The forex rate of a particular currency is directly tied to its economy and geopolitical situation of that particular country. Although price fluctuations in forex rates between two currencies follow the demand and supply trend based on “Purchasing Power Parity” and interest rates, the case of Iraqi dinar (IQD) becomes a special one due to its current situation. (PPP is an important economic concept; watch Investopedia's helpful video on the subject.)
The IMF, which monitors Iraq’s economy, is using a single fixed rate of 1170 IQD per US$. The official market rate of IQD-US$ keeps hovering around this fixed price. But in reality, a lot of variation exists in the bid/ask quotes for buy/sell prices at the various foreign exchange dealers, as the Iraqi dinar is no longer easily traded. The bid-ask spread is pretty wide, and dealers (legitimate or illegitimate) are known to charge a high mark-up fee for any transactions in IQD.
The Iraqi dinar has special attributes, as its valuation and volatility are tied to developments in Iraq. Given the reality of Iraq's being a war-torn country, a number of factors exacerbate risk,including: 1) multiple factions trying to control different parts of land; and 2) the withdrawal of Western countries.
Even if one is willing to take the bet based entirely on chance, the unknowns are considerable.
Changes in the price of Iraqi dinar will depend on lots of factors, including the following:
How soon the war comes to an end
Unless business participants and investors can be assured of a peaceful, secure and trustworthy atmosphere for making investments, the economy will struggle to recover. Investors already have to deal with enough risk as it is even under the best of circumstances; hence, they look for stable regions without political or other disturbances. The current war-like situation is the major deterrent in the Iraqi economy's recovery, and thus in the improvement in Iraqi dinar pricing. The sooner Iraq achieves normalcy, the better prospect the economy and the dinar will have for recovery.
Whether the country remains unified or is heading for a split
In the event of the latter, will the new authorities honor the debt and obligations of the existing currency and economy? If not, then it will be a sunk cost for all investors holding Iraqi dinars. High price fluctuations will continue on the downward trend, with much wider spreads in the unofficial forex trading markets, until the situation becomes clear at ground level.
Whether Western countries are ready to re-engage in rebuilding Iraq and its economy
Western countries have been phasing out their presence in Iraq. This may be a cause for the current disturbances that have sprung up. Just the sheer engagement of Western countries can give a kick-start to help building the investor confidence, thereby improving the economy and improving the forex rate.
Whether organizations like the IMF, World Bank, United Nations are willing to help
The forex rate IQD-US$ showed positive trends during the period when programs like the “International Compact with Iraq (IMF)” were introduced. A further step in this direction by introducing similar programs by capable organizations should be a big positive for enhancing IQD rate.
Whether erstwhile investor interest can be rekindled
As reported by Newsweek, in 2006, “The U.S. Chamber of Commerce reports 34,000 registered companies in Iraq, up from 8,000 three years ago.” Once past the current conflict, in the post war scenario Iraq should be able to attract the same large size investor interest which should improve the economy and leading to enhancement in exchange rates.
Iraq's potential to develop an oil revenue-based, solid economy
Iraq’s economy is clearly dominated by revenue from oil, which reportedly provides 95% of foreign exchange income for Iraq. Iraq's recent contracts with major oil companies have the potential to greatly expand oil revenues. Once stable, Iraq will need to upgrade its oil processing, pipeline, and export infrastructure to enable these deals to reach their full potential, paving the way for a rapid growth.
Whether Iraq can develop oil-associated industries
Iraq’s manufacturing, chemical and fertilizer industries are tied to the oil sector. Still, given a suitable business environment, they have a tremendous potential to grow.
Whether Iraq is able to develop other sectors
Within Iraq, there are significant opportunities available in the construction, retail and energy sectors. These sectors saw substantial interest and backing by foreign investors, during the post-Saddam period. Hundreds of foreign companies, backed to a good extent by their governments, continue to operate in Iraq in these sectors even during these troubled times. Unless there is a major wind-up of operations from these large organizations, the probability of Iraq coming back to recovery remains up for grabs.
Whether investors from non-first-world economies will get involved
Investment has come into Iraq not just from companies in developed countries like the US and UK, but also from companies in developing countries like India. The only need is an improved, secure and peaceful business atmosphere and the Iraqi economy should resume a normal course.
Whether regulatory deficiencies in Iraq can be sorted
Most foreign investors in Iraq had challenges with the regulatory framework, even during the post-Saddam period. List included problems in land acquisition, corruption and delay in implementing reforms which could support private sector. Iraq needs to find a way to get over these impediments to win foreign investors’ confidence.
Interestingly, the above mentioned challenges also exist in other developing economies like BRIC nations, but trouble in Iraq gets compounded by the war like situation and hence need more prompt resolution.
Whether promising signs from previous peacetime scenarios can resurface
Even after the eight-year long Iran-Iraq war, which had a devastating effect on both nations, Iraq was able to restore itself. It would not be impractical to assume that given sufficient time of established peace, Iraq does has the required potential of springing back to be a stable and healthy oil-based economy.
Whether other hidden gems in the Iraqi economy can be further explored
Due to political conflicts, in spite of having plentiful irrigation and water resources, Iraq remains a net food importer. Establishment of a stable government, and hence concrete policies, will ensure that the agriculture sector can add significantly to the country’s economy, further providing economic stability.
Investments are always subject to two unknowns – “How Much” and “When.” No one can say for certain “when” the IQD's recovery will occur.
The Bottom Line
Trouble with the Iraqi dinar is compounded by a war-torn situation, a non-existent legal market for forex trading and high mark-up charged by a limited number of legitimate forex dealers. Taking a short-term bet is a clear no-no. Long-term bets depend upon lots of unknown and uncontrollable external factors, which investors should keep in mind before proceeding.