Iraq gambles its future on currency reserves
Washington - The world’s central banks were, until recently, national institutions that symbolised sovereignty but little else. In 2007, fear of an impending cash shortage that would have clogged the US economy prompted the Federal Reserve to ship piles of cash to help American banks through the worst of the economic crisis. By 2009, documents published by Bloomberg News showed, Washington’s central bank had pumped — off its books — $13 trillion (the size of the entire US economy at the time) to rescue the country’s sinking financial institutions.
With inflation rates lower than the 2% goal, the Federal Reserve turned its money-printing experiment into an official programme, known as Quantitative Easing, through which it used new cash to buy non-performing bonds. Together with keeping interest rates low, the programme gave the US economy a jolt. Europe’s central banks followed with similar programmes.
Creating wealth out of thin air, however, is only possible for countries that have currencies that serve as world reserves. In countries such as Lebanon, Egypt and Iraq, central banks risk sending inflation out of control if they print money whimsically. For these countries, the stability of the national currency depends on hoarding foreign banknotes — mainly US dollars, euros and British pounds.
Baghdad is the latest government to find itself struggling with its thinning foreign-exchange reserves, putting the country’s finances in jeopardy and threatening the stability of the dinar. Iraq’s turbulence does not come on advice from the World Bank or the International Monetary Fund (IMF), which advise central banks to maintain “healthy reserves” — defined as six months’ worth of governmental expenditures. Rather, Iraq’s problems stem from mismanagement of the central bank, whose former governor, Sinan al-Shabibi, was reportedly fired for his resistance to executive meddling. Shabibi was replaced by Ali Allaq.
By the end of 2011, Iraq’s allies — Iran and Syria — were facing severe shortages in foreign currencies, the former due to strict international sanctions and the later because of a raging civil war. Former Iraqi Prime Minister Nuri al-Maliki wanted Shabibi to look the other way, as Iranian and Syrian exchange operatives syphoned US dollars from Baghdad to their economies. The fact that more than 70% of the Iraqi economy is cash-based made it easier for outsiders to load on Iraqi reserves.
From 2005-11, the Iraqi government tailored its budget based on the assumption that a barrel of oil would fetch $75 on the international market but with oil hitting lows in the $20-$30 range, Baghdad’s deficit skyrocketed. To pay for its expenses, the government opened the vaults of the central bank and, instead of issuing bonds, reverted to foreign borrowing.
In addition to Iranians and Syrians soaking Iraq’s foreign currencies and the government using foreign-exchange reserves as its exchequer, the Iraqi Central Bank suffered from rampant corruption. Some bank officials reportedly buy dollars at the bank’s auction at a rate of 1,190 dinars for the dollar and then sell those dollars on the market for 1,250 dinars, allegedly pocketing a handsome profit.
On May 7, the bank auctioned $159 million. On June 19, the bank auctioned $165 million more. The bank’s frequency of pumping dollars into the local market has been expedited, presumably to keep the dinar stable but such frequency might prove unsustainable, a fact that has alarmed the IMF, which urged Iraqi officials to replenish reserves and keep them closer to $50 billion.
Even though IMF sources say that Iraqi officials promised to heed the advice, the Iraqi Central Bank’s reserves seem to be lower, after hitting a peak of $78 billion in 2013. The bank does not publish statements about its reserve levels, similar to Lebanon’s central bank, which has also stopped publishing its levels. These central banks reason that confidence in the national currency can sometimes be boosted through bluffing and pretending that foreign-exchange reserves are higher than they actually are.
Some estimates stated that Iraqi foreign-exchange reserves will go as low as $30 billion in 2017, an alarming development, if true. The Iraqi government should understand that borrowing is a better way to fund itself, no matter the corruption and that foreign-reserve reserves are a weapon of last resort without which the national economy loses its anchor.