The Iraqi Finance Ministry has announced its plans to devalue the Iraqi dinar by 22%. Countries have devalued their currency for many years in an attempt to improve their local economy, but what does it really mean to devalue your currency?
Source: Banknote World
Countries establish an exchange rate between their money and other countries’ money. In a completely free market, the actual exchange rate is determined by the demand for a country’s goods, services and money. For example, if a business in the US wants to buy grapes from Chile, the business must convert their US dollars to Chilean peso and then buy the grapes. This increases the demand for Chilean pesos. And the pesos that were exchanged for grapes can go to pay worker’s salaries and local costs- in pesos.
Explained In Easier Terms
What happens if Chile devalues its peso? That same US business brings their US dollars to buy grapes but can get more grapes for the same number of dollars. The Chilean grape business sells more grapes and has more pesos to pay its workers and expenses. The worker has pesos that have the same purchasing power for goods and services produced inside the country but the cost of imports rise. If I am a Chilean coffee shop buying my coffee from Colombia, I will need more pesos to buy that coffee. At the end of the day, the countries’ citizens lose out. Their money cannot buy as much imports as before.
If devaluation hurts the local people, why do countries do this? A country needs money to pay its costs. It gets that money by selling products to other countries, adding value to local products and services or by borrowing. Many developing nations get money mostly by selling products such as natural resources to other countries. If the demand for that natural resource goes down, they get less money. While they still have the same costs (salaries, etc.). If a country is very dependent on imports for products, then the government might have no other choice but to devalue the currency until the demand for their exports go back up.
Source: Pixabay
Iraqi Dinar Set to Devalue
This brings us to Iraq. The Iraqi economy is based on oil exports and imports of most food and day-to-day products. Oil prices (sold in USD primarily) have been depressed throughout 2020 which means Iraq is getting fewer dollars for their exports. They still need the same number of dollars to buy the imports needed to feed its people. By devaluing the currency, the government is hoping to spur demand for Iraqi exports and investment in Iraq to strengthen the local ability to produce goods and services.
History indicates that devaluation does not solve inherent problems in a country. However it gives some breathing room for the government to fix some inherent issues. Issues like reducing costs, investment in its own people’s capabilities and making the country more attractive for international investment. Iraq has a long road to become more financially stable. Let’s hope this devaluation leads the Iraqi government to fix its issues and put the people on a stronger economic footing.
