Little help with currency auctions please

[djgabrielie]

Over the past month, I have been visiting the CBI website and copying the Currency Auction information into Excel.  I collected the following 16 thus far and it seems to me that there should not be any IQD left in the country. Does it seem like Iraq is running on the USD and not the Dinar?

 

Keep in mind that they have been having currency auctions for years.

 

I don't seem to know how currency auctions work. At least not in Iraq. Please help.

 

$184,714,000      

$204,399,000      

$  88,853,000      

$117,435,000     

$130,563,000      

$187,819,000      

$147,240,000      

$116,099,000      

$191,749,000      

$150,642,000      

$146,985,000      

$204,988,000      

$158,335,000      

$140,336,000      

$161,151,000      

$196,704,000       $2,528,012,000 USD       X  1166  = $2,947,661,992,000 Dinar

[sandfly]

I DONT KNOW I HOP THEY GOT IT OFF THE STREET

[rockfl9]

Djga: You are correct Iraq operates on dollars. Maybe not the way you would like!

W hen CBI BUYS dinar with those petrodollars, it gives the dinar to the MOF. The MOF then puts those dinar right back out to pay the nations expenses. The idea that the auctions are removing dinar from circulation , is an illusion. every dinar ever printed is still there and a lot of "electronic ones in bankaccounts and the ISX are still there!

[djgabrielie]

Thanks Rock, I really don't think many people such as myself understand the CBI Currency Auctions.

[keepmwlknfny]

Here ya go Djgabrielie......long read but quite informative.....Wish more would read this instead of listening to the gurus about how the auctions are removing dinar from the streets......

 

 

The Foreign Exchange Auction In Iraq (CBI)
Middle East Economic Survey


VOL. XLVIII

No 18

2-May-2005 

The Foreign Exchange Auction In Iraq


By Simon Gray

Simon Gray is Adviser, Markets and Financial Infrastructure, Centre for Central Banking Studies (CCBS), Bank of England. During his secondment to the Coalition Provisional Authority (CPA) in Baghdad, he was Senior Advisor to the Central Bank of Iraq. He wrote this article for MEES.

The Central Bank of Iraq (CBI) introduced a foreign exchange auction on 4 October 2003, just under a fortnight before the start of the currency exchange (which replaced the old banknotes, and ran from 15 October to 15 January 2004). The timing was to a large extent dictated by that of the currency exchange, but the underlying need reflects Iraq’s position as a major oil-exporting country.

Background

The government’s revenue is predominantly in US dollars, from oil sales. To this extent, Iraq’s position is similar to that of many countries in the region. And in common with many countries in the region, its expenditure is largely in domestic currency, in this case Iraqi dinar. The Ministry of Finance therefore needs to sell dollars for dinar.

Typically, a Ministry of Finance with foreign currency revenues will sell surplus foreign exchange (it will use some for the purchase of imports for government projects etc; and may keep some in a separate oil stabilization fund) to the central bank; and the central bank will on-sell dollars to the market, via the banking system. Under a fixed exchange rate regime – and many oil-exporting countries in the region operate such a policy – it is clear at what rate the Ministry should sell to the central bank. The central bank can then on-sell, at the same rate, whenever banks request dollars. Prior to the war, Iraq operated a fixed exchange rate regime (albeit with a hopelessly non-market exchange rate), supported by exchange controls. But post war, the central bank was not in a position to operate a fixed exchange rate regime, and in any case did not want to lock into the exchange rate prevailing at the time. 1

From the end of the war though summer 2003, the exchange rate was purely market-determined – the market in question being a street market for physical cash in three main locations in Baghdad. But the Ministry and central bank did not need to make use of this market, as official expenditure at that time was mostly in US dollar bills.2 From October, things had to change. Once the currency exchange was under way (from 15 October), it was clearly important – if only from a political point of view – for the government to make disbursements in the new Iraqi dinar, rather than predominantly in dollars as had been the case since May. This meant that the Ministry needed a reference rate at which it could sell dollars to the central bank; and the central bank needed a mechanism for on-selling dollars to the market. 

Without a mechanism to rechannel dollars to the economy, there would have been two consequences:
A shortage of dollars could hit the dinar exchange rate, leading potentially to a very sharp depreciation;
A dollar shortage would also cut off import supply, pushing up prices sharply. (Large amounts of dollar expenditure by the CPA and MoF had, predictably, fed through to a huge increase in imports, as previously suppressed demand could now be satisfied.)

Associating the introduction of the ‘new’ currency with sharp depreciation, cutting of the supply of consumer goods, and a hike in prices for those goods still available would have been disastrous.

An Auction As The Solution

The solution was to introduce a foreign exchange auction. This was kick-started by the CBI selling a small amount of its foreign exchange reserves to the market. Thereafter, the auction rate could be used for MoF dollar sales to the CBI (so that it would be a genuine market rate, rather than something based on a straw poll of street exchanges); and the market could bid for dollars in the auction to meet the level of demand. If demand was excessive, the rate would adjust.

We were aware that, once the new currency was available, the MoF would be selling several hundred million dollars a month to the CBI, and that auctions could easily exceed $10mn a time as the domestic demand generated by government expenditure (payment of salaries, pensions etc) fed though to import demand (since many consumer goods had to be imported), and thus demand for foreign currency. It was important to prepare the market for the auction system, and ideally to have a mechanism up and running, before the amounts became large. This meant starting in early October at the latest.

The full details of the auction need not be covered here. Importantly, several meetings were held with the commercial banks and the non-bank licensed foreign exchange dealers to discuss the mechanics and the purpose of the auction. Three dry runs of the auction were held, to give participants a better feel and ensure the mechanics worked. The first dry run was very messy; but by the end everyone understood not only how to complete bidding forms correctly, but how to participate in the price formation process and learn from the previous auctions.

All the banks and foreign exchange dealers also understood how the CBI would participate. It would look at the volume and price of bids from the market before deciding on its own participation, so that it could choose the cut-off rate. Clearly, no central bank can have full freedom in this: trying to keep the dinar too strong could lead to an unsustainable drain on limited reserves, while trying to hold back appreciation could have an inflationary impact. But at the margin, and for a time, the CBI could influence the rate. Since the market is allowed to participate in the auction in either direction (buying or selling dollars), it is possible that the central bank will not need to participate at all. But in practice there will nearly always be a large net demand for foreign currency by the market.

Banks and licensed foreign exchange dealers were allowed to submit bids directly to the central bank; but the dealers had to accompany their bids by a confirmation from their bank that funds were available to honor the bid, if successful. Settlement is book-entry only, across accounts at the central bank. Most bids are made in the 15-30 minutes before the cut-off time for the auction; and results are published 30 minutes after the close of bidding. Details can be found on the CBI website (www.cbiraq.org). Settlement is same-day. The short time-scale – only possible with book-entry settlement – helps to keep the auction and the rest of the market in line with each other.

The Auction, Exchange Rate Policy And Inflation

The first auction was held on 4 October 2003, and received a single bid, for $20,000. There was some debate about whether to accept it, since it was arguably below the market rate. But the CBI decided it was important to give a positive signal to the banks, to encourage participation in the future, and the bid was accepted. Within a couple of weeks, the bid rate at the auction and the street price – CBI staff went out three times a day to check prices at a range of locations (preferring those where prices were displayed, rather than given in response to a request) – had merged; and volumes were soon close to $10mn3. The majority of Iraqi banks participate regularly.

The CBI has said regularly in the auction result announcements that its aim is to achieve broad exchange rate stability, in order to support domestic price stability. There is no exchange rate target or band. The CBI has been able to meet demand, and there is not enough economic information for the market to take a strong view on what an ‘appropriate’ level of the exchange rate might be, certainly not to push for change in the rate. 

But while the ‘right level’ was not clear, the CBI could be confident that excessive volatility was harmful. After the massive shocks to the economy and to society more widely in the previous months, it was important as far as possible to engender an atmosphere of stability – particularly in the early days of the currency exchange, when many Iraqis would see their income switching from dollar cash to new dinars. In any case, in view of the upward stickiness of some prices, it was likely that exchange rate volatility would tend to increase the level of inflation.



Especially in the early days, it was not clear what a ‘normal’ level of day to day volatility might be, since there was no ‘normal’ period to compare with. The chart above shows the daily returns on holdings of new Iraqi dinar, and clearly indicates much more volatility in the early days of the auction, and of the currency exchange, than more recently. Two particular spikes in the chart – in early December and mid January – can be linked to the announcement of Saddam’s capture (when it was not clear what the long term impact would/should be), and the end of the currency exchange, when the trend appreciation of the dinar (arguably starting with Saddam’s capture) led to ‘irrational exuberance’. 

In the former case, the CBI made no attempt to stand against the trend, but did help to smooth it by the level and rate of its participation in the auctions. By contrast, the very sharp appreciation of the dinar in early January seemed unwarranted and almost certainly unsustainable; and it was clearly upsetting the market4. On this occasion – on 15 January 2004 – the CBI bought a small amount of dollars at the auction, and indicated that the recent appreciation of the dinar ‘was not supported by any recent political or economic announcements’. In other words, the CBI again avoided taking a stance on the appropriate level of the exchange rate, but merely noted that nothing had changed recently which would justify the very sharp movements in preceding days. This worked, as the chart below indicates.



Similar action in January 2005, just ahead of the national elections, was also undertaken in response to an increase in volatility, but otherwise the market has been remarkably quiet. 

Reducing exchange rate volatility, and then supporting a remarkably stable nominal exchange rate since the beginning of 2004, has proved to be a very powerful tool in meeting the CBI’s objective of low domestic inflation (formalized in the new CBI law, dated 6 March 2004). In Iraq, as in many commodity-exporting open economies, there is a rapid pass-through from the exchange rate to domestic inflation. The correlation is bound to be unstable, as it will be affected by expectations, changes in the level of demand (eg reflecting changes in the security situation), changes in the direct costs of importing goods in an unsafe environment, and periodic supply disruptions. But prima facie, there is strong evidence that a stable exchange rate has helped to support price stability. 

__________________________________________________ ______________

[gymrat76541]

Iraq is NOT the only country using dollars instead of their own money. Dinar is on the streets but not in large numbers.

[djgabrielie]

Thanks Keep.  Good article.

[DanielM]

I gotta question not sure where to ask. I've heard there are 5 different currency's that are supposed to RV! Does anyone here know which ones & are supposed to RV about the same time as the Dinar?