The Exchange Rate of Foreign Currency in Economic Feasibility Studies
Below are the central controls related to the exchange rate of the foreign currency to convert the project inputs and outputs from foreign currency to its equivalent in the local currency, and that is by calculating the net discounted present value standard and the internal return on investments in economic analysis that governs investment projects that costs excess one million dinars.
Estimate the shadow price of foreign currency:
1. It is necessary to put central controls to amend the official exchange rate * to reflect the shadow price of the foreign currency, and that is considered one of the necessary requirements to implement the net discounted present value standard and the internal return rate on investment in the economic calculation stated in the instructions, paragraph nine.
The central controls for adjusting market prices distinguished a group of outputs and inputs traded internationally, where the projects production or usage of them is reflected on the abundance of foreign currency in the economy and thus project outputs or inputs used of such are considered purely foreign currency outputs or inputs.
* What is meant by exchange rate: the number of units of foreign currency, expressed in dollar per one dinar.
In particular the following outputs and inputs of foreign currency were distinguished:
· Outputs marketed locally that substitute imports.
· Imported inputs.
· Inputs produced locally that usually go to exports.
· Foreign labor.
According to the pricing rules the value of the output and input (traded) is calculated using export prices (FOB) and import prices (CIF), according to what is listed in the pricing rules.
In other words the pricing rules calculate what the project produces from foreign currency (quantity of exports multiplied by the export price (FOB) in foreign currency or the quantity of substitute imports multiplied by the import price (CIF) in foreign currency, as well as what the project uses from foreign currency and imported inputs multiplied by the import price (CIF) in foreign currency .... etc.).
In a later step, project outputs and inputs must be converted from the foreign currency to its equivalent in local currency (dinars) by using a specific exchange rate for the foreign currency.
2. Justifications for exchange-rate adjustment: there are a number of important and powerful arguments which support the view that the official exchange rate reduces the real value of foreign currency for purposes of calculating the economic national profitability for investment projects and hence for the purposes of investment planning. It is demonstrated in this context to call for assessing the dinar for less than (3.208) dollar (official exchange rate) when assessing project outputs and inputs of traded goods of exports, substitute imports and imports... etc.
The justifications to call for the use of an exchange rate that is lower than the official exchange rate are:
· The use of an exchange rate that is lower than the official rate is the appropriate action at the investment planning level to translate the country’s economic strategy aiming at stimulating central investments in the sectors that encourage the development of non-oil exports, as well as sectors that encourage the expansion of domestic production base in order to reduce imports and compensate it with local commodities. This helps to reduce reliance on foreign exchange earnings from crude oil exports and increases the share of non-oil sectors in the local production.
· The application of the amended exchange rate on project imported inputs will assist in directing investments away from aggregated sectors dependent on imported inputs and the preference of those sectors that rely on locally produced inputs.
· The use of the amended exchange rate helps to correct the balance in favor of the traded goods sectors compared to non-traded goods.
· The real exchange rate has declined rapidly since the early seventies, through rapid rise of the level of prices and local costs which led by the steadiness of the official exchange rate to change in prices and actual local rate costs that gave an advantage for imported goods at the expense of locally produced goods, meaning that it led to deterioration of the competitiveness of alternative replacement goods and export commodities.
· This action shows that the official exchange rate overestimates the value of the dinar, compared to the foreign currency and from the promoting goods substituting imports and export commodities point of view of.
And in support to this view is the state’s utilization and in a broad approach to the customs and quantitative protection policies especially for consumer goods, as well as export subsidies that exports have through an amended export exchange rate.
3. Estimate the amended exchange rate of the Iraqi dinar to be used in technical and economical feasibility studies and for (1.134) dollar per dinar. This price should be approved for 3 years until re-appreciation by the competent authorities.
As you read the report you'll see that it's making a case for reducing the value of the dinar from the "official exchange rate" of $3.20 to $1.13. (They use the words "amend" and "adjustment".) Now, what's the official value of the dinar today? It's $.00086. So how could they adjust it from $3.20 to $1.13 when it's currently $.00086? The dinar hasn't been valued at over $3 in twenty years. There's no mention of the new constitution, the new economic climate in Iraq, or anything from the post-Saddam era. It's either a very old report or a report based on very old numbers. The idea here isn't to increase the value from $.00086 to $1.13. It's to set the value at $1.13 instead of $3.20.
Iraq didn't have a .iq domain extension until 2005 so the page has been uploaded since then. This report could be left over from the Saddam era when the dinar was officially valued at $3.20 but I don't see why the CBI would include a study from the Saddam era before the IQD was created. I think it's more likely that the Finance Ministry and the CBI were putting together a currency reform plan based on the idea of returning to the previous value. It's my belief that this report was written around 2006, about the time the CBI started getting inflation under control and started talking about redenominating.
"Iraqi officials have had a long-running plan to redenominate the Iraqi dinar. In 2006, the Finance Ministry recommended to the Central Bank that it carry out such a plan."
At the time they already had tens of trillions of dinars in circulation so you have to assume that they were factoring a reduction in the money supply into the equation, which is what a redenomination would do. By deleting the zeros (lopping) they could reduce the money supply and then return to their former official valuation of $3.20. But this report seems to be saying that they would be better served by keeping the valuation lower to remain competitive with exports.
Another interpretation is that they were referring to the exchange rate rather than the valuation, thus the 3.208 and 1.134 references. This interpretation suggests that they're indicating 3,208 dinar to the dollar and 1,134 dinar to the dollar. The CBI website says that the dinar's value in 1995 was about 3000 to the dollar, which isn't too far from the 3,208 figure. This interpretation suggests a target rate of 1,134 which is not too far away with the current rate at 1,166 to the dollar. The problem I see with this interpretation is that it clearly states at the end "1.134 dollar to the dinar" and even says that the official exchange rate overestimates the value of the dinar.
I think it's also interesting to note that it says:
"The real exchange rate has declined rapidly since the early seventies"
Kinda shoots down the theory from some that the dinar was suddenly devalued by the coalition as a war strategy in 2003.
Whichever interpretation you prefer, it's clear that they're not saying Iraq can support a straight up revaluation to $1.13 without a reduction in the money supply. It's quite possible the official exchange rate from the Saddam era was never adjusted prior to this report and they're just basing their numbers on that. Again, actually taking the time to read this stuff instead of just listening to the gurus could pay huge dividends.