Iraq's Dinar Devaluation Sparks Consumer Fears Amidst Oil Revenue Woes

Iraq's recent decision to devalue its currency has highlighted a conflict between the financial needs of households and the state. Residents are expressing concern over escalating living costs, while economists suggest the move might bolster public finances, especially with oil revenues in sharp decline. The Central Bank of Iraq adjusted the official dollar selling rate on October 7, increasing it from 1,320 to 1,520 dinars, marking a devaluation of approximately 15 percent. This action was taken as disruptions to oil exports via the Strait of Hormuz placed additional strain on government revenue and its ability to fund public spending.

"The situation is very bad," lamented one market owner in Erbil, noting that the prices of goods have been on the rise since the Iran war began in February, largely due to increased transportation costs as most items are imported from Turkey and Iran. Iraq relies heavily on imports for essential products, including food, medicine, and consumer goods. For Iraqis whose incomes are paid in dinars, the weakened currency threatens to diminish their purchasing power. However, the impact is not uniform; individuals earning in dollars might see their salaries convert to more dinars, while those with dollar-denominated expenses face a different financial calculation. In Erbil, where rent is frequently set in dollars, the exchange rate shift can directly affect tenants paid in dinars, increasing their costs as they need to purchase dollars with their dinar salaries.

The disparity between the official and parallel market exchange rates further complicates the pressure on households. While the official rate stands at 1,520 dinars to the dollar, individuals and businesses seeking cash dollars often resort to exchange shops, where prices fluctuate based on supply and demand. In Erbil, the dollar was trading at approximately 166,350 dinars per $100 earlier this week, about nine percent above the official rate. Following the devaluation announcement on October 7, the parallel market rate surged, with some exchange shops in Erbil quoting selling prices as high as 180,000 dinars per $100, though it later eased while remaining above the official figure. Employees at several exchange shops in Erbil's Eskan neighborhood declined to comment on the price fluctuations.

Dollar-denominated rents are part of a broader trend in Iraq, where the US dollar holds significant sway in certain segments of the property market and some business transactions, despite most salaries and daily purchases being conducted in dinars. Consequently, households can face increased costs on multiple fronts: rent may become more expensive when converted to dinars, and the prices of imported goods like food and household items could rise as businesses incur higher dollar expenses. Ahmed Tabaqchali, a non-resident senior fellow at the Atlantic Council, described this dual currency system as a fundamental issue. While those paid in dollars might benefit from converting their income, the advantage is less clear for individuals with dollar-based expenses like rent, as these costs do not decrease with a changing exchange rate. Ahmad Abbas, who receives his income in dollars, stated, "It's safer to be paid in dollars because it's unstable when it comes to the currency here. My rent is in dollars and my bills are in Iraqi dinars but I expect prices to go higher, so at the end of the day it will kind of be the same." He noted a significant price increase for a detergent he previously bought for 9,000 Iraqi dinars, which now costs 20,000 dinars, observing that prices were already rising during the earlier war but have escalated further.

The devaluation has drawn criticism from residents and political groups, with lawmakers demanding government explanations and proposing measures to curb price hikes. Conversely, some argue the adjustment was essential for Baghdad to meet its financial obligations. Mr. Tabaqchali commented, "There is no denying the affect is there but it's not as dramatic as people make it out to be." He added that the country needed to take action, expressing surprise at the proactive measure, stating, "In the past we didn't act but we acted while the reserves are still healthy."

At the Meri Forum in Erbil, Samir Fakhri, director general of the Statistics and Research Directorate at the Central Bank, defended the devaluation as necessary to safeguard the country's foreign currency reserves amid declining oil revenues. He emphasized Iraq's heavy reliance on oil, which constitutes over 90 percent of government revenue, making public finances highly susceptible to export disruptions. Fakhri explained the scale of government spending and the resulting pressure on the Central Bank of Iraq to supply dollars, asserting that the exchange rate adjustment must be viewed within the context of the nation's broader financial challenges. The rationale behind the devaluation is that Baghdad will receive more dinars for each dollar earned from oil exports, thereby enabling it to finance salaries and domestic spending despite reduced oil income. However, this fiscal benefit does not automatically translate into increased purchasing power for households.

The government, led by Prime Minister Ali Al Zaidi, has stated its commitment to maintaining public spending and ensuring salary payments despite the drop in oil income. However, opposition is mounting in parliament, with politicians questioning the rationale behind the measure and whether alternative solutions were thoroughly explored. The Co-ordination Framework, the primary alliance of Shiite political parties supporting the government, has called for measures to mitigate the impact on citizens. Rizgar Ali, a taxi driver in Erbil, expressed frustration with the government's actions, stating, "We can't catch a break from them." He added, "I have relatives who are public servants and their salaries are always delayed because Baghdad doesn't send us our budget and now they're weakening the money." Frequent delays, exacerbated by disputes between Baghdad and Erbil over oil revenue and budget allocations, leave many households with limited financial capacity to cope with rising prices and currency costs. Mr. Ali also complained about increased petrol prices, which necessitate frequent refueling and make his income from driving passengers more difficult, leading him to turn off his engine at most traffic lights.

Mr. Tabaqchali drew parallels to the 2020 devaluation, when Iraq faced a similar predicament during the Covid-19 pandemic due to a collapse in oil prices and declining revenue. That adjustment aimed to increase dinar revenue from oil sales, reduce the budget deficit, and help the government meet its spending obligations. In January 2023, the government under Prime Minister Mohammed Shia Al Sudani had moved in the opposite direction, strengthening the dinar and setting the official exchange rate at 1,320 per dollar after the currency weakened on the parallel market amidst stricter US restrictions on dollar transfers and increased scrutiny of Iraqi banks. That decision also caused concern among residents, as the dollar continued to trade at a higher value on the parallel market. The latest devaluation effectively reverses that strengthening.

The success of the devaluation in achieving its financial objectives will hinge on factors such as oil revenue and foreign currency reserves, as well as the government's capacity to prevent unwarranted price increases, safeguard lower-income families, and implement reforms to reduce Iraq's oil dependency. Mr. Tabaqchali suggested that government subsidies could help cushion the blow for lower-income Iraqis. Subsidies on fuel and essential services, along with the public distribution system for staple foods, can offer some protection against the immediate effects of a weaker currency. The government has pledged to maintain these subsidies and is considering customs relief for food and essential goods. Despite these measures, subsidies do not cover all household expenses, such as rent, and imported goods may still become more expensive. "The worst is over for us as long as we continue shipping through the [Strait of] Hormuz," Mr. Tabaqchali concluded, adding, "This doesn't mean we have passed the crisis because the damage has been done and we have to adjust. The devaluation is part of a bigger thing, like structural changes to our budget services."