'Our aim is to establish a forward market in Iraqi dinars in the near future,' say finance official

Iraq plans to establish an interbank foreign exchange market and dinar forward market and to step up its treasury bill activity in 2010 to help plug continuing budget deficits and foster treasury and foreign exchange markets, the Central Bank and Finance Ministry said in a submission to the IMF. Iraq aims to develop foreign exchange markets outside the framework of dollar auctions currently conducted by the Central Bank, a letter of intent submitted to the IMF for a US$3.6 billion standby arrangement said. Iraq said it would not return to a budget surplus until 2012.

"As our financing needs in 2010 will still be substantial, we will step up our efforts to mobilize domestic financing through the Treasury bill market," Iraq's Central Bank head and finance minister wrote.

"To that end, we will conduct regular auctions, and refrain from cancellations, while allowing interest rates to be determined by the market. This will have additional benefits by determining a benchmark interest rate, while the development of a secondary market for treasury bills will allow banks to improve their liquidity management."

"They are going to shift to building a local market, they have ample cash, loan-deposit ratios are very low and they will benefit from oil,"Turker Hamzaoglu, emerging market economist at BoA-Merrill Lynch, told Reuters.

"They have to develop a domestic bond market but it's still baby steps, it's still too early, it's not even a frontier market," he said, adding that Gulf Arab and Lebanese investors could be interested in Iraqi domestic paper.

Central Bank Governor Sinan al-Shibibi and Finance Minister Bayan Jabor said in the letter to the IMF that the country planned to introduce a sales tax, as a precursor to a Value Added Tax, "in the coming years".

Iraq's gross domestic product expanded by 4% in 2009 compared with almost 10% the year before, their submission reported. GDP growth would rise to almost 7% this year and 7.5%-8% in 2011 and 2012, they said. That improvement would be rooted in an increase in Iraqi oil output to 3.1 million barrels per day by 2012, from around 2.5 million bpd now, and exports of 2.5 million bpd, compared to just over 2 million bpd now. That outlook might be conservative following the signing of 10 multibillion-dollar deals with global oil firms to develop Iraq's vast reserves. If all the deals work out, Iraqi oil capacity could soar to 12 million bpd in six to seven years.

"The CBI will continue to be independent in the pursuit of its policy objectives. The CBI’s monetary and exchange rate policies will continue to be aimed at keeping inflation under control and safeguarding international reserves," the submission said. The banking sector is in urgent need of reform to foster financial intermediation and enable banks to contribute to the development of a strong private sector. With the help of the World Bank and other international agencies, Iraq has developed a banking sector reform strategy, it added.

"Iraq is committed to strengthening the management of international reserves by moving ahead with the implementation of new reserves management guidelines that were adopted in early August 2008. Iraq will follow the guidelines to diversify currency composition and establish appropriate duration and credit risk, build capacity for risk analysis, and work towards establishing a dealing room".

The IMF submission said Iraq's Central Bank planned to create a foreign exchange market outside the framework of regular dollar auctions now conducted by the bank. The bank uses the auctions to set the exchange rate, which has been held at 1,170 dinars per dollar for many months.

"To improve the functioning of foreign exchange auctions, we plan to develop organized exchange markets outside the central bank, including an interbank foreign exchange market," it said.

"Our aim is to establish a forward market in Iraqi dinars in the near future."

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