DASH FOR DINARS AS DOLLAR DEMAND DROPS

C O N F I D E N T I A L SECTION 01 OF 02 BAGHDAD 004058

SIPDIS

SIPDIS

E.O. 12958: DECL: 12/13/2017
TAGS: ECON EFIN IZ
SUBJECT: DASH FOR DINARS AS DOLLAR DEMAND DROPS

Classified By: Economic Section Deputy James Freund, reasons 1.4 b,d


1. (C) SUMMARY: Demand for the dinar has risen this past week
in response to the holiday period, a reported drop in
imported good prices in Baghdad due to an appreciating dinar
against the dollar and improved security, and speculation
among money traders of a sudden appreciation of the dinar
that occurred around this time last year. How the Central
Bank of Iraq (CBI) handles growing demand for the dinar will
be critical, especially in terms of expectations management
and injecting dinar liquidity into the market This is an
encouraging development for Iraq and reflects a vote of
confidence by Iraqis in their domestic economy and the
government's monetary policies. END SUMMARY.

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Surge in Dinar Demand
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2. (C) Growing demand for dinars began showing up in the
CBI's foreign currency auctions on December 9, when the
CBI-listed market rate was 1,208 dinar per dollar versus the
auction price of 1,216 dinar per dollar. On December 10 the
CBI-listed market rate appreciated to 1,194 dinar per dollar
and then on December 11 the CBI-listed market rate
strengthened further to 1,175 dinar per dollar. We do not
have anymore CBI-listed market rates, but a senior USAID
consultant to the CBI told us on December 13 the rate among
Baghdad money traders was hovering around 1,108 dinar per
dollar. A senior Task Force for Business and Stabilization
Operations (TF-BSO) consultant to the CBI confirmed with her
contacts there that the CBI bought 45 million dollars and
sold only 8.6 million dollars at the official auction price
of 1,126 dinar per dollar. Another USAID consultant to
Iraq's Central Office for Statistics and Information
Technology (COSIT) said employees there believe the market
rate could reach 1,000 dinar per dollar because today it is
between 1,100-1,105 dinar per dollar. Finally, our local
staff who are paid in dollars are complaining today of
difficulty in finding money traders willing to take their
dollars for dinars.


3. (SBU) In terms of background, the CBI maintained an
official exchange rate from 2004-2006 of approximately 1,477
dinar per dollar. The CBI moved to appreciate the dinar
through its foreign currency auction process in response to
high summer 2006 inflation rates reaching 76.6 percent for
August year-on-year (y-o-y). This auction process is managed
and is also referred to as a "crawling peg" exchange rate.
During the auction, the CBI invites banks to buy or sell
dollars at rates based on a combination of its monetary
policy and the effect of current market trends. The CBI has
worked closely with the International Monetary Fund in
designing and implementing monetary policy.


4. (SBU) Since September 2006, the dinar has appreciated
approximately 17 percent against the dollar, while the dollar
has declined by 12.6 percent and 6.9 percent against the euro
and Pound Sterling respectively. At the beginning of 2007,
the exchange rate was 1,304 dinar per dollar. During
December 12 trading, the CBI sell rate of 1,216 dinar per
dollar reflected an appreciation of only 6 percent against
the dollar for the major part of 2007. The slowing of
appreciation likely reflects the impact of significantly
reduced inflation for 2007, down to 15.5 percent y-o-y in
November.

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Confluence of Events Driving Dinar Demand
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5. (SBU) Observations over the last three years have shown
that prior to holiday periods, demand has been strong for
dollars rather than dinars. Here we see a change in the
trend, an increase in demand for dinars prior to the Eid
holiday and the beginning of the Hajj. Eid al-Adha is a two
day religious celebration starting on Wednesday, December 19.
Iraqis will have four days off with the weekend and due to
improved security levels, a greater number of Iraqis are
participating in the Hajj. The strong demand for dinars
represents a vote of confidence by Iraqis in their domestic
economy and the government's monetary policies.


6. (SBU) The dinar appreciation combined with better security
conditions also likely are increasing dinar demand because
dinar prices for goods appear to be beginning to drop in
Baghdad. This is especially true for imported goods, which
Iraqis are eager to buy. In a meeting today with staffers
for the Council of Representatives Committees on Finance and
Economic Affairs, they confirmed to econoffs that dinar
prices for vehicles are declining. One staffer said two
pickup trucks recently purchased for the Economic Committee
were bought for a lower dinar price than when the purchase

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was previously considered.


7. (SBU) Another factor is that last year there was a
substantial appreciation of the dinar against the dollar
between November and the end of December, and money traders
could be expecting this to happen again. A December 10 CBI
press release announcing the withdrawal of the three lowest
dinar denominated coins (dinar 25, 50, and 100) also could
have further spurred speculation. Iraqi markets are not
efficient or well integrated and prices are not well
arbitraged--this means rumors can have big effects
temporarily.

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CBI Action Will Play Key Role
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8. (C) COMMENT: How the CBI handles growing demand for the
dinar will be critical, in particular on expectations
management and injecting dinar liquidity into the market.
The TF-BSO consultant notes the CBI is taking this situation
very seriously, and when she was at the CBI this morning all
the key managers were going to a meeting on the issue. She
also said she had never seen such a long line of armored
trucks snaking around the block waiting to get dinars in her
entire three years consulting with the CBI. The CBI also
issued an immediate press release today to dispel the rumors
of sudden appreciation to 1,000 dinar per dollar or lobbing
off any zeros to the exchange rate. The CBI's foreign
currency auction's daily volume has fluctuated, but not
substantially diminished.


9. (C) This is a good news story for Iraq, and the CBI is
showing increased institutional capacity to respond to
monetary issues. A stronger dinar is helping to curb
inflation and imported goods are becoming cheaper for the
average Iraqi as long as security continues to improve.
Moreover, this gives the CBI a chance to continue to
de-dollarize the economy; something that often is difficult
to do in oil-rich countries. END COMMENT.
BUTENIS