KTFA (Don961)

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Don961:  Clarification on foreign reserves in the Central Bank of Iraq

June 25, 2020

The real financial surplus is the government’s revenue that is represented by the Ministry of Finance, which exceeds its public expenditures during a fiscal year. If the Ministry of Finance achieves revenues (crude oil sales in general) with a value greater than its expenditures (investment spending and current spending), it will achieve a budget surplus.

That the government invest it, either internally or externally in the form of sovereign funds or investment funds, etc., and vice versa if public revenues are less than expenditures and then achieve a real deficit that requires its financing, either by searching for additional revenues, enhancing existing revenues, or resorting to internal borrowing and / or Outer.

Here it is necessary to clarify that the foreign reserves held by the Central Bank are not surplus funds, but rather accumulate as a result of a specific mechanism in which the Central Bank conducts what is called the process of monetization, as the Ministry of Finance sells the largest part of its dollar revenues to the Central Bank with a view to obtaining the Iraqi dinar Issued by the Central Bank of Iraq to implement its domestic spending, and as long as the Central Bank of Iraq adopts a fixed price to exchange the Iraqi dinar against the US dollar, and it seeks through the window of selling the currency to maintain this constant value of the dinar, so the Iraqi dinar holder has a right to foreign reserves, which is a cover for the local currency.

We can refer here to the concept of foreign reserves according to the balance of payments guide and the international investment situation issued by the International Monetary Fund (are the external assets that are at the disposal of the monetary authority and are subject to its control to meet the needs of the balance of financing payments or interference in the exchange markets to influence the exchange rate of the currency, or other Related purposes (such as maintaining confidence in the local currency and forming a basis for external borrowing) and the reserve assets must be assets in foreign currency and assets that already exist, and excluding potential assets.

The concept of reserve assets is based on the concepts of “control” and “accessibility” With regard to monetary authorities, based on the definition of foreign reserves above, the following can be installed:

1. It provides a cover for the local currency and an instrument to support the exchange rate.
2. It is the primary tool of the central bank to intervene and adjust imbalances of the balance of payments structure.
3. It provides an important element in setting the country’s creditworthiness, and enhances the country’s credit rating in international transactions.

The optimal level of foreign reserves – that is, the minimum value of foreign reserves that the monetary authority must possess and that is calculated according to internationally approved standards – represents the ability of the monetary authority to defend the local currency exchange rate. The most important of these standards (the money supply standard, which represents the adequacy of foreign reserves to cover the supply of the local currency, and the trade standard, which represents the number of months in which foreign reserves can finance the country’s imports of goods and services) and adopt these standards assuming a shock that affects the accumulation of foreign reserves almost Exactly.

With regard to managing foreign reserves, there are internationally accepted rules that depend on managing foreign reserves in terms of their liquid assets (securities, deposits, gold …) and it envisions geographical distribution, currency diversification and other factors that reduce exposure to risks and provide returns that ensure sustainability These reserves.

It should be noted here that for internal borrowing by the government, whether funded by the Central Bank of Iraq directly any direct deduction of securities issued by the Ministry of Finance – which is prohibited by the Law of the Central Bank of Iraq – or indirectly by deduction in favor of local commercial banks, for both A negative impact on foreign reserves if we assume that the government’s priority is to finance that part of the expenditure represented by workers ’compensation, as this part is reflected in consumer spending, which is mainly met by imported goods and services, which in turn will generate a derivative demand for foreign currency and hence the exit of a portion Of foreign reserves to finance these imports, and this effect will continue until the date of maturity of the securities.

While external borrowing will positively reflect on the accumulation of foreign reserves, as long as the Ministry of Finance will monetize it for the purpose of obtaining the local currency, and handing the foreign currency to the central bank to be added to the foreign reserves.   link