Chapter 4

Hard Currency Auctions

The sudden reintroduction of Iraq’s oil industry into global finance and trade created a new challenge: the tremendous influx of petrodollars. The buildup of American-denominated currency in the Development Fund for Iraq created a liquidity crisis. Iraq’s ability to run a government, let alone a full-scale reconstruction depends on a replenishing supply of Iraqi dinars. Likewise, the dependence of the Iraqi businesses on imports results in a high demand for foreign currency. To correct the disequilibrium, a mechanism was needed to exchange dollars and dinars between Iraq’s foreign currency reserve and Iraq’s private sector. The solution put forth by the Central Bank of Iraq is the daily dinar / dollar auction. Each bank day, the Central Bank of Iraq sells the dollars in its vaults for dinars from local bankers.

As the primary site for the injection of US dollars into the Iraqi economy, the Central Bank of Iraq auction plays a crucial role in Iraq’s monetary system. The auction first and foremost prevents the government’s overaccumulation of dollars from oil exports through the controlled sale of dollars, therefore allowing the CBI to maintain a healthy ratio of dollars to dinars in its reserves. That ratio grants Iraqi ministries the flexibility to finance domestic and international expenditures. Government outflows distribute dinars into the Iraqi economy. As they are excluded currency auctions, the private sector exchanges their dinars for dollars with Iraqi banks in a parallel currency market. The auction then recycles those dinars back to the government when the Iraqi banks purchase dollars for their customers’ imports. This circulation of dinars and dollars through Iraq’s economy can be seen in Figure 5.

At a key juncture in the Iraqi economy, the Central Bank of Iraq’s auctions act as the central regulatory authority over Iraq’s supply of currency. Ordinarily, central banks conduct monetary policy by regulating the supply of money in the economy. But, Iraq lacks the interbank and secondary government securities markets required for open market operations. Instead, the Central Bank of Iraq’s currency auction acts as the primary tool for managing inflation and foreign currency reserves. Without accurate data on the status of Iraq’s economy, the Central Bank of Iraq relies on correlates to guide its monetary policy.

Auction data released by the Central Bank of Iraq suggests that spot oil prices are used to determine the amount of dollars sold on a given day. While other factors such as crude oil futures and Iraqi oil production levels may also be used, the spot price of Iraqi oil provides a more direct measure of incoming oil revenues. This reasoning is supported by the trends in oil prices and the average daily auction volume. Figure 6 graphs the average spot dollar price of one barrel of Basrah Light Crude Oil against the average daily volume of dollars sold at the Central Bank of Iraq’s hard currency auctions.