Iraqi Central Banker Sees Limited Risk of Devaluation Amid War

by Ahmed Feteha and Alaa Shahine
September 14, 2015
— 4:16 AM CDT

Updated on September 14, 2015 — 6:40 AM CDT

Central bank Governor Ali Mohsen Ismail said Iraq has enough foreign reserves to maintain its currency peg but didn’t rule out a minor devaluation to shore up government revenue hurt by the slump in oil prices and the war on Islamic State militants.

Reserves are enough to cover more than six months of imports, higher than what is typically needed to maintain the exchange-rate, Ismail said in an interview in Cairo on Sunday. This year’s budget deficit will likely be lower than the 25.4 trillion dinars ($20.9 billion) originally planned because the finance ministry is already cutting spending, he said.

“There is no fear for the dinar,” the governor said. However, if “the pressure remains, we could marginally change the exchange rate to increase revenues of the finance ministry,” he said. “This is just an option that needs to be carefully studied because we don’t want to give away what we have achieved in terms of the inflation rate, which is perfect now.”

Consumer prices rose 2.6 percent in July, according to official data.

Bond Sale

Ismail’s comments come as OPEC’s second-biggest producer plans to raise$6 billion in bonds to fund the budget shortfall, which the International Monetary Fund expects to widen to 17.4 percent this year from 5 percent in 2014. The IMF, which extended $1.24 billion in emergency aid to Iraq in July, described the peg as a “key anchor to the economy” in a report last month.

The nation is engulfed in armed conflict with Islamic State militants who took control of major Iraqi cities, and a surge in inflation would increase discontent among Iraqis already complaining about chronic shortages in water and electricity. Military success against Islamic State militants has been piecemeal, as the government has struggled to enlist support from mainly Sunni communities in parts of the country ravaged by attacks.

“Iraq has suffered a tremendous dual shock from low oil prices and war on IS," said Jean-Michel Saliba, a London-based economist at Bank of America Merrill Lynch, using an abbreviation for Islamic State. Government efforts to cut spending have not resulted in a major drop in the deficit, he said.

Authorities “have few options, one of them is to get the central bank to devalue to boost revenues," Saliba said. "We don’t see an immediate devaluation but we see more pressure on the peg the longer the situation continues as buffers get eroded.”

Concerns that oil-dependent economies may abandon their pegs intensified after Kazakhstan allowed its currency to float following China’s surprise move to revalue the yuan. Saudi Arabia, the world’s biggest oil producer, said it was committed to maintaining the riyal’s peg to the dollar.

At Risk

In the Middle East, the Iraqi dinar is among the most at risk, though the current exchange-rate regime is likely to remain, according to Emirates NBD, the biggest bank in Dubai.

The war, as well as the 50 percent plunge in oil prices, has shaken investor confidence, with the yield on Iraq’s $2.7 billion Eurobonds due 2028 surging 1.7 percentage points this year to 9.588 percent, the highest since 2009.

The central bank, in an attempt to ease pressure on government finances, has allowed local banks to use as much as 50 percent of their reserves at the regulator to buy treasury bills.

“Most banks have used that advantage,” Ismail said.