DINAR REVALUATION UPDATE: Iraq's Economic Challenges: Dollar Purchases, Inflation, and Currency Dependency, 23 AUGUST

Iraq's Economic Challenges: Dollar Purchases, Inflation, and Currency Dependency

Iraq's increasing demand for U.S. dollars reveals deeper economic issues that have implications for the country's fiscal health and financial stability [1]. This trend is mainly driven by two factors: the weakening of the Iraqi dinar and the growing dependency on foreign currency transfers. Both issues are interconnected and contribute to the inflation risks Iraq is currently facing.

Weakening of the Iraqi Dinar and Inflation Risks

The Central Bank of Iraq's (CBI) efforts to mitigate currency devaluation and reduce foreign currency dependence have not been as effective as anticipated [1]. By issuing more Iraqi dinars, the CBI intended to strengthen the national currency and limit the use of U.S. dollars. However, this approach has had the opposite effect, leading to a depreciation of the dinar and exacerbating inflation risks [2].

Rising Foreign Currency Transfers and Dependency on Imports

The increase in foreign currency transfers, particularly U.S. dollars, is closely linked to Iraq's heavy reliance on imports. The country's economy is heavily oil-dependent, with oil revenues accounting for a significant portion of its exports and government budget [3]. As a result, Iraq's fiscal stability is vulnerable to fluctuations in oil prices. When oil prices drop, the government faces budget shortfalls, prompting it to seek foreign currency to finance its needs. This, in turn, increases Iraq's dependency on imports and further strains its fiscal reserves.

Shortcomings of Current Economic Policies

Despite the government's efforts to implement a three-year budget, aimed at promoting fiscal discipline and economic diversification, the policies have fallen short of creating long-term stability [1]. The large fiscal expansion, initiated in 2023, while supporting a strong recovery in Iraq's non-oil economy, has also led to imbalances due to lower oil prices. The ongoing fiscal expansion is expected to boost growth in 2024, but it risks further deteriorating Iraq's fiscal and external accounts, making the country more vulnerable to oil price fluctuations.

The Need for Policy Adjustment

Given the risks posed by regional conflicts and the country's large dependence on volatile oil prices, there is a pressing need for sound macroeconomic policies and structural reforms [1]. These reforms should focus on securing fiscal and debt sustainability, advancing economic diversification, and achieving sustainable, inclusive, and private sector-led growth. Without such adjustments, Iraq faces a high risk of medium-term sovereign debt stress and potential external stability risks.

In conclusion, Iraq's struggle to gain control over its currency and reduce its reliance on the U.S. dollar underscores the complexity of the country's economic challenges. Addressing these issues will require a multifaceted approach that includes fiscal discipline, economic diversification, and structural reforms to ensure long-term stability.