The global financial system is undergoing significant transformations, with many nations seeking alternatives to the US dollar in international trade. Iraq, a resource-rich but economically challenged country, is actively working toward reducing its dependence on the dollar. 

This process, known as de-dollarization, aims to strengthen the Iraqi dinar, reduce external economic vulnerabilities, and establish a more independent financial system. However, this transition presents both opportunities and significant hurdles.

Why Iraq Wants to Reduce Dependence on the US Dollar

Iraq’s push toward de-dollarization stems from a mix of economic, political, and strategic considerations. Several key factors drive this shift:

• Economic Sovereignty: Reliance on the US dollar has left Iraq’s economy susceptible to external shocks, particularly due to US monetary policies and sanctions. In recent years, stringent US regulations on international financial transactions have disrupted Iraq’s banking sector. These regulations have led to currency instability, exacerbating the growth of black-market dollar trading, which undermines the official exchange rate of the dinar.
• Stabilizing the Iraqi Dinar: Iraq’s dependence on the dollar has fueled instability in the dinar’s value, making economic planning difficult. Dollar shortages have widened the gap between the official exchange rate and the black-market rate, creating uncertainty. The de-dollarization strategy aims to address this by promoting greater use of the dinar in financial transactions, reducing demand for US dollars.
• Geopolitical Independence: Iraq’s geopolitical position places it in a delicate situation. US sanctions on neighboring countries like Iran and Syria have had unintended economic consequences for Iraq. By reducing dollar dependence, Iraq seeks greater control over its financial system, mitigating the risks associated with external political pressures.
• Alignment with Global Trends: Iraq’s move toward de-dollarization aligns with broader global trends. Countries like China and Russia are leading efforts to shift away from dollar-based trade. The rise of alternative financial systems, such as China’s Cross-Border Interbank Payment System (CIPS), offers Iraq new pathways for conducting international transactions without relying on US-dominated systems like SWIFT.

Government Policies Encouraging the Use of the Dinar

The Iraqi government and the Central Bank of Iraq (CBI) have implemented several measures to accelerate de-dollarization:

• Banning Dollar Transactions: As of January 1, 2024, Iraq has prohibited cash withdrawals and transactions in US dollars. The goal is to curb illicit currency trading and stabilize the dinar by increasing its use in everyday transactions.
• Banking Reforms: The CBI has introduced regulations requiring banks to document wire transfers and meet international standards for financial transparency. These measures aim to modernize Iraq’s banking sector, improve liquidity management, and enhance public confidence in the financial system.
• Promoting Digital Payment Systems: The government is pushing for digital payments to reduce reliance on cash transactions, which have traditionally been dominated by the dollar. Encouraging businesses and consumers to adopt digital banking platforms could help formalize financial transactions and strengthen the dinar’s role in the economy.
• Encouraging Savings in Dinars: Public awareness campaigns are underway to rebuild trust in the dinar as a reliable store of value. By offering incentives such as higher interest rates on dinar savings accounts, the government hopes to reduce the tendency of Iraqis to hold wealth in dollars.

Challenges and Barriers to Full De-Dollarization

Despite these policies, Iraq faces several obstacles in fully shifting away from the dollar:

• Public Distrust in Banks: Many Iraqis prefer to store their wealth outside the formal banking system due to historical distrust in financial institutions. Approximately 90 trillion dinars are held outside banks, reflecting a preference for cash over electronic transactions. Without improved banking transparency and security, the transition to a dinar-based economy may struggle.
• Structural Economic Dependencies: Iraq’s economy remains heavily reliant on oil exports, which are priced in dollars. Until Iraq diversifies its economy and finds alternative ways to conduct oil transactions in non-dollar currencies, full de-dollarization will remain challenging.
• Persistent Black-Market Activity: The existence of a parallel black-market economy where dollars are traded at unofficial rates continues to undermine official monetary policies. Many businesses and individuals resort to this market due to limited access to official dollar channels.
• Regional Trade Dependencies: Iraq conducts extensive trade with neighboring countries such as Iran, Syria, and Turkey, where dollar transactions are common. Enforcing de-dollarization domestically while navigating these external dependencies poses a significant challenge.

How This Shift Could Impact Iraqi Dinar Exchange Rates

The success of de-dollarization policies could have profound effects on the dinar’s exchange rate:

• Short-Term Volatility: Restricting dollar transactions could initially create currency shortages and lead to exchange rate volatility as businesses and individuals adapt to new financial regulations.
• Potential Appreciation of the Dinar: If de-dollarization efforts succeed, demand for the dinar will increase, potentially leading to a more stable and appreciated currency. However, this depends on complementary economic reforms that strengthen Iraq’s financial system.
• Market Confidence and Long-Term Stability: The ultimate determinant of success will be whether Iraqis and international investors trust the dinar as a reliable currency. Without confidence in financial institutions and monetary policies, unofficial dollar trade will persist.

The Role of International Trade in Currency Independence

International trade will play a key role in Iraq’s de-dollarization strategy:

• Diversifying Trade Partners: Iraq is looking to expand trade with countries that are also moving away from the dollar. For example, China’s Belt and Road Initiative (BRI) could facilitate yuan-based trade agreements, reducing Iraq’s reliance on US dollar transactions.
• Strengthening Regional Trade Agreements: Developing regional trade agreements that enable settlements in local currencies can reduce the necessity of using the dollar for cross-border transactions. Expanding financial cooperation with Middle Eastern countries could further support this transition.
• Reforming Oil Revenue Management: Since oil exports form the backbone of Iraq’s economy, transitioning away from dollar-based settlements will require innovative financial strategies. Potential solutions include barter agreements, direct currency swaps, and partnerships with countries willing to pay in alternative currencies such as the euro, yuan, or ruble.

Conclusion

Iraq’s de-dollarization strategy represents a bold attempt to achieve greater economic sovereignty and reduce its vulnerability to US monetary policies and sanctions. While government policies such as banning dollar transactions and modernizing banking systems are essential, the transition is fraught with challenges, including public distrust in banks, economic dependence on oil, and persistent black-market activity.

The success of these reforms will depend on Iraq’s ability to diversify its economy, build confidence in the dinar, and strengthen regional trade ties using alternative currencies. If managed effectively, de-dollarization could stabilize the dinar’s value over time while positioning Iraq as a more independent player in an increasingly multipolar global economy. However, these efforts risk falling short of their ambitious goals without addressing fundamental structural weaknesses.

Without real change and long-term commitment, Iraq’s de-dollarization efforts may struggle to deliver the stability and independence the country seeks.