The Iraqi government decided, through the Ministry of Finance, to reduce the exchange rate of the dinar to finance the financial deficit with monetary issues. This decision has serious negative consequences, foremost among which is the deterioration of the citizens' already deteriorating living standards. However, the ministry sees the reduction in several positive aspects. On March 12, 2020, the Central Bank of Iraq website published a report by the governor entitled “Reducing the exchange rate of the Iraqi dinar. Determinants and alternatives ”. He highlights several disadvantages of lowering the exchange rate of the dinar, concludes the necessity of not resorting to this process, and suggests alternative mechanisms. This report, despite the valuable efforts exerted on it, does not address the real crisis of widespread corruption and mismanagement of financial affairs, especially from the spending angle.
On December 19, the Ministry of Finance issued a decision to lower the exchange rate. And it listed various financial, commercial, investment, industrial and tourism gains.
Why is this apparent contradiction?
It appears that the central bank report was written before the outbreak of the Corona pandemic, which led to a decline in oil prices and thus to a decline in general budget revenues and a deterioration in the trade balance. These revenues decreased as of last May. But the difference is wide between two things: The first is the timing of the currency devaluation decision. The second is the pros and cons of this process. The above justification is related to the first and not to the second. It is inconceivable that the devaluation of the dinar would lead to negative results before the Corona epidemic and positive after it. The negatives and positives are related to the Iraqi economy and how it is managed. The devaluation of the dinar resulting from issuances to finance the fiscal deficit necessarily leads to an inflation of the monetary mass, which reduces the purchasing power of citizens. This negative impact across the board occurs in the presence or absence of this or that epidemic.
It appears that the Central Bank has retreated from its point of view, as it participated, along with the Ministry of Finance and other institutions concerned, in preparing the white paper calling for the devaluation of the dinar and defending it vigorously. The Ministry of Finance issued a statement addressed to citizens in the form of questions and answers. The ministry’s opinion includes the implications of lowering the exchange rate of the dinar. We will discuss this opinion here and focus on five points.
Imported goods According to the ministry’s statement, the prices of “some commodities will rise at once, to compensate for the exchange rate adjustments.” The exchange rate adjustment should encourage the growth of domestic alternatives to imports. In due course, this will lead to price stability… ”. The Ministry believes that the growth of these alternatives will lead to many positive results, including an increase in job opportunities. The ministry's answer is vague, raises several questions, and is inaccurate. When do commodity prices rise once, twice or multiple times? What is the meaning of good time? In fact, the devaluation of the exchange rate leads in all countries to higher prices for imported goods. Which affects the standard of living of citizens. And the vulnerability increases because of the importance of import in the Iraqi rentier economy. The matter does not stop at the various industrial tools, but rather extends to the main food products and energy. Naturally the imports are in dollars. And since the rate of reduction of the dinar was 22.6%, the prices of imports rise, as a general rule, by the same percentage.
The Ministry of Finance differentiates between two cases: The first case if the savings are in dollars. Adjusting the exchange rate leads to an improvement in its value. The second case if the savings are in dinars. A person would earn a return on it if it was in the banks. According to the ministry, the devaluation of the dinar leads in both cases to gains. This position has nothing to do with scientific analysis and objectivity in the proposition. It neglects the most important and broader case of the savings of individuals without going through the banking institution or in a foreign currency. This money necessarily loses its purchasing power. Nor should it be said that the reduction leads to an improvement in savings in dollars. The ministry confuses value with quantity. There is an increase in the number of dinars, but there is no improvement in its value.
As for bank deposits that receive interest, they have lost their value due to the depreciation. The dollar exchange rate moved from 1182 dinars to 1450 dinars, meaning the value of the dinar decreased by 22.6%. Thus, in order for the value of these funds not to be affected, the interest rates must be at least equal to this ratio. At present, the deposit interest rate is only 7%. Meaning, these deposits lost 15.6% of their value. The lower the incomes, the greater the suffering. Those with limited incomes The Ministry of Finance poses the following question: What is the effect of the exchange rate on people with limited incomes? It provides the following answer: The government will take measures to offset the negative consequences of the exchange rate adjustment on the poor: increase social welfare allocations.
The Ministry divides retirees into three categories according to their place of residence. First class: Residents of Iraq. The ministry does not see any negative impact on the level of their salaries. Class II: Residents of the Gulf, Jordan, and European countries. The purchasing power of their salaries changes due to the reduction. Third class: Residents of Turkey, Egypt, Lebanon and Iran. The purchasing power of their salaries will not change because the currencies of these countries have fallen against the dollar.
The ministry believes that Iraqis traveling to Turkey, Lebanon, Egypt and Iran will not be affected by the devaluation of the dinar because the currencies of these countries fell against the dollar. Meanwhile, the costs of travelers to Europe, America and other industrialized countries are rising. The ministry compares the sums in the currency of the host country, which the Iraqi used to get years ago, and the amounts in the same currency that he is currently getting. For example, an Iraqi allocates one million dinars for tourism in Egypt. Before November 2016, the dollar exchange rate was 11.5 pounds in Egypt and 1182 dinars in Iraq. One million dinars was equivalent to 9,729 pounds. Now, the dollar exchange rate is 15.7 pounds in Egypt and 1450 dinars in Iraq. That is, one million dinars became equivalent to 10817 pounds.Retired The Ministry divides retirees into three categories according to their place of residence. First class: Residents of Iraq. The ministry does not see any negative impact on the level of their salaries. Class II: Residents of the Gulf, Jordan, and European countries. The purchasing power of their salaries changes due to the reduction. Third class: Residents of Turkey, Egypt, Lebanon and Iran. The purchasing power of their salaries will not change because the currencies of these countries have fallen against the dollar.
The decision to reduce the par value of the dinar was taken for one reason only, which is to finance the budget deficit, which reached an unprecedented amount. The matter has reached such a degree of danger that the government has become the next option: either to stop fulfilling its financial obligations, especially not paying employees' salaries or reducing the exchange rate. For this reason, the reduction does not produce positive results regarding local production, tourism, investment or employment opportunities. On the contrary, this monetary measure has several effects, all of which affect the decline in the standard of living of citizens, especially those with low incomes.
The devaluation of the dinar does not represent a solution to the financial crisis that the country has been suffering from for several years due to the failure of economic policy due to government options and rampant corruption. Rather, it is a logical and inevitable consequence of this policy. Thus, this crisis can only be addressed with a fundamental change in this policy.