The Euro Could Help Iraq’s Economic Recovery

This article appeared in the Financial Times, April 17, 2003

For all the speed of themilitary campaign against it,Iraq has sustained heavydamage: numerous civilian and militarycasualties; a battered physical infrastructure; disrupted trade; drastic political, administrative and social dislocation; and thepsychological difficulties and resentments of a vanquished people adjusting to the peculiarities of life under alien rule. Thesegrim realities promise no end of problems for postwar Iraq.

The victors - whether viewed as liberators or conquerors - have grand ideas about remaking the Iraqi economy and societywithin a year of the war's end. One of the items on the Bush administration's agenda is the establishment of a stablecurrency. Exactly what the cognoscenti plan to do with the currency remains a mystery, however.

To be successful, a currency reform plan must be informed by Iraq's history, well crafted and available fast. Speedyimplementation is of the essence because victors often find that good will on the part of the vanquished is apt to be shortlived.

Iraq established a central bank in 1947. Like central banks in most developing countries, the Central Bank of Iraq's historyhas been replete with mismanagement, coercive stop-gap measures and, yes, the production of an unstable, unreliablecurrency. The Iraqi dinar has not been tradable on international markets for years. Consequently, international transactionshave been possible only with foreign currencies. But access has been controlled by the Central Bank of Iraq's advisorycommittee on foreign exchange. Attempts to compete with Saddam Hussein's foreign exchange trading monopoly have been,to put it mildly, credibly deterred

Since 1979, when Mr Hussein came to power, the Iraqi dinar has collapsed. In 1979, 1 dinar was equal to Dollars 3.39. Morerecently, the official rate - unchanged since 1982 and available only to Mr Hussein and his cronies - has been 1 dinar toDollars 3.22. For Iraqis outside Mr Hussein's inner circle, the only way to obtain foreign currency has been through the blackmarket. But the black market rate is now reported to be about 3,000 dinars to the dollar.

Central banking and unstable money were not always the norm in Iraq. A century ago, what is now Iraq was part of theOttoman empire. The official currency of the empire was the Ottoman pound but the most widely used currency in Iraq wasthe Indian rupee, which was linked to the pound sterling. After the territory was captured by British forces in 1916, andremoved from the Ottoman empire, the British made the Indian rupee the official currency and retired the Ottoman pound.Iraq was thus officially "rupee-ised".

After prolonged agitation by Iraqis, Britain granted the country independence in October 1932. As part of the preparations forindependence, the Iraqi currency board opened in April 1932. It issued the Iraqi dinar at par with the British pound. Theboard fully backed the dinar with British pound reserves and maintained its fixed exchange rate to the pound. Until it wasreplaced with a central bank in 1947, the currency board operated without problems.

A currency reform for Iraq must not include a central bank. Iraq's history suggests two superior alternatives. The first optionwould require a return to an orthodox currency board. Designing such a system for Iraq would require discarding the modelused by the Inter-national Monetary Fund in Argentina, Estonia, Lithuania and Bulgaria. All of these systems graft centralbanking features on to the orthodox currency board model, and, as Argentina demonstrated, the mix can be explosive.