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With the Terms of Trade Shocks happening to Iraq, the plan of privatizing the country has become all the rave. Not a new concept and as a matter of fact the plans of privatization has been in the works heavily since 2004. Now I will not waste time building a case but please know that I form my opinion from much of the research out there (if interested I can share the sources), instead I will get straight to the point here. !The true test of Abadi's intent to privatize Iraq will be whether or not he promotes the Corporatization and Privatization of Iraq's key state-owned banks namely Rafidain & Rasheed! Regardless of what you read or hear or think, this is what needs to be watched for in the news. The World Bank performed a financial sector review of Iraq and listed "Medium to Long Term Task(s)" for the Ministry of Finance & CBI to pass into law these bullet point items as part of the economic liberalization effort: ■ Clarify the mandate of the specialized state- owned banks, and consider consolidation and conversion into a development banks with increasing their capital, which will not take deposits. ■ Ensure state-owned banks work according to commercial principles and on a level playing field. Early corporatization of state- owned banks should be considered a key element. ■ Over time the authorities should consider gradual privatization of the key state-owned banks. Why is this important? Because research has proven that as long as the banking structure is managed centrally (i.e. by government) whether fully or partially, a market economy is smothered. It is like finally being given a Lamborghini but a governor is placed on the engine limiting its top-off to 75mph. What is more, control of the banking structure will do just as bad if management is concentrated (a sleight of hand trick governments will attempt to retain control). Many are wondering what impact this might have on an RV. For those who believe value will be added to the currency once it is unpegged from the dollar, you should understand that moving to a flexible exchange regime has its risks. Those risks are high if the financial sector is not well structured and configured to properly absorb fluctuations and shock in the market. State owned or partially owned banks do not absorb shock well because their political and relationship interest get in the way of forming sound financial policy. For example a consistent problem with state run banks is loaning to bankrupt businesses to help them stay afloat because the owners of the businesses are your friends. Another common issue is with state run banks maintaining managers too inept for the job but appointed because of some personal affiliation. Whereas Privatized banks often change management and scrutinize lending practices to ensure the bank's efficiency at conducting business. Fully privatized banks without government intervention are more profitable. And so I am not here to argue against an overnight RV versus a gradual rise in value from an overnight exchange regime change. I am opining that Abadi will face the decision of his life - whether or not to fully privatize the key state owned banks. Remember that these key banks have been groomed for privatization and it is documented in the World Banks playbook for Iraq. For instance when you see articles about E&Y and other 3rd party financial firms coming into Iraq, typically it is not for existing private banks like Bank of Baghdad or North Bank, these banks are not ready to carry the load of an economy like Rafidain & Rasheed. The focus has always been to ensure the readiness of Rifidain & Rasheed Banks to properly privatize and handle the coming market economy because they are Iraq's financial powerhouse and dwarfs all other banking entities. Recall articles like these from yesteryear: "The acting Finance Minister, Ali Yousef Shukri (pictured), is reported to have held a meeting with a representative of the World Bank to discuss the restructuring of the state-owned banks in Iraq. According to the report from NINA, the discussions related particularly to the Rasheed and Rafidain banks." Well this IS the plan and a MAJOR cog in the engine for successful privatization of Iraq's economy. Can the GOI find within itself to relinquish its control of the money power and liberalize its banking sector? PS. The concept I am presenting is not new for developing economies. This is where many of them struggle when attempting to make that change from a socialist, government-centric economy to a true market economy. This is the story of Egypt who adopted a very similar reformation plan as Iraq (the similarities are incredible really) from the World Bank but when time came to execute on the banking component, the government would not fully comply with the plan and fully privatize its state owned banks. Egypt floated its currency in 2003, like any market-type economy should, but the long term effects have been troubling.
Current events in Iraq reveal the government is preparing to privatize in an effort to liberalize the market or best put institute a market economy. Why would Iraq decide such drastic change to its centrally managed economy? One short answer is that its budget deficit revealed economic fragility. Iraq finds itself in a precarious situation since its macroeconomic stability, as recently revealed, is tied to factors outside of its own control. A critical factor of oil price volatility, and the affect it has on developing oil producing economies pegged to the dollar, is known as terms-of-trade shock. (Nikola Spatafora and Andrew Warner completed an interesting research paper addressing this specific issue - read more). In a Sebastian Edwards article "Flexible exchange rates as shock absorbers", he states: We find evidence suggesting that terms of trade shocks get amplified in countries that have more rigid exchange rate regimes. We also find evidence of an asymmetric response to terms of trade shocks: the output response is larger for negative than for positive shocks. Finally, we find evidence supporting the view that, after controlling for other factors, countries with more flexible exchange rate regimes grow faster than countries with fixed exchange rates. Supporters of flexibility, on the other hand, have argued that under floating exchange rates the economy has a greater ability to adjust to external shocks. According to this view, which goes back at least to Meade (1951), countries with a flexible exchange rate system will be able to buffer real shocks stemming from abroad. This, in turn, will allow countries with floating rates to avoid costly and protracted adjustment processes. continued research reveals that Edwards is not alone in his findings concerning the dangers of rigid exchange rates for market based economies. Jbili of the IMF's Finance & Development Magazine wrote an article entitled "Should MENA Countries Float or Peg?" examining 6 MENA countries and their exchange regime. I note some of the identical remarks..... The prevailing view now is that increasing flexibility in exchange rate management would help countries deal with external shocks, reduce the risk of banking crises, and contribute to financial stability. There are, of course, dissenters who argue in favor of intermediate regimes, stressing the difficulty developing countries have in meeting the preconditions for a successful float and the negative impact of excessive exchange rate volatility on investment and growth. The above country-by-country analysis indicates that exchange rate regimes in the six countries had varying degrees of success. Exchange regimes in Jordan, Morocco, and Tunisia have not recently come under pressure, because real shocks were relatively manageable and macroeconomic policies were generally consistent with the choice of exchange rate regime. In contrast, the recurrent pressures in the foreign exchange markets of Egypt and Lebanon demonstrate that vulnerability to real exogenous shocks, volatile capital inflows (Egypt), and large structural fiscal deficits financed by heavy domestic and foreign borrowing (Lebanon) are incompatible with a pegged exchange rate. Popular opinion through much research shows that it is quite favorable for developing countries to free themselves from a fixed peg toward a more flexible exchange rate regime in order to protect their economies from terms of trade shock. A great example of this is Egypt by 1986 where the country began to experience serious macroeconomic imbalances and a dramatic fall in growth characterized by budget deficits of 17% of GDP. Egypt launched its Economic Reform Program to address dire economic conditions which really took off by 2003 for further liberalization of the economy. In 2003, the government began floating the rate of exchange of the Egyption pound, releasing it from its peg to the dollar (read more). Although Egypt continues to struggle with its economy for numerous reasons, it stands to reason that Iraq would be in a much better place should it head in the same direction. There are preconditions to a successful release from the peg and toward a flexible exchange regime. The country must establish a sound market economy, political energy must be aligned with it, a sound financial sector must be established, and capital markets should be in operation. Everything we see Iraq doing tells us the country's intent is to float the dinar. Government controlled economics with rigid exchange regimes can be the death of a country whose economy is subject to highly violatile exogenous terms of trade shock. It's tie to the dollar can create years of deficits. Iraq must take control of its economic future. It must liberalize its economy, harmonize its political landscape and float its currency. all of this is my 2c on the matter through my own research. take it for no more than that. be blessed my friends