Monday, 27 April 2015

Who is right about the currency auctions in Iraq?

Ahmed Chalabi’s campaign against the currency auctions is based on weak economics.

The currency auctions continue to divide opinions in Iraq. The Central Bank of Iraq (CBI) is appealing before the Supreme Court against the imposition of Article 50 in the budget law. The article, imposed by parliament, prevents the CBI from selling more than $75m a day in the auctions. Meanwhile, Ahmed Chalabi, the chairman of the parliamentary finance committee who is now spear-heading the attack against the auctions, has claimed that they have been a source of corruption, which led to the depletion of the country’s reserves. Undeterred by critics, the CBI has restarted the auctions on 6 April, after a few weeks’ suspension. Its daily sales averaged $133m in the first nine sessions, well above the limit set by parliament. Who is right and who is wrong in this debate?

1. On form alone, it was wrong to include Article 50 in the budget law. The budget law should be about fiscal policy: the government’s expenditure, sources of revenue, new taxes etc. Article 50, however, was about the conduct of monetary policy. It can be debated whether it intrudes into on the CBI’s independence, but the article was certainly out of place in a budget law.

2. Chalabi’s argument that the auctions were a source of corruption and have wasted the country’s reserves might be right. Around a quarter of the dollars sold in the currency auctions in 2013 were not used for their intended purposes, which is funding the private sector imports. But imposing a limit on dollar sales is not the right response.

If Iraq wants to maintain its peg to the dollar and eliminate the black currency market, it has no choice but inject enough dollars to meet demand. Failing that, market prices would decouple from the official price, making the peg redundant.

This is something that was confirmed time and again by Iraq’s recent experience, and is happening now too. Although the CBI no longer publishes data on the market rate, press reports suggest that the price of the dollar has reached 1340 as a result of the suspension of the auctions. This is 15% above the official exchange rate and represents the highest deviation probably since the data became available in 2004.

3. It may be argued that the official exchange rate itself should be revised. Iraq may need to either devalue its currency by choosing a higher price for the dollar or even let its currency float freely. Chalabi has hinted at that in his interview, saying that “the price set by the central bank is its choice and is not based on a particular rule”. This is a debate that could be had, especially against the background of of lower oil prices. But as long as Iraq wants to maintain its current peg and as long as it wants to eliminate the need for an unofficial currency market, the CBI should to be allowed to supply enough dollars without restrictions. 

Tuesday, 14 April 2015

Economic consequences of the peace with Iran

A final deal with Iran could depress oil prices by around $9.

On 2 April, the world’s major powers (the so-called P5+1) and Iran announced a framework for a final agreement on Iran’s nuclear programme. The P5+1 are demanding limits on Iran’s nuclear programme in exchange for lifting the sanctions which have crippled the country and its economy. The impact that this announcement will have on the oil market depends on three related questions: Will the announcement lead to a lifting of the sanctions on Iran? How much will Iran produce once the sanctions are lifted? And how will the extra Iranian production affect oil prices?

Will the announcement lead to a lifting of the sanctions on Iran?

The announcement was far from being a final deal. It merely represented a set of parameters which will form the foundation of the final agreement. Long and hard negotiations are expected before the 30 June deadline, and “nothing is agreed until everything is agreed”.  But, a deal looks now more likely than it before the announcement, if only because the framework was more detailed than expected.

Sanctions, in particular, remain a thorny issue. The framework suggests that sanctions will be lifted only after “after the IAEA has verified that Iran has taken all of its key nuclear-related steps”. This could take six months to a year after reaching a final agreement, according to John Kerry, the US secretary of state. So sanctions are unlikely to be lifted until the first half of 2016, which runs contrary to the Iranians’ desire for their removal on the day of the agreement.

How much will Iran produce once the sanctions are lifted?

According to the latest estimates by the International Energy Agency, Iran has a spare oil capacity of 0.76m barrels per day (b/d) which can be reached within 30 days. It is fair to assume that Iran will try to produce and export the bulk of this spare capacity once the sanctions are lifted.

How will the extra Iranian production affect oil prices?

Useful lessons can be drawn from the Libyan supply shock in 2011. In that episode, Libya’s production declined from around 1.7m b/d to only 0.5m b/d resulting in a 25% increase in oil price from mid-February to end-April 2011. Assuming that Iran will impact the market proportionally but in the opposite direction, the additional expected Iranian production will probably lower oil prices by 16% (=25%*0.76/1.2). This means that the lifting of sanctions on Iran could depress oil prices by around $9. This assessment is similar to that of the US Energy Information Administration, which expects that additional Iranian production would lower oil prices by $5-$15.

Conclusion. While there is still a long way before a final deal with Iran is reached, the recent agreement on a framework is an important step in that direction. Once a final deal is reached, it could result in a lifting of the sanctions in the first half of 2016. This would add 0.76m b/d of extra Iranian oil into the market, which could depress oil prices by around $9.