Guess Who's Coming to Dinar

Mr. Taheri, The Wall Street Journal:

In the Tehran moneychangers' bazaar on Manuchehri Street, traders are always on the lookout for the new sogoli. The word, which means "top flower," is used to describe anyone or anything that is popular at any given time -- a thoroughbred steed, a beauty in the harem and, on "Foreign Exchange Street," the dozens of currencies traded each day. These days the moneychangers' sogoli is a surprise newcomer: the Iraqi dinar. READ MORE

With the world media depicting Iraq as a ship sinking in a sea of blood, and self-styled experts predicting civil war or disintegration, it is hard to imagine why anyone would want to abandon such all-time favorites as the U.S. dollar and the euro, not to mention the oil currencies of the region, in favor of the world's newest money.

One reason, of course, is the sharp rise in the supply of dollars, a result of the dramatic increase in the price of oil. (Iran is earning something like $200 million each day from its oil exports.) Another reason is that hundreds of thousands of Iranians have registered to travel to Iraq to visit Shiite sites in Najaf, Karbala, Samarra and Kazemiah. Under a recent agreement, an average of 1,000 Iranians are allowed to perform the pilgrimage each day. (The number is to rise to 5,000 a day in two years.) To these must be added several hundred non-Iranian Shiites, mostly from the Indian subcontinent and the Persian Gulf, who travel to Iraq via Iran after visiting the Iranian holy city of Mash'had.

Yet another reason for the increased interest in the Iraqi dinar is the dramatic increase in the volume and value of unofficial exports from Iraq to Iran. Ironically, a good part of this trade consists of petroleum products, which are shipped from Iraq to four Iranian border provinces. Thanks to Iraqi government subsidies, petrol is 30 times cheaper in Iraq than in Iran. (There is also much smuggling of petroleum from Iraq to Turkey, where petrol costs 160 times more). Adventurous Iranian businessmen, often working on behalf of well-connected mullahs, are also making a killing by importing foodstuffs, medical supplies and consumer goods from Iraq, especially the Kurdish areas, at prices that defy competition inside Iran.

Iraq is also benefiting from a slow but steady transfer of Shiite religious funds from many foreign countries, notably Iran. The reverse was the case under Saddam Hussein, when the Shiite foundations were anxious to keep as little of their assets in Iraq as possible. In the past year or so, several foundations have started to withdraw their assets from Iran. The trend was accelerated last spring after the Iranian government seized assets worth some $200 million from the Khoi Foundation, named after the late Grand Ayatollah Abol-Qassem Mussavi Khoi. It is suddenly Iraq, and not Iran, that looks like the safe haven for Shiite foundations.

Angered by increasing state intervention in religious affairs, a small but growing number of Shiite mullahs are leaving Iran to settle in Iraq. There is further concern that President Mahmoud Ahmadinejad's new administration -- dominated by the Islamic Revolutionary Guard -- may order a crackdown against the clergy.

Iraq's economic attraction, however, is not solely due to the arcane calculations of mullahs and pilgrims. It is also reflected in the latest report by the International Monetary Fund, published last month. It offers a mixed picture. For example, the report estimates Iraq's annual economic growth rate at just over 4% for 2005, a sharp drop compared to last year, when the economy grew by 52%.

But a closer look shows that the Iraqi economy still performed surprisingly well. The 52% growth rate represented exceptional circumstances in the aftermath of liberation and was unsustainable. Furthermore, the current 4% growth rate is higher than the average rates for the members of the Arab League. It is also a full percentage point higher than the annual average Iran achieved during the eight years of President Muhammad Khatami's administration.

If oil prices hold, Iraq's gross domestic product per head is projected to reach $3,000 next year, making it number 12 in the Arab League; in 2003, it was number 18. The IMF report shows that Iraq absorbed only $4.2 billion in investments in the non-oil sector of the economy compared to the $5.2 billion forecast last year. That figure, however, ignores investments made by small and mid-sized businesses, as well as farmers and individuals. Anecdotal evidence shows that such schemes are acting as the engine of growth in many parts of the country.

The key reason for the strong performance of the Iraqi dinar, however, may be the sevenfold increase in the nation's foreign currency reserves -- from less than a billion dollars to $7.3 billion. And the real figure may be higher because the report, finalized last July, does not reflect the latest rise in oil prices.

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Some Americans might think that Iraq owes its robust economic performance to a flood of dollars provided by the U.S. taxpayers. The IMF report shows that this is not the case. Iraq is paying 90% of its own expenditures, including the cost of economic reconstruction. Of the remaining 10%, the U.S. accounts for four-fifths, with the rest coming from other donors. The bulk of the money the U.S. spends in Iraq is allocated to military and security operations, consultancy contracts and administrative costs.

The IMF speculates that within a decade Iraq could emerge as an engine of growth in the Middle East. Theoretically, this looks plausible. Iraq owns the world's second-largest deposits of crude oil and, once it produces its full OPEC quota, could take in up to $250 million a day from exports. It is also the only country in the Middle East that could easily double its agricultural production by introducing new farming techniques and equipment.

Nevertheless, Iraq's economic model suffers from two basic weaknesses. First, it is a rentier economy designed to distribute the oil income via state subsidies. Subsidies now account for 51% of the gross domestic product; the comparable figure in Iran is 22%, and 13% in Turkey. This limits the state's ability to invest in infrastructural projects, economic development programs and social services. It is clear that the current government under Prime Minister Ibrahim al-Jaafari lacks the political courage to reduce -- let alone abolish -- the subsidies that prevent the Iraqi economy from fully taking off.

The second weakness is the foreign debt inherited from Saddam Hussein, which amounts to $190 billion, including reparations distributed through the United Nations. (It excludes Iran's claim of over $1 trillion in damages.) Even under the best case scenario, servicing that debt could consume almost half of Iraq's GDP for the next decade. The best way to help Iraq would be for its creditors to write off the debts accumulated by an unrepresentative despot.

Iraq is in the process of crafting a more durable government. Economic reform should be a major part of that important effort.

Mr. Taheri is the author of "L'Irak: Le Dessous Des Cartes" (Editions Complexe, 2002).