Episode 3 (Oct 2012 – present): The CBI restricts dollar supply

Over this period, volumes in the CBI’s auctions averaged $177 million—a significant drop from the previous episode. This appears to be a deliberate policy as can be inferred from the appointment of the head of the BSA as the interim governor and CBI’s statements on 18 and 24 October 2012.

An unsurprising outcome of restricted supply is the significant rise in the market value of the dollar, which reached a high this month. It is hard to tell what is going to happen next, but the politicians who have been actively involved in the saga now seem concerned with the uncomfortable fall of the dinar.


The last part of the chart shows a sharp pick-up in the auction volumes over the last few days (almost to the levels reached by Shabibi before his dismissal) coupled with a narrowing of the gap between market and official rates. It would be a positive change if this trend continued. Currency smuggling, unnecessary depletion of CBI’s resources and money laundering must be fought of course. But this should be done through a legal and supervisory framework not through the excessively powerful tools of monetary policy. One should not starve the patient to death in order to kill the bacteria.

No comments:

Post a Comment