Monday, 9 March 2015

Are lower oil prices impacting the Iraqi dinar?

Lower oil prices and confusing policies are starting to cause a dollar crunch in Iraq.

1. Iraq gets almost all of its US dollars from the government’s sale of oil. To meet the private sector’s demand for dollars (to pay for imports, travel and medical expenses etc), the Central Bank of Iraq (CBI) holds daily auctions in which it sells dollars to the private sector at the official exchange rate (1,166 Iraqi dinar per 1 US dollar) as long as import receipts are provided.

2. The 2015 budget imposed a new restriction preventing the CBI from selling more than $75m a day in its currency auctions. The imposed limit reduces the volume of dollars available to the private sector by two thirds (daily volumes averaged $204m in 2014). The limit was not in the initial draft of the budget, but was later added by the parliament to prevent the depletion of international reserves as oil prices declined, reducing the availability of dollars in the economy.

3. The restriction on the currency auction brings back memories of the dollar crunch of 2013. Following the sacking of its governor, Sinan al-Shabibi, the CBI significantly reduced the volumes of dollars on offer at the auction. As a result, the market price of the dollar deviated from the official price. At its peak, the dollar was sold at 1,292 dinar in the market, almost 11% above the official price. But even during this episode, the volumes sold at the auction were about double the new $75m limit.

4. Following the approval of the budget, the CBI reduced the volume of the dollars sold in its daily auction to an average of $80m—above the ceiling imposed by the budget, but much lower than the $204m it sold daily in 2014. Unsurprisingly, the market price of the dollar began to deviate from the official price. It reached 1,237 dinar to the dollar on 19 February, 6.1% above the official price.

5. The CBI suspended the daily dollar auction after 19 February, leading to speculations that it would stop selling dollars altogether. The CBI denied these speculations, claiming that it has merely replaced the daily auction with a new mechanism based on direct bank transfers. Meanwhile, reports suggest that the government and the CBI are likely to appeal against the article restricting the CBI sales to $75m a day. Against this backdrop of policy uncertainty, the dinar has continued falling against the dollar. Anecdotes suggest the dollar was trading at 1,264 dinar a few days ago.

6. Why is the currency auction so controversial? Its controversy led to the sacking of a former CBI governor, the imposition of a limit on the auction’s daily sales and, ultimately, its outright suspension. Opponents claim that the CBI was lenient in selling dollars against fake import receipts. The dollars sold were then used for speculation and sometimes smuggled out of the country.

Are these claims right? Probably yes. My estimate of private sector imports of goods of services in 2013 is $41bn, which is below the $54bn sold in the CBI’s auctions in the same year. This suggests that some of the dollar purchases were indeed used for speculation and probably smuggled out of Iraq.

7. But is tightening the supply of dollars the correct response to this? Probably not. As in 2013, supply restrictions will only lead to a decoupling of the market price from the official price—a process that is ongoing now despite the CBI’s insistence that it is only temporary.

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