On Wednesday, Iraqis woke up to a new financial reality with the authorities reducing the exchange rate of the dinar to 1,520 to the dollar, from 1,320 dinars, in a move that sparked a widespread wave of public anger and forced markets and shops in a number of provinces to close, coinciding with the rise in the price of the dollar in the parallel market to about 1,900 dinars.
The decision came at a time when Iraqis are already suffering from living pressures, which has caused the devaluation of the currency to quickly affect the prices of food and imported goods, while citizens fear that the increase will be transferred to the costs of transportation and services, especially with the circulation of information about a government intention to raise the price of regular gasoline to 850 dinars per liter, from 450 dinars.
Reducing the exchange rate from 1,320 to 1,520 dinars to the dollar means a decline in the value of the dinar by about 13 percent against the US currency, and an increase in the cost of obtaining the dollar for importers and individuals, in an economy that relies heavily on imports to meet domestic demand.
The decision coincided with parliamentary movements to demand a discussion of its repercussions, as MP Ahmed Al-Shammari called on the Presidency of Parliament to hold an emergency session and host the Minister of Finance and the Governor of the Central Bank to discuss what he described as the repercussions of raising the exchange rate and “market confusion.”
While the Central Bank of Iraq confirms its continuation of taking measures that it said are in the interest of the economy and the citizen and ensure the safety and stability of the financial system, popular and political criticism of the decision has escalated, amid fears that the effect of devaluing the currency will turn into a new wave of rising prices and eroding incomes.
The government of former Prime Minister Mustafa Al-Kadhimi had reduced the value of the dinar at the end of 2020 by approximately 20 percent, bringing the exchange rate to 1,450 dinars to the dollar, following the severe financial crisis caused by the collapse of oil prices at that time. Later, the government of former Prime Minister Muhammad Shiaa Al-Sudani took a step whereby it re-raised the value of the dinar to 1,320 dinars to the dollar. This is a decision that experts and analysts described as “political and ill-considered.” However, the government of current Prime Minister Ali al-Zaidi was recently forced to approve a new reduction in the exchange rate under the weight of a stifling financial crisis, resulting from the cessation of the country’s oil exports for several months as a result of the US-Iranian war and the closure of the Strait of Hormuz.
Devaluing the currency raises the cost of importing
In an interview with Asharq Al-Awsat, economics professor Siham Youssef believes that lowering the dinar’s exchange rate in an economy that relies on oil to generate the dollar, and on imports to a large extent to meet local demand, does not lead to the same result that lowering the currency can achieve in industrialized economies.
She said that devaluing the currency “does not lead to an increase in the competitiveness of exports as happens in industrialized economies,” because the Iraqi economy does not have a diversified export base that could benefit from the devaluation of the currency.
She added, “The dollar becomes more expensive for the importer, and the cost of imported goods and production inputs rises, and part of this cost may be transferred to prices.”
Youssef believes that increasing treasury resources resulting from converting dollar revenues into a larger number of dinars does not become a solution for public finances unless it is directed to reducing the deficit and borrowing, warning that burdening the economy with the cost of the reduction without addressing the underlying financial imbalances may lead to more inflationary pressures.
This comes as fears of rising costs of living increase, especially with the circulation of information about the government’s intention to raise fuel prices. According to parliamentary voices, the price of a liter of regular gasoline may rise to 850 dinars, from 450 dinars, which would increase transportation costs and add new pressures on the prices of goods and services.
Budget deficit of 43 trillion dinars
The pressures are not limited to the exchange rate, as the new draft budget reveals spending amounting to 217.239 trillion dinars ($142.9 billion), compared to revenues amounting to 174.234 trillion dinars ($114.6 billion), with a deficit of 43.005 trillion dinars ($28.3 billion). The draft assumes the export of 4 million barrels per day at a price of $58 per barrel and an exchange rate of 1,500 dinars to the dollar.
Youssef believes that the decrease in the deficit compared to the 2023 budget is not due to reduced spending, as proposed spending increases by 9.2 percent, while revenues increase by 29.5 percent. Despite reducing the oil price assumption from $70 to $58, the government compensates for this by assuming that exports will increase to 4 million barrels per day, which makes oil revenues hostage to the price, the volume of exports, and the exchange rate, especially in light of the region’s unrest and the disruption of Iraqi oil exports.
The break-even price is much higher than the assumed price
Youssef believes that the oil price necessary to achieve financial equilibrium is one of the most prominent indicators to measure the fragility of the assumptions on which the budget is based.
According to the published tables, Iraq needs a price of approximately $77.6 per barrel at an exchange rate of 1,500 dinars to the dollar in order to cover all budget expenditures without a deficit. The parity price rises to about $90.8 if revenues are calculated at an exchange rate of 1,300 dinars to the dollar.
Thus, assuming an oil price of $58 per barrel is not enough to achieve financial balance, which means that the budget will still need additional funding even if the production and export assumptions contained therein are achieved.
Youssef says that this difference “means that the budget, although it assumes an oil price of $58, still needs a much higher price in order to reach the break-even point.”
Current spending narrows the room for maneuver
The structure of expenditure reveals that current items continue to rise. Employee compensation amounts to 68.1 trillion dinars ($44.8 billion), social welfare is 33 trillion ($21.7 billion), and debt service is 17 trillion ($11.2 billion), collectively equivalent to about 54.4 percent of total spending. Yousef believes that this limits the government's ability to quickly reduce spending when oil revenues decline, while the rise in debt service reflects the growing cost of previous borrowing.
On the other hand, investment spending declined to 47.9 trillion dinars ($31.5 billion), a decrease of 11.7 percent, which raises questions about the budget’s ability to support growth and diversify the economy. Youssef believes that the most important challenge remains financing the deficit of 43 trillion dinars ($28.3 billion), warning that increasing internal borrowing will mean a higher cost of servicing the debt in the future, at the expense of investment spending.
Oil remains the main source of revenue
For his part, economic expert Ziad Al-Hashemi records a set of observations on the reduction in the exchange rate and the draft budget, considering that the current crisis has not prompted the government to fundamentally reconsider the structure of public spending.
Al-Hashemi said, in a blog post on the “X” platform, that the government raised public spending despite financial pressures and the supposed drop in the price of oil to $58 per barrel, and kept operating spending at a high level of 78 percent of the total budget, compared to 22 percent for investment spending.
Al-Hashemi pointed out the continued expansion of government appointments and contracts, instead of re-adjusting the size of the government apparatus and operational spending, which devours about 78 percent of the budget, in exchange for investment spending that is less able to support growth.
He believes that raising the exchange rate to 1,520 dinars to the dollar allows the treasury to obtain more dinars in exchange for dollar revenues, “but from the citizen’s pocket,” without addressing the essence of the financial imbalance, as the deficit remains at about 20 percent of total spending.
Dependence on oil also remains high, with oil revenues reaching about 145 trillion dinars ($95.4 billion) out of total revenues of 174 trillion ($114.5 billion), or about 83 percent, which leaves public finances highly sensitive to fluctuations in oil prices and exports.
