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Impact of COVID-19 on the Iraqi Economy (excerpt)

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https://www.iq.undp.org/content/dam/iraq/docs/Health/UNDP%20Iraq,%20Impact%20of%20Covid-19%20on%20the%20Iraqi%20Economy%20FINAL_web.pdf


Impact of COVID-19 on the Iraqi Economy (excerpt)

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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.


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