December 21, 2020 | banking

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


Faced with the twin shocks of dwindling oil revenue and the coronavirus-induced slowdown, Iraq devalued its currency by about 23 per cent against the US dollar on Saturday, the first time the peg was 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, for sales to the finance ministry.

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 Central Bank of Iraq said in a statement 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.”

Under the country’s provisional budget, an allocation of 150 trillion dinars ($103 billion) was earmarked for spending, against expected revenue of 92tn dinars, 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”, about 5.5 million Iraqis could be pushed into poverty, the Washington lender said.

Opec’s second-largest producer depends on oil revenue to meet 90 per cent of government expenditure, including $5bn spent on salaries for public servants each month.

Iraq’s economy was forecast to shrink by 12.1 per cent this year before the devaluation, the third-steepest contraction in the Arab world after Lebanon and Libya, according to the International Monetary Fund.

Fitch Ratings said last month that a 20 per cent devaluation would increase next year’s budgeted oil revenue in dinar terms by about 6 per cent of gross domestic product.

A weaker dinar also means inflation in the country will rise as the cost of imports increases.

“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 wage bill for public servants, which is about 25 per cent of GDP.

Monetary financing from the central bank increased to 28.5tn dinars by the end of August, from 14.1tn dinars at the end of May, according to the credit rating agency.

The pandemic, lower oil prices and declining revenue forced the finance ministry to borrow from banks to pay salaries and meet other needs, widening the deficit.

However, the ministry was left with little room to manoeuvre after it exhausted its domestic borrowing capacity.

“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 distribute 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.

“But that does not mean that these interventions remain open without controls or ending.”

The central bank said that while it understood the “difficulties” government faces in bringing about structural reforms, this did not prevent the monetary authority from taking effective steps to carry out reforms.

The regulator said the legislative authority would “have an important role” in supporting its decision to adjust the exchange rate.

“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 faces its worst economic crisis since 1943 and its currency has lost 80 per cent of its value against the dollar on the black market while inflation has increased to 137 per cent.

A foreign currency crunch in the country resulted in capital controls that prevented depositors from withdrawing their money.

Iraq’s central bank said the depreciation would not be repeated as it would use foreign reserves to defend and stabilise the currency.

The exchange rate had become “a major obstacle” to the growth and development of the economy, the central bank said, prompting it to respond to the requirements of financing the budget at a rate that provides sufficient cover to the government’s needs.

In a separate statement, the ministry of finance said that the devaluation was a political decision made by Iraq’s leadership and supported by political, parliamentary and economic actors who were involved in lengthy discussions with government that resulted in the peg being adjusted.

The country’s finance minister, Ali Allawi, said the move was a “pre-emptive 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 a “reformative step” to stimulate the economy and private sector as domestic producers had struggled to compete with imports, which had become cheaper.

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