Iraq Economy Watch

"However, a surprise jump in inflation from 32 percent at end-2005 to 65 percent a year later raised serious concerns (see Chart 1). The increase was caused mainly by shortages of key commodities, especially fuel products, which were largely the result of the continuing lack of security in Iraq. In a recent poll, 62 percent of Iraqi respondents complained about the availability of basic household goods, up from 38 percent in 2005. But underlying inflation (excluding fuel and transportation costs) was also stubbornly high, at about 30 percent. Given that the Central Bank of Iraq (CBI) maintained a tight grip on Iraqi dinars in circulation while the budget was in surplus, the high inflation appears to have been accommodated by the pervasive cash dollarization of the economy.

In mid-November 2006, the authorities initiated a strong policy response to the inflationary pressures. One of the objectives of the government budget for 2007 was to prevent current spending from putting further inflationary pressure on the small non-oil economy. The CBI, meanwhile, raised its policy interest rates sharply and allowed the dinar to appreciate against the dollar, which was possible in view of Iraq’s comfortable level of international reserves (almost six months of import cover). These measures were intended to dedollarize the economy to enhance the CBI’s control over monetary conditions and also to reduce imported inflation. This policy appears to have had some success in increasing the demand for local currency. Moreover, in February 2007, overall inflation came down to 37 percent, and core inflation fell to 24 percent. Similar rates of inflation were recorded for March. But it is too soon to declare victory over inflation.

Despite strong initial political resistance, the authorities began in December 2005 to increase fuel prices gradually. Before the adjustments, fuel prices were extremely low, even by regional standards, with regular gasoline selling in Baghdad for 3 cents a liter and, outside the capital, for less than half that price. But fuel shortages worsened and inflation increased during 2006, making it an urgent priority to ease supply bottlenecks in the fuel market.

The authorities took action on two fronts: first, raising the price of fuel products to reduce the incentive for smuggling; and second, allowing the private sector to import fuel products. By March 2007, the prices of regular and premium gasoline were near the average levels in other oil-exporting countries in the Middle East and North Africa, and prices for diesel exceeded the regional average (see Chart 2).

One important outcome of the price increases was a reduction in budgetary subsidies, which allowed budgetary resources to be shifted to priority public services. Despite the increases, official fuel prices are still lower than the black market prices that most people have to pay. By and large, Iraqis seem to have largely accepted the higher prices because they consider it more important to have a regular supply of fuel.

With the passage of new legislation last October to allow private fuel imports, the increase in fuel prices is expected to make it more attractive for the private sector to become active in this area. It is hoped that better fuel availability in 2007 would help reduce black market prices and ease inflationary pressures."

-Iraq takes steps to stabilize and reform its economy