Currency Troubles Pile on the Misery for Iraq Low oil prices could lead to devaluation of the dinar

Any currency crisis usually comes with dire consequences for a country, and the threat of one in Iraq shows how the impact can go beyond the economy and markets. A foreign-exchange crunch because of a drop in oil prices could force a devaluation of the dinar and risk making the fight against self-proclaimed Islamic State militants even tougher. The nation, currently OPEC’s biggest producer after Saudi Arabia, is dependent on oil revenue to fund its operations on the battlefield and quell growing unrest over the economy. Dollar reserves tumbled about 20 per cent to $59 billion as of 23 July since the fighting escalated a year before, and the losses are accelerating. In the first 25 days of August, the central bank sold $4.6 billion of currency to keep the dinar at a pegged rate, a daily outflow of about $184 million, data compiled by Bloomberg show. “Iraq’s perfect storm means the country will continue to lose reserves until the government of Iraq decides to devalue the dinar,” says Frank Gunter, author of The Political Economy of Iraq. The currency could weaken as much as 20 per cent over the next year, he says.

It raises the prospect of Iraq joining other developing nations in a new wave of devaluations as emerging markets, led by China, take a hammering. The Iraqi dinar is one of those most at risk in the Middle East from that happening, though the current exchange-rate regime is likely to remain, according to research published on 25 August by Emirates NBD, the biggest bank in Dubai. Saudi Arabia’s central bank last month said it’s committed to the riyal’s dollar peg, the Saudi-owned Al Arabiya television reported, amid speculation the country would devalue its currency after the plunge in oil prices.

In Iraq, market forces are complicating Prime Minister Haidar al-Abadi’s efforts to win back territory from the so-called Islamic State, also known as ISIS. Military success has been piecemeal as the government has struggled to enlist support from mainly Sunni communities in parts of the country ravaged by attacks. The US and its allies have sent arms to the Kurds in northern Iraq and President Barack Obama’s administration plans to spend another $700 million in 2016 on support for the military. The government in Baghdad, though, pays for the bulk of the operations from its budget since the Americans pulled out their troops in 2011.

A collapse in the value of the dinar would raise the cost of living for Iraqis already protesting against government corruption, power cuts and water shortages. “The policy now is to meet the demand for dollars,” says Waleed Eedi, a director general at the Central Bank of Iraq. The reserves won’t be depleted because of oil sales and the dinar won’t devalue, he says.

The Iraqi central bank’s fixes the dinar’s exchange rate at 1,166 per dollar and there’s pressure on the peg. As a result, Iraq’s foreign-currency reserves may drop to about $45 billion by the end of 2016, according to Exotix Partners, a London-based investment firm specialising in frontier markets. “The authorities will try to hold on to the peg as long as possible, but may be forced to devalue if pressures continue,” says Jakob Christensen, a director at Exotix.

The central bank has so far resisted government pressure to print money to meet an estimated $30 billion budget deficit. It announced plans for a $6 billion bond programme last month, which follows about $1.2 billion from the International Monetary Fund, though neither is big enough to plug the shortfall.

That leaves the Finance Ministry with few easy choices. The government is seeking to cut spending and tackle corruption. Other options include borrowing domestically from public banks or even forcing the central bank to buy dollar-denominated bonds from the Finance Ministry, says Gunter. “Iraq will be able to finance its 2015 deficit, but if the battle against Islamic State and low oil prices continues, Iraq will then hit a wall,” he says.