Impact of COVID-19 on the Iraqi Economy (excerpt)
5.3 The external sector and monetary impacts
The fall in oil prices combines with other effects to pressure Iraq’s external position.
The oil price decline represents a massive income shock to Iraq as a whole.
Overall, far fewer dollars are flowing into the region from either oil exports, non-oil exports or foreign direct investment (FDI).
The United Nations Economic and Social Commission for Western Asia estimates that the Arab region is likely to lose 45 percent of FDI inflows in 2020.53
Iraq will be particularly affected since its FDI was already heavily skewed towards the oil sector.
At less than 1 percent of GDP, remittances to Iraq are very low compared to the regional average.54
A drop-off will not materially affect the country’s external position, but will have an impact on households that rely on remittances to supplement their income.
UNDP – Impact of COVID-19 on the Iraqi Economy 19
With foreign exchange reserves gradually being used up, the dinar to dollar peg is threatened.
The World Bank predicts that current reserves can last until the end of 2021 before moving below the benchmark of three months of import cover.55
This provides a window of stability to prevent an immediate and unplanned monetary adjustment.
A slight recovery in oil prices towards the second half of 2020 is expected to reduce the speed of the outflow of dollars, but this merely postpones rather than halts any unscheduled adjustment.
Should the government choose to instruct the Central Bank to sell its foreign reserves to finance its deficit, which is one of the options for meeting immediate financing needs, this would accelerate depletion and bring forward the date at which they are exhausted.
There are scenarios where a rapid monetary adjustment caused by the exhaustion of foreign reserves creates potentially serious macroeconomic dislocations:
• Rapid devaluation of the dinar:
If reserves are used up rapidly, and/or citizens and businesses lose confidence in the dinar, a massive run on dollars and basic goods could result. If people divest their excess dinar holdings, buying goods or dollars, prices could rise rapidly on the basis of a self-fulfilling cycle of inflation and devaluation.
At this point, the pegged exchange rate will likely be unsustainable and lead to a sudden and massive devaluation.
This will result in high inflation, likely operating alongside price increases as a result of the hoarding of basic goods.
The purchasing power of households and the Government will significantly decline.
• Inflation as a result of direct financing of the deficit:
In another scenario, if the Central Bank finances the government deficit directly, this will likely lead to high inflation and potentially hyperinflation, although this practice is currently prohibited under Article 26 of the 2004 Central Bank law.
• Profiteering and corruption from parallel rates:
If there is a prolonged period of parallel market currency rate differentials with the bank rate, this will facilitate profiteering from those with ready access to dollars and reduce market confidence in the Central Bank’s currency arrangements.
While foreign reserves last and confidence in the value of the dinar continues, these scenarios can be avoided, but the current relatively positive situation of subdued inflation may not remain.