Chronicle of the Middle East and North Africa

Iraq Financial Crisis Brought on by U.S. Restrictions

Iraq was not anticipated to have a financial crisis in contrast to other Arab nations that have been dealing with a drop in the value of their local currencies.

Iraq Financial Crisis
A street money exchanger counts banknotes at al-Kifah stock market in Baghdad as the value of Iraqi dinar against US dollar drops further. AHMAD AL-RUBAYE / AFP

Ali Noureddine

This article was translated from Arabic.

The value of the Iraqi dinar has been under pressure since the last months of 2022 as a result of a renewed financial crisis in Iraq.

This pressure intensified in the first week of 2023, pushing the value of the dollar on the black market to 1,580 Iraqi dinars at the time of writing. In comparison to the beginning of September 2022, when it never topped 1,475 Iraqi dinars, this represents a 7 per cent increase in the value of the dollar.

These events have caused the local currency’s value to drop to its lowest historical level, mirroring the first few months after the overthrow of Saddam Hussein’s administration more than 18 years ago. The most pressing issue at the moment is the widening gap between the actual black market dollar exchange rate and the Central Bank’s official rate, which amounts to only 1,460 dinars to the dollar.

This discrepancy demonstrates the Central Bank’s incapacity to meet the demand for dollars at the official exchange rate as well as its inability to control the exchange rate on the parallel market. As a result, the official exchange rate only applies to specific Central Bank transactions with commercial banks, while the parallel market price now accurately represents the supply and demand rate.

It is common for numerous exchange rate systems to exist during financial crises, as is the case right now in various Middle Eastern and North African nations including Iran, Lebanon, Syria, and Egypt. A confluence of external economic pressures and domestic fragility concerns is causing simultaneous falls in the exchange rates of each of these countries’ national currencies.

The Iraqi crisis defies expectations

Analysts claim that the current economic situation in Iraq was wholly unforeseen. According to all economic indicators, the Central Bank of Iraq was expected to maintain stability despite internal political turmoil, in contrast to other nations that are currently experiencing financial difficulties.

According to estimates from the Ministry of Oil, Iraq’s oil earnings rose to $115 billion in 2022, the greatest level since the start of the coronavirus pandemic over three years prior. This surge was principally brought on by rising global oil prices, which were impacted by the war between Russia and Ukraine and the market recovery in the wake of the pandemic.

The International Monetary Fund forecast that Iraq would enjoy a large growth rate of 9.3 per cent in 2022 – the greatest in the nation’s history. Iraq being the second-largest oil producer in OPEC with an average daily production of 4.6 million barrels, was well situated to profit from any improvements in world oil prices.

Due to these positive developments, the Central Bank of Iraq was able to boost its foreign currency reserves to reach $100 billion. These reserves enabled the Central Bank to intervene in the currency market and meet the demand for the U.S. dollar, thereby preventing a decline in the value of the local currency. Additionally, these reserves should have allowed the Central Bank to cover the demand for U.S. dollars for import financing for over 20 months.

Iraq’s Central Bank consequently avoided any crisis or shortage in foreign currency liquidity, unlike the situations currently facing countries such as Syria, Egypt or Lebanon. In fact, government data from Iraq shows that the country’s balance of payments, which tracks net financial transactions between Iraq and other countries, recorded a surplus of 15 per cent of GDP in 2022.

Iraq was therefore not anticipated to have a financial crisis, in contrast to other Arab nations that have been dealing with serious balance of payments issues that have caused a drop in the value of their local currencies.

The causes of the Iraqi monetary crisis

It is critical to look at some of the restrictions the U.S. Federal Reserve placed on the Central Bank of Iraq in order to comprehend the factors that led to the country’s current financial crisis in spite of favorable economic indicators and the presence of foreign exchange reserves.

The Fed imposed stringent new rules requiring the Central Bank of Iraq to compile thorough information about any individual or entity wishing to buy dollars from the Bank. The intent of these conditions is to confirm compliance with U.S. and international sanctions.

The Federal Reserve also established a stringent process for review and approval of dollar purchasing requests. It resulted in a decrease in daily dollar sales conducted through the Central Bank of Iraq.

This has constrained the Central Bank of Iraq’s capacity to sell dollars on the domestic currency market, despite the significant inflow of foreign currency. The Central Bank must now execute transactions over a period of seven days or more, according to financial analysts, before any dollar sales can occur on the market. It should be mentioned that in order for the Central Bank of Iraq to continue to accept transfers executed through US correspondent banks, it must abide by these new U.S. requirements.

These factors have allowed the dollar’s value rise on the unregulated parallel market, which operates separately from the Central Bank and authorized financial institutions. This demonstrates that the Central Bank has been unable to meet the demand for dollars despite having sizable reserves.

Numerous Iraqi institutions have opted not to purchase dollars from the Central Bank as a result of the tighter regulations placed on these transactions, which has expanded the size of the informal parallel market.

In practice, the new U.S. regulations come as part of the U.S. government’s efforts to prevent Iran from using the Iraqi market to bypass sanctions. The United States believes that Iranian businesses frequently use Iraq as a conduit for their operations, disguising themselves as Iraqi companies to avoid restrictions on conducting transactions in US dollars within Iran.

As a result, these new measures are an attempt by the United States to monitor the flow of dollars into the Iraqi market and prevent Iranian access.

Social and political repercussions

As a result of the Iraqi dinar’s ongoing depreciation, numerous protests have taken place, and the government and central bank have come under scrutiny for their failure to address the issue. Along with the public protests, a number of Iraqi MPs from different political parties have begun to explore the possibility of a vote of no confidence in the administration that was formed in October 2022.

Simultaneously, the Iraqi government is facing a loss of support from some coalition members owing to disagreements over regional matters, particularly the prime minister’s openness to the Arab Gulf states.

Due to inflation and growing import costs, which have decreased their purchasing power, Iraqis are currently experiencing the effects of the dinar’s depreciation on a daily basis.

According to World Bank statistics, impoverished families in Iraq make up over 40 per cent of the population, hence these developments are anticipated to have a substantial impact on their lives. The hardship of this demographic will also worsen as a result of the state-provided social safety nets eroding due to the recent decline in government services.

Analysts concur that the Iraqi government and Central Bank must cooperate to deal with the latest challenges by engaging with the US to relax the new financial regulations and reduce their effects on the market value of the dollar and the dinar.

The Central Bank is also required to streamline the operations of the electronic platform allocated for processing orders in to put into practice approved bureaucratic procedures for buying dollars in compliance with US regulations.

The Central Bank will also need to take action against the speculative currency operations of some powerful people who benefit from a monopoly on dollar trading in some regions of Iraq.

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