Critical analysis of central banking in Iraq

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Content CRITICAL ANALYSIS OF CENTRAL BANKING IN IRAQ I / by Fawzi A. El-Kaissi A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (Economics) August 1957 UMI Number: DP23268 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Dissertation Publishing UMI DP23268 Published by ProQuest LLC (2014). Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code ProQuest LLC. 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 4 8 1 0 6- 1346 Ph- D E c . ' 5 ? £¥3 T h is dissertation, w ritte n by FawziA.. . . El-Kaissi u n d e r the d ire ctio n o f hi SG uidance C o m m itte e , and a p p ro ve d by a ll its members, has been p re sented to and accepted by the F a c u lty of the G radu ate School, in p a r tia l fu lfillm e n t o f re quirem ents f o r the degree of D O C T O R O F P H I L O S O P H Y i o l o £ Dean G uidance C om m ittee C h a irm a n \J£j 1 4 6 9 10 17 17 17 19 21 21 23 26 28 30 32 TABLE OF CONTENTS INTRODUCTION .... ................... Statement of the problem ........... Importance of the study ............. Sources of data ..................... Organization of the dissertation . . THE IRAQI ECONOMY . . ................... Land and population ................. L a n d ................... ............ Population ........ ............... Agricultural and industrial conditions. Agricultural conditions ........ . . Land tenure system ............... Recent trends in agricultural development ................... Industrial conditions ........ Industrialization of Iraq . . . . The petroleum industry ........... CHAPTER Foreign trade and balance of payments Foreign trade ............... . . . Exports ........... Oil exports . . . ............... Balance of payments ............. Public finance ..................... Public revenues ................... Public expenditures ....... i ; Public debt ...... ........ ! ! Conclusion | III. BANKING SYSTEM OF I R A Q ............... ] j Commercial banks ................... | Characteristics of the expatriate | banks ............................ i | Distribution of assets. ........... i Deposits ....... i Ancillary services ............... Non-commercial banks ............... The agricultural bank ............. ! Bank administration ............. iv i s PAGE 37 38 44 ! 45 47 50 j 51 | l 55 58 ; 6° ; 62 62 : i 63 67 j i 74 ; 75 ; 77 78 ; 79 ! CHAPTER v PAGE i IV. Capital structure and sources of funds ........ ......... 80 ‘’ 5 s - The bank's operations ....... 81 The industrial bank . ............. 84 Bank management ......... 84 Capital structure and sources of f u n d s ............ 84 The bank's operations . ........... 86 The mortgage bank................. 91 Bank management . . . . . . . . . . 91 Capital structure and sources of funds ............... 91 The bank's operations ............. 92 The credit mobilier ............. 95 The cooperative b a n k ............. 97 Conclusion ........................... 97 THE STRUGGLE FOR MONETARY INDEPENDENCE . . 100 National currency versus the Indian rupee .......................... 102 The opposition of the mandate authority......................... 104 VI CHAPTER PAGE The passage of the national currency law ............... 106 Iraq Currency Board . 109 Composition of the Currency Board . . 109 Duties and powers of the Currency Board . Ill The Government share in the earnings of the B o a r d .............. . . . . 113 Note issue and reserve requirements . . 114 Note issue .......... 115 | Reserve requirements ................ 117 i i i Operations of Iraq Currency Board, \ \ 1932-1939 ........... 119 | Development of money in circulation . 119 ' Status of the monetary reserve . .... 123 j Operations of Iraq Currency Board, ■ 1940-July 1949 125 Inflationary pressures .......... 125 Deflationary tendencies ........... . . . 129 Development of the monetary reserve . 130 V. MONETARY EXPERIENCES OF WORLD WAR II . . 133 CHAPTER v n PAGE Foreign exchange control ............. 133 Exchange control regulations .... ,134 Lawful purposes for exchange . . . 135 Control of the proceeds of exports . 136 Control of bullion, securities and foreign currency notes ...... 137 J Development of Iraqi sterling balances. 139 | Iraq's relations with the sterling ! I a r e a 140 I The dollar pool..................... 142 i The development of Iraqi sterling balances............ 145 Balances of the Iraq Currency Board ................. 145 Other balances ................. 147 Anglo-Iraqi sterling agreement . . . 149 The suspension of free convertibility of sterling....................... 154 CHAPTER VI. ! Vlll PAGE Sterling balances agreement of 1952 . 162 Conclusion............................ 166 THE ESTABLISHMENT OF THE CENTRAL BANK OF IRAQ........ . ..................... 170 The evolution of central banking ideas in Iraq during the 1930's ...... 172 The chambers of commerce favored a central bank . ................... 173 The report of Sir Hilton Young . . . 175 The attitude of the Iraqi Government. 181 The development of central banking ideas in Iraq during the 1940's . . . 183 Arguments for a central bank: Economic......................... 184 Money supply and liquidity .... 185 Rigidity of the rate of exchange . 187 High cost of the money supply . . . 188 The lack of a supervisory authority 190 Arguments for a central bank: political......................... 191 Was the establishment of the CBI f premature?....................... 195 i IX CHAPTER PAGE The central bank of Iraq— an'outline . 197 The management of the CBI . . . . . 197 Financial resources of the CBI . . . 197 Objective and functions of the .CBI . 198 Conclusion . 199 VII. ADMINISTRATION, CAPITALIZATION AND RESERVES OF THE CENTRAL BANK OF IRAQ . 200 Administration of the Central Bank of Iraq . . .......................... . 200 Principles of central bank adminis tration ............................ 201 Administration of central banks in leading countries .... ........... 202 Board of administration of the , Central Bank of I r a q ............... 208 The Governor General ................ 209 Members of the Board of Adminis tration ............................ 210 Duties and privileges of the Board of Administration ........ 215 Audit and publicity.................... 217 CHAPTER x PAGE VIII. Capitalization of the Central Bank of I r a q . . . 223 State versus private ownership . . . 224 The capital structure of the Central Bank of Iraq. . . . . . . . . . . . 227 Reserve funds of the Central Bank of Iraq ....................... . 231 General principles ............... 231 Reserve fund, provisions of.the Central Bank of I r a q ........... 232 Conclusion ........ ........ 234 THE MONETARY SYSTEM UNDER THE CENTRAL BANK OF I R A Q ....................... 236 Note issue and reserve regulations . . 238 Note issue regulations in leading countries......................... 238 Currency issue and administration by the Central Bank of I r a q ........ 243 The monetary standard............. 244 The monetary reserve . ........ 247 The determination of money supply . . 254 CHAPTER I IX. XI PAGE The supply of currency......... 254 Changing the volume of current accounts in the commercial banks....... 260 Changes in the Iraqi money supply, 1949-55 .............. ........ 265 Conclusion........................ 270 EVALUATION OF THE PRESENT MONETARY SYSTEM............................ 274 The objectionable features of Iraq's relation with sterling ............. 275 Subservience of the dinar to sterling 275 Impediment of political independence 278 A critique of Iraq's membership in the sterling a r e a ........... 279 Convenience...................... 279 Stability . . . I .............. 283 Access to the London capital Market . 286 The road to monetary autonomy.... 289 Assumptions................... 290 An increase in Iraq's dollar earnings................... 290 CHAPTER X. The pound, sterling remains inconvertible ..................... Approaches to alter Iraq's relation - with sterling............ . .... . Relinquishment•of the sterling-area - immediately ....................... Securing more privileges from Britain ......................... Gradual withdrawal from the sterling area ..................... Conclusion ............................ THE CENTRAL BANK OF IRAQ AS CONTROLLER OF FOREIGN EXCHANGE ................... The general principles of exchange control . . Definition of exchange.control, . . . The principal functions of exchange control ............................ The technique of exchange control . . The regulation of imports . . . . . The regulation of exports ......... PAGE 294 299 299 303 305 310 312 314 314 315 317 317 319 CHAPTER XI. xiii PAGE Multiple exchange rates............. 321 Exchange control practices in leading countries . . . v............. 322 Exchange control in I r a q ............... 324 Main features of exchange control in Iraq .... . . . . . . . . . . . 326 Exchange rate system ........ 326 Prescription of currency ......... 327 Nonresident accounts ............... 328 Imports policy ..... 329 j Exports policy . . . . . . . . . . . 334 Invisibles policy .... ......... 335 Policy toward capital movements . . . 337 Evaluation of the Iraqi exchange control policy ....................... 339 The need for a simplified exchange control system..................... 340 Conclusion.............................. 346 THE CENTRAL BANK OF IRAQ AS CONTROLLER OF COMMERCIAL BANKS..................... 348 Commercial banking legislation in leading countries ............ . . ._. __350 CHAPTER I xiv PAGE Canada.............................. 351 England.................... 353 France....................... 354 The United States .... ..... 355 Supervision of the commercial banks by the Central Bank of Iraq ..... 359 Application of the law ....... 361 Formation and liquidation........... 362 Formation.......................... 362 Liquidation .............. 364 Regulations during the operating life of a bank . . . . . . . . . . 365 Surplus .......................... 365 Restrictions on assets ........... 366 Deposits and interest ....... 371 Reports and inspection ........... 373 Penalties..................... 375 Reserve, foreign.investment and rediscount regulations .......... 375 Legal reserve requirements ..... 376 The ratio of banks* investments abroad....................... 377 XV CHAPTER PAGE Rediscount regulations. ............. 379 Conclusion ^ . 381 XII. ROLE OF THE CENTRAL BANK.OF IRAQ.IN . ECONOMIC DEVELOPMENT .................... 384 The development program, 1955-1960 . . 388 Scope of the development program. . . 390 Financing the development program . . 394 Experience of the years 1952rl955 . . . 395 Place of the Central Bank of Iraq in the development program . . . . . 401 The supply of adequate currency . . . 402 Channeling credit facilities........... 404 General instruments of.credit ........... 406 ! Principles of the general instruments of credit control.................... 407 Application of the general instruments of credit control by the Central . . Bank of I r a q ........................ 410 Adapting the general instruments of . credit control ...................... 412 Relation with sterling ............. 412 xvi j CHAPTER PAGE Liquidity of commercial banks . . . 413 Commercial banks.borrowing. . . . , from abroad................. 414 ; The absence of advanced money and . capital markets............ 415 Selective instruments of credit . . control....................... 419 Principles of selective credit control ..................... 419 Adaptation of selective credit, control by the Central Bank of, Iraq . . . . ..................... 421 I Existing instruments of selective * i i | credit control ............... 422 Suggested instruments of,selective, credit control....... ... 423 Coordination of monetary and fiscal policies....................... 427 Conclusion....................... 429 XIII. SUMMARY AND CONCLUSIONS............. 431 Problems confronting the Central , ____ Bank of Iraq . . . . . . ._. . . . ._____432^ xvii CHAPTER PAGE The future of the Central Bank of Iraq. 440 Summary of recommendations. 443 Relinquishing the sterling.area . - . 443 Eliminating the high liquidity of commercial banks ........ 445 Developing the capital and money markets ........... ....... 446 BIBLIOGRAPHY ..................... 448 f i LIST OF TABLES TABLE PAGE I. Value of Iraq Principal Imports... 39 II. Quantities of Iraq Imports of Textiles, Sugar and T e a ..................... 41 III. Balance of Payments, 1947 to 1955 . . . 48 IV. Budget Accounts, 1938-39 and 1950-51 to 1954-55 53 V. Main Liabilities and Assets of Commercial Banks in Iraq, 1952-1955 69 VI. Money in Circulation, 1933-1939 ....... 121 VII. Currency Liabilities and Reserves ; of Iraq Currency Board, 1933-1939 . . . 124 VIII. Indices of Volume of Money in Circulation, Cost of Living and Wholesale Prices in Iraq, 1940-1949 127 IX. Volume and Ratio of Iraqi Currency Reserves, 1939-1949 ................... 131 X. Iraqi Sterling Balances, 1947-1950 . . . 157 TABLE XI, XII. XIII. XIV. XV. i i { The Central Bank of Iraq Balance Sheet as at December 31, 19............ Status and Composition of Monetary Reserve Held by the Central Bank of Iraq .............................. The Iraqi Supply of Money December 31, 1949 to December 31, 1955 ............. Estimated Expenditures and Revenues of the Development Board March 1955- March 1960 .................................. The Impact of the Development Board Expenditures on the Price Level, Supply of Money and Foreign Trade 1952-1955 .............................. xix PAGE 220 i 249 267 391 i I 396 | CHAPTER I j INTRODUCTION i i Although central banks are quite old institutions, | i the art of central banking is still going through a slow i but continuous evolution. The first central bank to be ! J established was the Riksbank of Sweden in 1656; but “the Bank of England was the first bank of issue to assume the ! i position of a central bank and to develop what are ; t f i generally recognized as the fundamentals of the art of | J central banking."'*' The greatest efforts in establishing j i : a large number of central banks came about after the : I ( 1 meeting of the International Financial Conference at ! i i Brussels in 1920, which favored the formation of central j i 1 I ! j banks to restore and maintain the stability of the value » of money and to facilitate international financial i cooperation. j Up to the middle 1930's, the central banks were •4l. M. De Kock, Central Banking, revised edition (London: Staples Press Limited, 1946), p. 11. highly regarded as the main institution for eliminating economic fluctuations. Unwise operations for a central bank, it was said, could bring about the ruin of the financial machinery and monetary mechanism along with the I collapse of theeconomic structure of the country. Gustav | i Cassel, and many others, did not hesitate to consider the ! faulty monetary policies (for which the central banks were largely responsible) the main, if not the only, cause of depression. During and after the Great Depression, many j economists expressed their doubts regarding the ability of j i monetary policy, and the central banks, to prevent business I f cycles. They pointed to the acute depression then prevail-- i : ing as the best example of the accuracy of their opinion. They demanded that monetary policy should be supplemented by fiscal policy with taxation, public expenditures and j I public debt management as the main instruments.2 This 2 I "One of the most striking facts about the develop-^ I ment of fiscal policy in the past decade is that while it j I grew out of monetary policy and was designed to supplement! j and strengthen it, fiscal policy has ended up by threaten-J J ing to supplant monetary policy altogether.” John H. ' j Williams, MThe Implications of Fiscal Policy for Monetary | Policy and the Banking System,*' The American Economic I Review, 32:234, March, 1942. J i I point of view gained much ground during the late 1930's and the Second World War. It was accepted and adopted by a large number of economists and politicians. At the end of the Second World War, fiscal policy | j was unable to eliminate, or at least terminate, the hyper- j inflation which threatened the economic structure of many countries. Under these circumstances, the role of monetary | policy in economic stability was "rediscovered.’1 With the \ | j \ rediscovery of monetary policy, the importance of central i j banks as vital agents in the execution of economic policy i I | j was reconsidered. Presently, it is almost universally ! accepted that to achieve economic stability, the instru- i ! ments of both monetary and fiscal policies should be ' j j applied. The members of the ’ ’ Douglas Subcommittee” in the t » ! United States, for example, declared, j | ■ ! i . . . we believe that an appropriate, flexible, and vigorous monetary policy, employed in coordi nation with fiscal and other policies, should be 1 one of our principal instruments for achieving and maintaining economic stability. For several 1 reasons we reject the idea, held by few economists and others [underlining not in the original] that for stabilization purposes little or ho reliance should be placed on monetary policy and that we should rely exclusively on other measures, such as fiscal policies.^ Today central banks are once again resuming their authority as monetary stabilizers, mainly through the instruments of rediscount rate, open market operations, i legal reserve requirements, as well as some selective j i i instruments. As a result of this new importance of central banking, the post-war period witnessed the formation of many new central banks. Among those established at that ! time was the Central Bank of Iraq, hereafter to be referred' j to as the CBI,^ which was organized in 1947 and commenced j business in 1949. ! Statement of the Problem r The CBI was organized in 1947 with the objectives j of maintaining the stability of money and redirecting I ^United States Congress, Joint Committee on the | Economic Report, Monetary, Credit and Fiscal Policies, j | Report of the subcommittee on Monetary Credit and Fiscal i ! Policies, 81st Congress, 1st Session, Senate Document No. J 129 (Washington: Government Printing Office, 1950), p. 1 8 : ^The Bank was first called the "National Bank of Iraq," but in 1956 it was changed to the "Central Bank of j Iraq," hereafter the Central Bank of Iraq will be referred | to as the CBI. ! 5 credit facilities with due regard for the public inter est.-* The Bank is entrusted with most of the functions usually performed by central banks in advanced countries. Among these functions are: note issue, control of com mercial banks, control of foreign exchange and fiscal agent for the government. To pursue its objectives, the Bank, on the other hand, is authorized to use the instru ments of credit control usually associated with the art of ! central banking. The Bank, nevertheless, up to 1956, was unable to perform its functions satisfactorily. It was, for all practical purposes, a mere "currency exchange agency." The crux of tht e problem, therefore, is: the CBI possesses the fruits of central banking experience of ! jwestern countries, but is confronted with the problem of |being unable to adapt this experience to its own environ- i ment. By reviewing the historical, organizational and functional aspects of the bank, this dissertation hopes to accomplish two main purposes. First, to discover and i ----------------- i | ^Al-Waqayi'a Al-Iraqiya, No. 3818 of July 1956, Law i of the Central Bank of Iraq No. 72 of 1956 (Baghdad: The j Government Press, 1956), Article IV. 6 • ) make explicit those underlying problems preventing the 1CBI from functioning effectively. Second, to determine the possible solutions to these obstructions. Importance of the Study j i Much has been written on the subject of the eco- | i nomic structure, activities and conditions of Iraq. J Although in some of these works due regard has been paid | to the CBI, no work dealing with the Bank per se has, up i | to the present, appeared. This dissertation is an attempt ! to fill this gap. j I The CBI is a new institution established according j to a law promulgated, as noted, in July, 1947 and enforced j | in July, 1949. It is of great importance, therefore, to i j examine the background, structure, administration, opera- : i j tion and functions of the Bank in the light of past experi-j i I I j | ence, as well as to evaluate it in terms of the theory and | : I | art of central banking. The object is to find the short- j I I comings and defects of the Bank in order to stimulate I i interest in their removal. I Iraq is a member of the sterling area; its monetary I unit is completely tied to the pound sterling and its j i foreign reserves are kept with the Bank of England. It is ■ 7 of vital necessity to determine whether it is in the inter est of Iraq to remain in or to abandon the sterling area. The discussion will be based mainly on, first, World War i I II experiences of freezing the Iraqi assets. Second, the recent changes in the pattern and volume of the Iraqi i balance of payments. Third, the decline in the importance I of the pound sterling as an international currency. j Iraq, at present, is undertaking a comprehensive ! I program for economic development and it is witnessing a j i j radical shift from a semi-static to a dynamic system. Thej i t CBI is not only affected by this process, but it is also i i a factor in effecting it. Consequently, it is essential i to examine the role which should be played by the CBI to j i f aid the economic development of Iraq, and to analyze the ' structural and functional changes required to bring about i fl an effective monetary policy. J C I °According to a contract with his government, the ; writer is required to emphasize in his study, the field of | money and banking. Also the writer worked in the CBI for about three years and has a special interest in this I institution. Consequently, in choosing the subject of ! the CBI, the writer hopes to fill a gap in the economic j studies of Iraq, to satisfy his own desire, and meet, at , the same time, his obligations to his government. ' 8 | Limits of the Study ! It is beyond the scope of this dissertation to analyze and compare the theoretical or practical aspects of monetary and fiscal policies. The primary concern of this study is to analyze critically the organization and I i main functions of the CBI with the intention of finding the problems facing the Bank. These policies, however, are touched upon throughout the dissertation inasmuch as they are related to the discussion of the functions of the Bank. Hence, this study of the CBI should be understood to be the study of an institution in its organizational j i and functional aspects. j | In order to appreciate the CBI's significance and J : to understand its problems, it is necessary to study its I : economic background and environments. This requires the | discussion of (a) economic conditions in Iraq, (b) compo- \ i j I sition and characteristics of the banking system and j ! (c) the monetary system and development prior to the 1 I establishment of the Bank. ■ i i Due to the negligible importance of the function • of "fiscal agent for the government," it is not discussed ! i | in this study. Up to the middle of 1956, for example, thej i 9 government deposits were kept, not with the CBI, but with the Rafidain Bank, a state-owned commercial bank. Some references to this function, nevertheless, are made in | different chapters in relation to other functions. . i Throughout the dissertation, the writer is con fronted with the abundance of material in certain segments I i of the subject, and the inadequacy or complete lack of 1 l i it in other areas. Some of the statistical data, for j ! example, could be obtained up to 1956, other could be obtained up to 1953. Other data were completely unob- j \ tainable. The writer hopes, however, to open the road I for further and better studies of this vital institution i (CBI). I i ! | ; Sources of Data ; ! I As stated above, as yet, no book has been written ! ! dealing with the CBI but some references and brief treat- j ! I I ments could be found in books or reports on the Iraqi | i ! economy in general. For this reason, the writer had to j rely extensively on primary sources, particularly the | laws, by-laws, regulations, annual reports and quarterly bulletins of the CBI and other related institutions. j Secondary sources were used in connection with j _ 10 "j the theoretical and comparative aspects of the study. i t j Books and articles dealing with the central banking theory j ! and practice^ and with a specific bank of a certain country! were the backbone of the secondary sources. Books on the j subject of money and banking and general economics were also consulted, but to a limited extent. The publications of the United Nations, International Bank for Reconstruc- i i tion and Development, and the International Monetary Fund ! s 1 | were also utilized to some degree. j i i ; i j ! Organization of the Dissertation 1 ; A central bank does not operate in a vacuum; it is . interrelated with the economic system in general, and | j ! with the banking system in particular. The success or i I I | failure of a central bank's operations is determined to ! ! ! 1 a great extent by the conditions of these two systems. A ; i f I central bank, on the other hand, can well participate in 7 The following books proved more useful: C. B. Kisch and W. A. Elkins, Central Banks (London: Macmillan ; and Company Limited, 1932); R. G. Hawtrey, The Art of i ; Central Banking (London: Longmans, Green and Company, 1933); W. A. Shaw, The Theory and Principles of Central i Banking (London: Sir Isaac Pitman and Sons, Ltd., 1930); ! T. Newlyn and D. C. Rowan, Money and Banking in British ! Colonial Africa (Oxford: Clarendon Press, 1954). i i developing these systems. Accordingly, a brief review of the present economic conditions in Iraq, stressing the i recent economic changes, is outlined in the second chapter. The review centers around: land and population, agri cultural and industrial conditions; foreign trade and the i ! balance of payments; and, public finance. The purpose | i of Chapter II is not to give an exhaustive or complete I ! account of Iraq s economic structure for this would be beyond the scope of this dissertation. In Chapter III, i the banking system, excluding the CBI, is discussed. It I t shows the characteristics of expatriate and indigenous | banks; the distribution of their assets and liabilities; ! jand, the objectives and operations of the four state-owned i non-commercial banks. When the CBI was established in 1947, it was j I largely influenced by the monetary system as well as the monetary development preceding its establishment. For the purpose of furthering the understanding of the Bank, therefore, it is necessary to examine these two monetary ! ! I aspects, and this is the subject of Chapter IV. As it j i i will be shown, Iraq was under the Ottoman rule until 1918 ! t i when it was occupied by the British. The latter maintained! their hold over Iraq up to 1930 when they were driven out by a popular revolt. From the beginning, British occupa tion was opposed vigorously by the Iraqi people. The latter demanded immediate liberation of Iraq. The demand for monetary independence was a contingent part of Iraq's struggle for liberation. Within Iraq, there was a struggle, going back as far as 1927, between two groups: one favored the institution of a currency board in London, and the other group advocated the establishment of a central bank. The first force finally won the case in 1931, when a law was passed authorizing a currency board in London to issue and manage the Iraqi notes and currency. Because this predated the CBI a large portion j i ! of Chapter IV is devoted to the monetary system under the ; Iraqi Currency Board, with emphasis on the inability of ; I i j the Board to halt the inflationary pressure which pre- i vailed during the Second World War. I Chapter V takes up the subject of two monetary j developments, other than inflation, during the Second j I | World War. They are: the foreign exchange control and ; I the Iraqi blocked sterling balances. The discussion of J foreign exchange control in this chapter is rather brief | 13 because this subject is to be examined in a later part of the dissertation. The development of Iraqi blocked sterling balances is examined carefully from its origin in 1941 to its final settlement in 1952. Chapter VI deals with the establishment of the CBI in 1947. The struggle between the forces for and against the establishment of a central bank is analyzed with i special attention being given to the report of Sir Hilton j Young, the financial advisor of the Iraqi government. The forces of rising nationalism and inspiration of independ ence in monetary matters, and the pressing economic needs i in Iraq are particularly discussed and evaluated. j In determining the organization of a central bank, the main consideration must be to provide a constitution j that will, from its nature, be directed towards the furtherance of the public interest. In addition, a central bank must be adequately supplied with capital to give confidence to the public; to provide a fund for the carry- j i 1 ing out of its operation in the money market, as well as , ! 1 to enable it to acquire premises and equipment for the j purpose of its business. Chapter VII analyzes the Bank's j i administration and organization; the method of j capitalization; the provisions related to reserves and profits distribution; and the procedures of liquidation. The objective of the chapter is to discover which of the above mentioned structures, provisions and procedures are I I adequate to secure.the proper functioning of the Bank in j the public interest. Chapters VIII through XI represent the core of the dissertation. They provide a critical analysis of the »o principal functions and duties of the Bank. Note issue, management of the supply of currency, the development of money in circulation and related aspects of the monetary j ! system of Iraq are discussed in Chapter VIII. Some ! iemphasis is placed on the impact of the Jewish immigration | j . . . ' ;and economic development spending, on the volume and |composition of the money supply. The analysis is cen- I ! i itered, however, around the problem of the relation between j | I ;the Iraqi dinar and the pound sterling. In Chapter IX the evaluation of the present monetary system is presented. I Heavy emphasis is placed on the arguments in favor of and j %he functions of the CBI are listed in the Law of the Centfral Bank of Iraq No. 72 of 1956, op. cit., Article IV. 15 against maintaining the status quo with the sterling area. The second important function of the Bank is exchange control. The Bank undertook this responsibility from the “Exchange Control Committee” in 1950. Chapter X deals with the development of the principles of exchange control since the Bank took over this function. The chapter emphasizes the impact of the monetary and trade relations with the sterling area, as well as the enactment of Bretton Woods Agreements on these developments. The third important function of the Bank is the control and supervision of the commercial banks. In Chapter XI, the discussion is directed toward the objec- i i : tives to supervision, the limitations of supervision and ' I | the functions of supervision. An attempt is made in ; this chapter to answer questions regarding what procedures,! i ! practices and allocation of responsibilities will be most j t ! ! effective in the accomplishment of the public interest, i not only with respect to individual banks and their ] ( particular problems, but also with respect to problems j affecting the whole banking system and the general economic situation. Chapter XII studies the role of the Bank in the economic development of Iraq. It shows the relation between the Development Board’s activities and the means through which the CBI can assist the process of economic : development. Special stress is placed upon the importancej of the traditional instruments of credit control as well t as upon the obstacles limiting their effective application.j In Chapter XIII the writer hopes to bring together i the outstanding findings, reflections and conclusions of the previous chapters. j CHAPTER II THE IRAQI ECONOMY ! Iraq is a small country with a total population in 1947 of about five million and an area of 168,400 J I I square miles. It is located in the heart of the Middle I East with Iran to the East, Syria and Jordan to the West, j Turkey to the North and Saudi Arabia and Kuwait to the J i ! South. Although an independent country only since 1932, j Iraq has a long and checkered history. It has witnessed I I the rise and fall of many civilizations and seen many conquerors. Since time immemorial it has been the ; frontier land where rival civilizations, penetrating from i : i , the East and the West, have contended for supremacy. ! i I s I. LAND AND POPULATION ! I Land Limited on the East side by the mountains of Iran, i and on the West by a more arbitrary line in mid-desert, Iraq's several regions vary considerably in character and j I even in climate. In the South is the alluvial plain, , 18 irrigated by the two great rivers, Tigris and Euphrates. In the North are the undulating uplands of the old area of Mosul. These are the main divisions, but also included within its frontiers are a large slice of the Syrian I Desert and approximately one-third of mountainous I I i Kurdistan. The Southern alluvial plain encloses within its ! boundary an expanse of entirely flat and stoneless river- ! born soil. It is potentially very fertile but it requires artificial irrigation to compensate for climate i i shortcomings as the annual rainfall averages only about j six inches. ! i Depending for its cultivation on artificial irriga- I tion, the entire plain is threaded and crisscrossed with 1 j waterchannels and the remains of ancient canals, testify- i I ing to the sixty centuries of human industry and ingenuity,| i It is also flecked with innumerable mounds, each repre- j j senting the accumulated remains of some human settlement, ! now abandoned. The greater part of northern Iraq may be called upland country. It is undulating, gravel steppe and rich ploughland, with some stone. Here the average rainfall , i ~ 19 is sufficient for it to yield a single crop without irriga tion, wherever the soil is suitable, so that only gardens < i |and plantations are artificially watered. Between the j two rivers, in the center of northern Iraq, is a wedge of ; i i uncultivable gypsum desert known as Al-Jazirah, itself I i divided by a strange deserted wadi, called Thar-thar. This! wadi runs due north and south and ends in a salt lake j ] which was recently converted into an irrigation reservoir. i i Indications point to the existence of extensive j I ' * mineral deposits in Iraq. Of these, by far the most ; important is petroleum. There are also important deposits of copper, iron, chromite and other ores. j t ! ! i Population ‘ J The first (and last) census taken in 1947 gave a I 1 j total population of 4,566,185A (excluding nomads estimated [ ! at 250,000), of whom 2,127,345 were males and 2,438,840 were females. Psychologically and historically the Iraqis are an old people, but biologically they are very young. •1-All figures shown in this Section unless otherwise mentioned are taken from: United Nations; Department of Economics and Social Affairs, Demographic Yearbook, 1955 (New York, 1955), Tables 1, 5, 7, 10, 21 and 26. Like all other countries at a similar stage of development, about half of Iraq's population is under the age of twenty. Although demographic statistics are far from adequate, it appears that the population has been growing at an annual rate of somewhere between one and one-half per cent. Most of the population is rural: about 66.2 per cent live in villages and towns of less than ten thousand inhabitants. About five-hundred and fifty thousand people live in the municipality of Baghdad, another three hundred thousand in the next three largest cities of Mosul, Basrah and Kirkuk. The majority of the population is Moslem or belongs to offshoots of the Moslem religion. The density of population in Iraq averages eleven inhabitants per square mile. A comparison of Iraq's density figure with those of other countries indicates its capacity to support an enormous additional population. The proportion of literates in the population is quite low, being about 12 per cent. It is generally higher in the cities than in the villages and it is much lower among women than among men. There is no systematic calculation of the national income in Iraq, but a rough estimate by the Statistical Office in the United Nations put the income per head in 21 ! o 1949 at eighty-five dollars. The standard of living of the people is extremely low and they are subject to debili tating diseases. This situation leads to and is caused by j the low output and low productivity of the country. II. AGRICULTURAL AND INDUSTRIAL CONDITIONS Agriculture has always been the principal activity of the country and still employs over 60 per cent of the workers. Their productivity is extremely low because of the land tenure system, the lack of irrigation facilities, i and the limited use of fertilizer and machinery which ! i necessitates allowing part of the land to lie fallow each i ! year. Manufacturing had a late start in Iraq but expanded ! i i | to a limited extent in the 1940's under the stimulus of | war and the government policy of industrialization. i | | Agricultural Conditions ! In no other Middle East country outside Egypt is ! ' ; soil of such potential fruitfulness to be found as in Iraq, with its rich silt land between the two rivers. Yet, ^International Bank for Reconstruction and Develop ment, The Economic Development of Iraq (Baltimore: The Johns Hopkins Press, 1952), p. 131. r~~ n ” ] | i agriculture could hardly be considered developed. Crop yields are generally low. The water supply is frequently j inadequate because of the absence of irrigation projects. Agricultural methods are still the same as thousands of years ago. Animal manure or fertilizer is scarcely used. Crop rotation is wholly insufficient and makes little or no provision for soil-building crops. Poor drainage has caused salinity, which in turn has lowered the productivity l of land in the irrigation zone. The efficacy of the j i fallow system is limited by allowing weeds to grow in the : i uncultivated part of the land to afford grazing for | animals. The productivity of livestock is also low resulting from improper feeding, poor breeding, disease and insufficient shelter. Barley, wheat, rice, dates, other fruits and vegetables, and, more recently, cotton, are the principal crops. Animal husbandry is of great importance, but at present is not really integrated with agriculture. There is virtually no mixed farming. It is the opinion of the writer that any scheme for agricultural development in Iraq should give more atten tion than is being done to the abandonment of the present land tenure system and the devotion of greater efforts to erect sound irrigation and transportation projects. i When this is done, all factors contributing to the low productivity and low standard of living would lessen and j perhaps in time would cease. Land tenure system. The land tenure system in Iraq is based on large-estate holdings by the sheiks, aghas or the cities* notables. Usually, the owners are either engaged in some political activity, or use the I income from the land for living purposes, without con- I tributing anything to the national dividend. They are a ! parasitic class of absentee landlords who have little \ ! | : interest in the development of agriculture. Consequently, j ! ' this system is keeping the major portion of the population j ill-fed, ill-housed, ill-educated and ill-cared for in j i j j every way. In response to a report prepared by Sir Ernest Dawson, one of the most penetrating students of Iraq's land questions, the government enacted the Land Settlement 3 Law Number 50 of 1932. The important provision of the Law is the establishment of a number of so-called Land Settlement Committees to carry out cadastral surveys. By the end of 1953, titles to 16,126,000 hectares (hectare = .62 acres) had been settled; this represented 68.4 per cent of the area of the country, excluding the desert regions. As to the distribution of land, the agricultural j census of 1953 shows that eighty-five thousand holders, i i or 68 per cent of the total, owned about 8 per cent of the j total area. At the other extreme, some thirty-three I i thousand holders, with over one hundred hectares each, | * owned some 85 per cent of the total area. The majority ; I i of the agricultural population is landless.^ ! Since 1945, the government has been attempting to remedy this situation, by settlement schemes on government-' owned land which accounts for nearly two-thirds of the settled area. In that year the Dujailla Settlement Act ^Government of Iraq, Principal Bureau of Statistics,: "Land Settlement," Statistical Abstract, 1950 (Baghdad: The Government Press, 1952), p. 108. ^United Nations, Department of Economic and Social Affairs, Economic Development in the Middle East, 1945 to 1954 (New York: 1955), p. 95. Number 23 was passed and put into effect in 1946. Follow ing the successful, though limited, experiment in the Dujailla, the government in 1951 passed the Law of the Development and Exploitation of the Miri Sirf 5 Land Number 43. According to this Law, the land which was recognized as state-owned in the cadastral survey, will | be reserved for distribution among the landless farmers. Naturally, the big landlords opposed these schemes and fought them bitterly. In the Dujailla Settlement, for example: j . . . the supply of local farm workers was seriously endangered when 50,000 land hungry fellaheen applied for the 1,200 Dujailla tracts. To still the clamor of the sheiks of five neighboring tribes, the government gave title | to 127,680 donums earmarked for the project, I while only the remaining 147,840 donums were set aside for the original purpose. To create small holdings, the government had at the same time to create or consolidate some very large properties. Despite this, in 1945, local sheiks, in order to prevent a movement of fellaheen from their estates to Dujailla, threatened to break the dykes, which would have flooded the entire I settlement.6 - * Miri Sirf land is the one which is acknowledged to belong to the state although it is particularly vacant or idle. ^Gabriel Baer, "The Agrarian Problem in Iraq," Middle Eastern Affairs, 111:390-391, December, 1952. However, the settlement schemes went on and at the end of 1954, there were six projects, and approximately j ten thousand and two hundred farmers had been settled on I i five hundred and ten thousand hectares. Farmers are organized into supply and marketing cooperatives. They are given the land free of rent for ten years, after which those who made good are granted title without charge. Further projects are under way, including the distribution I of 1,125,000 hectares in Mosul province, the distribution of one hundred thousand hectares near Baghdad, the expansion of the Hawijah Settlement and the distribution j i 7 1 of land near Basrah and along the southern Euphrates. ; Recent trends in agricultural development. The i i - i | year 1951 could well be considered the turning point in j i [ the economic history of Iraq. That year the oil agreements between Iraq and the oil companies were revised with the effect of expanding petroleum production and increasing the oil royalties to be paid to Iraq. Under the stimulus j of the anticipated rapid increase in revenues, the Iraqi j ^Economic Development in the Middle East, 1945 to j 1954, op. cit., p. 95. . 27 Government initiated an over-all plan to develop the resources of the country. In 1950, a Development Board was established and a comprehensive plan of development, which has been revised many times, was drawn up. Origi- i nally, all the proceeds from oil royalties were earmarked for economic development, but in 1952 this was amended to 70 per cent plus such other sums as may be allotted to it by Parliament, and the proceeds of any foreign or domestic loans. j The latest development program, 1955-1960, calls [ for expenditures of I.D. 500,007,320,® (Iraqi Dinar = one j ! i pound sterling = 2.8 dollars). Flood control, irrigation i i and drainage projects claimed the largest share (30.7 per j cent) of these expenditures. The total estimated area I I ^Government of Iraq, Development Board, Law No. 54; | for the Year 1956 Amending the Law of the General Program me of the Projects of the Development Board and the Ministry of Development No. 43 for the Year 1955 (Baghdad: The Al-Ani Press, 1956), p. 3. One should bear in mind j that this five-year plan will be affected directly by the | destruction of the Iraqi petroleum pipe lines, as a I result of the Anglo-French-Israeli invasion of Egypt in ! October, 1956. j i Time Magazine reported that Iraq had lost, as a j result of this destruction, about seventy million dollars | in oil revenues. Time Magazine, LXIX:30, May 27, 1957. which will be irrigated by the various project schemes is 1.8 million hectares; 1.24 million hectares on the Tigris and 560,000 hectares on the Euphrates. Work is also proceeding on the drainage of 233,000 hectares. The j program provides for an expenditure of thirty-five million dinars for land reclamation. Since April, 1956, the work on two important flood control projects, namely, the Tharthar on the Tigris and the Habbaniyeh on the Euphrates, has been completed.^ The data available on agricultural conditions j i indicate that, since World War II, Iraq extended its area j i under cultivation and increased its output, mainly ! | j through increased irrigation and greater mechanization. | It is expected that this trend will not only continue for ! some time to come, but also will proceed at a faster pace owing to the planning undertaken by the Development Board. ! | i Industrial Conditions 1 "l _ " 1 " , r i r i " r "- T " 1 r r " ' I In spite of the expansion registered during the past twenty years, industry, excluding petroleum, occupies l ^Government of Iraq, Development Board, Major ' Irrigation Projects (Baghdad: No Press, 1956), pp. 1-3. j 29 I a minor place in the economy of Iraq. It is estimated that fewer than 5 per cent of the working population are in industry. Many industries are still close to the handi- I craft stage and still use methods which are obsolete in i _ « countrie, The £radltional craftS , „ U | I I account for a sizeable part of total output; they com- j pletely dominate certain fields, such as rug-making, and i i i play an important part in pottery-making, weaving, shoe- j j making, leather work and some other industries. In 1 j i certain cases a partial adaptation of the craft to modern j conditions has taken place through use of power-driven [ machinery to supplement hand work. With few exceptions, I j | even the modern enterprises are not capitalized to an j f t extent at all comparable with similar industries in j ; western countries, and with the oil industry in Iraq. | i J Among the industries which have advanced beyond the handicraft stage are cotton ginning, spinning and weaving; rayon weaving; beer brewing and the distilling of alcohol; manufacturing of cement and building materials; and the making of vegetable oils and soap. No comprehensive figures on investment or employ ment are available. Available statistics do show that 30 less than half of the manpower employed is engaged in handicrafts proper. The petroleum industry employs about i i thirteen thousand, the textile and leather industries about fifteen thousand, building materials industries i about six thousand, food and beverage industries about j i forty-five thousand and the tobacco industry around four j i 10 ' thousand workers. The capital invested in the major ! t I industries, excluding petroleum, increased from three million Iraqi dinars in 1943 to I.D. 4.4 million in 1952. i The value of production rose from I.D. 1.4 million to I.D. | | 3.6 million for the same period.H i j Industrialization of Iraq. The government attempted : to promote industrialization as far back as 1929 with the ! i I J enactment of the Encouragement of Industries Act which | exempted industrial machinery from certain taxes. In i 1935, the Agricultural and Industrial Bank was founded to j extend loans to both agriculture and industry. A separate j | i i Industrial Bank was set up and started its operation in Carl Iverson, A Report on Monetary Policy in Iraq (Baghdad: National Bank of Iraq, 1954), pp. 71-72. 11Economic Developments in the Middle East, 1945 to 1954, op. cit., p. 99. 31 j 1946. In 1950 the Encouragement of Industries Act was replaced by new legislation to grant limited exemptions i for some industries from income and surtaxes for four ! j years; exemptions for some industries from import duties | i i on machinery, material, equipment and spare parts; j i exemptions from property tax for ten years; and use of ] I rent-free government land not in excess of twenty-five j ! ; thousand square meters for a period of ten years. Further- more, industries are protected by.high import duties on j I competitive foreign goods. j In recent years, the Development Board has paid more attention to industrialization than when it was first ' I ! founded. While only two hundred and twenty thousand j t ( i j dinars were devoted to industrial purposes in the initial | j j j t I development program, the Board allotted I.D. 67,119,217 j I J for industry, mining and electrification in its latest l ! plan. These figures include I.D. 11.5 million for improv- i ing and expanding existing industries; I.D. 12.3 million for new industrial projects; I.D. 10.7 million for indus trial projects under study; and I.D. 4.8 million for other industries, including one million dinars for atomic j ^2 j industries. The new industrial projects which have been studied already include plants for sulphur extrac tion, paper, dates syrup, dates folder, a steel rolling mill, a steel furnace and rayon textile mills. Among the industrial projects under study are: fertilizers, plastic materials, caustic soda, mining and a gas pipe line. The petroleum industry. Mineral oil has been known and utilized for various purposes by the inhabitants of Iraq for several thousands of years. Yet, its indus trial importance was not recognized until the early years of the present century. Political and other exigencies, however, delayed the development of Iraq*s resources until | after the First World War, when in 1925, the Iraq Petro- j ; leum Company obtained the first oil concession from the j Government of Iraq. The company discovered oil in large j quantities in 1927, when the famous Baba Gurgur well near I Kirkuk came in with a production of sixty-thousand barrels | per day. By 1938 there were four oil companies operating j in Iraq. •^Law No. 54 for the Year 1956 . . . , op. cit., pp. 29-35. 33 j Up to 1950, the concessions required that the oil ) I ! companies pay a royalty of four gold shillings per ton of oil exported or sold in Iraq. In 1947, the Iraqi Govern- ! ! ment demanded that the "gold*1 should be translated into i. sterling at unofficial open-market rates. This led from 1947 to 1951 to repeated discussions between the govern ment and the company, relative to the demand by the government for a revision in the amount of royalty. The question of royalty revision resulted in 1950 in a partly retroactive and conditional agreement to raise the four ! shillings gold per ton to six gold shillings. However, \ i two important events occurred at that time: the national- | ! \ j ization of the Anglo Iranian Company and the announcement i i of the Arabian-American Oil Company in Saudi Arabia that ; I ' i it was going to follow a new principle of half-and-half j i division of the profits in its oil agreement. These events brought about a lengthy negotiation between the Iraqi Government and the three oil companies operating in Iraq, ! on the principle of a fifty-fifty sharing of profits. In 1 February, 1952, a new agreement was reached, retroactive to January 1951. This agreement provided for an equal sharing of j profits, with profits to be determined before deduction of i I foreign taxes, on the basis of fixed values and costs of petroleum. Minimum production was agreed at thirty million tons a year from the end of 1955 onward. Minimum receipts to Iraq were guaranteed to be twenty million dinars in 1953 and 1954, and twenty-five million dinars in 1955 and thereafter. \ Actually, the new agreement left the oil companies with more than half of the profits, as: . . . under the equal profit-sharing agreements concluded during 1950-1952 between the governments of oil producing areas [including Iraq] and the concessionary oil companies, the parent companies of the latter were able to obtain petroleum at a discount of 15 to 20 per cent from the posted ! prices. Thus, profits of the producing companies,and consequently the oil revenues of the governments, j were reduced.^ ! In 1955, the Iraqi Government reached an agreement with the oil companies to reduce this discount to 2 per cent and made it retroactive to 1954. Iraq's oil income for that year was consequently raised by 18 per cent. Negotiations are still in process to make the provisions ■^United Nations, Department of Economic and Social Affairs, Economic Developments in the Middle East, 1954- 1955 (New York: 1956), p. 66. "~35 I I retroactive to 1953. The difference for that year amounts to about twenty-two million dollars.*-4 The petroleum industry in Iraq has made striking progress since the end of World War II. Production, which had been as low as one hundred five thousand metric tons in 1927, rose to 4,680,000 in 1946 and to 29,550,000 in 1954, representing in the latter year 4.5 per cent of the world*s crude petroleum output as against 1.5 per cent j I in 1938. This production may be compared with proved i oil reserves, which were estimated at 2,300 million tons i at the end of 1954.^-> j Iraq is exclusively an exporter of crude petroleum, j f The value of petroleum exports was one hundred and sixty- j eight million dinars in 1955, compared with ten million | dinars in 1938. j i Refining activities are expanding. At the end of i 1953 there were three refineries with a combined annual 1 capacity of nearly eight hundred thousand tons of crude throughput. In late 1955 a government owned refinery at 14Ibid., p. 67. ^ Economic Developments of the Middle East, 1945 to 1954, op. cit., p. 96. 36 Dora, with a capacity of 1.2 million tons a year, began operation. Consumption of petroleum products increased from about one hundred and ninety thousand tons in 1938, to three hundred and eighty-five thousand tons in 1946, j and eight hundred and thirty-five thousand tons in 1954. ! , ■■ | This growing domestic demand for petroleum products is due \ I i to increased industrial and transport activities, as well as gradual mechanization of agriculture and increased use ! t of petroleum for lighting, heating, cooking and other j i i household uses. ! i | Iraq's petroleum revenues increased sharply after i 1950 as a result of rising oil production and exports, as i I i well as improvements in the terms of payment to the j l l j government. In 1938, royalties received by the Government j of Iraq were I.D. 1.98 million, in 1946 were I.D. 2.33 | million, and in 1950 were I.D. 5.35 million. After the conclusion of the equal profit-sharing agreement, the revenues of Iraq from oil jumped to I.D. 37.41 million in 1955. It is estimated that in 1955, oil income plus local expenditures of the petroleum companies represented approximately one-third of the national income in j i 37 Iraq.-*-** It is expected that this trend will continue for some time because of the construction of new pipe lines and because of the increasing demand for petroleum in the world markets. Oil royalties and local expenditures by the oil companies are paid in sterling and they constitute a great part of Iraq's receipts of foreign exchange which facilitate the implementation of its economic development program. III. FOREIGN TRADE AND BALANCE OF PAYMENTS The normal pattern of Iraq's foreign trade, like many underdeveloped countries, is that imports consist mainly of manufactured products, while exports consist almost entirely of primary products. In recent years the most outstanding feature of Iraq's foreign trade has been the growing importance of oil exports which, through the payment of royalties, helped to meet the deficit in the balance of payments. • ^Economic Developments in the Middle East, 1954- 1955, op. cit., p. 66. 38 Foreign Trade Trade, domestic and foreign, is the second impor tant occupation in Iraq. Iraq produces most of its foods, but apart from fuel, tobacco, and some building materials, most of its other requirements must be imported. Even the small local industries and handicrafts depend to some extent on imported raw materials. Much of the trade is therefore foreign trade.^ Imports. Table I shows the value of the principal imports of Iraq for 1938 and for the last four years. The Table indicates that, up to 1955, more than half of the imports were consumer goods, of which textiles, sugar and tea were the most important. In order to eliminate the price factor, Table II gives the quantities of the principal consumer goods imported. It is to be observed that the imports of sugar and tea are more than triple what they were before the war, and are increasing continuously. This explains the great desire on the part of the Development Board to establish a sugar factory in Iraq to satisfy all or part of the local needs. Imports of woolen and cotton textilesj i ■^The Economic Development of Iraq, op. cit., p. 155. 39 TABLE I VALUE OF IRAQ PRINCIPAL IMPORTS (In Millions of Dinars) 1938 1952 1953* 1954* 1955* I. Consumer Goods 3.6 23.0 22.2 26.1 29.0 Sugar 0.5 6.3 5.1 5.3 5.3 Tea 0.4 3.5 4.8 6.4 8.1 Food, Beverages and Tobacco 0.4 0.4 0.5 0.6 0.6 Cotton and Rayon Piece Goods 1.3 8.1 7.7 8.5 8.6 Other Textiles and Clothing 0.9 2.2 2.0 2.6 3.0 Soap and Matches 0.1 0.9 0.7 0.8 0.8 Chemical Pharma ceutical Products 1.6 1.4 1.9 2.6 II. Capital Goods 3.8 23.0 20.8 25.3 29.0 Cement and Timber 0.5 1.3 1.1 1.5 3.1 Iron and Steel 1.1 8.7 5.6 6.8 11.3 Automobiles, Trucks and Parts 0.5 3.8 4.0 5.8 9.1 Machinery, Elec trical and Other Transportation Equipment 1.7 9.2 10.1 11.2 15.5 *Excluding the value of imports by the oil companies. 40 TABLE I (continued) 1938 1952 1953* 1954* 1955* III. Miscellaneous 2.0 15.8 12.2 15.6 22.9 Total 9.4 61.8 55.2 67.0 90.2 Oil Companies' Imports 1.0 14.4 - - Net Imports 8.4 47.4 55.2 67.0 90.9 Source: Quarterly Bulletin of the Central Bank of Iraq, I January-March 1956 (Baghdad: Thomas Printing j Press, 1956), pp. 99-120 and International Bank j for Reconstruction and Development, The Economic J Development of Iraq (Baltimore: The Johns j Hopkins Press, 1952), p. 156. ! I i 1 I TABLE II QUANTITIES OF IRAQ IMPORTS OF TEXTILES, ..SUGAR AND TEA Piece Goods Sugar Tea Cotton Ar.- Woolen Silk (in million square meters) (000 Tons) 1953-39 Av. 60.6 17.3 2.2 40.5 3.0 1952 37.9 23.9 1.3 90.4 8.6 1953 37.6 38.1 1.2 101.3 12.2 1954 38.0 48.2 1.8 120.2 12.7 1955 34.5 66.4 2.2 123.3 16.5 Source: Quarterly Bulletin of the Central Bank of Iraq, . January-March 1956 (Baghdad: Thomas Printing Press, 1956), !p. 21,and International Bank.for Reconstruction and j Development, The Economic Development of Iraq (Baltimore: ; ;The Johns Hopkins Press, 1952),p. 157. j i i ; hi i 42 show some decline when compared with the pre-war average. This could be explained by the increase in domestic production of textiles; the shift in the pattern of con- ; sumption from cotton and wool textiles to rayon and nylon ! whose imports are triple the pre-war level; and the j j increase in the imports of secondhand clothing from the j { United States. Because of the great demand on artificial 1 i silk products, the Development Board allotted in its \ I Five-Year Plan the’ necessary funds for the establishment ; of rayon textile mills and a rayon plant. j / ! Both soap and matches are made in Iraq, but soap j | manufacture was, until recently, a '’ backyard" industry ; and the quality of the product was poor. The rise in the j • { imports of chemicals and pharmaceutical products coincides! i * i with the ever increasing endeavor to improve the health I standard of the masses. The impact of the development expenditures on the t I | importation of capital goods is quite clear, as for the j i first time in 1954 these imports, excluding the oil companies' imports, exceeded the imports of consumer goods. The value of these goods in 1954, for example, i increased by 32.1 per cent over the previous year. j Machinery, iron and steel, and automobiles lead the parade Among the leading categories of machinery are irrigation pumps and agricultural machinery; imports of the latter having greatly increased since the war. Other items include equipment for electricity production and distri bution, and plants for the various new industries, such as textiles, distilling and cement. I ; The miscellaneous category includes such items as Iraw materials or other products used in industry, glass ware and ceramic products. The United Kingdom has been, and still is by far, the most important country of origin of the imports of Iraq. She is followed by the United States, Japan, Ceylon and Germany. The United Kingdom in 1955 claimed 24.5 per cent of Iraq imports; the United States 15.5 per cent; Japan 9.0 per cent; Ceylon 8.4 per cent; and Germany 8.3 per cent.*-8 Here it is worth mentioning that Japan was ! ! j the second largest supplier of imports to Iraq prior to the Second World War. Today the United States has taken l 1 18 I The Quarterly Bulletin of the Central Bank of Iraq, January-March 1956 (Baghdad: Thomas Printing Press, 1956), p. 22. 44 its place. Exports. Exports of commodities, other than petroleum, fluctuate considerably from year to year, with changes in the size of crops, but an upward trend may be discerned in the post-war period. Merchandise exports, i excluding oil, increased from an average of I.D. 3.9 million for the years 1936-39 to an average of I.D. 12.6 million in 1945-47, and to 18.7, 19.1, 18.0 and 17.0 j | million Iraqi dinars in the years 1952, 1953, 1954 and I - 1 Q 1955 respectively.1- 5 The comparative decline in exports I during the last two years was mainly due to the flood of ; 1954, the increased domestic consumption of foodstuffs and the enlarged utilization of domestic raw materials i in the home industries. I | The three predominant groups of exports are dates, | i ; | cereals and animal products. The combined value of ! cereals exported was little over 50 per cent of the value I of total exports for the last four years. The export of j barley was by far the leader among them. The second j i 1 ; I 19Ibid., p. 23. ! _ -4-5 -] I outstanding item is dates. Iraq has long been the fore- | most exporter of dates in the world. The ratio of dates exports to total value exported for the last four years ! was 20-25 per cent. Animals and animal products exports j constituted 10-15 per cent of total exports for the same period. If exports of petroleum are excluded, the United Kingdom is the most important market for Iraqi goods. During the last three years, however, Germany, Denmark and Holland came very close to claiming this importance. 1 I j In 1954, as a matter of fact, Holland was the leading t | importer of Iraqi goods, followed by Germany, then the [ i j United Kingdom. In 1955, the United Kingdom regained ; ' ' its first position. Regarding the position of the United ; I States, it was recently dropped from the list of the major i j importing countries. The principal cause for the change 1 | in the importing countries was due to the change in their ; i j 1 demand for Iraqi barley. Holland, Germany and Denmark have increased their demand at the expense of barley ; ( | exports to Britain, India and Italy. 1 j Oil exports. So far, oil exports have been 1 excluded from Iraq exports, the main reason being that J . 46 1 I oil exports affect Iraq*s foreign trade only through the receipts of royalties rather than the value of oil exported. Exports of oil have increased tremendously during i the 1950fs, owing to the construction of new pipelines to ! the seacoasts; the revision of oil agreements, which raised the previous minimum quantity to be produced i annually; the increased demand in the world markets for j i petroleum; and the discovery of new oilfields. While the j value of oil exported in 1949 was about forty million j dinars; it jumped to 79.6, 120.1, 156.0 and 168.1 millions | of Iraqi dinars in the years 1952, 1953, 1954 and 1955 j respectively. j The seven principal countries importing Iraqi crude i ) oil in 1955 were in the following order: France, Italy, j i i 1 United Kingdom, Indonesia, Germany, Belgium and the United: i ; States. It should be kept in mind that this shows only t I j the distribution of the crude oil exports from Iraq and ; i I t ! can not be used as an indication of the geographical dis- | i ■ tribution of the final consumption of Iraqi oil; nor does j i ■ i i | ^Ibid., p. 26 and Iverson, o£. cit., p. 92. ” 47 "i » it allow any conclusions regarding the distribution of currencies from the sales proceeds of the company. Many , of the countries import Iraqi oil for refining and later exportation. j ! j Balance of Payments Table III shows the main items in the balance of payments of Iraq. It will be seen that in every year except 1950, when exports were high while imports were reduced by rigid controls, there was a large import t I surplus, which was only partly covered by such items as I i expenditures made by pilgrims and tourists in Iraq, j i i I receipts from transit trade and expenditures by foreign | i ! | vessels in Iraqi ports. | The deficit in the non-oil sector has, since 1950, j i ; ■ been more than covered by the surplus in the oil sector. i | In the years 1948 to 1950, the combined value of imports | made by the petroleum companies and the profits and ! j salaries remitted abroad by them exceeded the value of ! i ; the petroleum exported. The large amount of capital ; i brought in by the companies for investment, however, j i resulted in an over-all surplus in the oil sector. Since j i ' ! 1950, the value of petroleum exports has greatly increased! TABLE III BALANCE OF PAYMENTS, 1947 TO 1955 (Millions of Iraqi dinars) Item 1947 1948 1949 1950 1951 1952 1953 1954 1955*** 1 j Petroleum companies* Exports f.o.b. 14•04 11.20 14.10 29.59 39.12 80.79 120.87 156.09 169.12 Imports c.i.f. -5.06 -9.55 -10.29 -9.39 -8.77 -14.42 -13.17 -5.78 -6.27 Remittances of - profits -6.35 -2.11 -5.76 -22.46 -18.37 -42.36 -51.33) Capital ) -83.57 -69.13 Movements 5.06 11.56 9.59 10.12 6.85 13.23 3.26) Total 7.69 11.10 7.64 7.42 19.32 48.44 55.43. 66.74 93.72 Other Goods and Services* - Exports f.o.b. 17.33 10.34 14.82 26.03 33.10 22.53 23.04 20.68 15.80 Imports c.i.f. -35.02 -36.88 -30.96 -28.94 -43.24 -48.61 -56.91 -68.70 -90.80 Services 0.13 1.83 2.92 4.30 -0.17 -0.81 -0.07 -0.27 3.22 Total -17.56 -24.71 -13.22 1.39 -10.31 -26.89 -33.80 -48.29 -71.87 Private Donations and Capital* - - > 0.25 -0.23 -0.35 0.83 -0.39 1.25 0.92 0.99 0.87 Official Donations and - long-term capital -0.95 -0.53 -0.02 2.53 0.21 1.12 -0.92 0.70 0.19 4> 00 TABLE III (continued) BALANCE OF PAYMENTS, 1947 TO 1955 (Millions of Iraqi dinars) Item 1947 1948 1949 1950 1951 1952 1953 1954 1955*** Net Errors & Omissions, . 2.18 1.20 4.22 -3.93 -8.39 -12,87 0.16 3.21 -2.40 Total, excl. trans. of Pet. Co.s. -16.08 “24.26 -9.38 0.82 -18.88 -37.39 -33.64 -43.39 -73.21 Monetary Move ments** 8.39 13,16 1.74 ~8.24 -0.44 -11.05 -21.79 -23.35 -20.51 j Source: International Monetary Fund, Balance of Payments Yearbooks, 1947-1955 j (Washington, B.C.). j *Minus sign indicates debit. i **Minus sign indicates purchase of securities or increase in assets. 1 ***Pre1iminary I 50 and the surplus has risen considerably. During the years 1947 to 1949, the surplus in the oil sector failed to cover the deficit in other sectors, ! and Iraq drew heavily on its sterling balances and other foreign assets. ^ Beginning with 1950, there has been an increase in foreign assets, owing to the surplus on current account; and recently this surplus was very large, j The foreign assets of the CBI increased from I.D. 35.1 million at the end of 1949 to I.D. 41.9 million in 1950, and after a small drop in 1951, to I.D. 46.7 million in 1952; I.D. 64.6 million in 1953; I.D. 83.3 million in j i 1954; and I.D. 102.1 million in 1955. At the end of 1955, j 99 all but I.D. 3.4 million consisted of sterling assets. | I IV. PUBLIC FINANCE ! i The relative importance of the public sector in | the total economy of Iraq is as great as in the more developed countries. It is estimated that between 15 and I ^ C f . ante, pp. 156-158. ^^Quarterly Bulletin of the Central Bank of Iraq, j January-March 1956, op. cit., p. 8. j 25 per cent of the national income passes through the J treasury and is spent by the government on the satisfac- j tion of collective needs.^3 This does not mean that I i public expenditures are very large in absolute amount, j but rather that the national income is very small. As a matter of fact, until recently, fiscal policy played a very minor role in promoting economic activities. The * Iraqi Government had followed the traditional attitude j ! of balancing the budget annually, rather than the ”new j philosophy” of deficit spending. Public debts have j always been negligible and the resort to borrowing abroad : I had rarely been used. In recent years, the situation has I I been changing, since the use of fiscal policy is increas ing, mainly through the planned expenditures of the Development Board. | Public Revenues Total revenues and expenditures, in Iraq, are not i incorporated in a single budget. A number of public entities (like the Basrah Port and the State Railway) and -- I ^Iverson, pp. cit., pp. 57-58. 52 enterprises have autonomous or annexed budgets. Since 1951 there has also been a separate development budget. The largest item in receipts has been tax revenues. This is clear from Table IV. The tax system is charac terized by the preponderance of what may loosely be termed indirect taxes which account for well over 50 per cent of the total tax revenue. The income tax is of unappreciable importance and very limited in scope. Agriculture is j scantily taxed despite the fact that it is the predominant j occupation in Iraq. ! i Budget estimates indicate that the yield of taxes ! I on income and wealth has tended to decrease in relative j terms. This seems to be due chiefly to the fact that ■ these taxes are levied greatly on some external indicators: i i of income, such as rentals, rather than on income itself. ; This prevents yields from automatically following the rise in incomes. Additionally, the rate of personal income tax was reduced somewhat in May 1954.^ ! 24 Income tax rates were reduced on income up to i I.D. 1,500; the maximum amount for tax exemption and the j credits for dependents were raised. Rates were lowered j from 9 per cent to 4 per cent on incomes between 150 and 500 dinars, and from 12 per cent to 8 per cent on incomes between 501 and 1,000 dinars; rates on incomes between TABLE IV BUDGET ACCOUNTS, 1938-39 AND 1950-51 TO 1954-55 (Millions of Iraqi dinars) Item 1938-39 1950-51 1951-52 1952-53 1953-54 1954-55* I. Public Revenues Direct taxes on .income & wealth 0.45 3.20 4.02 3.00 2.77 - Taxes on land and produce 0.85 4.99 4.61 3.86 3.55 3.07 Custom duties 2.63 10.33 12.22 11.86) Other Indirect ) 19.24 20.00 taxes 0.77 4.03 4.06 4.78) Oil revenues 1.98 5.29 5.38 21.62** 15.01 18.13 Other receipts 1.16 5.65 7.24 5.42 — 5.11 - Total 7.84 33.49 37.53 50.54 47.37 48.51 TABLE IV (continued) BUDGET ACCOUNTS, 1938-39 AND 1930-51 TO 1954-55 (Millions of Iraqi dinars) Item 1938-39 1950-51 1951-52 1952-53 1953-54 1954-55* II. Public Expenditures Education 0.72 3.60 4.09 2.22*** 2.54*** 4.19 Social welfare and health 0.36 2.01 2.53 3.15 3.46 4.89 Communications and agriculture 0.58 1.88 1.98 2.75 2.30 4.87 Defense 1.62 7.26 7.94 13.75 11.99 17.92 Capital works 2.46 3.60 2.19 4.35 3.60 _ Other expenditures 3.30 10.97 12.09 18.18 14.57 - Total 9.04 29.32 30.82 44.40 43.67 57.61 Source; Government of Iraq, General Directorate of the Budget, The Iraqi Government Budget, 1938-39 and 1950-51 to 1954-55 (Baghdad; The Government Press). *Estimated. **Including five million dinars transferred from the Development Board and amounts ..received as settlement of claims on the petroleum companies. ***Excluding primary education. Calculated yields from indirect taxes--custom duties mainly--rose in absolute amount in 1954/55 and still further in 1955/56. It appears from the budget j estimates that the share of these taxes in total receipts j I also increased generally. j i Oil revenues since 1952 (30 per cent of the royalties) represent a major source of revenue. Total oil revenue rose from I.D. 5.3 million in 1950/51 to I.D. ! 21.6 million in 1952/53; I.D. 15.1 million in 1953/54; J I.D. 18.1 million in 1954/55; and to I.D. 22.8 million j in 1955/56.25 I Public Expenditures One of the prime characteristics of government expenditures is the large outlay on defense and police. ! Together, they absorb well over one-third of the total I ( budget. 1,001 and 1,500 dinars were reduced from 15 per cent to 12 per cent. Le Commerce du Levant (Beirut), June 22, 1955; and United States Department of Commerce, Foreign Commerce Weekly (Washington, D. C.), June 28, 1954. ^Government of Iraq, General Directorate of the Budget, The Iraqi Government Budget 1950/51 to 1955/56 (Baghdad: The Government Press). 56 1 The increase in the relative importance of military expenditures is partly due, however, to the fact that capital work expenditures has gone down . . . because they have been taken out of the budget of the government proper and trans ferred to the budget of the Development Board.^6 J Expenditures on agriculture and irrigation, which are of critical importance to the economy, up to 1952 have been very small. In fact, in 1949-50 they were even i further reduced so that they represented only a little j over 5 per cent of the total. At the present time these ! expenditures have been given a priority over the others 1 in the budget of the Development Board. I ! Expenditures on education, health and other social j services were very low. Lately, however, they have ! increased slightly, but are still very deficient. i i Local government expenditures to carry out improve- , i i ments and even to maintain existing facilities are limited.! This is due to the fact that they have not been receiving all the proceeds of the property and petrol taxes which are assigned to them by law. For example, in the years, t j 1948-1950, the provincial administration received only one ! j hundred and seventy-five thousand dinars out of a total 26iverson, op. cit., p. 59. 57 of I.D. 2,626,000 due to t h e m .27 As to the impact of public expenditures on the price, level and the cost of living, it is surprising to note j i that each has declined relatively with the increase in i public outlays. The wholesale price index declined from 503.3 at the end of 1950 to 498.2, 420.1, 431.5 and 455.0 at the end of years 1952 to 1955, respectively.^ This ; j decline is attributed to the stimulation of imports; the j I restriction of exports; the fall in prices of certain ' I commodities in the countries of origin, and the availa- 1 OQ bility of foreign currencies, particularly sterling. y The cost of living index was 506.6 in 1950, jumped to I 546.1 in 1952, but took a dip in 1953 to 470.0 and in j i 1954 to 484.7. In 1955, it climbed to 512.9; a record , higher than what it was in 1950. This increase was mainly ; due to the rising cost of foodstuffs and fuels, j In general, expenditures in recent years were i ■ I i ^7The Economic Development of Iraq, op. cit., p. 173. ^The Quarterly Bulletin of the Central Bank of Iraq, January-March, 1956, op. cit., p. 28 and The Annual Report of the National Bank of Iraq, 1952 (Baghdad: The Baghdad Printing Press, 1953), p. 16. 29Ibid., p. 11. 58 I i covered without giving rise to inflationary pressures, and government receipts often exceeded the expenditures, which j | exerted some deflationary effect on the money supply. i J Public Debt . The public debt in Iraq has always been small. As previously stated, the Iraqi governments have always i preferred to balance the budget through limiting expendi- 1 tures to the extent of the revenues. j I In 1944, a twenty year lottery loan and an ordinary ; three-year bond loan, each of one million Iraqi dinars, | were floated. They were easily absorbed. In 1947 and ; I 1948, other bond loans amounting to a total of five million j dinars were issued, but for a number of reasons, it proved 1 more difficult to sell the bonds and a large part had to j i be bought by the commercial banks and the Currency Board, i In addition, the CBI and the Development Board granted loans to some government institutions. At the end of ; 1955, the value of government securities amounted to about I , fifteen million dinars. Loans extended by the CBI and the Development Board to the government and semi-government institutions were about seven million 59 I I dinars.30 The foreign debts consisted of two loans at 4 per cent interest from the United Kingdom for financing the Iraqi State Railways. The first amounted to one million Iraqi dinars, obtained in 1939 and fully redeemed in 1942/43; the second amounted to three million dinars and was incurred in 1950. It was not fully drawn upon and has j i been repaid. Also, the government obtained several advances free of interest from the oil companies, totaling J I.D. 4.5 million, which have now been repaid. The other ; major foreign debt was a loan of 12.8 million dollars in j 1950 from the International Bank for Reconstruction and j I Development to meet the foreign exchange requirements of I the Wadi Tharthar irrigation scheme. In January 1955, the ; i government cancelled the unused balance of 6.5 million j dollars and the amounts drawn between 1952 and 1954 were ! ; repaid in March 1955. j i 30The Annual Report of the Development Board, 1954- 1955 (Baghdad: Tafaiyudh Press, 1956), p. 10. 3-^The Economic Development of the Middle East, 1954-1955, op. cit., p. 107. 60 V. CONCLUSIONS Iraq has great potentialities for economic develop ment. The Tigris and the Euphrates, besides the rainfall, supply Iraq with large amounts of water for irrigation. The soil is very fertile and the cultivable land is plentiful in comparison with its population of about five j < million. Labor is cheap and capable of acquiring skills I ! with a little training. Oil furnishes Iraq with large ' t sums of capital needed for economic development, foreign exchange, and a cheap source of power and raw materials. J I i Preliminary investigations indicate that Iraq possesses under its surface many other mineral resources, like iron, coal and zinc. I Since 1950, Iraq has undergone an economic revolu- j tion. Unlike many other countries which are under- } developed, Iraq is not handicapped by a lack of capital i or foreign exchange or over-population in its economic I development endeavor. It is receiving from oil royalties a large income in the form of sterling. Since 1952,70 per cent of this income is earmarked for economic develop ment. The Development Board is executing a Six-Year . 6 1 Program, 1955-1960 which calls for capital expenditures of over five hundred million dinars. The general Iraqi budget is in a healthy position, j It is free of the burden of a huge public debt. Recently : fiscal policy was used to promote the full utilization of the factors of production. The CBI with its monetary policy could well cooperate and promote the process of ( economic development on sound principles and help bring I i i 1 i i ! about a balanced economic growth with the least possible ! hardship. I \ f CHAPTER III BANKING SYSTEM OF IRAQ The banking system of Iraq consists of the Central Bank, nine commercial banks, fifteen sarrafs (individual money lender and exchanger), the post-office savings bank and four state-owned non-commercial banks: the Industrial j Bank, the Agricultural Bank, the Mortgage Bank and the i j Credit Mobilier. With the exception of the Central Bank, this chapter is concerned with the discussion of the above institutions. It is hoped that such a discussion will lay the groundwork for an understanding and evaluation of central banking in Iraq. I. COMMERCIAL BANKS i Prior to the 1900's, most of the commercial banking I I I activities were handled by private banks or sarrafs, and by one modern commercial bank, the Imperial Ottoman Bank. The latter bank, which was under Anglo-French control, had branches in Baghdad and Basrah. In the early 1900's two commercial banks appeared; the British Bank of Iran and the Middle East, and the Eastern Bank, both owned and controlled by Britishers.^* These three foreign banks, i i together with the local sarrafs continued to dominate the | field of commercial banking until the establishment in 1941 of a state-owned institution called the Rafidain Bank. In 1945 the Arab Bank, chartered in Jordan, opened a branch in Baghdad, followed in 1953 by the establishment of two more banks, the Federal Bank of Lebanon and the j Iraqi Commercial Bank. In 1955 a new bank called the | African Bank was established, followed in December 1956 i i by the Baghdad Bank. The total number of all commercial j I banks * branches operating in Iraq as of 1955 was twenty- four and it is increasing steadily.. 1 Characteristics of the Expatriate Banks 1 Today there are six expatriate banks: four branches of British banks (The Ottoman Bank, the Eastern Bank of Iran and the Middle East, and the African Bank), and two branches of banks operating in the Arab countries (the Arab Bank and the Federal Bank of Lebanon). As the ■ * • 3 . H. Longrigg, Iraq, 1900 to 1950 - A Political, Social and Economic History (London: Oxford University Press, 1953), pp. 28 and 54. branches of the British banks have unique characteristics and claim the largest share of business, they will be discussed here in detail. A noteworthy, outstanding feature of these banks is their close connections with London. These London connections have at least three consequences. First, they increase the influence of British banking traditions on i the outlook and policy of the banks. Second, they encour- ! i age the banks to rely upon the London money market for ! I liquid assets, and on the London security market for the investment of surplus funds to local requirements. Third, they give the bank additional financial strength, for it j i is unlikely that the Eastern Bank, for example, would be ! I i unable to obtain support from, say, the Midland Bank, ' \ should it be required. Thus, these banks, in an important j sense, are part of the British banking tradition and the ; London money market. It should not, however, be supposed | that the traditional policies of British banking remained i | unaffected by local experience. I | The fact that the control of these banks is located ! at such a distance from their field of operation appears to be a disadvantage as regards flexibility to suit the 65~i | requirements of the local situation. The local managers can not be expected to enter into new ventures without the approval of their boards of directors in England, and it may often take a long time to obtain such approval.2 Another characteristic of the branches of British I i banks is that they tend to maintain offices only in those j towns (like Baghdad, Basrah, Kirkuk and Mosul) in which 1 ( ! i expatriate enterprises (and/or government enterprises) are j well established. This leads to low branch densities in \ I relation to the total population. Available statistics show that these banks have nine offices in cities with i more than one hundred thousand inhabitants; one office in j i cities with one hundred thousand to fifty thousand inhab- j itants; two offices in cities with twenty-five thousand i to fifty-thousand inhabitants and none in cities with less j than twenty-thousand inhabitants.3 Clearly, total popula tion is not the determinant of banking offices. ! I Since the banks' contacts with the indigenous ^Carl Iverson, A Report on Monetary Policy in Iraq (Baghdad: The National Bank of Iraq, 1954), p. 18. 3Ibid., p. 17. 66 population are usually imperfect, lending to Iraqi enter prises is small. This, in turn, compels the banks to employ a considerable portion of their local resources outside Iraq, i.e., through the London money and securities market. Such employment of funds in London usually results in low yields, and since advance ratios are generally low and cash ratios rather high,^- the result is a low yielding portfolio of assets. An aggressive policy to attract deposits based on high interest rates is, therefore, impracticable. To earn profits the banks rely heavily on charges for remittances,!transfer facilities and other banking services. These are the third and fourth charac teristics of expatriate banking in Iraq. i i Separate statistical data are not available for the ; i expatriate banks. The only published materials in this j respect are the consolidated statements of accounts for all commercial banks operating in Iraq. Unfortunately, it has been impossible to obtain information on the breakdown of the balances with respect to the individual banks (or group of banks) e.g., the Rafidain Bank versus the - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - j ^Cf. post, pp. 68-72. | 67 foreign banks.^ Therefore, it is not possible to discuss the manner in which the assets and liabilities of the expatriate banks are distributed among the different accounts. It is suggested J here that the CBI should separate in its publication the consolidated statement of commercial banks owned by the j Iraqis; banks owned by Arab citizens; and, banks owned by | others. This is vital in order to deduce the impact of | the sources of capital on the operations and functions of J i the banks. In the absence of such information, the ; i interested writers will have to resort to experiences in other countries with similar institutions; to logical j consequences; and, sometimes to mere speculation. j Under such circumstances, the discussion below ; deals with all commercial banks combined. One fact, however, should be kept in mind, i.e., the branches of jBritish banks are the largest, most predominant and the j I joldest in operation. ! Distribution of Assets All the banks engage in ordinary commercial banking .^Iverson, op. cit., p. 28. business. They accept deposits, discount bills, deal in foreign exchange, and make loans against acceptable security. In keeping with the British custom in banking J practice, they restrict themselves to short-term assets J ! and self liquidating loans. No definite information is j available regarding their general lending policy. Broadly | i I speaking, the main outlet for their funds is in the finance i of foreign trade. They buy foreign trade bills, open j letters of credit, and make other short-term loans to ! i i those engaged in foreign trade. These are usually against , trust and warehouse receipts, personal security, or the hypothecation of movable property. j Table V presents the main assets and liabilities j of the commercial banks operating in Iraq. As indicated j by the table, the banks carry a great proportion of highly ; liquid assets. In 1955, for example, cash, balances with other banks and bills of exchange made up 33.1 per cent of their total liabilities. If this figure is added to their holdings of investment--mostly sterling securities and some Treasury bills--the ratio becomes 61.9 per cent. This preponderance of liquid assets is, of course, partly to be explained by the fact that Iraq is an overwhelmingly : TABLE V MAIN LIABILITIES AND ASSETS OF COMMERCIAL BANKS* , IN IBAQ, 1952-1955 ......... In thousands dinars In per cent of the total 1952 1953 195? 1931 1952 1953 195? 1953 i Assets i 1. Cash items Notes & coins 4.073 4.249 4.897 4.939 8.9 7.5 7.2 6.5 Reserve with CBI 6.167 8.589 6.288 7.930 13.5 15.4 9.3 10.5 Balances with banks in Iraq 2.633 3.256 4.199 4.137 5.7 5.9 6.2 5.4 2. Loans & investments Iraq government bonds, bills & loans 1.571 1.298 1.641 1.540 3.5 2.3 2,3 1.9 Bills discounted 1.780 3.366 5.332 8.081 3.9 6.0 7.9 10.7 Advances 9.022 12.161 19.512 23.020 19.7 21.8 29.8 30.4 Deposits & investments .abroad 19.021 21.265 23.674 21.780 41.7 38.1 35.1 28.8 3. Other assets 1.361 1.726 2.162 4.355 3.1 3.0 3.2 5.8 Total assets 45.628 55.910 67.705 75.782 100.0 100.0 100.0 100.0 'TABLE V (continued) MAIN LIABILITIES AND ASSETS OF COMMERCIAL BANKS* , IN IRAQ, 1952-1955 , , In thousands dinars In t Der cent of the total TOZ.: ..T953....1954...T955 1955I W 5 T 1954 1955 Liabilities 1. Deposits Current savings.& deposits Fixed deposits 14.883 .801 18.293 1.582 21.792 1.980 24.079 2.860 32.7 1.8 32.6 2.9 32.4 3.1 31.7 3.8 2. Government and semi- government deposits 15.648 19.891 24.965 26.018 34.2 N 35.6 35.5 34.3 3. Deposits against .guarantees & credits 6.313 6.005 5.673 6.049 13.8 10.8 8.5 7.9 4. Debit balances With banks in Iraq Abroad .....- ..........-...- 2.873 .103 2.695 .65 4.048 1.671 5.035 1.110 6.3 .2 4.8 .1 6.0 2.8 6.5 1.4 TABLE V (continued) MAIN LIABILITIES AND ASSETS OF COMMERCIAL BANKS* . - ■ ■ . IN IRAQ, ..1952-1955 . . . . - .... . In thousands dinars In t >er cent of the total 1952 ..1953 ' ’ 1954 " 1 1955 1951I I553T..1954' 1555 5. Paid-up capital & reserves 3.002 4.037 5.077 6.307 6.6 7.2 7.9 8.3 6. Balance on profit . & loss accounts .398 .672 .689 1.155 .9 1.2 1.1 1.5 7. Other liabilities 1.601 2.670 1.810 3,169 3.5 4.8 2.7 4.6 Total liabilities 45.628 55.910 67.707 75.782 100.0 100.0 100.0 100.0 Source: Annual Reports of the National Bank of 1J£M > for the years 1952-1955 and the I Quarterly Bulletin of the Central Bank of Iraq, January-March 1956 (Baghdad: Thomas Printing Press, 1956), p. 10. ^Excluding sarrafs. 72 cash economy, and the possibilities of a large scale withdrawal of cash are much greater than in more advanced countries. At the same time, it serves to explain the fact pointed out above, that the banks are influenced by British banking principles. j The table also shows that the banks keep a large j i ratio of their resources abroad and especially in London. ' In 1952 little over 41.0 per cent of total assets was in ! the form of deposits and investments abroad. This is | mainly due to the lack of acceptable borrowers to the banks, and the dependence of Iraq foreign trade on sterling' I I which forces the banks to maintain considerable working ; i i balances in sterling. However, it is to be noticed that in recent years the ratio of discounted bills and advances has increased i ■ while the ratio of deposits and investments abroad has j i decreased. The first has increased from 23.6 per cent of i the total in 1952 to 27.8 per cent in 1953; 37.7 per cent in 1954 and 41.1 per cent in 1955, while the latter declined from 41.7 per cent in 1952 to 38.1, 35.1 and I 28.8 for the same periods respectively. The execution of the development program which necessitated the with- 7 3 ' drawal by the Development Board of part of its deposits l with the Rafidain Bank is the major cause of the decline in deposits and investments abroad. The increase in the ratio of bills discounted and advances could be related, first, to the establishment of Iraqi banks who naturally have more contact with the local merchants. It could be also attributed to the increase I i of economic activities under the stimulus of the execution j of the economic development program. A third explanation ! of the increase of the ratio of bills discounted and ! I . . . many of the big firms which started to ! carry out development projects did not rely on ; commencing their operations on imported capital but resorted to overdrafts from the local banks. t All the same, this increase is certainly an encouraging ! sign, because as Professor Sayers stated, . . . in a country where there are no alternative sources of finance the smallness of bank advances is a symptom of deficiencies both in its economic structure and its banking system.? 6Annual Report of The National Bank of Iraq, 1954 (Baghdad: Al-Najah Press, 1956), p. 19. ^R. S. Sayers, editor, Banking in the British Commonwealth (Oxford: The Clarendon Press, 1952), p. 407. ! 7*4 ~ Deposits As yet, the use of the checking system is not wide spread in Iraq. As a consequence, the ratio of current deposits to money in circulation is considerably low. At the end of 1955 the notes and coins in circulation totaled t.D. 43.2 million, while the total of private current and saving deposits was only I.D. 24.1 million. Although the absolute figure of private deposits j has increased appreciably during the past five years, its ratio to the total remained almost constant. The same is true in regard to government and semi-government deposits. ! Most of the Iraqi Government accounts are kept j with the Rafidain Bank. However, in May 1956, the govern- j ment announced the transfer of its accounts to the CBI. In January 1956, these deposits amounted to twenty-nine [ i i i million dinars and accounted for about 45 per cent of i ■ total deposits in commercial banks.^ j 1 i The*small extent to which Iraqi's hold bank deposits j reflects the fact that they have not yet advanced to the stage of economic development at which they use banking ^International Monetary Fund, International Finan cial News Survey, June 8, 1956. facilities. It is appropriate here to suggest that the CBI should conduct a survey of the ownership of private deposits, separating time from current deposits and showing those owned by business, individuals and others. This survey is of great importance for economic analysis because each type of ownership hears a different impact on economic fluctuations. Ancillary Services The banks perform all the usual services offered by banks elsewhere; such as, opening credits for importers; discounting bills and drafts for exporters; and providing remittance facilities within Iraq and from it to centers outside. The most import ancillary service which the banks provide is the opening of credits for traders. Even where i j those do not involve the provision of finance, the sub- ( | stitution of the bank’s name for that of an importer is i an important service, especially in an economy where the importers are small merchants whose credit standing is unknown abroad. The amounts of credits opened by the commercial banks for the years 1952, 1953, 1954 and 1955 76 were 35.4, 35.6, 43.0 and 53.4 millions of Iraqi dinars, respectively.^ i The charges levied for the ancillary services seem j to be regulated by agreement between the banks. The 10 minimum rates agreed upon as of 1953 were: i Discount on bills (normally 3 months) . 4-1/2 per cent Interest in secured advances and ! overdrafts.................... 4 per cent j Interest on unsecured advances and overdrafts....................... 5 per cent J The rates on deposit accounts are much lower, thus leaving the banks a wide interest margin. No interest is i i normally paid on current account. On fixed accounts, i.e.,1 accounts from which money can be released only at six i I month's notice, the banks normally pay 1-1/2-2 per cent ! interest. Savings accounts yield from 1-1/4 to 2 per cent on the first one hundred to five hundred dinars, ' f j and no interest is paid on amounts exceeding that I J ^Quarterly Bulletin of the Central Bank of Iraq, January-March, 1956, op. cit., p. 15. lOiverson, pp. cit., p. 30. 77 11 limit. Similar arrangements apply to deposits with the postal savings offices, but here the rate of interest is 3 per cent. It seems that a more favorable treatment of savings deposits, with regard to both interest rates and to the size of accounts, is necessary in order to promote I I dishoarding and to stimulate voluntary saving. j I j II. NON-COMMERCIAL BANKS j ! - - - — - — I i ; in Iraq with their head offices in Baghdad, and with a I : limited number of branches in other provinces. These are, . i ! the Agricultural Bank, the Industrial Bank, the Mortgage j * • . ! ; Bank and the Credit Mobilier. All four institutions are ! i . ; ; owned and controlled by the state. The fact that these ; S i i 1 I institutions were undertaken by the state is an indication I . I ; of the reluctance of the commercial banks to engage, to | , any large extent, in agricultural, industrial, urban real 1 « ! estate, mortgage and consumer lending. Prior to the i establishment of these banks the borrowers were forced i to resort to private lenders who charge extortionate \ ! -^Loc. cit. 7g ( rates of interest. Being non-profit making institutions, the banks are able to charge low rates of interest, not exceeding 7 per cent in any case. The administration, capital structure and Opera-* tions of each of these institutions will be examined 12 briefly in the remainder of this chapter. ^ lhe_Agrlcultural_^ank The Government of Iraq, in the mid-thirties, recog- nized the inadequacy of credit facilities to agriculture. The customary term of farm loans was far too short a period for the repayment of a loan out of the products j of the land; the methods of repayment were not satis- ; ' I factory; the possibility and conditions of renewal were ■ 1 uncertain; and, the interest rate was much higher than necessary for farm credit in competition with commercial credit. The outcome of such defects was the establishment I ! i j .......... ... ■^For a detailed study of the non-commercial banking institutions, the interested reader is referred to Fawzi A. El-Kaissi, "An Analysis of Iraqi Government Institutions for Agriculture, Industrial and Mortgage Banking" (unpub lished Master's thesis, The University of Southern California, Los Angeles, 1954). . . ... _ . 79 ; i in 1935 of a state-owned bank to serve both agriculture j and industry called the Agricultural and Industrial Bank. Owing to its multiple task, the Bank was incapable of achieving its objectives. Beside the responsibility of j developing agriculture and industry, the Bank had to ] | undertake some commercial transactions for the Government, I ’ i t ^ and to perform some of the commercial bank s operations ! like foreign exchange, accepting deposits and opening j ^ I I checking accounts. In 1940, a law was passed breaking 1 I i < the Bank down into two separate institutions: the j Agricultural Bank and the Industrial Bank. Because of the J war, the banks did not start their separate operations until April 1946. Bank administration. The Agricultural Bank is ! governed by a board of five members, including the j i General Director of the Bank. One of the four members represents the Ministry of Finance, one represents the Ministry of Economics, and the other two represent the large farmers. The Chairman and members are appointed by the Council of Ministers for terms of four years, so arranged that, with the exception of the Chairman, half of the members should be changed every two years. The designated member may be reappointed for another term. The Board of Directors has charge of the opening of branches, issuance and sale of debentures, writing-off and renewal of debts, and every matter concerning the committees and officials of the Bank. Capital structure and sources of funds. The Bank has a capital of two million dinars supplied by the state j in the form of a loan to be repaid to the Treasury in j I 1 I ; installment payments over a period of seventy-five years. ! In addition to its capital funds, the Bank could borrow from the public, the Treasury and semi-government agencies, by issuing negotiable bonds, or by any other method approved by the government. In 1954, the Bank ! ! borrowed two hundred and fifty thousand dinars from the i 13 ' CBI to meet the shortage in its financial resources. The Bank is also empowered to accept current and 1 i fixed deposits, with or without interest, in order to supplement its financial resources. In 1952, the Iraqi ■ Date Association deposited one hundred thousand dinars i •^Annual Report of the National Bank of Iraq, 1954, op. cit., p. 20. with the Bank to be advanced to the date growers in Basrah province.^ In an agricultural country like Iraq, the develop ment of an agricultural credit market with sufficient financial resources constitutes an indispensable factor in economic development. The Agricultural Bank with its limited financial resources, lags far behind the actual needs of the country. Its capital must be increased to at least ten million dinars, and some devices should be utilized to enable the Bank to rediscount its short- and medium-term papers with the commercial banks or with the CBI. Without establishing a second market to discount its papers, the Bank will always fail to meet the growing farmers* demands for credit. The Bank1s operations. The Agricultural Bank has manifold functions; besides advancing production and real estate loans for farmers, the Bank acts as a mediator, i , rental and sale agency, agricultural entrepreneur and aids in the establishment of cooperatives. • ^Annual Report of the Agricultural Bank of Iraq, 1950-1951 (Baghdad: The Government Press, 1953), p. 8. 82 1 The Bank grants loans directly to farmers. Short term production loans, which may not run for more than eighteen months and which may be secured by a wide variety of collateral, are extended to finance the raising of crops, expenditures for insecticides and fertilizer, and purchase of cattle. The Bank can make medium and long term mortgage loans up to ten years for permanent installa-| i i tions, repairs, irrigation, purchases of farm machinery, and. - I the refinancing of previously unsecured debts. ; Up to March 31, 1952, the Bank had loaned I.D. 2.05 , i million to 8,770 borrowers; of this I.D. 1.07 million had j i been repaid. In 1952/53, a further sum of six hundred | i t and sixty thousand dinars was advanced to 1,246 borrowers, ! i I and one hundred and forty-six thousand dinars on out- i standing loans was repaid.^ The year 1953 witnessed a | remarkable increase in the Bank*s lending. The number of loans made was 2,186 and valued at I.D. 1.35 million. But, as a result of this stepping-up of activities, the delay in the repayment of matured loans by borrowers, and ■^United Nations, Department of Economics and Social Affairs, Economic Developments in the Middle East, 1945 , to 1954 (New York: 1955), p. 104. 83 1 the flood disaster, there was some dullness in the Bank's lending during 1954. The number of loans was only 1,894 for a total of I.D. .88 million.^ The Bank owned many projects related to agriculture, but during 1954 these projects came to an end. The fishing scheme was liquidated; work on five other schemes was stopped, namely the cotton ginning schemes in Baghdad and Aziziyah, the electricity scheme in Aziziyah, the sterilized , medical cotton scheme and the boric lint scheme, j owing to the failure of the first and to the j Bank's tendency to regard the other schemes as f being outside its province. ' Notwithstanding, the Bank is still participating j i in some agricultural projects, although at the end of j i ♦ 1954, its participation amounted to only thirty-five ' i thousand dinars. So far, the accomplishments of the Bank have not been very impressive. This is partly due to its : i i inadequate resources, unscientific management, the land tenure system, and the poor legal arrangements of loan terms. A thorough study of the Bank's organization, ! operations and administration by a group of experts is • ^Annual Report of the National Bank of Iraq, 1954, op. cit., p. 19. ■^Loc. cit. 84 ~! i badly needed to put the Bank on firm and sound foundations. The Industrial Bank The Industrial Bank was created by a law passed in 1940 and started its operation in April 1946. It is the second successor of the old Agricultural and Industrial Bank. I s ! j Bank management. The Industrial Bank is governed j ! j by a Board of Directors consisting of six members, includ- ! j ing the General Director of the Bank as Chairman. Except ( ♦ that one member of the Board is a representative of the I merchants and one member is an expert in industry, all j I other arrangements of the Board are similar to those of i the Agricultural Bank. f I Capital structure and sources of funds. The main sources of funds are the Bank's capital and its power to i borrow from the public, banks, government and semi-govern- < ment agencies. The original capital of the Bank was five hundred thousand dinars provided by the government as a loan with out interest and for a term of sixty years. The original cost of the shares of the dissolved Agricultural and 85 Industrial Bank in the different industrial enterprises, and its loans to the various firms were transferred to the 1R Industrial Bank and considered as part of its capital. In June 1950 the capital was increased to one million dinars, and in 1953 again was raised to three million dinars. At the end of 1956 the nominal capital became eight million dinars. In order to meet the Bank*s j increasing needs for funds, its paid-up capital was increased from two million dinars at the end of the finan- | cial year 1952 to I.D. 2.7 million at the end of 1953, and f then to three million dinars at the end of the 1954 financial year.^ Besides its capital, the Bank is authorized to borrow money by the issue of negotiable bonds, or any other means decided upon by its Board, and approved by the Ministry of Finance. In addition, the Industrial Bank, like the Agricultural Bank, is empowered to receive l^Kamil Al-Sammera'i, Compilation of Laws Concerning the National Bank of Iraq (Baghdad: Al-Hokomeh Press, 1951), p. 258. ^ Annual Report of the National Bank of Iraq, 1954, op. cit., p. 20. 86 “1 I money on current accounts. The Bank1s operation. The object of the Bank is to develop and assist the industry of the country and to 90 carry on banking business relating thereto. More par ticularly, the Bank was set up to conduct the following operations: (1) to directly undertake industrial enter- i prises on its own account; (2) to form public or private j j industrial limited liability companies and to subscribe | thereto; (3) to subscribe to industrial companies existing t . . . . . . j J or to be formed; (4) to make advances against raw mate rials imported by factory owners and against their exported; products; (5) to make loans to industrialists for the purpose of setting up, extending or improving factories; ! i (6) to act as agent for the importation of machinery, I tools and raw materials for the account of owners of ' factories and industrial undertakings and government and ( quasi-government institutions, and for the export of manufactured products in Iraqi factories; (7) to make ^®A1-Waqayi*a Al-Iraqiya, No. 1783 of March 25, 1940, Law of the Establishment of An Industrial Bank, No. 12 of 1940 (Baghdad: The Government Press, 1940). 87 advances to merchants who deal with the institutions of the Bank, and who buy and sell materials or products relating to the undertakings, against deposits and condi tions prescribed by the Bank's regulations; (8) to make advances to owners of factories and industrial undertakings for the purchase of machinery, tools and the raw materials required for their undertakings, and to dispose of their manufactured products within and without the country; and l i (9) to accept deposits and securities and to open current ! i * i 1 | accounts for a fixed term or otherwise, with or without { j interest, and to undertake foreign exchange and other j I I operations so as to facilitate the transactions of indus- j I trial ventures. The Bank may not make loans or participate in i industrial ventures unless the majority of their capital ; i is held by Iraqi nationals. The Bank may lend for a term of up to ten years, but the term of the loan may not exceed | three years unless it is covered by a mortgage ,on immovable; property. Loans may not be less than one hundred dinars or more than ten thousand dinars to any one person; however, the upper limit does not apply on advances in which the Bank acts as agent for the import of raw 88 H materials or the export of products. The Bank may make unsecured loans for a term not exceeding one year and in i amount not in excess of three thousand dinars. In finan- i cing installment sales of machines, implements, motors, and pumps, a minimum down payment of 25 per cent is required. i By the end of 1951/52, the Bank had made 351 loans J aggregating seven hundred and seventy-two thousand dinars; j l t j of this, two hundred and ninety-six thousand dinars had I been repaid. In 1952/53, 153 loans totaling six hundred ] and fifty-seven thousand dinars were made and one hundred j and ninety-two thousand dinars were repaid.^ During the j years 1953 and.1954 the Bank made 423 loans amounting to i one million, three hundred sixty-seven thousand, six 99 hundred and two dinars. A The Bank holds a large proportion of the share of | eleven major Iraqi concerns, nine of which are industrial, , 21 Government of Iraq, Principal Bureau of Statis tics, Statistical Abstract, 1953 (Baghdad; The Government Press, 1955), p. 302. ^ Annual Report of the National Bank of Iraq, 1954, op. cit., p. 20. 89 one partly so and the other non-industrial. The total nominal value of the Bank's share in these enterprises amounted, at the end of March 1953, to nine hundred and ninety-five thousand dinars out of a total capital of I.D. 4.77 million. By March 1954, the Bank's share had risen to I.D. 1.12 million. Recently, the Bank has been gradually disposing of its share in enterprises to the i public when these enterprises are firmly established, in j 1 I • f ; order to stimulate more interest and to divert its capital 1 | to other new enterprises. In addition to its lending activities, the Indus- j trial Bank is studying various projects in cooperation with! I the Development Board. Among these projects are: the : I i setting up of a paper and cardboard factory, the extension ! and modernization of the Fao Salt Works and the exploita- ; tion of salt domes in Iraq; the construction of a caustic soda and chlorine plant; the establishment of a glass industry using local sand; the setting up of a steel i foundry; and the establishing of a beet-sugar mill and a ! plant for extracting the date sugar from inferior dates. Several other industrial studies and surveys are being _ 9 0 , made.23 i The Industrial Bank, unlike the Agricultural Bank, has been quite successful in carrying out its operations. ; All enterprises in which the Bank has participated are very successful and profitable. There has been only a small ratio of delinquency in the repayment of its loans. However, there still exist numerous defects in the finan- 1 1 i | cial resources, organization and operation of the Bank. The capital of the Bank should be increased to at least ! j i fifteen million dinars. The Bank should include in its ; I f t I organization personnel highly trained in industrial I ; I engineering, business administration and other related j j fields for the purpose of supplying advice and supervision ! j 1 I to many small enterprises who resort to the Bank for such ; i j guidance. The terms of loans should be lengthened to at ; least twenty-five years. Lastly, but not least, the Bank i should work in closer cooperation with the Development Board to prevent duplication in industrial research and conflict in authority. Today, the importance of the Indus trial Bank in the Iraqi economy is greater than ever, which I 23Economic Development in the Middle East, 1945 to 1954, op. cit., p. 105. makes it necessary to adjust its structure and operations to the present stage of economic development. The Mortgage Bank The Mortgage Bank was established by Law Number 18 in 1948, to provide cheap credit for owners of dwelling houses against the security of immovable properties. It ( started its actual operation in 1950. ! i J Bank management. The Bank is managed by a Board of Directors, composed of the General Director of the t i Bank and four appointee members. The General Director is { appointed by a Royal Decree and the four members are appointed for a term of two years by an order from the I I Minister of Finance. There is no group or professional representation on the Board. The Board of Directors is charged with the opening of branches, determining from time to time the rate of j j interest and fees to be charged, issuance and sale of | debentures, writing-off bad debts, and all matters con cerning the officials of the Bank. Capital structure and sources of funds. The original authorized capital of the Bank was one million dinars provided by the government as a loan without inter est. At the beginning of 1952, the capital was increased to three million dinars, which is now all paid-in in order to finance the growing urban real estate mortgage market. The Bank supplemented its need for money through borrowing from the CBI an amount of two hundred and fifty thousand dinars, the acceptance of four hundred forty-five thousand dinars as a deposit from the Department of Minor* Property. In addition, the government has undertaken to provide the bank with an amount of two million dinars for j \ the financing of a new building scheme. In August 1956, the Bank obtained a loan of five million dinars from the Development Board, half of which was paid in 1956, and the other half to be paid in 1957. At the same time, the Bank received a new loan of two hundred and fifty thousand i J dinars from the CBI to be guaranteed by the Ministry of I 1 i Finance. The Bank * s operations. Originally the Mortgage Bank was set up to relieve the owners of mortgaged ^International Monetary Fund, International Financial News Survey, August 24, 1956. 93 -j dwelling houses from the usurious rate of interest they were paying. In 1953, the objects of the Bank were expanded to include: (1) advancing loans on security of fixed property, thereby encouraging new building activity on the part of private individuals; (2) converting old high interest loans into loans advanced by itself and v bearing 4 per cent interest; (3) building on its own account modern dwelling houses which were to be sold or j rented to officials and employees and other persons with limited income and bearing 1-2 per cent interest; and (4) j establishing public or private mortgage or building com- j ( panies, or cooperative mortgage or building societies, or companies for the sale and purchase of immovable l properties and the construction of houses and other 1 i I buildings thereon. j s J Since its establishment, the demand on the Bank*s ; ! ! services is persistently increasing. Lately, the loan | i 1 period was extended from four years to eight and the | interest rate was reduced to 4 per cent or less. Loans i ! ^Al-Waqayi'a Al-Iraqiya No. 3075 of March 20, 1952, j l*aw No. 22 of 1952 Amending the Law of the Establishment of iL Mortgage Bank No. 18 of 1948 (Baghdad: The Government | Press, 1952). 94 issued in 1953 numbered 2,752 valued at one million, five hundred ninety-three thousand, four hundred and thirteen dinars. In 1954 loans numbered 3,320 valued at two million, thirty-one thousand, five hundred and thirty- four dinars. ^ The Bank has already acquired for its building program plots of ground in various parts of Baghdad; one scheme at West Bank, Baghdad, provides for a complete town of five hundred houses. The Bank is t negotiating also with local administrations to carry out J I a building program in the provinces of Kut, Basrah, i Diwaniydi and Hillah. j Ordinarily speaking, the Mortgage Bank in its I i short life has rendered a great service in the urban real | l i estate mortgage market. It helped to reduce the interest I rate in this market and encouraged the construction of 1 many new dwelling houses. However, the Bank has not yet reached the poor class in its activities. The majority j I ; i of Bank loans was granted to the well-to-do and middle j income groups. A liberal treatment in connection with the , monthly payments is required to suit the needs of the I < i i i ^ Annual Report of the National Bank of Iraq, 1954, j op. cit., p. 21. 95 low-income group. Now, the Bank is engaging in building houses ranging in value from fifteen hundred to two thousand dinars. This is definitely out of the reach of the poor people. Cheaper housing units should be given priority, as they are most urgently needed in the present set of conditions in Iraq. i ! The Credit Mobilier ; The Credit Mobilier, in effect, is a mortgage bank against movable properties. In 1951 the government 1 sought to enter a new field of lending to combat usury; i namely, the field of personal financing. For this purpose \ \ \ the Credit Mobilier was established and started operation ! in October 1951.^ As the operation of the Credit I Mobilier is obscure it will be discussed very briefly. The original capital of the Credit Mobilier was I two hundred and fifty thousand dinars, which was increased j in 1952 to one million dinars. By 1954, the government J had paid to the Credit Mobilier all its nominal capital besides an advance of two hundred and fifty thousand ^ Annual Report of the Credit Mobilier, 1952-1953 (Baghdad: Thomas Press, 1954), p. 34. 96 dinars to enable it to expand its operations. The object of the Credit Mobilier originally was to supply loans to government officials against personal guarantees and to others against the security of consumable movable property. In 1952 the Credit Mobilier was author ized to lend to employees and officials of semi-government instituions. In the same year the maximum amount of a i ! loan for each individual was increased from one hundred * i to one thousand dinars and the rate of interest was i i reduced from 4 to 3 per cent. , i r During the years 1952, 1953 and 1954 the Credit ! i Mobilier made loans totaling 286,311; 262,789; and 234,473 i j dinars respectively. The above figures reflect the I limited scope of operations of the Credit Mobilier. This i is mainly due to the fact that it is operating presently ' i only in Baghdad. The Credit Mobilier has been in operation for over five years and it is necessary to expand its | operation to, at least, the provinces of Basrah and Mosul. ! In these cities, like in Baghdad, there is a great number of government officials who could use this institution's facilities to pay for medical care expenses and other contingencies. 97 The Cooperative Bank In line with the policy of encouraging cooperatives, the Iraqi Government announced during the second half of 1956, its decision to establish a cooperative bank. Its main object is to provide credit to cooperatives. The initial capital of the Bank will be two hundred and fifty thousand dinars, half of which will be contributed by the Ministry of Finance and half by the cooperative societies. All cooperative societies operating in Iraq will be able to receive from the Bank advances up to twice | 23 their participation in the capital. j The Bank is still in the formative process and is i j expected to start its operation very soon. i j III. CONCLUSION i ! I It has been shown that the expatriate banks (and the indigenous banks to a certain extent) discussed above have a common background in the commercial banking history | of the British Isles. As a result of this, and their j i . s ^International Monetary Fund, International Financial News Survey, May 18, 1956. . J close connections with British banking interests, the j banks have certain definite traditions and attitudes. It : I should be clearly recognized that these traditions and j » attitudes have enabled these institutions to make some ! i i contribution to the economy of Iraq. However, these attitudes and traditions derive from a situation removed from that in which the banks are called upon to operate in Iraq. It follows that their operations present certain ‘ characteristics, which may be summarized as follows: j 1. A branch-banking system with low branch density t in relation to total population. ! I 2. Concentration of branches at commercial ! centers. j 3. A high proportion of business associated with ! external trade. i i 4. Restricted local employment of funds. 5. Reliance upon an external capital market. i I ' Today, commercial banking in Iraq is undergoing f j institutional and functional changes. They reflect the ' present economic revolution in the country and they serve 1 ! 1 to cope with the increasing uses of banking facilities. Some of these fundamental changes and the control of , 99 : commercial banks by the CBI will be discussed in a later chapter of the dissertation. The above review of non-commercial banking institu tions in Iraq shows that there are four banks in operation;! one in the field of agriculture, the second in the field of industry, the third in the field of urban real estate mortgage, and the fourth in the field of movable property mortgage. All of these institutions* are newly established; » ! the oldest being in operation for only ten years. Another j ! i 1 characteristic is that all these banks are owned and i | I j controlled by the state through the Ministry of Finance. : : A third characteristic is that their operations are con- j | | • centrated in Baghdad with the exception of the Agricultural j Bank. The capitals of the banks are not commensurate for I the multiple tasks assigned to each of them and the ! mounting demand on their services. It is the belief of the writer that the banks need i I a thorough and exhaustive study by a group of experts on ! i i the aspects of past experience, present economic conditions! ! 'in Iraq and its future economic development. CHAPTER IV j THE STRUGGLE FOR MONETARY INDEPENDENCE ! i i Iraq, from 1534 to 1918, was under direct Ottoman rule. Its monetary system, up to 1880, was based on j bimetalism at a ratio of 1 to 15.909. The monetary unit i was the Turkish golden lira which was equal to 4.40 j dollars. The circulation of paper money was nonexistent. The English pound, French franc and Russian ruble were in I j circulation side by side with the legal monetary unit. | i i During World War I two significant changes took place. I I • The Turkish piastre replaced the lira as the monetary i unit and banknotes were issued for the first time. Despite i i | i j these changes the Ottoman Empire remained on the gold istandard. In 1918 the combined forces of the Arabs and the ;British defeated the Ottoman armies on the battlefields |of Iraq. Having occupied Iraq, the British ultimate aim j f i ; iwas to give it the status of a colony or protectorate to ; i 1 be annexed to India. The initial step in the British i plans was the introduction of the Indian rupee as the , 101 official monetary unit replacing the Turkish piastre. The Indian monetary system was based on the gold exchange standard with an official rate of exchange of one British pound for fifteen Indian rupees. Notes and currency t were issued by a semi-public agency as there was no ! central bank in India. When England abandoned the gold ! standard in September 1931, India followed in its steps i immediately and adopted the sterling exchange standard.*- The British aim to maintain the occupation of Iraq was not fulfilled. In 1920 there was the Euphrates rebellion, and in 1930, there was more drastic revolt i throughout the country. As a result, in 1932 the British i Mandate was terminated and in October of that year, Iraq I was accepted as a member of the League of Nations. With 1 ? the declaration of its independence, Iraq issued its own i ' i monetary unit instead of the Indian rupee. The birth of the Iraqi monetary system was not without difficulties *-For further details on the Iraqi monetary system under the Ottoman and British occupations, the reader can consult: Abdul R. Al-Jalili, Monetary System of Iraq (Cairo: Metba'at Nehthet Misir, 1946), pp. 89-109 and the United States Office of the Director of the Mints, Monetaryi Systems of the Principal Countries of the World (Washing ton, D. C.: United States Government Printing Office, 1914). 102 for it faced continued opposition from the British. „ The discussion of the above mentioned developments, the issue and management of the currency by the Currency Board as well as the inflationary pressures of the Second I World War, are the subjects of this chapter. Owing, however, to the fact that the monetary system under the Currency Board was quite similar to that under the Central I i Bank of Iraq, its detailed evaluation is postponed to | 2 succeeding chapters. | I. NATIONAL CURRENCY VERSUS THE INDIAN RUPEE ; I ‘ i i The question of establishing an Iraqi national ! monetary system reflected the national pride of the new ;state of Iraq. It had always resented the alien Indian rupee for the Iraqis felt that the existence of the Indian rupee in circulation was one aspect of the proposed annexation of Iraq to India. In 1923 there was a considerable export of specie | from Iraq to India. The effect of this proved to be: . . . very embarrassing to the banks and large I ^Cf. post, pp. 184-191 and pp. 274-289. 103 ] I users of specie, and the phenomenon has stimulated ! the movement towards the direction of a national currency. The danger perhaps occasionally overlooked that the remedy may be worse than the disease. Because of this, the idea to establish an Iraqi central bank to be charged with the responsibility of j issuing and managing the national currency gained support. This idea could have been stimulated by the monetary I trends prevailing during that period. The International I ! Financial Conference which met in 1920 in Brussels passed j ! a resolution urging that in countries where there is no ; Central Bank of Issue one should be established. As a i I I ( | j result of this resolution central banks emerged in some J of the Balkan countries, in some of the South American i I states and in South Africa. j _ i < Another factor contributing to the intense desire ! i | for the issuance of a national currency was the fresh | memories of the Iraqi merchants and politicians concerning t ! the tremendous depreciation of the Turkish notes. They felt that any foreign monetary unit which circulated ^British Colonial Office, Iraq: Report on Iraq . Administration, April 1922 to March 1923 (London: His i Majesty's Stationery Office, 1924), pp. 106-7. , - _ -- - - 1041 legally in Iraq would have the same fate. The Mandate authority itself admitted, although at i a later date, that the Indian rupee in Iraq was . . . open to objection since, apart from the natural desire of the people to have a national currency the cost of maintaining the rupee currency falls on the Iraqi Treasury which has no share of the profits derived therefrom by the government of India. j j The Opposition of the Mandate Authority I ! The Mandate authority, since 1923, opposed the J ! . ! | Iraqi requests for the establishment of a central bank and | i ■ the issuing of Iraqi currency. They maintained that the ! i j remedies suggested above nmay be worse than the disease.’* j ! The Mandate authority argued that the scheme for estab- ! ! lishing a national bank with a monopoly of note issue had ♦ l ! to await a satisfactory arrangement concerning the basis i 1 , for a national currency. On the other hand, the same t j authority stated, "the introduction of an Iraqi currency ^British Colonial Office, Special Report by His Majesty's Government in the United Kingdom of Great Britain and Northern Ireland to the Council of the League of Nations on the Progress of Iraq During the Period 1920- 1931 (London: His Majesty's Stationery Office, 1931), pp. 127-28. 105 "! t in replacement of the Indian currency must be postponed whilst the National Bank proposal matures." In other words, the creation of a central bank had to wait until specific arrangements satisfactory to the Mandate author ity were agreed upon, and the question of the national currency had to wait until agreement was reached regarding the basis for creating a central bank. i ! However, during the year 1927, a proposal to intro- ' duce an Iraqi currency based on sterling exchange and |controlled by a currency board was put before the Iraqi I | | jGovernment. The proposal was rejected by the Council of ; I Ministers and an alternative proposal was adopted to I establish a central bank with monopoly of notes issue. i i , I No progress was made during 1929, as the Council of i Ministers again rejected the idea of issuing notes on the j ; basis of sterling exchange. The Mandate authority was unhappy about the situation and stamped both the Iraqi i | ipublic and officials with ignorance. It claimed 1 1 it was ; » clear that both public and official opinion required ,„6 education on this point." i ; ^Report on Iraq Administration, 1928, p. 64. t £--- I l __ ^Report on Iraq Administration, 1929, p. 66 , 106 1 The Passage of the National Currency Law Early in 1930, the Minister of Finance, under the stimulus of a reported forthcoming fall in the sterling value of the rupee, revived the proposals for the estab lishment of a national currency. The Council of Ministers then agreed to base the currency on the sterling exchange standard, with the monetary unit to be known as the dinar j i and to be equivalent to, and convertible into, the j l English pound sterling. The necessary draft proposals i j I ! concerning the basis for the issue and control of the new ^ | currency were prepared and, in April 1930, were handed | I for further study to Sir Hilton Young, the financial { l J advisor of the Iraqi Government. In October 1930, a ! J draft based on Sir Hilton Young's proposals, was submitted: j : | to the Iraqi Parliament and was passed on April 19, 1931. ; The National Currency Law provided for the introduction of! ; the new currency from July 1, 1931. Active measures were ' i ■ taken by the government to secure estimates, designs I ! ! ' and quotations for the new notes and coinage. i i , The basic lines on which the new currency was set 107 7 up are as follows: The monetary unit was the dinar with an exchange value of one pound sterling. The dinars were to be issued against equivalent rupee or sterling value which would be invested in securities of the countries i on the gold standard. The securities were to be held by j a Currency Board residing in London and to be represented i by a Currency Office in Iraq. The Currency Board was to i be independent of the executive branch of the government. i It is to be noticed that the Law entrusted the Currency Board with the issue, control and management of I ! the money. It had postponed the idea of forming a central ; I ' I bank. Nevertheless, the Law pointed out that the duties of the Currency Board should cease in event of the estab lishment of a central bank which would undertake these i duties. i i However, because of the uncertainty of the future of sterling, the government postponed the introduction of the new monetary system first for three months to October ^For thorough discussion of the Iraqi monetary system under the Currency Board, cf. post, pp. 114-119. " 108 *1 1, 1931, and again to January 1, 1932. When Great Britain abandoned the gold standard, the Currency Board advised j the government to pass a law to remove the gold basis of j the monetary system. In December 1931, the government, t i following the advice of the Currency Board, passed a law j i which abandoned the gold basis and postponed the intro- j duction of the new money indefinitely. j In the beginning of 1932, the Currency Board in | : i : London convinced the government in Baghdad that the ! ! i comparative steadiness of the pound sterling called for j the issuing of the new money. Therefore a Royal Iradeh I (order) was issued authorizing the introduction of the i new money starting April 1, 1932. i i l I The local apprehension of the effect of the I change which have themselves felt and had been I sedulously fostered in certain quarters during ; the previous year had been substantially allayed , by careful propaganda on the part of the govern- I ment, and the change was effected smoothly I without any noticeable disorganization. The ! reception of the new currency<was on the whole favourable, and in commercial circles it was , J accepted, if not with enthusiasm, at least with j j benevolent acquiescency. 8 j ^Report on Iraq Administration, 1932, pp. 25-26. 109 | II. IRAQ CURRENCY BOARD The Iraq Currency Law of April, 1931 and its amendment of December of the same year provided for the [ i establishment of a Currency Board to issue and manage the Iraqi currency on behalf of the Iraqi government. The Currency Board started its duties in July, 1931 and the new monetary unit was introduced in April, 1932. 1 * I Composition of the Currency Board j I The Currency Board was composed of five members; ! I I i two members represented the three commercial banks then ! ! j operating in Iraq, one member was to be chosen by either * j the Bank of England or the Financial Committee of the i ' i League of Nations^ and the other two members were to be j chosen by the Iraqi Government. In practice, the Iraqi i ! Government was accustomed to appointing a British expert ! as one of its representatives and the Iraqi General ! 1 ! Council in London as the second representative. The i t ! Chairman of the Currency Board was appointed from these 9jjp to the termination of the duties of the Currency i Board the Iraqi Government preferred the appointment of ; this member by the Bank of England. j l i d | members by the Iraqi Government, who chose Mr. Young for the post. Each member was appointed for three year terms and could be reappointed again for indefinite terms. The writer feels that there were many deficiencies in the above arrangement. First, Iraq interest in the Currency Board was represented only by one member, because the commercial banks then operating in Iraq were all British and were represented by two members. In addition, the Iraqi government in practice appointed one Britisher as one of its Representatives and the Bank of England was represented by one member. The main objection to such an t | arrangement is that it is natural for British representa- | tives to serve the interests of their own country before | serving the interest of a foreign government in the event i that a conflict in interest should arise between the two . countries. To make matters worse, the appointment of ( the Iraqi General Council in London as the other repre- | sentative of the Iraqi Government was a very poor decision. As this official was mainly a politician and lacking the knowledge of economics in general, and money and banking in particular. A third weakness is that the terms of membership in the Board were very short. This _ _ 1X1 ..J I left all members at the mercy of the executive branch of the government. The failure of the Iraqi Currency Law i to require the Iraqi Government's approval of the members j i chosen by the commercial banks and the Bank of England ; i was the fourth defect. Those members were considered, by law, Iraqi officials and it would therefore have been reasonable for the government to control the appointment of its employees, i i I i j Duties and Powers of the Currency Board ^ I The Currency Board's principal functions were to j provide for and to control the supply of money and to ensure that the currency was maintained on a satisfactory j basis. The Board also had the authority to make all I necessary arrangements for the minting and supplying of ' | ; I coins and the issue and re-issue of paper money. The : Board was authorized to make arrangements for the can- : cellation of notes withdrawn from further circulation, for ' I | the destruction of such cancelled notes and for recording the issue and cancellation of notes. The Board was 1 i required to issue, on demand, Iraqi currency equivalent , to the value of sums of pounds sterling received by the ; 1 i j I 5 Board in London. Also the Board was required to pay, on ! 112 demand, pounds sterling in London equivalent to the value of Iraqi currency received by the Currency Officer in Baghdad. The Board was empowered to appoint officers for the discharge of duties in connection with currency in the United Kingdom or in Iraq at such rates of salary as the Board thought fit, subject in each case to the i approval of the Iraqi Government. The two main officials | assisting the Board in performing its duties were the Currency Officer in Baghdad, and the Currency Agent in London. The Board was required to invest its funds in foreign governments securities (or private securities j guaranteed by these governments) whose currencies are I i i convertible directly to gold or to sterling. The Board !vas also required to hold a proportion of its monetary ! I reserve in a liquid form. I i For accounting and auditing purposes, the Board . was required to submit to the Ministry of Finance a semi- i annual statement of the position of the Currency Reserve Fund on the last day of each six months including a state- ' ment of securities and the amount of coinage and notes " - - il3 I in circulation. A copy of the statement was to be sent to the Comptroller and Auditor General who in turn submitted it to Parliament. The Board was required, further, to i submit to the Ministry of Finance an annual statement of , its transactions during the preceding year. Also, the Board had to make up and publish in the Government Gazette, a monthly abstract, showing: (a) the whole amount of the coinage and note circulations on the last day of each month, (b) the total amount of the Currency 1 Reserve Fund on the said days besides a half-yearly 1 abstract showing the nominal value, price paid and latest 1 known market price of the securities forming the investment! portion of the Reserve Fund. i ! The Government Share in the Earnings of the Board » J The Law of 1931 required (1) the maintenance of a | monetary reserve of not less than 100 per cent of notes I and coins in circulation and (2) a special reserve against I i the unforeseen decline in the prices of securities con- ! stituting the monetary reserve fund. Having provided for : 1 such reserves, the Board, at its discretion, was authorized' i to pay part or the whole of its profits to the Iraqi Treasury. It is to be noticed in this connection that ! 114 ' i t t the Board was not required to make such payments, but \ ! rather it was given a choice of action. | During the first two years of operation (1932-1934),! i the Board retained its entire earnings and utilized these ■ earnings in building its reserve fund. From 1935 to 1939 the Board paid varied sums to the Treasury amounting to I five hundred and forty-six thousand dollars. Since 1939 j f I I and until 1947, the Board fixed the annual payment to the ! Treasury at a sum of sixty thousand dinars and kept the i I rest of the earnings. By the time the Central Bank of j i i Iraq replaced the Currency Board the accumulated surplus ! I j of retained profits was about five million dinars which was transferred to the Bank as its nominal capital. ! i j III. NOTE ISSUE AND RESERVE REQUIREMENTS i The monetary unit of Iraq was called the !*dinar" and it was divided into one thousand ’‘ fils.*1 The paper ! ' 1 money was composed of the following denominations: one- j [ half, one, five, ten, and one-hundred dinars. The sub- i | sidiary coins consist of the following units: one, two, four, ten, twenty, fifty and two-hundred fils. Each ' denomination of paper money had unlimited legal tender in the payment of all debts while that of the coins was limited and varies according to the value of the coin. When the CBI took over the functions of note issue in 1949, the above arrangements were maintained with immate rial modifications. Notes Issue The monetary system of Iraq established by the original Law Number 44 of 1931, was the gold bullion exchange standard. The Dinar was equal to 7.3223 grams ! i 1 ! of pure gold and equal to one pound sterling. The dinar I ! i was not directly convertible to gold but rather to pound | i j sterling, which in turn could be converted to gold j i : bullion. This provision of the Law never went into : effect, as in September, 1931, England abandoned the i t ; gold bullion standard which made it necessary for Iraq : to do the same. Law Number 101 of 1931 was enacted i • removing the gold provision and established a sterling j i 10 . exchange standard. ^Al-Waqayi’a Al-Iraqiya, No. 974 of April 23, 1931 and No. 1066 of November 17, 1931 Law of the Iraqi i Currency, No. 44 and the Amendment of the Law of the Iraqi , Currency, (Baghdad: The Government Press, 1931). 116 The Currency Board was required to issue dinars on demand to persons who pay the equivalent value of the I pound sterling. Consequently, when merchants or others | acquired sterling abroad, it was converted immediately and J i i on demand into Iraqi dinars. The supply of the Iraqi j money was linked to its balance of payments in almost the same manner which prevailed under the gold standard. It is apparent that under such arrangements the external value of the dinar depended upon that of the sterling. The Iraqi dinar was no more than the pound ; i sterling by another name. It is obvious, too, that the iBoard did not have control over the rate of exchange of ! jthe dinar to other currencies. This rate of exchange 1 was dependent upon the rate of exchange between the ; sterling and those other currencies. ( It is evident from the short account given above that the Board was a "currency institution" in a restricted, i : sense; it had no banking functions and exercised no ; control over the volume of money in circulation. Since I the Board did not hold local securities, the Iraqi Government was unable to use fiscal policy as a means of influencing economic activities. The government was thus 117 precluded from following an independent monetary policy. From the broad point of view, the Board was a money- changing and accounting device. Beyond exchanging Iraqi I dinars for sterling or the sterling for dinars and invest- ; ! ( ing the sterling so obtained in securities, it engaged only in currency administration. The impact of these defects was felt clearly during the Second World War when the pressure of a run away inflation could riot be controlled by the Iraqi Government. I I | Reserve Requirements I Article 16, Section (h) of Law Number 101 of 1931 ' « ! required the Currency Board to keep a monetary reserve I i I sufficient for the convertibility of the currency. Section | ; j (2) of the above article entrusted the Board with the i ! investment of its assets !,in securities of or guaranteed ! by states with a currency convertible directly into gold 1 1 or pound sterling.** A The Board must, also, hold a pro- ; portion of its reserve in a cash form. Article 19 of the ! ^Law No. 101 of 1931 . . ., op. cit., Article XVI, Section (h). 118 ; j same law pointed out that the ratio between the value of money in circulation and its reserve must be at a minimum of 100 per cent. The Minister of Finance stated in his discussion of this law in parliament that the reserve j i I ratio could reach as high as 200 per cent of money in circulation. This could have been accomplished through the retaining of the Board's profits instead of paying I [ these profits to the Treasury. i * f The Iraqi currency, then, was backed by a 100 j per cent reserve of pound sterling (or securities con- ' vertible to gold or sterling), and there was no gold or appreciable ratio of silver in the reserve. Moreover, i as the Board was not a central bank it could not discount commercial papers, and the Currency Law itself limited the investment of the reserve into "securities” only. Annual Report of the Board indicates that the ! reserve was kept at over 100 per cent of money in circula- < tion, a fact which contributed a' great deal to the con- j fidence in the Iraqi money. As to the nature of the I I ! reserve fund, it was mainly composed of short and inter mediate term securities. These were twenty-seven in number , fifteen of them securities issued by the British 119 ; government; two issued by British corporations and j guaranteed by their government; and the rest, securities j 12 of some governments of the British colonies and dominions. ; ! IV. OPERATIONS OF IRAQ CURRENCY BOARD, 1932-1939 ! i i Under the authority of the Iraqi Currency Law Number 44 of April, 1931, its amendment by Law Number 101, and according to a Royal Iradeh, the Minister of Finance formulated and authorized the Currency Board in London to i introduce the new money on the first day of April, 1932. j The period elapsing between the enactment of the statute i 1 I land the actual introduction of the Iraqi currency, was j |utilized to determine the nature of the note reserve, in j providing the proper personnel and necessary equipment for ' l j the supply and control of the currency; and in securing i estimates, designs and quotations for the new notes and . coinage. The Development of Money in Circulation In March 1932, the new coins and notes were shipped , | ^Annual Reports of Iraq Currency Board for the ! years 1932 to 1948 (Baghdad: The Government Press, 1933- j 1949). I 120 from London to Baghdad and kept in the vaults of the Eastern Bank which was chosen by the Currency Board as its agent in Baghdad. The new money was distributed among the Sub-Treasurers of the government and the financial institutions. On April 1, 1932 the new money was cir culated and was accepted favorably by the people. As a result, the exportation of the Indian rupees to India in June 1932 totaled 32,909,864 rupees (about I.D. 2,468,239 at a rate of 75 fils for each rupee) and the total remain- | ing in circulation was estimated to be around seven j million rupees (about I.D. 525,000). A year after intro- ! duction of the new currency (March 31, 1933) the total ! money in circulation was I. D. 2,248,185, in the form of i both notes and coins.^3 From 1933 on, the amount of money in circulation | continued to increase, particularly in 1937, as shown in i Table VI. Among the several reasons for that increase were: the enactment of a Law in 1933 forbidding the •^The Currency Board shipped to Iraq in new notes and coins a total of I.D. 3,750,000, but the money in actual circulation was I.D. 1,512,000 less than that total. The difference was kept in the vaults of the Eastern Bank and the Sub-Treasuries. 121: TABLE VI MONEY IN CIRCULATION, 1933-1939 (In Iraqi dinars) Year Notes and Coins Ratio of Coins to Notes 1933 £January (June 2,086,185 2,363,445 One-fifth 1934 ^January (June 2,928,363 3,174,365 Less than one-sixth 1935 (January (June 3,534,321 3,714,320 Less than one-sixth 1936 (January (June 3,760,320 3,938,312 More than one-sixth 1937 (January (June 4, 701,312 5,113,311 One-seventh 1938 f “ ““ 7 (June 4,958,301 4,628,297 More than one-seventh 1939 (January (June 4,693,297 4,883,296 One-eighth .Source: Government of Iraq, Principal Bureau of Statistics, Statistical Abstracts, 1950 (Baghdad: The Government Press,* |1952), p. 282, and Abdul R. Al-Jalili, Monetary System of Iraq.(Cairo: Metba’at Nehthet Misir, 1946), pp. 215-217. 122 ! circulation of the Indian rupee; the increase in the volume of Iraqi exports; the increase in the prices of exported goods, and, the increase in the export of gold, ^ CO Syria W « « « u ! The Table indicates also a startling phenomenon, namely, the low quantity of money in circulation. If this quantity is related to the number of population, it i i will even be more startling. The population of Iraq in 1939 was estimated to be little over four million, while ! the total money in circulation was I. D. 4,883,296 for I ! ! I the same period. In the United States, for example, the i > I population in 1939 was about 132 millions while the total | ! money in circulation was about nine billion dollars. One i 1 ; might erroneously conclude that this fact indicates the i i j large use of a checking system rather than using cash. l i ! Nothing could be farther from the truth. Although there j are no statistics available for checks clearing during 1 } f ! that period, the writer believes that this low ratio , : { reveals the low purchasing power of the people, the j Annual Report of Iraq Currency Board, 1935 (Baghdad: Government Press, 1936), p. 17, and Al-Jalili, op. cit., pp. 216-19. 123 existence of a large segment of population outside the monetary economy and the low volume of national income. It is of value to mention, too, that the ratio of coins to paper money in circulation continued to decline. While this ratio was one-fifth of the total money in circulation in 1933, it declined to one-eighth in 1939. The decline shows the increased public confidence in paper money but it may have also denoted a rise in the cost of j i living which required the use of money of larger j I denominations. ; i i i I | Status of the Monetary Reserve j i J i As early as 1932, the Currency Board, in compliance ! | . i ■ with the law of 1931, adopted a conservative reserve j ! policy. The reserves held were adequate on the most ! i ! | cautious assessment and they exceeded total currency ! liabilities. Table VII gives the position of the reserves ! for each year from 1933 to 1939. i i 1 It is apparent from this Table that the Iraqi currency was covered always by a reserve of 100 per cent i or more. The reserve was chiefly composed of sterling | securities together with a considerably small ratio of I ! I silver and liquid assets. TABLE VII CURRENCY LIABILITIES AND RESERVES OF IRAQ CURRENCY BOARD, 1933-1939 (in thousands of Iraqi dinars) Year Currency Liabilities* Reserve* Reserve Ratio to Currency Liabilities .Per cent 1933 2,363 2,898 122 1934 3,174 3,199 101 1935 3,174 3,803 102 1936 3,938 4,104 104 1937 5,113 5,127 100.2 1938 4,628 4,845 105 1939 4, 883 4,956 102 'Source: Annual Report of Iraq Currency Board, 1939 [(Baghdad: Government Press',"'' l940), p. 9.. ^Currency in circulation and reserves as at June 30 of ' . . each year. V. OPERATIONS OF IRAQ CURRENCY BOARD, 1940-JULY 1949 This period covers the operations and activities of i the Board from World War II until the transfer of its I duties to the CBI on July 1, 1949.^ j As in other countries, the Second World War brought tremendous changes both in the composition and volume of j the Iraqi currency in circulation and its reserves. These and other developments are the subjects of this section. I i , jInflationary Pressures ! During the Second World War, Iraq experienced severe |inflationary pressures. The rise in prices, even with | rationing, price control and tax measures, was distinctly j jgreater than in Britain and the United States. There was J no index number to measure the cost of living until the j end of 1944. Since 1945, however, the Principal Bureau iof Statistics started to publish a cost of living index. ■^It is intended here, to examine briefly, the development occurring during this period to help understand how the present central banking in Iraq came into i existence and to show the elements contributing to its 1 present status. i 126 1 In that year this index was 584 compared to 100 in 1939. | i An idea about the pressure of inflation, nevertheless, j can be obtained from the wholesale price indices and from the volume of money in circulation. In 1943 the wholesale i price index was six times greater than in 1939, while the volume of money in circulation was seven times more for the same period. Table VIII shows the relation between 1 j these three indicators of the inflationary pressure. ! | During the war, the principal cause of inflation j was the increase in the expenditures of the Allied forces j j stationed in Iraq. These expenditures amounted to 8.1, i i j j 15.4, 30.1 and 10.4 million pounds sterling in the years J 1941, 1942, 1943 and 1944, respectively. ^ The system i ■ of notes issue in Iraq facilitated, to a great extent, j the financing of the Allied troops in Iraq and removed j 1 the difficulties which could have arisen had Iraq possessed j : an independent monetary system. When Iraq money was i i needed by the British forces, England deposited with the 1 I Currency Board in London, British securities and the Board , I 16 i0United Nations, Department of Economic Affairs, Review of Economic Conditions in the Middle East, 1950 (New York, 1951), p. 77. , TABLE VIII INDICES OF VOLUME OF MONEY IN CIRCULATION, COST OF LIVING AND WHOLESALE PRICES IN IRAQ, .1940-1949 . . . (1939= 100) Year Circulation of Notes & Coins Cost of Living Wholesale Prices 1939 100 100 100 1940 131 - 138 1941 164 179 1942 261 - 383 1943 538 - 590 1944 798 - 534 1945 858 584 503 1946 850 567 482 1947 802 601 527 1948 715 673 558 1949 707 540 463 Sources: United Nations, Department of Economic Affairs, Review of Economic Conditions in the Middle East, 1950 •"(New York,' "1951)","' pT™B4^ and Governrnent of Iraq, Principal Bureau of Statistics, Statistical Abstract,.1950 (Baghdad: ;The Government Press, 1952), p. 282. 128 I I supplied the Iraqi dinars. In this sense the Board acted as a lending agency to the British government rather than being a fiscal agency for the Iraqi Government. Undoubt- | edly, this arrangement was an awkward one; it imposed i i inflationary pressures on Iraq, not as a result of the Iraqi Government expenditures but mainly as a reslilt of the expenditures of the British authorities. To make I matters worse, the British government froze the Iraqi sterling balances in London and made it impossible to use j them for purchasing materials from England or elsewhere, ! which would have reduced the inflationary spiral to a j i certain degree. ! ! i Among other inflationary factors were the general i i increase in import prices and the shortage of supplies. t , , The reduction in the quantity of imports was only partiallyj offset by diminished exports and by some increase in the I I domestic production of consumer goods. The shortage of ! supply was intensified by speculation, hoarding and the inadequacy of transport facilities. i | The government attempted to control inflation i through increased taxes and rationing, but these were only / ! partially effective owing to illiteracy and the lack of 129 I skilled administrative personnel. Measures which attempted' direct or indirect control by means of subsidies, price ceilings and restriction of profits were also unsuccessful. ! The writer feels that if there had been a central ! bank in Iraq during that period with an independent mone tary unit, the situation would have been different. The i central bank with its credit and monetary policies, and the Treasury with its fiscal policy coupled with some j measures of direct controls, may have been able to i ; | obstruct the continuous increase in prices. Iraq might 1 have acquired gold and hard currencies to use freely ; during and after the war to facilitate stability and to i ) achieve economic development. I Deflationary Tendencies j ! j After the war, there existed a downward trend in | prices. The wholesale price index dropped from 534 in t ’ | 1944 to as low as 482 in 1946. The index of money in circulation declined also from 858 in 1945 to 850 in 1946, and down to 802 in 1947. In 1947 prices took an upward course owing mainly to the poor crop of that year, the appearance of budgetary deficits and inadequate I I I 1 imports of consumer goods. At the end of 1948, however, : X30 J the situation changed considerably as the indices of money in circulation, cost of living and wholesale prices i declined. The main contributory factors to the downward t trend, during the latter part of 1948, were the cut in i i I private investment as a result of the Arab-Israeli war, j the embargo on exports of wheat and barley and the prospect of an abundant 1949 crop. jDevelopment of the Monetary Reserve ! i j j Due to the increase in the demand for Iraqi i currency to finance the Allied troops stationed in Iraq, i the money supply was Increased and resulted in a similar trend in the monetary reserve. Table IX shows the volume of Iraqi currency reserve and its ratio to money in cir culation. The Currency Board maintained during the war and post-war periods 100 per cent reserve of sterling j j ! securities behind the notes issue. Similar to the pre- ; war period, the Board invested almost all of its assets i I in sterling securities issued by the British Government : i i or its colonies or dominions. j The Board continued to pay the Iraqi Government ! ! the sum of sixty thousand dinars a year as part of the I ! profit realized from investing the reserve fund. In the 131| TABLE IX VOLUME AND RATIO OF IRAQI CURRENCY RESERVES, 1939-1949 Amount of Reserve (in Iraqi dinars) Ratio of Reserve to Money in Circulation Year* 1939 4,956,234 102 1940 6,609,651 103 1941 8,099,994 101 1942 15,536,174 112 1943 30,591,850 102 1944 42,239,591 102 1945 43,694,443 104 Year** 1946 44,653,497 108 1947 43,754,232 112 1948 39,326,125 112 1949 34,655,458 100 i Source: Based on material from Abdul R. Ai-Jalili, Monetary System of Iraq (Cairo: Metha * at Nehthet Misir, 1946), p. 216; Government of Iraq, Principal Bureau of Statistics, Statistical Abstract, 1950 (Baghdad: The Government Press, ,1952)* p* 282, and Annual'Report of the National Bank of ; Iraq,. July, 1949 - December, 1950~TBaghdad: The Times !Printing & Publishing Co., Ltd., 1951), p. 26. ; *Year ending June 30. **Year ending March 31. _ _ 132 fiscal year 1947-1948, however, the Board stepped up the share of the government to five hundred thousand dinars and continued to pay this sum up to the termination of its operation in July 1949. In the above treatment, mention was made regarding two outstanding experiences: the imposition of foreign exchange control and the accumulation of frozen sterling balances in London. As these two major developments have a direct impact on the present Iraqi monetary system and i constitute the main arguments in evaluating this system, a separate chapter is devoted to their analysis. There- ! fore, the following chapter deals with the development, status and evaluation of (1) foreign exchange control and (2) the problem of Iraqi blocked sterling balances. ^Statistical Abstract, 1950, op. eit., Table ! 236, p. 289. CHAPTER V MONETARY EXPERIENCES OF WORLD WAR II Several important monetary developments took place in Iraq during the Second World War, the most important being the imposition of foreign exchange control and the accumulation of blocked sterling balances in London. The analysis of each of these developments is the subject of this chapter. A major emphasis is placed on the relation between these developments and Iraq*s membership in the sterling area. The development of the blocked sterling balances until their final settlement in 1952 is discussed in some detail. Due to the fact that the system of foreign exchange control will be I treated in Chapter X it is discussed here briefly. » i I. FOREIGN EXCHANGE CONTROL Upon the outbreak of the war, the British Govern ment imposed many restrictions on foreign exchange. Following Great Britain, the Government of Iraq also : undertook a policy of exchange control. Under the Law - 1.34 ' i of Foreign Exchange Control Number 71 of 1941, the govern- j i ment was authorized to exercise exchange control, starting November 24, 1941.^ In compliance with the law a special committee, j called the "Exchange Control Committee," was set up. This committee was empowered to impose restrictions on the purchase of foreign exchange; to acquire foreign exchange; to impose restrictions on purchases and export of securi- ; ! ties; and to acquire foreign securities. Accordingly, ! I j all dealings in foreign exchange had to be transacted | . ! J through authorized dealers, and three commercial banks J J operating in Iraq were licensed for such purposes. j I i I i i Exchange Control Regulations ! i For the purpose of exchange control, the British i | 1 Government formed what is called the sterling area. This | 1 i area originally included the countries of the British J i Empire (except Canada, Newfoundland and Hong Kong), Egypt, 1 I Iraq, Jordan, Palestine, Iran, the Belgian Congo, Iceland j I i 1 I , Al-Waqayi’a Al-Iraqiya, No. 1972 of November 24, 1941, Law of Foreign Exchange Control, No. 71 of 1941 (Baghdad: The Government Press, 1941). 135 and the Free French Territories.2 At first, no restrictions were put on the free transfer of funds within the sterling area. But the j i purchase and sale of currencies outside the area were i I subject to rigid control. Through special agreements, payments between certain foreign countries and the sterling area were permitted only in sterling, and trans- i fers between the accounts of these countries and other : i non-Empire countries were prohibited. ; Remittances to countries outside the sterling area | were not allowed unless the remitter filed an application ! i form stating the purpose for which the remittance was required. I [ Lawful purposes for exchange. Article V of the Law j j of Foreign Exchange Control stated that remittances might | * \ i | ! be required for: (1) Payment for any form of imports, i I provided the applicant produced custom entry forms as i evidence that the goods had been imported into Iraq. i I (2) Petty private remittances. (3) Traveling expenses j j 2 Paul Einzig, Currency After the War (London: j | Nicholson and Watson, 1944), p. 35. ; to a limited amount. (4) Other trade purposes like freight, profit and royalties. (5) Capital remittances, which were only permitted in exceptional circumstances and had to be referred to the Exchange Control Committee. The purpose of these regulations was to insure that foreign exchange was sold only for the finance of trade and for a few other approved purposes. They were designed to.prevent any flight of capital and to make speculative operations in exchange impossible. i At first, the licensed banks were given consider- I able latitude in the sale of foreign exchange. As the war advanced, however the gold and foreign currencies j reserve of the sterling area was exhausted. This i j necessitated the curtailment of the licensed banks i I j privileges. Subsequently, they were unable to sell i , exchange without prior reference to the Exchange Control i Committee, for making payments for licensed imports and ! ; a few private remittances. A rigid control on imports was instituted, with no imports without a license being allowed from outside the sterling area. Control of the Proceeds of Exports The exchange control regulations were gradually 137 1 tightened as necessary. An important development was the institution of a scheme for controlling foreign exchange proceeds of exports to the hard currency countries, i.e., j I United States, Switzerland, Netherlands and Belgium. As j j a result, Article VIII of the law necessitated that export transactions should be executed according to the require ments and conditions imposed by the Foreign Exchange j Committee. The aim of the scheme was to obtain control j i of the foreign currency proceeds of exports, and also to j see that the full proceeds of exports were received at ' j j j control rates. ! i 1 ! The balances accruing to Iraq (and all other members i ! | of the sterling area) in the United States had to be : i | handed over to the British Government and constituted j the "Dollar Pool," to be utilized for purposes of war. j ■ ^ Control of Bullion, Securities and Foreign Currency Notes i i In addition to ordinary commodities, control was : also exercised over the export and import of bullion, j securities and currency notes. Export of gold could be^ J made only under license. Exports to the United Kingdom j were permitted providing the gold was consigned to j authorized brokers in London. Licenses for exports to 138 the United States could be granted only if the authorized dealers would promise that the dollar proceeds would be surrendered to the proper Iraqi agency. Imports of gold { 1 i were licensed, but were freely permitted providing they did not involve the expenditure of any important currency, especially dollars. j In regard to securities, they could neither be ( 1 acquired from non-residents nor could they be exported j | without the permission of the Foreign Exchange Committee. I If one wanted to export foreign securities, a license was ! required and this would be given only if the foreign exchange proceeds were surrendered to the foreign agents i i of a bank in Iraq. ! j | Restrictions were also placed on the exit of S i | jewelry and cash from Iraq. A specified minimum amount i ■ of cash could be taken out without a license but beyond i i ! i that amount, a license had to be secured from the Foreign ; i ! i ; , Exchange Committee. I i In summary, before the close of 1941 with the ; i „ . exception of a few supplementary measures to tighten the i control in case of any loopholes, and to simplify or to slacken the unnecessary restrictions during the war period, 139 the Iraqi Government followed the British Government in establishing complete control over Iraqi foreign exchange transactions. II. DEVELOPMENT OF IRAQI STERLING BALANCES For decades> Great Britain was the financial center of the world and the major power in politics. As a result, i many countries made strong financial ties with Great I Britain under the names ’’sterling bloc" and "sterling area." These terms have undergone many changes. Sterling bloc countries were those who pegged j their currencies to sterling, maintained sterling balances in London and removed many of the obstacles to trade i 1 3 | between their respective countries. | The term "sterling area" in its new sense was men- ! tioned for the first time in the Defense Order of July 7, i 1940.^ The order defined the sterling area to mean the ^Carlton L. Wood, "Sterling Area’s Characteristics Change Under World Stresses," Foreign Commerce Weekly, August 7, 1948. ^D. F. Heatherington, "The Sterling Area," Inter - national Reference Service, 32:20, November, 1945. United Kingdom, the Isle of Man, and such other territories I as might be declared by order of the Treasury to be included in the sterling area. The countries comprising the sterling area changed from time to time with the addi tion of a new member or the dropping of an old one. The characteristics of the sterling area are the same as those of the sterling bloc, plus the imposition of unique foreign exchange controls by the members in their dealings j with outside countries. i Iraq*s Relations with the Sterling Area 1 Officially, Iraq became a member of the sterling j area December 22, 1941 according to a declaration issued i by the Minister of Finance and published in the official | gazette of that date.“* This declaration was issued in ■ I compliance with Articles 1-3 of the Law of Foreign Ex- 1 change Control of 1941. Actually, Iraq was a member of the sterling bloc and later of the sterling area since the issuance of its national money in 1932. This relation was broken only j ^Al-Waqayi'a Al-Iraqiya, No. 1983 of December 22, 1941, Declaration of Iraq1s Entrance in the Sterling Area ( (Baghdad: The Government Press, 1941). 141 for a short period during the war between Iraq and Great j Britain in May, 1941. j Iraq*s monetary system, as shown in the previous | I chapter, was based on the pound sterling. Legally, the i official rate between the Iraqi dinar and the pound sterl ing was fixed at a ratio of one dinar for each pound. Moreover, Iraq maintained its balances and its monetary ; reserve in London. The settlement of foreign trade trans- | actions was completed through the Bank of England. In ; i ; addition, Iraq maintained an almost free flow of trade ; i with the sterling bloc and participated in the ’’sterling 1 i ; ; dollar pool.” All these elements indicate that Iraq J was practically a member of the sterling area long before : t its official entrance. As one student of this problem f |explains: ; j | | The sterling area as we know it today first ! ! made its appearance in 1931 when Britain was j forced to leave the Gold Standard and allowed her currency to depreciate in terms of gold. ; All the Commonwealth countries, with the excep tion of South Africa and Canada, immediately j decided to keep their exchanges stable in terms of sterling and so allowed their gold parities to alter; the same policies were carried out 142 6 simultaneously by Egypt and Irak [Iraq], . . . Presently, Iraq is still a member of the sterling y'\ ‘t ‘ « area. The evaluation of the relation between Iraq and the sterling area will be discussed later.^ I * i The Dollar Pool j It was shown that before the war Iraq held all of its foreign exchange balances in London in the form of sterling. Sterling was freely convertible into other currencies. Through such a device, countries which held j sterling balances could convert them at will into any cur- ; i Irency they happened to need in order to fulfill their 1 ; i i international obligations. With the outbreak of war and the resultant increasing difficulty in securing the con vertibility of sterling, this system assumed a degree of i i t jrigidity which had not been anticipated. Those members j of the sterling bloc who continued to be members of what Jwas later known as the sterling area were forced to impose j restrictions on the expenditures of foreign exchange, in ^A. C. L. Day, The Future of Sterling (Oxford: At the Clarendon Press, 1954), p. 35. I ?Cf. post, pp. 274-289. order that the limited resources of the sterling area of I i foreign currencies might be utilized to the best advantage j I in the prosecution of the war. The sterling area*s entire holdings of foreign exchange were held in one pool in the i custody of the Bank of England and the British Treasury. As the United States dollar was the most important foreign currency in this pool, this whole arrangement came to be known as "The Empire Dollar Pool," instead of the"sterling Area Pool of Foreign Exchange." In the working of the i Dollar Pool during the war, the individual countries of j the sterling area were not limited as to the various i foreign currencies which they were entitled to spend. i i As a means of restricting expenditures the countries1 i concerned agreed not to spend foreign exchange unless it was essential and could not be satisfied within the sterling area. The test of essentiality varied in severity from time to time as the volume of the Pool i increased or decreased. At the conclusion of the war, j and for a considerable period before it, the test was whether a particular demand was necessary for the prose- j cution of the war or for the maintenance of the civil ■ economy at a war-time level. ; __ _ i4'4~i Iraq*s spending of hard currencies amounted to I.D. 4,640,551 for the fifteen month period ended March 31, 1945. The first official agreement between Great Britain and Iraq concerning the allotments of hard currencies was signed May 28, 1945. According to this agreement Iraq was allowed to spend for the remaining part of the year 1945 an amount of three and one half million dinars. | The agreement was renewed three times providing for addi- j | tional amounts of allotments, until its expiration on | ( ! July 15, 1947. From the beginning of 1946 and up to July 15, 1947, England allotted to Iraq the sum of I.D. ! | 5,624,393 of hard currencies which was composed of, for j I [ the most part, American dollars, Canadian dollars, Swiss ) i o | francs, and Swedish krone. i I f ! j Statistics are unavailable regarding Iraq's i earnings of hard currencies for the period discussed, but i ^ one could safely estimate that its earnings were far I t : greater than its expenditures of those currencies, on the j I i i ■ assumption that Iraq should have received part of its oil 1 ( ■ royalties in the form of hard currencies. This portion | ! 8 1 Abdul R. Al-Jalili,.Lectures on the Economy of ■ ,Iraq (Cairo: Al-Risaleh Press, 1955), pp. 57-62. j 145 of the oil royalties could have been determined by cal- - j culating the ratio of Iraq’s oil exports to hard currency areas. If 30 per cent of the oil exported went to hard I currency areas, then the oil companies should have paid I 30 per cent of Iraq’s royalties in those currencies. It is very likely that the earnings from that part of the oil royalties, plus Iraq’s exports to hard currency areas, ! plus the invisible expenditures of hard currency countries ] I in Iraq, were greater than what England had alloted to iIraq. I I t ! I |The Development of Iraqi Sterling Balances | Iraqi sterling balances as used in this content mean all sterling accumulated in the name of the Iraq j |Currency Board, the Iraqi Government and the Iraqi citizens: i i ? i "and institutions, from the beginning of the war until ! I 1 July 15, 1947, when the Anglo-Iraqi Sterling Agreement was signed. j , i ! Balances of the Iraq Currency Board. According j : i to the National Currency Law of 1931 and its amendments, I the Iraq Currency Board, as noted, was required to invest i its monetary reserves in securities of states or those 1 - _ „ I 4 _ 6 I guaranteed by states with a currency convertible directly into gold or pound sterling. As shown in the previous chapter, the Board followed a policy of investing almost t all its reserves in sterling securities. During the war the monetary reserves jumped from about five million Iraqi dinars in 1939 to over forty-four and one-half million dinars in 1944. This means that money in circulation t i | increased eight-fold. As it was noted before, this i | tremendous increase was due primarily to the expenditures } * of the Allied Armed Forces in Iraq. Whenever the British j ! | Government desired Iraqi dinars to spend in Iraq, it i issued British securities, gave them to the Iraq Currency i Board in London and received Iraqi dinars for them. Also, when the United States or other governments needed the j dinars { I * » I . . . there existed an agreement between the j British and the American Governments whereby dollars were paid directly to the British ! Treasury. . . * in return for Iraqi dinars provided in Iraq. Against \ ^B. R. Shenoy, The Sterling Assets of the Reserve Bank of India (London: Oxford University Press, 1946), Footnote, p. 13. I 1 ' * " 147 > ‘ these dinars the British Government passed on sterling securities to the Iraq Currency Board. Other balances. Beside the previous balances, which comprise the majority of the Iraqi sterling balances, there existed some balances belonging to the Iraqi Govern ment, Iraqi citizens and Iraqi institutions. It is very difficult to estimate each of these balances, because the government^ in its publications of data never separated these balances except for the recent holdings of the com mercial banks. At all events, the balances of the Iraqi ' Government and the Iraqi citizens were very minor and 1 negligible. Table X indicates the relation between the i j balances of the Iraq Currency Board (later transferred to j I the CBI) and those of other financial institutions. It I ! is clear from the Table that the balances of the Iraq t ' Currency Board constituted the great bulk of the Iraqi i ; balances. It is also evident that these balances ; declined after 1946 and began to rise again in 1950. This decline was principally due to the poor harvest in 1948, which led to a heavy withdrawal of the released sterling : balances. 148 A solution to the blocked sterling balances in general and the Iraqi balances in particular could have been approached either on an international basis or on a bilateral basis. The creditor countries, led by India I and Egypt, preferred the first approach. They demanded the inclusion of a solution for the sterling balances in the Bretton Woods Agreement. Having a different view on the problem, the British Government, supported by the United States, objected to a solution along inter national lines. The British objection was based on the l i argument that the blocked balances differ in many respects from one country to another and so would be better settled through bilateral agreements. As a i result, the Bretton Woods Agreement ignored completely i i • the balances problem and confined itself to future i ! transactions. In 1947, therefore, the British Government i began a series of negotiations with the creditor countries I concerning the solution of the blocked sterling balances. A sterling agreement between the Iraqi Govern- I ment and England was signed in August 1947. The main 1 principles of this agreement are analyzed in the following pages. 149 j Anglo-Iraqi Sterling Agreement I i It has always been realized that the sterling area I arrangements were discriminatory to other currency areas I i in general, and the American interest in particular. Many j observers have demanded the removal of such restrictions and the return to free trade with complete convertibility of currencies. Consequently, the United States entered I i i j Into negotiation with Great Britain, and on July 15, 1946, I i j ! the parties agreed on certain principles. In order to j i overcome the dollar shortage of the United Kingdom, the United States granted her a loan of 3,750,000,000 dollars 1 ! i | which was extended on the understanding that one year I after the date of the ratification of the agreement, full ! convertibility would be awarded to sterling area countries’1 earnings, and all regulations of a discriminatory charac- ; ter would be abolished. This agreement states: i The government of the United Kingdom will complete arrangements as early as practicable ! and in any case not later than one year after ; the effective date of this agreement . . . , i i under which immediately after the completion j of such arrangements, the sterling receipts i from current transactions of all sterling area j countries . . . will be freely available for j current transactions in any currency area without i discrimination. . . .^ The agreement went even further to stipulate some principles for the settlement of the frozen sterling ! t balances. It suggested the division of the blocked j j balances into three categories, with the first category to be released at once, the second to be freed gradually I in annual installments, and the third to be deducted from ! the total balances as a contribution by the creditor ; countries to Great Britain. I In compliance with this agreement, the United j i Kingdom took the necessary steps to put the agreement into ' operation. It started negotiations with the different I i i countries concerned and made special financial agreements ! with each of them. 1 Regarding Iraq, a financial agreement was signed between the two parties on August 13, 1947, to be effective from July 15, 1947 to July 14, 1952.11 ^United States, Anglo-American Financial Agreement (Washington, D. C.: United States Government Printing Office, 1946). i j Government of Iraq, Financial Agreement Between the Government of Iraq and the Government of the United Kingdom Regarding Iraq Sterling Assets (Baghdad: The Government Press, 1947), p. 11. ! " '... 151 1 I In defining “sterling assets,” Article XI of the j agreement pointed out that these assets included: (1) net current and saving accounts deposited with banks in i the United Kingdom, (2) money wherever held at call or I notice in the United Kingdom, (3) advances in sterling, (4) Treasury Bills of the British Government, (5) com mercial and other bills in sterling, and (6) all other I kinds of sterling securities with two specified exceptions. The agreement established two types of accounts: i Number 1 Account and Number 2 Account. The Number 2 i < 1 Account represented the blocked account while Number 1 I j Account represented the freed account. J i 1 j According to Article I, Number 2 Account should be | | credited with: 1. All holdings of sterling assets of the Govern ment of Iraq, the Iraq Currency Board and each office in Iraq of any other bank, at the close | ] i l of business on July 14, 1947. 2. Interest received by the Iraq Currency Board on its sterling assets after July 15, 1947. 3. Transfers from other Number 2 Accounts. 4. Any sums paid to the Iraqi Government by the j "152“ "! 1 British Government on or after July 15, 1947. 5. The proceeds at maturity or on realization of any investments purchased in accordance with established customs with funds standing to the credit of a Number 2 Account. 6. The net capital movement from the countries of j i the sterling area to Iraq. 1 i 7. Such other transfers as might be agreed upon : by the contracting governments. ! Paragraph 4 (b) of the same article stated that Number 2 Account should be debited (credited to Number 1 Account) with the following: 1. To each bank in Iraq, the release of an amount equal to the outstanding liability as at the close of business in July 14, 1947, provided . that this amount did not exceed the amount of the sterling assets held by that bank as of the ; above date. 2. The release of the following amounts to the j Iraq Currency Board: i (a) The sum of fifteen million pounds over a « five year period. (b) The equivalent of any portion of the scarce currencies provided in the Scarce Currency Agreement of May 1945 (as finally extended ! in February, 1947), which was not spent j before July 15, 1947. j j (c) The sum of five million pounds as a special! provision to facilitate for the Government j of Iraq the transition to the new • t circumstances. (d) The sum of two million pounds as a working j l balance to meet any temporary shortage in ; the means of payment. (e) A sum equivalent to a special proportion of the interest earned on the sterling i assets. 3. The release of other sums to meet various j obligations, the most important of which were: I . . . the repayment of advances made to the 1 Government of Iraq by the oil companies, the repayment of the debt of the Port of Basrah, the fulfillment of obligations entered into with the Government of Iraq, the Iraqi State Railways or the Directorate of the Port of Basrah before July 15, 1947, and payment of the cost of military j supplies purchased by the Government of Iraq before July 15, 1947, and the cost of surplus military stores, equipment or fixed assets 154 ! i disposed of by the Government of the United j Kingdom to the Government of Iraq before that date and of those which will be disposed of to j the Government of Iraq or the public after that J date.12 4. The release of amounts equivalent to the net capital movement from Iraq to other countries ! | of the sterling area. j I In order to fulfill the provisions of the Anglo- ' i American Loan Agreement, the United Kingdom promised I (Article II) not to impose restrictions on sterling j i received on or after July 15, 1947, in respect of current ' I i | transactions. In other words, Iraq could use the sums j | released to Number 1 Account, plus its earning of sterling j ! | j from current transactions on or after July 15, 1947, for ; i - j payments on current transactions in any currency area. | i i The Suspension of Free Convertibility of Sterling ‘ Shortly after the conclusion of the Anglo-Iraqi , i i I I Sterling Agreement on August 20, 1947, the British Treasury « 1 ' suspended the free convertibility of sterling released to ' I the Number 1 Account and the receipts from current ! Annual Report of the National Bank of Iraq, July 1947-December 1950 (Baghdad: The Times Printing and Publishing Company, Ltd., 1951), p. 43. i 155 i transactions, thereby violating not only the Anglo-Iraqi I Agreement but also the Anglo-American Loan Agreement. This; violation raises a question as to the value and validity of international agreements. | I Notwithstanding, the British Government argued that the reason for the suspension of convertibility was the high per week average drain of 273 millions on Britain’s j gold and dollar reserves. This reserve reached as low as j ■ 13 I ! 582 millions on August 10, 1947. Under such circum- j ; I I stances, the British Government maintained it could not 1 i j help but suspend the convertibility. ; ! < ! Naturally, this one-sided step by Great Britain ! shocked Iraq as well as other members of the sterling area i i ■ I and the United States. Iraq, among other members of the ; I ! sterling area, had hoped to use the released balances to I I j expand its imports of capital goods and to carry out a i I ; long-range development program. The suspension of the ; I I convertibility definitely delayed this action for many i years. 1 In order to meet the new condition, a temporary ' ■l^The Economist, August 16, 1947. 156 agreement had to be reached to regulate financing of Iraqi foreign trade. In November, 1947, Iraq and the United Kingdom concluded an agreement providing for the suspension of convertibility of sterling in Number 1 Account, and fixing the maximum sum which could be withdrawn from that account for financing current transactions with the hard currency areas. The original duration of the agreement 1 J was from July 15, 1947 to June 30, 1948, and was renewed J I ; j three times. 1 » ! I Table X shows the relation between Iraq's out- i | standing sterling balances, the released balances and the j \ - I > sums actually spent. It is clear from this table that i i ' ' the balances decreased sharply during the year 1948. The I i sum spent from January to December of that year was I.D. j 12,902,000. The free balances in June 1948 reached as low . ! ! , as I.D. 3,500,000 which was considered very critical, j ! | The Central Bank of Iraq reported that: . . . the marked decline in the free balances during 1948 was due to the poor harvests in that year and the preceding year, to the smuggling of a large part of the values of exports, to the 1 inflation of the sums actually or nominally spent to finance imports, and to a number of other factors, including the events in Palestine and TABLE X IRAQI STEELING BALANCES, 1947-1950 . (In thousands of Iraqi dinars) Periods Outstanding Sterling Balances With the ifith Central Commercial Total Bank of Banks . Iraq Free Balances Amounts Spent July 14, 1947 40,613 17,291 57,904 December 31, 1947 38,957 18,237 57,194 11,300 1,777 December 31, 1948 33,908 10,384 44,292 5,100 12,902 December 31, 1949 35,136 8,023 43,159 10,300 1,133 December 31, 1950 41,885# 7,550 49,435 18,400 6,274 j Source: Annual Report of the National Bank of Iraq* July, 1949 - December, 1950 : (Baghdad: The Times Printing & Publishing Co., Ltd., 1931), pp. 44-48. i i *This figure includes cash balance of No. 3 free account which represents a loan to , „the Iraqi State Railways. 158 the expenditure they entailed.^ The Iraqi balance of payments is the best mirror to reflect the fluctuations in the Iraq's sterling balances. ! i In 1947, the deficit in the balance of payments (excluding transactions of petroleum companies) amounted to little i i over sixteen million Iraqi dinars, and in 1948 the deficit rose to I.D. 24,260,000. Hence, "during the years 1947 to j 1949, the surplus in the oil sector failed to cover the i } deficit in other sectors, and Iraq drew heavily on its ! I | sterling balances and other foreign assets."^ ; i 1 Since 1949, Table X shows a continuous increase of i I s | | both the free and the outstanding balances. This was mainly i ! , due to the imposition of some restrictions on foreign j ! i \ trade, the improvement in the harvest and the cessation ! ! | of the conflict in Palestine. As a result, from 1949 to j ' • 1950 the total balances increased by over six million ' J ! Iraqi dinars and the free balances by over eight million, j Late in 1950, the gold and dollar reserves of the I ^Annual Report of the National Bank of Iraq, July, ! 1949-December, 1950, op. cit., p. 44. •^United Nations, Department of Economic and Social i Affairs, Economic Development in the Middle East, 1945 to 1954 (New York, 1955), p. 102. 159 ! United Kingdom improved substantially. This encouraged 1 Iraq to open negotiations with the United Kingdom regard- J ing a permanent settlement of the sterling balances. The ! negotiation started in October 1950 and took the form of i an exchange of letters between the two parties. The parties agreed only on certain principles concerning the amount of the free balances as well as with the proportion ; : ! of such balances which could be converted into hard : S I ' currencies. j ; 16 The principles agreed upon were as follows: 1 1. Release of two million pounds to increase the I i 1 working balance of the CBI to four million I I I ! pounds. ! | i 2. Release of an amount of B2,143,000 which represented the blocked part of interest I earned on the sterling assets. ! i 3. Credit all interest earned after October 1950 i • on the above assets to Number 1 Account. I 4. Release of a sum not exceeding six million i pounds in installments of two million pounds •^Annual Report of the National Bank cf Iraq, ; July 1949-December 1950, op. cit., pp. 44-45. whenever the total balance of Number 1 Account of the CBI was less than six million pounds. 5. Provide Iraq with all its requirements of hard currencies for essential imports and other essential payments for a period of one year beginning October 1, 1950. It should be noticed that principle Number 5 was a deviation from the old principle where Britain used to allocate to Iraq a fixed sum for a certain period to be converted into hard currencies. This change no doubt reflected the continued improvement of the sterling area reserves of gold and dollars. Due to that later agreement, Iraq's free sterling balances increased from t 19,506,000 in February, 1951 to h 24,553, 000 in April of the same year. This increase, together with Britain's readiness to supply Iraq with all necessary amounts of scarce currencies, encouraged the foreign trade of Iraq, and particularly its imports from the United States. In 1951, Iraq's imports from the United States increased by 45 per cent compared with its 1947 imports. Total imports in general in 1951 increased ”161 n by 13 per cent over those of 1947.-^ Another significant change regarding the status of Iraq's sterling balances was the removal of Switzerland from the list of hard cur- j i i rency countries. In theory, this change had no effect on the ability of Iraq to import from Switzerland, as there was no limit on the Swiss francs which could be j i spent by Iraq. In practice it made it easier for Iraqi ! i j importers to deal with Switzerland. Consequently, Iraq's i | I > imports from that country in 1951 increased by 432 per | I cent over the figures of 1947. Additionally, the Iraqi I s Government made arrangements to facilitate the importation I i j of goods from Japan who regained its strength in world j i i j markets at a remarkable speed. As a result, Iraq's j I j | imports from Japan rose from a negligible amount in 1947 J 1 I j | to the extent that Japan became the fourth principal j exporting country to Iraq. Naturally, there are reasons other than facilitating payments with Japan which brought i j : about this immense shift in the pattern of Iraq's trade, ' but this is beyond the sphere of this subject. •^Government of Iraq, Principal Bureau of Statis tics, Statistical Abstract, 1951 (Baghdad: The Government > Press, 1954), p. 198. 162 The amendment of the 1947 agreement discussed above, remained in effect until it expired in July 1952 when j negotiation for a new agreement was necessary. J ! ] Sterling Balances Agreement of 1952 i i The Sterling Balances Agreement of 1947 was designed l for five years and expired in July 1952. It was revealed j 1 i : | that the agreement was never put into practice because of ; l ; J the suspension of the convertibility of the pound sterling j ! in August 1947. Instead, Britain resorted to negotiating I ! j I amendments to the agreement at different intervals of time ; j i until the agreement finally expired. ! I I Britain, together with other members of the sterliijgJ t j i ' 1 j area was at the end of 1952 in an extremely improved j ! ■ i economic position compared with that at the end of 1947. i ! While the reserve of gold and foreign exchange of the i i i ! sterling area amounted to only h 582 million on August i j 10, 1947, it rose to t 3,298,000 in 1950 and fc 4,543,000 in 1952. This came about because of increasing exports of Britain and the sterling area to the hard currency areas, and because of the grants and aids received from j the United States through its different plans to bring : i about a speedy recovery of Europe. As far as Iraq was . concerned, its exports of oil increased enormously during 1952 helping the sterling area to acquire appreciable sums of both hard and soft currencies. All these factors supplied the Iraqi Government with excellent reasons to open negotiations with Britain in order to achieve a final settlement of the blocked sterling balances. On July 10, 1952, agreement on these negotiations was reached on the following principles: 1. The release of all balances held on August 10, 1952. This meant the release of L 23.2 million, which brought the total of free sterling balances to B 56.6 million, the highest since the war. 2. Iraq agreed to maintain its membership in the sterling area and to keep the link of the dinar with the pound sterling at the existing rate of exchange of one dinar to one pound sterling. 3. Britain agreed to supply Iraq with all its essential needs of scarce currencies to finance its visible and invisible foreign payments. It is believed that: . . . the outcome of these discussions, together with the considerable oil revenues, made it pos sible for the import trade to be generally________ _____ " 164 expanded. Moreover, the new accord between Iraq and the U. K. provided for the removal of certain restrictions which had been imposed on payments to Japan as being a scarce currency country, thereby removing an obstacle to importation from an important source.18 The agreement of 1952, then, not only brought about a final settlement of Iraqi blocked sterling assets but also made a long run arrangement concerning the future ! relations of Iraq with the sterling area in general, and ! ! ! the pound sterling in particular. ; ! The question might be raised relative to the J generosity of Britain in releasing all blocked sterling , - i | assets at once, rather than on an installment basis. The ( i Iraqi Government publications indicated that the main , I : | reasons for the release were the improving reserves of t I t I I gold and dollars of the sterling area and the increasing i exports of oil from Iraq. The actual reason for the whole- t ' sale release was supplied by the Counselor to Her Majesty’s Embassy at Baghdad. He wrote: ! . . . during the discussions leading to the agreement it was stated that the Government of Iraq intended to hold it [the balances] as part ^Annual Report of the National Bank of Iraq, 1952 (Baghdad: The Baghdad Printing Press, 1953), p. 29. 165 of the cover for Iraq's currency. In view of Iraq's prospects of earning additional sterling under the oil agreement it. was most unlikely that the sterling in question would be drawn upon in the foreseeable future Tunderlining is not in the original].^ It is apparent that the release of all Iraqi blocked sterling assets could not, practically speaking, result in their convertibility to other currencies and Britain apparently was assured by the Iraqi Government it had no intention of doing so. It is apparent that the Iraqi Government then in ; power succeeded, to a certain extent, in quieting the i | increasing demand by many sectors in the country to » I abandon the sterling area. The government had something | | to boast about: the release of all blocked sterling | balances and Britain's promise to furnish Iraq with all S its essential needs of hard currencies. The price of I [ these two concessions was Iraq's agreement to maintain its ' monetary relationship with the sterling area. In reality, Iraq lost 30.5 per cent of the value of its sterling : balances in terms of dollars as a result of the l*S. Simmonds, Economic and Commercial Conditions : in Iraq (London: Her Majesty's Stationery Office, 1953), i p. 4. 166 ! devaluation of the pound sterling in 1949. Additionally, the release of the blocked assets did not change the I situation much, as in both cases these assets were kept in London, invested in sterling securities. The slight difference between their status before and after the release is that Iraq, theoretically speaking, could convertj these securities to any currency it desired. j I The merit and demerit of linking Iraq with the j i ! * , i i sterling area will be discussed thoroughly in a later I j ! ; chapter, following the analysis of the present monetary . i I I ! system in Iraq. i ! t | i III. CONCLUSION | ( i j i It was shown that in 1941 Iraq followed the steps of Great Britain by imposing foreign exchange restrie- f i tions. The system of foreign exchange control in Iraq I was similar to the systems of Britain and other members ! of the sterling area. Exchange control was placed on • ' I current transactions as well as on the transfer of capital. The main purpose of the control was to direct the available gold and foreign currencies reserve into financing the ; ! war. I It was further shown that the major cause of the | I accumulation of sterling balances in London was a defective! i i monetary system. During the war the United Kingdom and j i the allies made purchases in Iraq with payments being made J in London. Sterling balances created to Iraq were con verted into sterling securities to be kept for the Iraqi Currency Board. Against these securities, notes were issued in Iraq for making payments to the Iraqi sellers i j ; of goods. Therefore, the sterling assets were debts which ! Great Britain had incurred in Iraq. Most of them were ! I “forced debts1' and emerged because of the inflationary j ' methods of war finance. British opinion, however, hesi- I | | tated to regard these sterling balances as a debt in the j , i j 1 I ordinary sense of the word. The Iraqis felt that the j 1 “ 5 j balances represented painfully accumulated savings of the | Iraqi public and must be repaid to the last penny in the j i interest of the reconstruction of Iraq*s economic life. I : They should not be scaled down as suggested by the Anglo- American Loan Agreement. I It is the conviction of the writer that Iraq could ; have avoided the accumulation of such balances. The Iraqi | i Government should not have received payments in terms of j 168 sterling in London. Payments from Britain and her allies i should have been received in either some or all of the following forms: 1. Gold 2. Liquidation of British assets in Iraq?® 3. Raising dinar loans in Iraq on behalf of Britain and her Allies on the security of i I British assets in Iraq. | Had these measures been adopted there would have | ! been no sterling securities available to form part of the I t assets of the Iraqi Currency Board against which notes ' | i 1 could be issued. j ! I : i I In regard to the payment of the sterling assets of j ! | | the sterling countries in full, Britain could not convince I \ i i those countries to write-off part of their balances. Great: i i Britain used economical, political and moral arguments for J / ; this purpose but without effect. While Britain did not scale down the balances of its creditors, in reality, it deducted 30.S per cent of its sterling debts in terms , 20 Liquidation of some British assets took place in 1947 in compliance with the sterling balances agreement j signed that year. These assets were mainly composed of , Iraq's debts to Britain incurred in 1930 when the ownership! i 169 ! of dollars through the devaluation of the pound sterling on September 19, 1949. The outcome of the devaluation j i caused Iraq to lose about thirteen million pounds of the i i I value of its sterling assets in terms of the dollar. This ; and the other experiences of World War II should be kept in mind, as they will be the basis for the evaluation of the existing monetary and central banking systems in j Iraq. j j j i i | of the Port of Basrah and the Iraqi Railway System were j transferred to Iraq. CHAPTER VI THE ESTABLISHMENT OF THE CENTRAL BANK OF IRAQ The well-being of every country depends to a great extent on the stability of the value of its money cir- *culating in a dynamic economy. The value of the monetary 1 ! * * {unit is an excellent barometer of the economic conditions 1 i j 'and progress of any nation. From this stems the importance^ I j of the central bank. Among its major functions is the I i jmaintenance of the stability of the value of money. Note j • issue and the task of upholding their value is one of the ; ! | oldest responsibilities of any central bank. This explains! [ |why many orthodox economists called the central bank the i bank of issue. 1 Today, a central bank assumes greater responsibil- i ities apart from issuing and managing money. A central ; bank is entrusted with credit control, is fiscal agent for ; ! the government, and has supervision and control of the commercial banks, foreign exchange control and the like. All these duties are vital in every growing economy and ! they are better conducted by a central bank. As it was ! 171 noted earlier, owing to the importance of a central bank, the International Finance Conference, meeting in Brussels in 1920, passed a resolution urging that "in countries where there is no Central Bank of Issue one should be established.11^ Consequently, a great number of countries established central banks and some other nations reorgan ized their existing banks. ! ! During the depression of the thirties the central i banks lost some of their importance in the eyes of a great j j many economists. These economists claimed that the ability of central banks to bring about stability and prevent j depression is very limited. They asserted that fiscal policy should replace monetary policy and they were sup- i i i ported in this viewpoint by many politicians and much of j j the public. Today, in many quarters this point of view ' I i ; is still upheld with some modifications. But, as it was ! i : noted in Chapter I, after the experiences of the Second World War and its run-away inflation, the role of monetary . policy was "rediscovered.1 1 The central banks again ■*-As quoted by C. H. Kisch and W. A. Elkin, Central Banks (London: Macmillan and Company, Limited, 1930), p. 2. 172 resumed their responsibilities of maintaining the stability of the medium of exchange. The opinion of the majority of economists and laymen now, is that fiscal and monetary policy should go hand-in-hand to achieve the goal of progress and stability. Also, it is very nearly agreed that monetary policy through the central bank plays a less important role in times of depression compared with its role in eliminating inflation. The best examples given to illustrate these conclusions are the experiences of the United States, both during the depression of the thirties and the post-war period. > I. THE EVOLUTION OF CENTRAL BANKING IDEAS IN IRAQ DURING THE 1930‘S The interrelation between economic progress, mone tary stability and the presence of a central bank was realized by the Iraqis even before they gained their political independence from the British in 1930. They felt that.political independence with monetary dependence would impair their aspirations for economic development and prosperity. Consequently, the Iraqi Government then | in power and the British Mandate authorities were faced 173 with strong demands from the opposition political parties and chambers of Commerce of the different cities in Iraq for the establishment of an Iraqi central bank, empowered with the issue and management of a national currency independent of the pound sterling. The Chambers of Commerce Favored a Central Bank In December 1930, both the political parties and | the chambers of Commerce who were the only organized pres- i 1 sure groups, asked the government to enact a law laying down the following principles:^ 1. The establishment of a central bank with its j head office in Baghdad. i j j 2. The bank should be given the sole responsibility of note issue. 3. The coinage of 40 per cent of the monetary reserve in the form of gold dinars should be ! authorized. The purpose was to convert on demand the paper money into gold dinars for those desiring it. ^Abdul R. Al-Jalili, Monetary System of Iraq (Cairo: Metba*at Nehthet Misir, 1946), pp. 113-15. 4. The monetary reserves should be kept in Baghdad and not in London, in order to prevent Britain i from freezing them in case of a conflict between the two countries. As regards the type of ownership of the bank, the j Chambers of Commerce demanded that the bank be privately owned, while the opposition political parties did not specify any form of ownership. It should be noted that ! * while the political parties asked to place the gold dinars | I ! into circulation, the Chambers of Commerce wanted them | i only to be part of the monetary reserve. Both groups agreed that the head office of the bank should be in ; 1 Baghdad and that the monetary reserve be kept in the i » country, rather than in London. It should also be noted that the demand for the coinage of gold dinars came before I the abandonment of the gold standard by Britain and other ! nations. The reader can appreciate immediately that the i content of the principles reflected, overwhelmingly, urgent i political considerations in Iraq. Everything was seen through political binoculars. In reality, this was very j natural -for that period in Iraq’s history, as the years j 175 ! i I 1930 and 1931 witnessed the climax of Iraq*s long struggle j I for political independence and freedom. In 1932 Iraq j E i became a member of the League of Nations and so achieved ! I her political independence, though with some limitations | i in the Anglo-Iraqi Treaty of 1930 and in the setup of its I i monetary system, as revealed in the fourth chapter. ; The Report of Sir Hilton Young Under the mounting pressure for a central bank from j the opposition parties, the Chambers of Commerce and the i public in general, the Iraqi Government called on her j i i ; i British financial expert, Sir Hilton Young, to make a j | !study of the question. Sir Hilton Young presented his | report to the Prime Minister of Iraq on October 20, 1930.^ j He emphasized that neither the economic nor the political I j conditions were suitable for the establishment of such a \ * Ibank. He warned that such a step would be very harmful, ^ and without gains to compensate for the disadvantages. t , After examining the functions of a central bank, i i Sir Hilton Young discussed whether there were enough ^Sir Hilton Young, Report Concerning the Establish- 1 ment °f j* Central Bank in Iraq (Baghdad: The Government Press, 1930). ~ 176 functions to be performed by a central bank in Iraq. The main arguments used by Sir Hilton Young against establish ing a central bank could be summarized as follows: 1. One of the main functions of a central bank is to act as a fiscal agent for the government. Therefore, as long as the Iraqi Government was satisfied with the services of the Eastern Bank (a British conanereial bank operating in | Iraq), there was no need for a central bank. I Also, the Iraqi Government had no public debt to be managed and serviced by a central bank, i One suggests that Sir Hilton Young did not give adequate attention to the fact that depositing the govern ment accounts with one commercial bank constituted favoritism. Several other limitations are immediately apparent in continuing the traditional arrangements. First, the Eastern Bank did not pay interest on the government account, despite the financial and moral sup- i port it received through handling these accounts. Second, every government before the establishment of a central bank usually deposited its accounts with different com mercial banks, later transferring them to its central 177 ' bank after it was established. Third, even if the Iraqi Government did not have a public debt at the time, the growth of such a debt could be anticipated in the near or far future. Furthermore, who stated that a government should have a public debt in order to justify her desire for establishing a central bank? Mr. Young*s arguments fail to indicate that any of these aspects were taken into consideration. From all appearances, he thought only iabout the period when he wrote the report and neglected |the near and the distant future. | 2. Another essential function of a central bank is I the issuance of notes. Relative to this, Sir I _ % Hilton Young pointed out that it had been already decided to give the Iraqi Currency | Board the power to perform this function, and therefore there was no justification for a central bank. He pointed out that it had been I ' decided beforehand to place the Iraqi currency < ! on the sterling exchange standard and to invest ; the monetary reserve funds in sterling securi ties in London. Therefore, there was no metallic reserve to be managed and maintained 178 by a central bank.. It is evident from the above reasonings that Sir Hilton Young missed the point tinder discussion. It seems to the present writer that the question under considera tion was whether to have a central bank with the sole right of notes issue, based on gold and securities, or, to have a currency board located in London perform this service and to issue notes based on the sterling exchange standard. It is true that the Iraqi Government agreed on the principles of having a currency board, but it seems that when the government again asked Sir Hilton Young to study the possibilities of establishing a central bank, it had in mind the substitution of the Iraqi Currency Board with a central bank. Accordingly, it was illogical to argue that the existence of a currency board made the establishment of a central bank dispensable. 3. A further function of a central bank is to maintain the reserves of the commercial banks and exercise some control and supervision over reserves in order to maintain the stability of the monetary standard. Sir Hilton Young stated in his report that Iraq was still in a backward 179 economic stage and unless it showed some agri cultural, industrial and commercial progress, there would be no urgency in establishing a central bank. It is the present writer*s view that the central bank and economic conditions are interrelated. A central bank based on sound principles can promote the economic conditions of the country. In turn, a prosperous and highly industrialized economic system makes possible the ; development of an efficient central bank. As two students ! of this problem explain: | ! There is . . . much to be said for the view i that the risk of prematurity in the creation of a j central banking system should not necessarily be i regarded as a decisive factor, because there is j no influence so potent in the way of developing the credit system on sound and progressive lines | as a well-founded Central Bank.^ i | Foregoing chapters have indicated that it would i have been in the interest of Iraq to establish a central bank for it could have helped the government in its policy to minimize the depression of the thirties and to control I the hyper-inflation of the Second World War. In addition, ^Kisch and Elkin, op. cit., p. 12. ■ 180 it could have assisted in the agricultural and industrial development of the country. 4. Regarding the capitalization of a central bank, Sir Hilton Young objected to state ownership of the bank. He also objected to the idea of commercial bank participation in the central bank's capital. Hence, the remaining source of i capitalization, was the public. As the public i was very poor, continued Sir Hilton Young, | i 1 great dificulty would be faced in securing i t I i ! adequate capital for the central bank. j i 1 Sir Hilton Young's attitude towards state ownership j ! I i of the central bank represents the prevailing opinion ] j ! during and prior to the 1930*s. Even if Sir Hilton i Young's belief is judged according to that period, the ' 1 ! t ; present writer sees no reason why the state should not own I j the central bank in a country like Iraq, where private J initiative and adventure were lacking. A central bank j cannot be looked upon in the same manner as an ordinary , : . I : commercial company trading for profit. As Kisch and Elkin observed: The Central Bank of a country stands in a j special relationship to the government, seeing ! _ - 181 that by its discount policy and the subsequent reactions on credit, gold reserve and note issues it controls the amount of purchasing power available, and is thus responsible for safe guarding the currency standard established by law.-* Judging from the unsound arguments used by Sir Hilton Young against the establishment of a central bank in Iraq and the bad monetary experiences of Iraq under its Currency Board, it appears that the Iraqi Government should i have insisted on the establishment of a central bank. | i However, all indications show that the establishment of- ' I a central bank was postponed by considerations which were i essentially political in nature rather than economic. ! ! i I The Attitude of the Iraqi Government i | The opinion and advice of Sir Hilton Young was j | highly regarded by the Iraqi Government. The government j ! | j used his arguments as an answer to agitation of the Chambers I * | of Commerce, the opposition political parties and the I I public for,a central bank. When the government introduced the National Currency Law of 1931, it completely abandoned , ; i the idea of establishing a central bank. It stated that 5Ibid., p. 16. 182 the establishment of such a bank at that time was a pre mature step. In the Explanatory Notes to the above men tioned Law, the government raised two objections to the establishment of a central bank. 1. It deprived the Iraqi Treasury of the profits which would result from a note issue. 2. Such a bank would be Iraqi in name only, while it would be a 'foreigner* in capital and t administration because of lack of funds and i 1 trained personnel in Iraq. I I The first of these two objections shows that the t i Iraqi Government looked upon the central bank as a means of generating revenues rather than performing a public i i service. This was undoubtedly a mistaken attitude. As i i Kisch and Elkin explain, j The activities of a Central Bank have such far- ! reaching effects on the economic welfare of the whole nation that no inducement must be allowed to divert the Bank from the pursuit of the public I interest with the object of earning increased ! profits.^ i As far as the second point is concerned, it contains some truth, although it would have been possible for the i 6Ibid., p. 50. Iraqi Government to supply at ,least part of the capital i required, and to resort to the help of other foreign trained personnel apart from the British. I i At any rate, the idea of establishing a central j bank in Iraq was killed by this move and was not revived until the end of World War II. As explained in Chapter IV, instead of having a central bank, the Iraqi Government preferred to entrust a currency board located in London with the task of note issue. i i II. THE DEVELOPMENT OF CENTRAL BANKING IDEAS | i IN IRAQ DURING THE 1940*S j The time when Sir Hilton Young wrote his report opposing the establishment of a central bank had passed. Iraq*s economic and political conditions of 1947 changed j drastically in comparison with those prevailing in 1930. ; Now, Iraq could look back and evaluate the monetary system i under the Iraqi Currency Board suggested by Sir Hilton j I I Young. The same situation did not exist in 1930. For the ! i most part the economic factors supporting the establishment I of a central bank were derived from the shortcomings and J I the implications of the monetary system under the Iraqi : _ • -- - 184 ! I Currency Board. Hereafter, the writer will enumerate or { recapitulate some of the more essential arguments for reconsideration of this issue in the post-war period. Because both economic and political considerations were equally important, these are given separate treatment in the following catalogue of forces. I i Arguments for a Central Bank: Economic j i As society's demands places considerable emphasis ! I j on the objective of economic development, the monetary | } system will be judged according to its ability to: j [ j j 1. Maximize the rate of growth in real income i per capita over the long period, and, 2. Minimize the short-run cyclical as well as j random fluctuations. : I I The discussion of the Iraqi Currency Board in j } ! • • i i ■ Chapter IV shows that the monetary system had the follow- ; 1 i ! ing features: I i i j 1. The Currency Board variant of the sterling | exchange standard entailed the absence of any ^ ! i ; monetary authority capable of influencing the ! I money supply in accordance with business needs, j Also, since the Currency Board always acquired ; assets only passively and was unable to engage I in credit operations, the sytem lacked a local source of liquidity. 2. The rate of exchange was determined by Britain and not by the Currency Board or the Iraqi Government. 3>. The money supply was comparatively costly. 4. There was no effective authority concerned with the operations and development of monetary and i financial institutions. ! Money supply and liquidity. Generally speaking, j i the money supply is determined by the monetary authority, j In the absence of such an authority, money supply is ; I determined by the balance of payments and the credit J i policy of the commercial banks. ! i In Iraq, the money supply was determined in large by the balance of payments because of the absence of a j monetary authority and because the commercial banks tended j to follow a passive policy in regard to advances and 1 l loans to business. Under such circumstances most changes in domestic incomes originated from external disturbances. Since the 186 i money supply responded automatically to changes in the balance of payments, and since the greater part of invest ment was externally financed, the supply of money had exhibited an elasticity during seasonal and cyclical j I expansion. Putting the argument in somewhat different form, any great fall in external receipts, would result in a i fall in domestic income. Ceteris paribus, such a decline i i i in domestic income was essentially accompanied by a rapid i contraction in the money supply, including local bank ; j deposits, and by a corresponding contraction in sterling , i reserves. In other words, the fall in incomes from I j foreign trade would force contraction of domestic credit | I j J or liquidation of many bank loans. The holders of tempo- ■ i ; I rarily idle balances suffering from the decline of income, I i | ! would tend to dissave in an effort to maintain their I i I standards of consumption. This would involve a severe | drain of cash from the Iraqi banks, which might well, if | i ’ 1 the contraction developed rapidly be difficult for the | J i commercial banks to absorb. This suggests that, in terms ! I of the objectives mentioned before, the monetary system | under the Currency Board provided no ultimate source of i ' 187 '] liquidity for the Iraqi banks. This was an unhappy arrangement since any collapse of the Iraqi banks would, of course, not only intensify the recession, but also impair the development plans. Additionally, the currency board system precluded official influence on the money supply and an anti-cyclical I i policy on the part of the Iraqi Government. The system, | I theoretically speaking, put severe limitations on the i j development of a vigorous fiscal policy. In the first 1 j place the values of the multiplier (the coefficient relat- j ! ing the deficit expenditure to the additional income ■ | i i generated by it) is likely to be low. This low value of ( I I I the multiplier is produced not by high marginal propensity ; to save but by high marginal propensity to import. Since ; j the income propagation period is small, deficit finance , could more result in a large and rapidly increasing drain | . on overseas reserves. There is no doubt that this pos- I I ' sibility posed a severe restriction on both monetary and fiscal policy. i Rigidity of the rate of exchange. The rate of • ■ ■ ■ iiiM H a a a M a M M jM B i iB H M a ih ■ M u m n n M . mm mmmm* M w a M iM M H M in exchange between the dinar and sterling, as noted before, i is one dinar to one pound sterling which was fixed by the 188 Currency Law of 1931. This rigidity has its advantages and disadvantages, and a full discussion of it is post poned until later.^ It is the present writer*s conviction, I however, that the rigidity in foreign exchange rates should I be removed and replaced by a system which allows variation i ! of exchange rates to be used as equilibrating device. ;Such a system would not preclude exchange stability, but I it would allow conscious choice to be exercised. High cost of the money supply. The cost of the money supply under the currency board system was high and i j resulted principally from maintaining the monetary ; I reserves at, what is in some sense, an uneconomically j l I high level. i * j \ From a purely formal point of view, the currency i ! t system was not dissimilar to a 100 per cent gold standard. ’ ! i I |It had, however, the merit that reserves were held, not 'in gold, but in the form of interest bearing assets. Since the rates of return received on the securities were | low, the income obtained was not substantial. Because there was no possibility that the entire money in 7Cf. post.. pp. 376-378. 189 ! circulation could be presented for conversion into ster ling, it is very likely that this arrangement entailed the maintenance of reserves at an uneconomically high level. j To remedy this defect, at least part of the reserves should; j have been freed to meet deficits in the balance of pay- j ments. As Newlyn and Rowan pointed out: I . . . the principle of freeing reserves from the domestic money cover function has received wide application throughout the monetary systems of j the developed countries. In particular it received ■ its final expression in the United Kingdom in j 1939, when the gold held by the Bank of England j as cover for currency was transferred to the j Exchange Equalization Account. Since that date ; the whole of the reserves of the United Kingdom I have been available for their proper function „ j | and the whole of the currency has been fiduciary. j j ' The problem of incoriie stabilization in Iraq is much , i ' ; greater than in England, with the result that Iraq needs ; to hold a higher ratio of free reserves to the national I j income; and the fact that Iraq is an underdeveloped country ( f | makes this a greater burden. It must be reckoned a defect , | of the monetary system that it imposed, in addition to : these difficulties, the requirements of an outdated ®W. T. Newlyn and D. C. Rowan, Money and Banking in British Colonial Africa (Oxford: The Clarendon Press, 1954), p. 204. 190 ] i orthodoxy. i i i The lack of a supervisory authority. In any under developed country like Iraq, the financial structure is undergoing a continuous evolution. Therefore, it is extremely important to establish an authority to develop the commercial banks and other financial institutions, to encourage the development of local capital market, and j { to achieve an effective monetary policy. Yet, the Currency ' i Board, with its narrow circumscribed responsibilities, had ! i j i ! displayed little interest in these problems. The results had been failure to consider the problems involved in j monetary and financial evolution, and to place an undue j | administrative burden on government officials. In effect, j the Currency Board proved to be nothing more than an [ ! exchange agency, converting dinars to pound sterling and j ! 1 i : vice versa. i | In summary, the economic conditions prevailing in | i p the post-war period made it necessary to replace the Iraqi | i Currency Board with a central bank. The defects of the j monetary system under the Currency Board became more » , apparent in the war period. These defects manifested i ! p themselves in the form of hyper-inflation, frozen sterling j 1 9 1 I I assets, a declined foreign exchange rate of the dinar with currencies other than the sterling and the lack of an intelligent monetary and fiscal policy. Arguments for a Central Bank: Political | It has been rightly charged that most demands in j the dependent areas and the underdeveloped countries for j central banks are motivated by political factors. Pro- ! fessor Sayers, in his discussion of central banking in the ; ; British Dominions, stated, ’ ’looking back, it is impossible ! I ; I ! to resist the statement that the foundation of central 1 i i i ; ! Q I | banks has been partly a matter of fashion.’ Professor j Plumpter, on the other hand pointed out, ’’the world-wide ! i I demand for central banking arose from fundamental economic i I ! * in j and political trends towards nationalism. ”iU It derived I j | ; partly from the close association which existed in the j 1 minds of many individuals between the desire for political ! independence, on one hand, and monetary and financial • i i I i ................................... - ....................................... I ^R. S. Sayers, editor, Banking in the British ; 1 Commonwealth (Oxford: The Clarendon Press, 1952), p. xi. 1 ' . I ■^A. F. W. Plumpter, Central Banking in the British Dominions (Toronto, Canada: The University of Toronto Press, 1940), p. 159. 192 independence, on the other. In the post World War II period central banking was even more attractive than during the 1930's to political leaders, and particularly to the fairly con servative leaders. For this there were several reasons. A glance abroad showed that it was what was being done in other new countries. Moreover, and this paradox was most important, the acceptance of central banking supplied a departure from the status quo. It was an innovation that I ------------------------------------ nr,,. 1.1 I jcould serve to meet, in part, the agitation of radical .reformers. Appreciating the political advantages attached to the introduction of central banking, political leaders took it up, sometimes with more enthusiasm than discrimi nation. The Iraqis, during the Second World War, were inspired by the signing of the declaration of the United Nations on January 1, 1942, embodying the principles of the Atlantic Charter with its liberal promises. Iraq was flooded with literature containing declarations, 11 Ibid., pp. 159-72/. 193 i propaganda and broadcasts appraising the democratic way of life and promising improvement in the internal condi tions of the country if the democratic countries won the war. As a result, the position of the liberal and moderate nationalists was enhanced, and in turn they undertook an active part in Iraqi politics. Furthermore: i The Iraqis endured a serious increase in prices . . . , as well as martial law, security laws, and regulations which restricted personal | liberty and the freedom of the press, trusting j that the end of the war would bring the promised ; ! better life.^-^ I I i I 1 i When the war ended, the Pachachi Government then i 1 i I j in power hesitated in the fulfillment of the long awaited j » i 1 j promises of progress and democratization. On the other j I hand, the nationalist forces grew so strong that they j ! | ( j ! could exercise a substantial pressure on the government. ! ■ ! jThe bitter struggle between the government in power and i < the nationalists for liberal reforms continued for a short ; : i time, when the government was forced to resign and was succeeded by a liberal government headed by Al-Suwaydi. ; On December 27, 1945, the Regent of Iraq delivered J ■^-^Majid Khadduri, Independent Iraq, A Study in Iraqi! Politics Since 1932 (London: Oxford University Press, i 1951), p. 264. | 194” ] a speech calling for the formation of political parties, and promised full freedom for their activities and the inauguration of economic and social reforms.-^ This was i l the first victory for the nationalists. When the Al-Suwaydi Government took office, the Prime Minister promised to honor the reforms mentioned irj the Regent*s speech. He spoke of, I 1 . . . revision of the Anglo-Iraqi Treaty, help j to local industry, a state-owned oil refinery, a National Bank [underlining not in the original] j more and better education and university, public j works, greater administrative development, ! encouragement to trade unionism, and the firmest resistance to Communism. The reactionary forces i.e., forces that wanted to I keep the status quo, looked upon the above promised reforms ! I I unfavorably, forcing the government to resign on May 30, i i 1946, after being in office for only three months. By , i I ; 1 reason of the resignation of the Al-Suwaydi Government, j the idea of establishing a central bank was shelved. It ] did not appear in government plans until one year later, j i ; in mid-1947, under the government of Salih Jabr. • * - 3lbid., pp. 265-66. ^Stephen H. Longrigg, Iraq, 1900 to 1950: A 1 Political, Social and Economic History (London: Oxford University Press, 1953), p. 341. 195 The Jabr Government drafted the Bill of the National Bank of Iraq and introduced it to Parliament, which approved it in July 1947. i Was the Establishment of the CBI Premature? A period of two years elapsed between the enactment of the Law of 1947, providing for the Central Bank of Iraq, and the actual establishment of the Bank as an operating institution on July 1, 1949. The first Annual Report of the Bank pointed out: . . . the enforcement of Law No. 42 of 1947 . . . : was contingent upon the issue of a special Royal Decree, which for various reasons [underlining i not in the original] was not issued until March 31, 1949. . . ,15 The Report did not state any of these "various ! reasons." Naturally, some of the time was utilized in j ! i providing the proper personnel and necessary equipment for j the management and operation of the Bank. The real reason 1 t for the delay in issuing the Royal Decree was a political one. Nouri es-Said, •^Annual Report of the National Bankof Iraq, July 1949-December 1950 (Baghdad: The Times Printing and Publishing Company, Ltd., 1951), p. 5. (an elderly orthodox politician^ was 196 the Prime Minister of Iraq at that time. He disliked the idea of establishing a central bank, especially if it was realized that he himself was the Prime Minister at the time of the establishment of the Iraqi Currency Board. He emphasized the point that the formation of a central bank “at the present (1947) is a premature action.” As a result, the Bank was almost killed while still in its infancy. The few employees of the Bank were asked to look for new jobs as a preliminary step to closing the door of the Bank even before it began its operation. At ithis point, two ex-Prime Ministers interfered to save the i Bank, Al-Suwaydi, who first promised to establish a central bank in 1945, and Jabr, under whose administration |the Law of 1947 was passed. Due credit also should be given to Dr. Salih Hayder, the first Assistant Governor General of the Bank. He presented sound and convincing arguments in favor of maintaining the Bank. With the passage of time the Cabinet changed and es-Said was no longer in power. The Bank survived the storm and events have since proved that it was not established prematurely. 197 III. THE CENTRAL BANK OF IRAQ— AN OUTLINE The Management of the CBI The CBI is managed by a "Board of Administration," composed of nine original and four additional members including the Governor General and the Assistant Governor General. The members are required to have experience in economics and finance and are appointed by the Council of Ministers for a specific period capable of renewal for an unlimited number of terms. The organization of the CBI is composed of three departments. First, the Chief Cashier's Department, which j is divided into four directorates: the issue, the vault, the banking and foreign exchange. Second, the department of control of banking. Third, the department of statistics; and research, which has three sections: the statistical, the foreign relations and research. Each of these depart ments is charged with one or more of the duties of the CBI, the Chief Cashier's department being the most important. Financial Resources of the CBI The original nominal capital of the CBI was five 198 million dinars and the paid-in capital was two million and one half dinars. This was supplied by the Treasury t I from the accumulated surplus fund of the IraqiCurrency { Board. In 1956, the nominal capital was augmented to fifteen million dinars. The CBI is required to pay 50 per cent of its profits to the Treasury, while transferring the other half j i to the capital account. After the realization of stipu- J lated conditions, the CBI will have to pay all of its j ! ' i | profits to the Treasury. i I i | Objectives and Functions of the CBI ; The objectives of the CBI are: (1) to manage the | i ! j currency and insure its stability; (2) to serve the state j i l finances; (3) to facilitate internal and external payments : i i 1 and (4) to influence the credit movement to the best i , interest of the country. In order to achieve these i I objectives the CBI has the following duties: (1) the i i issue and management of money; (2) control and supervision , I of commercial banks; (3) control of foreign exchange; (4) fiscal agent for the government; and (5) management of international financial relations. IV. CONCLUSION After a struggle of nearly one-fourth of a century, Iraq finally succeeded in establishing a central bank. | The factors contributing to this major event in the modern history of Iraq were both political and economic. No one could say which of these factors was more dominant. In its broad outlines, the CBI resembles the Bank i ! i { of England and the Bank of France, in that it is a single { | institution. It does not resemble the Federal Reserve i iSystem of the United States. The Bank is completely | owned by the state. It has a monopoly over note issue J ' ; and it is in charge of most of the duties of an orthodox i ; central bank. CHAPTER VII ADMINISTRATION, CAPITALIZATION AND RESERVES I i OF THE CENTRAL BANK OF IRAQ The organization of an institution determines largely its failure or success. As the tasks, objectives j and operations of an enterprise are performed by the < ? ! | governing body, this should be organized on well-founded i ' j and sound principles. If this is vital in any type of j i j j undertaking, it is twice as vital in the banking field in j general and the central banking field in particular, owing ! i to the nature of their operations. The decisions of a j i i i central bank may have a great effect on employment and j . business, and so, these discussions are a matter of great | ! concern to the ordinary citizen. Public confidence, there- i j fore, is very much to be desired. A good board of adminis- i : ' tration judiciously chosen is more likely to win and hold this confidence. I I. ADMINISTRATION OF THE CENTRAL BANK OF IRAQ ! I ! The organization of the administrative machinery of j 201 ] i central banks offers an interesting and fruitful field for study. This section deals with the general principles of central bank administration as well as the actual manner I in which different countries have given effect to those principles. Then, the section takes up the discussion of I the administration of the Central Bank of Iraq. \ j Principles of Central Bank Administration The fundamental principle in central bank adminis- I 1 ! tration is to provide a consitution which, from its nature,' I is directed towards the furtherance of public interest, j ; i meaning the interest of the state and of industry from the , x j widest point of view. I The governing board should be free from undue inter-; | ference or influence of the government or of private stockholders, where the latter exist. They must recognize I that the institution is not an instrument of private advantage but rather an organ of public policy. It is ; further desirable to make public accurate statements i showing the condition of the bank and the country. ^C. H. Kisch and W. A. Elkin, Central Banks (London: Macmillan and Company, Limited, 1939), pp. 57-58. 202 The constitution of the governing board is a prob lem in itself. The directors of state-owned banks are naturally appointed by the legislative or executive depart ments of the state. The boards of privately owned banks I are usually composed of some government appointees and some members elected by stockholders. However, as a matter of sound principles, "the composition of the governing | body should not be wholly left to the decision of the I j shareholders, as is usual with an ordinary private : 0 ! company. . . i l Administration of Central Banks In Leading Countries j In the past, the close and continuous cooperation I between the central bank and the government was taken for ! i ; granted; but, as a rule, it was not found necessary to incorporate in the statutes any provisions as to the i ! "independence" of the central bank or its "subordination" to the state. There were, of course, a few exceptions. ! 2 1 Loc. cit. O 1 JAn excellent summary of the charters, laws and ( statutes regulations of thirty-one central banks at the j pre-World War II period can be found in: Ibid., Appendix ! I, pp. 163-406. i 203 Apart from the Soviet State Bank which forms part of the People's Commissariat of Finances and is directly sub ordinated to the People's Commissary of Finances, specific provisions governing the general relationship of the t central bank and the state can rarely be found. In recent years, and especially after the Second World War, the relationship between the central banks and the state has been defined in central bank legislation. As Mr. Kriz explains: i Today the world is living under a system of extensive State intervention in business and finance . . . which is brought about by the changing political and social concepts as well as by the demands of post-war reconversion and reconstruction.^ Management of the Bank of Canada lies with the ,Board of Directors composed of a Governor as Chairman, ! f I a Deputy Governor, and twelve directors appointed for three-year terms by the Minister of Finance. The appointed directors are selected from diversified occupations, and none may be a director, officer, or employee of a ^Miroslav A. Kriz, “Central Banks and the State Today," A Selection of Reading in Money and Economic Activity (Lawrence S. Ritter, editor; Boston: Houghton Mifflin Company, 1952), p. 25. 204 chartered bank. Any shareholder of a chartered bank who is appointed director of the Bank of Canada must dispose of his chartered bank shares within three months of his appointment. The Deputy Minister of Finance, or an alter- I nate nominated by the Minister, is an ex officio member of the Board of Directors but without the right to vote.'* Except when the Board is in session, its powers are delegated to an Executive Committee, composed of the Governor, Deputy Governor, one director selected by the Board, and ex officio the Deputy Minister of Finance or his alternate, who sits, as on the Board of Directors, without the right to vote.** The insulation from direct government interference secured by an orthodox corporate i I structure is supplemented or perhaps balanced by a further power which the Governor of the Bank holds over the Board , \ 1 of Directors itself. The Governor, or in his absence or incapacity, the Deputy Governor may veto any decision of the Board of Directors or of the Executive Committee. The Minister of Finance must be informed of the veto within ~*Bank of Canada Act, 24-25, George V., Chapter 43. ^Loc. cit. 205 seven days, and the veto, along with the views of any director or member of the Executive Committee who wishes ■ ; ■ . i ' to be heard must then be submitted by the Minister to'fhe Governor in Council to be confirmed or disallowed. The Affairs of the Bank of England are administered by a Court consisting of a Governor, Deputy Governor and sixteen other Directors. Under the Act of 1946 the Crown appoints all members of the Court. The Governor and Deputy Governor serve in their offices for a period of five years, while the directors serve for a period of four years, so arranged that four of them retire each year. Members of ; the House of Commons or aliens are not eligible to member- ! ship in the Court. The Court of Directors does not have I lcomplete freedom in managing the Bank*s affairs as the Treasury has authority "from time to time to give such j ! directions to the Bank as, after consultation with the Governor of the Bank, they think necessary in the public interest ^As quoted by John E. Wadsworth, "United Kingdom of Great Britain and Northern Ireland," Benjamin H. Beckhart, editor, Banking Systems (New York: Columbia University Press, 1954), p. 790. 206 8 The Bank of France is governed by a General Council composed of the Governor, Deputy Governor and twelve members. Four of the Council members serve as ex officio and they are the directors of four credit institutions, j i I seven members are appointed by the Minister of Finance on ! I the nomination of the appropriate Ministers and one member is elected by secret ballot of employees of the Bank. The Councilors may not sit for more than three consecutive years; each year one third of the members must retire, and be replaced by new members. The General Council of the Bank may delegate the whole or a part of its powers to a ! permanent committee, consisting of the Governor, Deputy Governor and four Councilors. The General Council, in ! i I • 1 | supervising the operations of the bank, is assisted by I ; two committees, namely, the Discount Committee and the 1 i Control Committee. i The management of the State Bank of the U.S.S.R.^ ^Kenneth Mackenzie, The Banking Systems of Great Britain, France, Germany and the United States of America (London: Macmillan and Company, Limited, 1947), pp. 128- 138 and Henry G. Martin, "France," Banking Systems, op. cit., pp. 225-310. ^Kisch and Elkin, op. cit., pp. 366-7 and Gregory Grossman, "Union of Soviet Socialist Republics," Banking Systems, op. cit., pp. 732-768.____________________________ 207 (Gosbank) rests with the Board of Directors, the Chairman of which is ex officio Deputy Minister of Finance. The Board of Directors is charged with the issuance of instruc tions and orders in conhection with the operation of the Bank, fixing rates of interest, the opening of provincial offices, branches and agencies, subject to the sanction of the Commissary of Finances, the drafting of proposals concerning the alteration of provisions in the statutes and all matters connected with the internal working of the Bank. The general supervision of the Bank is vested in the Commissary of Finance. In particular, he directs the general policy of the Bank, approves all the general rules j i for operations of the Bank, as well as the rate of inter- j est and commission to be paid, exercises a general super- vision over the operations of the Bank, and ratifies the annual expenditures and annual reports and balance sheets. In case the Chairman disagrees with the majority's decision, the question is referred to the Commissary of Finances for decision. In the United States the Banking Act of 1935 requires the,appointment of a Board of Governors for the t proper conduct of the affairs and management of the twelve 208 banks under its jurisdiction. This Board consists of seven members appointed by the President of the United ' States and confirmed by the Senate. Members devote their full time to the business of the Board and are appointed for terms of fourteen years, with the terms so arranged that one expires every two years. The President of the United States appoints one member as Chairman and another Vice-Chairman for terms of four years. In his selection of members of the Board, the President must not choose more than one from any one Federal Reserve district. The Board's expenses are paid out of assessments upon the Reserve Banks, and the Board's accounts are audited twice each year by qualified outside auditors. In general, the I Board is largely responsible for formulating national { credit policies and for supervising their execution.'*'® i Board of Administration of the Central Bank of Iraq The management of the CBI is entrusted to a Board of Administration consisting of nine original members, -*-®United States Board of Governors of the Federal Reserve System, The Federal Reserve System; Purposes and Functions (Washington, D. C.: 1954), pp. 77-80 and Mackenzie, op. cit., pp. 218-20. J 209 including the Governor General and the Assistant Governor General.^ The Governor General. The Governor General is I appointed for terms of five years by the Council of Ministers, subject to confirmation by a Royal Decree. He is eligible for reappointment for an unlimited number of terms. The first Governor to be appointed in 1949 was Mr. Al-Suwaydi who served for about one year. He was succeeded by Dr. A. I. Hafidh, the present Governor. i In case of the absence or death of the Governor General, his duties and privileges are exercised by the Assistant Governor General. He is appointed from the members of the Board for the length of his membership term. A sound practice in the art of central banking realized by most legislatures is the requirement that the i Governor General should be a person of recognized banking and financial experience. In Iraq, no mention to this •^Al-Waqay^a Al-Iraqiya, No. 2499 of July 27, 1947, Law of the National Bank of Iraq, No. 34 and No. 3818 of July 1956, Law of the Central Bank of Iraq No. 72 of 1956 (Baghdad: The Government Press). 210 effect could be found in the laws or by-laws of the CBI. It is suggested here that the Iraqi Legislature should follow the steps of Canada, New Zealand, Argentina, Union of South Africa, Mexico and many other countries by specifying that the Governor General should be a man of proven banking experience. The same should be applied to |the Assistant Governor General. I Members of the Board of Administration. The J f | remaining eighth members (excluding the Governor General) I !of the Board of Administration are also appointed by the i l Council of Ministers. The term is four years, so arranged ; i J ;that half of the members should be changed every two years. i 1 i j The designated members are eligible for reappointment. j i The law of 1947 required that each member should be ■ ! i lof proven financial experience and good conduct. One of i i the members must have practical experience in trade, the •*^M. H. De Kock, Central Banking (revised edition; London: Staples Press, Limited, 1946), p. 320. ^ Besides the original members, the law required the appointment of five additional members to replace the former in case of death, absence or resignation. The conditions of their appointment are the same as for the original members. other in agriculture and the third in banking. Each is, appointed from a list of three persons nominated by the chambers of commerce, the chambers of agriculture and by those licensed banks in Iraq whose paid-in capital is not less than one quarter million Iraqi dinars. The remaining five members are selected on the basis of their personal capacity. The Board's Chairman and Vice-Chairman are elected by the Board's members from among them, for terms 14 of two years. In practice, the Governor General was I j always elected as the Chairman of the Board. i j Two points deserve comment. First, the law of 1947 i | had adopted the much criticized and almost abandoned | ' principle of special group representation on the Board of i i | Administration. Up to the end of 1955, the CBI had three i bankers on its Board. As far back as 1930, Kisch and ! Elkin stated: j I i j The appointment of individual members of the ; Board by special interests, such as commercial banks, manufacturing or agriculture associations, carries the risk of introducing sectional influences ^Al-Waqyi'a Al-Iraqiya, No. 2639 of July 20th, 1948, By-Law of the Administration Board of the National Bank of Iraq No. 28 (Baghdad: The Government Press, 1948), Article I. 212 1 on the Board. Representatives elected by special bodies necessarily have to look to these* bodies for re-election and may be drawn unconsciously into regarding questions of credit policy from j the point of view of its effects on the special ! interests they represent rather than from that • of the country as a whole. j ! Mackenzie, writing about the Bank of England, pointed out, "it was long a rule of the Bank that no i English Banker was eligible for election to the Director- > i ! * 1 / * j j ate.” ° Aside from "introducing sectional influences,” j i j J the presence of special groups on the Board of a central ; bank contradicts its functions. The central bank should ' i be in a position to bring pressure to bear upon the com- i ! fraercial banks, whereas commercial banks should be unable } I ! j to influence, or even know beforehand, about the decisions j t 1 | of the central bank. j , I ! ' ! However, this does not mean that the central bank j t i | should deprive itself of the special knowledge and experi- i ! ence of such persons, nor does it mean that the special i interest groups should be denied the right to present their ( point of view. This knowledge and these views are more appropriately presented in a consultative body. I i ■^■^Kisch and Elkin, o£. cit., p. 63. •^Mackenzie, op. cit.» p. 219. 213 The above mentioned drawbacks of special interests representation were realized by the Iraqi Legislature and were abolished by the enactment of the Law of the Central ! ! Bank of Iraq Number 72 of 1956. The law specifically stated, ”it is prohibited for any director or officer of a banking institution to be a member of the Administration i Board.It is clear that the term "banking institution1* l I |includes all banks: commercial and non-commercial, private and state-owned. The requirement that the member I I I should possess economic and financial experience was I I i intact in the new law. In order to benefit from the experiences of bankers, the law of 1956 established an Advisory Board composed of the Governor General, as Chairman, and representatives of the commercial banks to ; advise the Board of Administration on the general banking j policy.*"® i ! ; It is the opinion of the present writer that the Iraqi Legislature should require the shareholder of a ; licensed bank who is appointed as a member of the Board : 1 ^ Law of the Central Bank of Iraq No. 72 of 1956, : op. cit., Article VI, Section (B). : ^Ibid., Article VII. j 214 1 of Administration to dispose of his shares within a stipu lated period. This is as important in preventing the "conflict in interest" as the disqualification of the j I ! bank's officers and employees for the Board's membership. | The second point deserving comment is the practice of electing the Governor General as Chairman of the Board. Professor Iverson questioned the wisdom of this practice and wondered, . . . whether it is appropriate that the adminis trative leader of the Bank--whose work should also j I in a certain sense be supervised by the Board--is j | a voting member of the Board or even . . . its ! i chairman.19 I ! It is a matter of public knowledge that the Governor of a I central bank exercises a preponderant voice in shaping | i the general policy of the bank. For this reason the | charters and practices of eost central banks accepted the j ( principle of appointing the Governor of the bank as a ! ! ! member of the Board of Administration and as its chairman. Experience showed that, by following this principle, more i 20 1 had been gained than lost. ^Carl Iverson, A Report on Monetary Policy in Iraq ! (Baghdad: National Bank of Iraq, 1954), p. 7. ; ^Kisch and Elkin, op. cit., pp. 58-64 and De Kock, ; op. cit., pp. 319-24. i 215 | Duties and privileges of the Board of Administra tion. Beside managing the general operations of the Bank, the duties of the Board of Administration are the follow ing: (1) Appointment of the internal organization. (2) Opening and closing of branches and agencies at home t or abroad. (3) Appointment of foreign correspondents. (4) Deciding questions relative to officials, their ! j i salaries and any necessary disciplinary measures. (5) ! Arrangements for the general supervision and control of ! i ; the Bank's business. In practice, the Board delegates j some of its duties and powers to the Governor General and ! : to special committees. | In case the Governor General disagrees with the j | Board or with the Minister of Finance, the question is ! referred to the Council of Ministers for decision. There fore, the CBI is unlike that of England, Australia or I s Russia, who are under the authority of the Minister of Finance rather than the Council of Ministers. One of the privileges of the members of the Board of Administration is that each member receives an annual allowance of four hundred dinars. The Chairman (who is the Governor General) receives in addition, the sum of 216 1 21 ! two hundred dinars per year. Also, the government cannot remove from office any member of the Board (including the Governor and his Assistant) unless he is convicted by a court for a crime. The third privilege is that the Board I of Administration, individually or collectively, is not I liable for actions taken in conformity with the Law of 1956. i In conclusion, the present organization of the ! Board of Administration, aside from its minor defects, ! ’ is based on sound principles which can well serve the I public interest. Generally speaking, the Board enjoys j i a great measure of independence from the state; the j t i ! authority of the Minister of Finance over the Bank is I 99 ! limited ^ and the dismissal of the members is complicated, j i The Board can discharge its responsibility without fear I 21 It is worthy of mention that, besides the annual ' allowances, the Governor receives his monthly salary, because he is a full-time official of the Bank and pro hibited from holding any other office. The members, on the other hand, are mostly businessmen or officials in the various governmental departments. They do not devote all their time to the Bank's business, hence they receive only the annual allowances. ^As compared with the practice in Britain, Australia and Holland. See Kriz, op. cit., pp. 323-25. 217 ] I or prejudice. Also, the danger of possible "conflict in { interest" in the Board's decisions is very remote. This ! i. ■ , should enable the Bank to formulate its credit and monetaryj policy in accordance with the general welfare rather than ! I in terms of special groups. Audit and Publicity i I Due to the importance of the duties of central | banks, their operations are subject to rigorous scrutiny. i j In the case of privately owned central banks the charters ; I , i usually lay down rules for the appointment of auditors, t | the definition of their duties and their responsibilities j i | toward the shareholders and the state. When the banks are i i j owned by the state, the statutes of many countries provide : * for the appointment of a state commissioner with wide : ■ powers of supervision and the assignment of independent ! ! auditors. ‘ i i : The accounts of the CBI are audited by an inde- 1 pendent certified public accountant (chartered accountant) , i appointed by the Bank and approved by the Minister of j Finance. Further, the Bank's business is inspected and audited by the Accounts-Controller General who reports ' ■ directly to parliament. The auditor submits his report to the Board of Administration, who, after passing the annual balance sheet, forwards it to the Minister of i Finance for approval. If the latter does not accept it J within sixty days, the balance sheet is considered final.^3 i Aside from auditing, publicity is an important i element in the case of a central bank. Again as Kisch j and Elkin explain: ; | As the currency authority, and in particular as the note-issuing authority, it is incumbent i upon it to produce prompt and regular returns, showing its position in regard to its assets and liabilities.24 i The efficacy of a central bank, on the other hand, j is to no small extent conditioned by the understanding and sympathy with which its various actions are received by ! I the money market and the public. It follows that some i type of publicity is needed through wfrich the agency may make clear its views. Skillful publicity can also combat I the growing tendency of political and sectional business interests to interfere with the discretion of the central bank. ^Law of the Central Bank of Iraq, No. 72 of 1956, op. cit., Articles XI and XIII. 24Kisch and Elkin, op. cit., p. 67. I 219 For these reasons, all central banks' charters and laws require monthly or weekly statements, an annual balance sheet and profit and loss account. Besides, the central banks, voluntarily or legally, publish annual 25 ! reports and periodical bulletins. Usually these pub- I lications are of statistical matter--with or without written interpretation— relating to the various aspects of financial and economic activity. In compliance with the law, the CBI publishes a monthly statement, bi-annual statement and an annual balance sheet. The information to be included in them I is not specified by the law but left to the discretion of : the Bank. Table XI on the following page is a sample of items usually appearing in the annual balance sheet of 1 : the CBI. j I It is suggested that: (1) "Government bonds" shoul ^^Certainly the annual reports and periodical bul letins issued by the Board of Governors of the Federal Reserve System are invaluable documents. They contain essential data of both national and international interest. In contrast the reports of the Bank of England are very meager. This is also true of the Bankcf France but to a less degree. Every factor is in favor of the policy of detailed reports of the Board of Governors of the Federal Reserve System in the United States. 220 ! TABLE XI THE CENTRAL' BANK OP IRAQ BALANCE SHEET AS AT DECEMBER 31, 19. I I Assets Liabilities 1 ISSUE DEPARTMENT | Investment in Sterling Notes and Coins Issued......... j British Treasury Bills.... In Circulation......... > Other securities........... In Banking Department.. 1 Investment In Other j Foreign Currencies ..... I -U.S.A. Dollars........... Others.*................. Value of Silver in Coin in Stock ............ Iraqi Government Loan Bonds Total.............. Total.................... BANKING DEPARTMENT* Authorized capital . Paid-up Capital............ Reserve Fund............... Current and Deposit Accounts. .............. Other Accounts (including j provision for contingen- * cies) ;.............. Shares of Profits Due to Iraqi Government ........ i i Iraqi Government and Semi- i.Government Guaranteed Loan ! Bonds .... iInvestment in Sterling..... Deposit and British Treasury Bills............ Other Securities.......... Investment in Other Foreign Currencies........... ....... ! U.S.A. Dollars............ I Others ............ I 221 i TABLE XI (continued) THE'CENTRAL’BANK OF IRAQ BALANCE . SHEET AS AT . DECEMBER' 31, 19 Assets Liabilities Advance for Purchase of Land for New Building..... Other Assets............ . Notes and Coins............. Total _____* ........................................................ Total............................................. .... Source; Annual Report of the National Bank of Iraq, 1954 (Baghdad; The Al-Najah Press, 195^J7~"p*^~3T *The following are not incorporated in the above balance „sheet; ’ ' v (1) Securities deposited with the Bank in accordance with . . . the Iraq Banking Control Law. . (2) Securities, Bills and valuables held by the Bank for safe custody. I i 222 be presented separately from "semi-government securities." (2) The "British Treasury Bill" should be separated from "sterling deposits." (3) The "current and deposit accounts" should be classified to show deposits of the commercial banks, of the government, of the semi-govern ment institutions and of the general public. Apart from, publishing the monthly statements and the annual balance sheets, the CBI issues voluntarily, quarterly bulletins and annual reports. While the quarterly bulletins provide statistical data alone, the annual reports supplement them with interpretation. A few remarks, in this respect, may be helpful. First, the annual reports of the Bank are published but only after a great delay. The Annual Report of 1954,for example, was published in 1956. Obviously these reports i are much more useful when they provide current rather l than historical data, steps should be taken to minimize this delay. Second, quite often the reports contain con tradictory and inaccurate statements,^6 which lead to ^Many examples could be cited, but for the purpose i of illustration, one is enough. The Annual Report of 1953 states, "the numbers of sarrafs and their agencies 223 1 i I misinterpretaion and confusion. Third, little or no infor-j i t mation is published concerning the operations of the CBI | and the commercial banks. The reports, furthermore, pro- • I vide no information on financial conditions in foreign j j countries and the international financial situation. It j is hoped that, in the future, the Research Department of the Bank will cooperate closely with the other govern- j mental statistical agencies to improve and expand the i t ' ! I information published in its reports. Full and detailed j reports would be of inestimable value to the people of j I i Iraq. II. CAPITALIZATION OF THE CENTRAL BANK OF IRAQ A central bank must be adequately supplied with i capital in order to give confidence to the depositors and ! j i note holders; to carry out its operation in the money 1 ; market and to acquire premises and equipment for the pur pose of its business. The capital, on the other hand, increased to 15 as against 13 during the previous year.*1 i The Annual Report of 1954 contained exactly the same statement word for word. Annual Report of the National Bank of Iraq, 1953 (Baghdad: The Baghdad Printing Press, 1954), p. 9 and Annual Report of. the National Bank of Iraq, 1954 (Baghdad: Al-Najah Press, 1956), p. 18. ! 224 should not be execessive to the extent that part of it might remain idle or induce the bank to indulge in undue speculation. State Versus Private Ownership Despite the recent trend toward nationalization of i central banks, the issue of state versus private ownership I I is still of value and is far from settled. The adherents of state ownership base their belief on the proposition j j that since a wise central banking policy is the basis of ; ! a sound national economic life, the bank should be owned j and controlled by the national government. The advocates i t j of private ownership argue: j ! ! I . . . if the Bank is under state control con- | tinuity of policy cannot be guaranteed with ; I changing governments, nor can freedom from political i | bias in its administration be assured. . . . i I The network of financial and commercial life j ! if so intricate, and the decisions of the Bank on important points have such widespread results, that all interests are not affected in the same | way . . . if the government has a controlling | influence over the Bank, there are obvious ways by which the more powerful interests in the country can try to enforce their wishes. ^ ; i Prior to the Second World War there were only ^Kisch and Elkin, op. cit., pp. 20-23. 225 ' fifteen state-owned central banks. Today, there are more than three times that figure. This sweeping change came about through the nationalization of many previously privately-owned banks and the establishment of numerous t t I new government-owned central banks. j At first, the Bank of Canada was a privately owned institution with a capital of five million dollars. In j 1936, the Bank of Canada Act was amended to secure govern- ‘ t ment ownership of 51 per cent of the capital stock through 1 Ian increase in capitalization from the original five ! | imillion dollars to ten million and one hundred thousand ! • ! idollars, all the extra being held by the Minister of i | |Finance. In 1938, a further amendment of the act brought i i about the complete nationalization of the Bank and reduced the capital to five million dollars.2® j i At the beginning of 1946 an over-all nationalization < i ! ; I program was carried out in France. The movement resulted iin the nationalization of the Bank of France. The total capital held by the public was exchanged for state bonds 28Milton L. Stocks, The Bank of Canada (Toronto: l The Macmillan Company of Canada Limited, 1939), pp. 241-2 and Donald B. Marsh, "Canada*1 Banking Systems, op. cit., pp. 119-182. 226 carrying less than 2 per cent interest. Thus the present status of the Bank of France was founded.^9 The private ownership since 1694 of the Bank of i England came to an end in 1946. When nationalized, the Bank's capital was little over fourteen and one-half million pounds. This entire capital was transferred to the Treasury in exchange for government stocks bearing J I 5 3 per cent interest. The reason given by the Labor | ! Government for the nationalization was to secure the full ! ; cooperation of the English banking society in an effort j J i ] _ A t I to further a full employment policy. 0 j In the United States the fever of nationalization j j did not reach that height, and the ownership of the j | « j Federal Reserve Banks remains unchanged. It is true that j | the private ownership of the Banks was challenged, but j 1 29 i "French Banking Nationalization Law," Federal I Reserve Bulletin, XXXII:483-88, May, 1946. •^The London Economist thought that the one indis putable gain which could result from the nationalization was "the Chancellor of the Exchequer will no longer be able to hide behind the screen of a technically private institution when monetary policy is called in question before Parliament." The London Economist, February. 16, 1946. 227 not to an effective extent. The Federal Reserve Banks are still owned by the privately owned commercial banks who i are the members of the Federal Reserve System. The Capital Structure of the Central Bank of Iraq j Originally, the capital of the CBI was five million ; J dinars, held entirely by the government. In June 1949, the CBI inherited from the Currency Board the amount of I.D. i 4,004,471; of which two and one-half million dinars were used as the Bank's paid-in capital and the rest was kept in a "suspense account" until 1956 when it was added j to the capital. The Bank's authorized capital was augmented in July 1956, to fifteen million dinars. At the end of that year the paid-in capital amounted to I.D. 4.2 million, the i difference being guaranteed by the Iraqi Government. The paid-in capital is increasing annually by sums equal to 50 per cent of the Bank's net profits. | i t i in— m m i r i n r ^ 3^The cbj is required by law to pay 50 per cent of its profits to the Treasury and to add the rest to the paid-in capital till it equals the authorized capital. Law of the Central Bank of Iraq No. 72 of 1956, op. cit., Article III, Section (A). ! 228 Was the augmentation of the capital of the CBI necessary? To answer this question one should ask: what is the standpoint from which an increase in the Bank's capital is to be judged? Generally speaking, the size of a central bank's capital is determined by its functions and the scope of its operations. Using this as a yard stick, it seems that the increase in the Bank's capital jwas unnecessary, as shown below. J 1. The Law of 1947 made it the duty of the CBI I to extend credit to agriculture, industry and i ! commerce. Inasmuch as these professions could | | and can resort to the agricultural, industrial j and commercial banks for their credit needs, | j the Law of 1956 relieved the CBI of this < | r e s p o n s i b i l i t y .32 ^s a matter of fact, since I I ! the start of its operations the CBI has not ; granted such loans. The logical consequence, i then, is to reduce the Bank's capital rather i ' than increase it. 2. The CBI does not perform for the general public ' 32j[bid., Article IV and Law of the National Bank of Iraq No. 34 of 1947, op. cit., Article IV. 229 the ordinary banking business which might necessitate a greater capital. 3. Commercial banks operating in Iraq are in a highly liquid position and the majority of them are branches of foreign banks. When cash is needed they either utilize their liquid reserves or borrow from their head offices. Therefore, they seldom have recourse to the CBI for redis counting or borrowing. During the period 1949-1955 the CBI neither made loans to com mercial banks nor discounted commercial papers. 4. Among the present functions of the CBI is the granting of loans to the government and semi government institutions. Up to 1954 the accumulated amount of these loans was about twelve million dinars. However, in recent years the Development Board has shared this function with the CBI at an increasing rate. The rise in the Development Board's loans contributed to the decline of the demand for loans from the National Bank of Iraq [CBI]. Some institutions which had previously borrowed from the Bank . . . repaid their loans wholly or in 230 I I part. 3 3 5. Owing to the absence of a well-developed capital, market, the functioning of the CBI in the open market operation is very limited. 6. When the bank notes of a country are con- i i vertible to gold, the central bank would need an adequate capital to acquire sufficient gold reserves for convertibility. In Iraq,the bank notes are convertible to pound sterling. At | the present, the Iraqi money is covered by a • reserve of more than 100 per cent, which j i removes the need for increasing the Bank's | capital; ! 7. Finally, since the first quarter of 1956, the working capital of the CBI was increased by j about twenty million dinars. This represented the transfer of government deposits from the Rafidain Bank to the CBI. j All these factors lead to one conclusion; the ; i augmentation of the capital of the CBI was a hasty step ^Annual Report of the National Bank of Iraq, 1953, op. cit., pp. 10-11. 231 and was taken as a mere imitation of what was done by the noncommercial banks. However, due to the non-payment of all the Bank's icapital, the danger of excessive capitalization was |reduced. The increase in the Bank's paid-in capital is |to be done gradually by the annual transferring of part j of the Bank's net earnings. III. RESERVE FUNDS OF THE CENTRAL BANK OF IRAQ General Principles The profits on the year's operations of a central bank should be arrived at after taking into account all working expenses and after making provisions for certain reserves. The usual reserves provided for by a central bank are: (1) bad and doubtful debts of customers, (2) depreciation in assets, (3) superannuation of staff and (4) some other minor items. The net profits have then to be distributed between reserve funds, remuneration of capital (if privately owned ) and the state. The maintenance of adequate reserves by central banks is more essential than in the case of other com mercial concerns, because the subject matter with which 232 central banks have to deal is more important and the con sequences of a breakdown more serious. Speaking generally, the law or charters of the newly created central banks provide for liberal accretions to the reserves. In most j leases the banks are allowed to accumulate reserves at Q/ least up to the amount of their capitals. Reserve Fund Provisions of the Central Bank of Iraq The CBI was originally authorized to build-up a 35 reserve fund equal to the paid-up capital. Each year the Bank transferred 25 per cent of its net profits (but not exceeding one-quarter million dinars) to the reserve and paid the remainder to the Treasury. Up to 1954 the accumulated reserve fund was I.D. 1,442,396.36 The | : I |accumulated net profit for the same period was I.D. 16,484,356 and the difference was paid to the Treasury. ^ \ ^De Kock, op. cit., p. 332. ^~*Law of the National Bank of Iraq No. 34 of 1947, op. cit., Article III. I 36Annual Report of the National Bank of Iraq, 1954, op. cit., p. 4. 0 7 i J'It is to be noted that the Currency Board paid thej Iraqi Treasury about two and one-half million dinars in seventeen years, compared to little over five million dinars paid by the CBI in less than six years. ___________ ; 233 1 / In 1956, a more liberal treatment was given to the reserves. The law now provides that after proper pro- 1 vision has been made for doubtful debts, depreciation in assets, pension funds, and all such other matters as are | i I properly provided for by banks, the Board of Administration! i I disposes of the net profits of each financial year as j follows: (1) As long as the paid-up capital is less than I the nominal capital, 50 per cent of the net profits must be allocated to the paid-up capital and the residue must i be paid to the.Treasury, not exceeding one million dinars. (2) When the nominal capital is paid-up, the Treasury must continue to receive 50 per cent of the i ; * * j net profit and the rest must be allocated to the reserve i i j fund. (3) If the reserve fund reaches five million ! j dinars, the Treasury must receive 90 per cent of the net ! i j profit and the remaining 10 per cent must be transferred 1 i | to the reserve fund. (4) When the reserve fund becomes i twice the capital, the whole of such profit must be paid to the Treasury. | i Undoubtedly, the building up of reserves on the < scale discussed above will strengthen the position of i the CBI and will establish its solidarity beyond all ■ 234 question. IV. CONCLUSION In comparison with other state-owned banks, the CBI enjoys a great deal of independence. It is true that the entire Board of Administration is appointed by the government. Nevertheless, the Board is free from detailed interference on the part of the latter. The authority of the Minister of Finance over the Board, for all practical purposes, is very limited. Another feature of the CBl's administration is the disqualification of ' officers and employees of banking institutions from the I j memberships of the Board. The licensed banks are only i represented on the "Advisory Board," which, as its name indicates, has no power of policy making. As to "public ity," there is ample room for qualitative and quantitative « | improvements in the Bank's quarterly bulletins and annual t I reports. In the beginning, the Bank's capital was five million dinars and, in 1956, was raised to fifteen million dinars. Judging from the limited sphere of the Bank's operations and the banking structure of Iraq, the present writer thinks that this increase was unnecessary. However, j the Bank at the present could not be considered excessively capitalized, as the increase will be effected on an j installment basis. j i The CBI maintains all the usual reserves provided for by central banks with one exception. It does not have a "reserve fund" at the present time. This is due to the | transfer of the Bank’s share of its profits to the capital j account instead of into a reserve fund. When the paid-up ; i , : j capital will equal the authorized capital, the Bank's | share of profit will be devoted to accumulating a reserve ; fund twice the amount of the capital. There is no doubt ! i 1 j ; that these arrangements are sound and adequate. CHAPTER VIII THE MONETARY SYSTEM UNDER THE CENTRAL BANK OF IRAQ I Prior to the 1930*s, the idea that note issue and administration was the first and most essential function of a central bank was nearly universally accepted. It was j further agreed that the bank should be given the sole j right to exercise this function.'*’ Today, however, a j : i | central bank in a developed country is more concerned J with credit control than with the note issue. Notwith- ! i i j standing, the latter is still considered one of the most I i i ! essential functions of a central bank. In Iraq, due to i I I I i ithe absence of a well developed credit market, note issue i j ; ;and administration is by far the first and most important i i ' | !function of the CBI. | ^C. H. Kisch and W. A. Elkin, Central Banks (London: Macmillan and Company, Limited, 1930), p. 74. However, there were some writers who thought that a central bank had no necessary part or place in the pure theory of currency t issue. They suggested that the bank should be excluded J altogether from the working of the currency system. William A. Shaw, The Theory and Principles of Central Banking (London: Sir Isaac Pitman and Sons, Ltd., 1930), p. 80. After describing briefly, for comparative purposes, the monetary arrangements in some leading countries, this j I I i chapter will explain the monetary standard and system ! i under the CBI. It will establish that the monetary set- j ! t tings under the CBI are very similar to those which pre- | i j vailed under the Iraq Currency Board, which was discussed j in Chapter IV. The present chapter will deal with the determination of the Iraqi monetary supply. The conclusion is reached that the CBI has only a minor influence in managing the quantity of money. The supply of money, as this chapter will show, is mainly determined by the foreign exchange market. The evaluation of the present monetary system, and particularly the ties between the dinar and the pound sterling, occupies a special place in this dissertation. The relation between the Iraqi monetary system and the sterling area is considered throughout the dissertation as the major obstacle to the execution of an autonomous monetary policy. The total account of the monetary system, therefore, will be postponed and dealt with in the coming chapter. 238 I. NOTE ISSUE AND RESERVE REGULATIONS i i If a bank note system is to be efficient and satis factory, it should provide for the expansion and contrac tion of notes according to business and trade needs, and especially seasonal needs. In order to understand and evaluate Iraqi experience more completely, below is a brief review of the method of note issue in some leading i countries. As shown on the following pages, the actual i : manner in which different countries have given effect to j 1 ' t j this principle varies considerably. ( j { i Note Issue Regulations in Leading Countries i i j Since 1930, the Bank of Canada has had the sole ! right of note issue. Redemption of the Bank's notes in \ I gold (400 ounce bars) was provided for in the Bank Act ! of 1934; but the Act also provided that the Governor in Council could "from time to time and for such period as he may deem desirable" suspend the Bank's obligation to ! o redeem its currency in gold. Gold payments were never i made in fact by the Bank of Canada, as the gold redemption ^Bank of Canada Act, 24-25, George V, 25 (1) and ; (2). 239 I clause has never been operative since the Bank was estab lished in 1934. Reserves against notes and deposit J liabilities, formerly 25 per cent in gold coin and bullion, j have not been required since May 1, 1940. The suspension j - . i t of the gold reserve requirement leaves the Bank with j j complete discretion regarding note issue and deposit liabilities. At the end of 1956, Canadian Government j i short-term securities represented 60 per cent of the j reserve. The remaining 40 per cent consisted of Canadian ; ! ! « * Government long-term securities, United States dollars, United Kingdom pounds, commercial papers and some other j > securities.^ t I | The Bank of England has had the exclusive right to | issue notes since 1844 subject to the then existing note I , i j issue privileges of the country s banks. The notes issued ■ I over and above a fixed figure were covered 100 per cent ; by gold prior to 1939. Although the-fiduciary issue (notes I issued against securities) is limited to a fixed figure, j the Treasury can vary it from time to time at the request I j of the Bank. The Currency and Bank Notes Act of 1939 j I 3International Monetary Fund, Intemational Finan cial Statistics, X, March, 1956, p. 60. _ . _ _ _ _ _ _ 240 transferred all the gold, except one hundred thousand pounds, to the Exchange Equalization Account and restricted the fiduciary issue to a total of three hundred million pounds. Since then, the Bank has been issuing its notes without regard to gold holding, and hence, the fiduciary issue has been increasing repeatedly and rapidly. At the end of December, 1956, the fiduciary issue amounted to 1.84 billion pounds. The assets held against the note issue consist now almost entirely of British Government i I securities, Treasury Bills, some Commonwealth Governments ! securities, five million pounds of silver coins and a | trifling amount of gold. It is, therefore, now about 100 | per cent a fiduciary i s s u e . ' According to the rules set out in its statutes, the; successive renewals of its charter, and the nationaliza- i T I i ; ; tion law of 1946, the Bank of France, since 1848, has had i ; I : ; a monopoly of the note issue in all of France proper. i i ; Until 1928, the amount of the note issue was subject to a ; "ceiling" limitation, but in that year a fractional reserve ^John P. Young, The International Economy, third j edition (New York: The Ronald Press Company, 1951), , pp. 666-67. I ^International Financial Statistics, op. cit.,p.22oJ system was put into effect. Under the new law the Bank of France was required to keep a reserve in gold coin or bullion equal to 35 per cent of the notes in circulation and demand deposits. This requirement was abolished by a decree-law in September, 1939, and the ratio of the gold reserve fell from 50 per cent in 1939, to less than 3 per 6 cent in December, 1956. Legally speaking, the Federal Reserve banks of the j United States do not possess the sole right of note issue. i jFor all practical purposes, however, the banks enjoy I i almost a complete monopoly in this field. At the end of ! February, 1957, for example, Federal Reserve notes in I circulation were about twenty-eight billion dollars out of a total circulation of little over thirty billion dollars. I i The issuance of Federal Reserve notes is surrounded by a jvariety of highly technical and involved requirements, i which reflect the endeavor of the legislators to make the note holder a preferred creditor of banks and to protect , him against overissue. In brief, the Federal Reserve note is protected by a reserve of gold certificates of at least 6Ibid., p. 102. ___ . ■ - - - - - 242 ' ' ] 25 per cent, including a redemption fund of at least 5 per cent deposited with the Treasurer of the United States. The note is further secured by 100 per cent collateral, consisting of the aforementioned gold certificates and the remaining 75 per cent collateral consisting of gold certi- ; | ficates, government securities and eligible papers. The gold dollar is the declared standard unit of value, but i i no gold is coined. No currency is redeemed in gold except I I for the purpose of making payments to central banks in i l I foreign countries. The United States, then, has a highly j -j * , | restricted, international . . . gold bullion standard. u | The above summary reveals that today the note issue \ I ‘ ! | and reserve regulations are characterized by the following:, f I 1. The central bank has a complete (or nearly * t | complete) monopoly over note issue. i I I 1 2. Gold coins are out of circulation and bank notes I . I are irredeemable in gold. The note issues are j t almost entirely fiduciary issues. I 3. Gold is seldom used as monetary reserve. ! __________________ i ^Major B. Foster, et al., Money and Banking, fourth edition (New York: Prentice-Hall, Inc., 1953), pp. 55-67. ; ' " ' 243 ; Instead, it is used almost exclusively in international payments and for legitimate com- | mercial and industrial purposes. J 4. Elasticity of note issue is thought to be j i achieved through the issue of notes against commercial papers and government securities. 5. Note issue and reserve regulations have become of secondary importance, compared with credit [ regulations. The main reason is that the bulk i i \ , of payments, in the above discussed countries, j is made through the.circulation of bank deposits^ j rather than by means of bank notes. Currency Issue and Administration by the Central Bank of Iraq j In the National Bank Law of 1947 and in the Central | ! Bank Law of 1956, the first function mentioned is the issue1 I j and administration of the currency. In practice, this j l function is still by far the most important. As it was noted earlier, prior to the establishment J t i of the CBI, the issue and management of the currency was i i * 1 exercised by the Currency Board, in compliance with the I Iraqi Currency Law of 1931. However, the law stated that | the Currency Board's functions should cease "on the forma tion by statute of a National Bank of Iraq or another bank i g jwith an exclusive right of note issue in Iraq." Accord ingly, when the CBI was established and the necessary i Royal Decree was issued, the Currency Board was terminated in July 1949, when its duties were transferred to the 1 ;Bank. The monetary standard. It was shown in Chapter IV jthat in 1931, Iraq had legally adopted the gold exchange I f [standard. The dinar was equal to 7.3234 grams of pure gold and was convertible to one pound sterling. But, because Great Britain abandoned the gold standard in September 1931, the gold exchange standard was never 1 applied in Iraq. Instead, when the first Iraqi currency I was introduced in 1932, it was based on the sterling q exchange standard. Upon the establishment of the CBI, an amendment of Al-Waqayi*a Al-Iraqiya, No. 974 of April 23, 1931, Law of the Iraqi Currency, No. 44 of 1931 (Baghdad: The Government Press, 1931), Article 24. ^Cf. ante, pp. 115-119. the Law of 1931 in 1947 restored the valuation of the i I dinar in terms of gold. j It seems that there were two reasons at least for i restoring the value of the dinar in terms of gold. First, i as mentioned in Chapter VI, the years 1945-1947 witnessed a strong public opposition to maintenance of the ties between the dinar and the pound sterling. In order to satisfy public opposition, the Iraqi Government in 1947 ; i avoided any direct mention in the law of the unity of j the exchange rate between the dinar and the pound sterling.' j But the government, at the same time took care to see j that although the de jure link between the dinar and the | sterling would thus be broken, the de facto link should i continue. The gold value of the dinar was, therefore, j fixed with reference to the stabilized exchange rate of ■ i one dinar to one pound sterling. Thus, for all practical i purposes, the dinar-sterling link continued despite public opposition. Second, in 1945, Iraq became a member of the Bretton Woods Agreements which established the Inter national Monetary Fund and the International Bank for Reconstruction and Development. The International Monetary! f Fund Agreement required, ; 246 The par value of the currency of each member shall be expressed in terms of gold as a common denominator or in terms of the United States dollar of the weight and fineness in effect on July 1, 1944.10 Thus, in order to satisfy the above requirement, j the Iraqi Government expressed the value of the dinar in terms of gold, rather than in terms of pound sterling. i jln 1947, the value of the dinar was fixed at 3.5813 grams |of pure gold, which was a little less than 50 per cent of the value of the 1931 dinar. In September 1949, due to the devaluation of the pound sterling the dinar was further devaluated to 2.4883 grams of pure gold. The i present value of the dinar, in terms of gold, is a little over one-third of the dinar's value in 1931.^ The amendment law of 1947 gave the Bank a choice lsto redeem, on demand, the Iraqi notes and coins either in gold or in any foreign currency. Legally speaking, ^International Monetary Fund, Articles of Agree ment (Washington, D. C.: 1944), Article IV, Section 1 (a). ■^Further evaluation of the present monetary system will be found in the next chapter. Cf. post., pp.275-278. ■^Al-Waqayi'a Al-Iraqiya, No. 2499 of July 27, 1947 I Law No. 42 of 1947 Amending the Law of the Iraqi Currency No. 44 of 1931 (Baghdad: The Government Press, 1947), Article VI, Section (C). 247 I the Bank, then, was given an option to adopt the gold | i standard or the gold exchange standard or the sterling (or any other currency, like the United States dollar) exchange standard. The Board of Administration of the i Bank, in 1949, chose the sterling exchange standard and \ this is the present monetary standard of Iraq. The monetary reserve. The provisions of the mone- jtary reserve against note issue as established by the law i | ! of 1931 were almost entirely modified in the amendment i i ■ law of 1947. The law of 1931, as shown before, required j la sterling security reserve of not less than 100 per cent ' 1 ! iof the nominal value of notes and coins in circulation. ; ; The amendment law of 1947 also required the maintenance of ; !a 100 per cent reserve behind notes and coins in circula- ( 1 ition, but it required further that the reserve must be : i "composed of gold and foreign currencies at a ratio of not ■ ! less than 70 per cent and of Iraq government securities at la ratio not exceeding 30 per c e n t . 1* - ^ It is evident from the above-mentioned provisions 'that the principle of fiduciary note issue was, for the ! — — — | i ■*•3Ibid. s Article V Section (a) . j 248 ' first time, introduced in the Iraqi monetary system. As j will be clear later, the amendment law of 1947 made pos- j sible a somewhat more flexible note issue than in the days of the currency Board. I (to the other hand, the amendment law of 1947 stated,! The proportion of the gold reserve . . . and the kinds and amount of foreign currencies and securi ties and the maturity thereof shall be determined from time to time by decision of the Board of ■ Administration of the Bank . . . (provided that ! the said securities shall be of a maturity not ! ! exceeding ten years from the date of purchase). • However, up to the end of 1955, the CBI followed the; i jCurrency Board's traditional policy of maintaining a ster- t i 'ling security reserve of close to 100 per cent or more i 1 j against notes and coins in circulation. 1 In order to explain the development of the monetary t reserve, Table XII shows the amounts, composition and ratio i i of the reserve from the start of the Bank's operation in t I 1949 to 1956.15 ! ^Ibid., Article V, Section (b). _ " i ■^The majority of central banks is required to hold , the reserve against the combined total of note issues and current accounts or other immediate liabilities. The Law of the Iraqi Currency of 1931 and its amendment of 1947 specified the reserve to be held only against notes and i coins in circulation. But, because the current accounts I TABLE XII STATUS ADD COMPOSITION OF MONETARY RESERVE HELD BY THE CENTRAL BANK OF IRAQ December 31, 1949 - December 31, 1955 Amounts in Thousands of I.D. Ratio to Money in Circulation and the Bank's Deposits Items 1949 1950 1951 1952 1953 1954 1955 1949 1950 1951 1952 1953 1954 1955 I. The Monetary Reserve Sterling assets 35.137 41.885 39-941 44.787 62.645 81.915 98.820 91.9 84.1 87.1 89.4 85.2 90.4 84.0 U.S. dollars - - .671 1.432 1.943 1.405 3-357 . _ 1-5 2.8 1.2 1.5 ‘ 2.9 Silver in coin in stock • 151 • 155 .144 .140 .140 .112 .098 .5 .4 .2 .2 .1 .1 Iraqi Government bonds 5.620 6.160 6.660 5-318 7.811 10.334 15-359 14.6 12.5 14.6 10.6 10.6 11.4 13.I Gold bullion - - - - - - 3.001 - - - - . 2.6 Total 40.908 48.200 47.416 51.677 73.539 97.936 125-045 107. 0- 97.0 103.4 103.0 97.1 103.4 102,6 II. Money in Circulation 36.356 42.210 37-125 34.106 40.245 45-353 48.085 - - - - - - III. Current Accounts with the Bank 1.843 7.563 8.636 16.032 30.958 45.227 69.548 - _ _ Total II and III 38.199 49-773 45.761 50.138 71.203 90.580 117.633 107.0 97-0 103.4 94.0 97.1 103.4 102.6 IV. Ratio of I to II - - - - - - - 112.4 114.2 127-8 151.6 182.8 193-6 260.1 Source: Compiled and calculated from tbe Annual Reports of the National Bank of Iraq, for the years 1949-1955, Baghdad. 250 The startlingphenomenon revealed by the table is the considerable increase in the Bank's holdings of ster ling assets. These assets rose from thirty-five million dinars in 1949 to about ninety-eight million dinars at the close of 1955. Their ratio to the combined value of currency in circulation and the Bank's current accounts fluctuated from year to year. Nevertheless, as set forth i J in Table XII, they maintained their position as the prin- J cipal type of assets held by the CBI. The increase in the sterling assets reflected the recent increase in Iraq's i I income from oil in which the CBI has played a passive ! role. ; The process that brought about the increase in i > sterling reserves could be explained as follows: the oil ] j royalties were paid to the Government of Iraq in sterling i | through the London office of the Rafidain Bank. Of the I total amount, 70 per cent was transferred to the Develop- I ment Board, which, in turn, sold the sterling to the CBI deposited with the CBI could be transferred to bank notes without a notice, it is felt necessary to incorporate in Table XII the assets of both Issue and Banking Departments and to calculate the ratio of the reserve to both notes and current accounts. 251 and was credited in the books of the Bank with a corre sponding amount in dinars. When the Board made use of I this deposit to buy foreign goods and services, it | repurchased foreign exchange from the CBI. However, up j to 1956, the Board used only a relatively small part of its means, and since, again, only limited amounts thereof were spent on goods from abroad, a considerable amount of sterling was left at the disposal of the Bank. In part this amount was used to cover the deficit on the balance i i j of payments apart from oil revenues. But, as apparent i f j in Table XII, it has been possible to increase the ster- ! i ling assets to a great extent. , Table XII also shows that at the close of 1949 and j | j J 1950 the monetary reserve contained neither gold nor \ j | foreign assets other than sterling. This was due to the ! fact that, like other members of the sterling area, Iraq i { i ! was required (and still is required) to surrender its ; t gold and dollar earnings to the common pool on which, J ( i alternately, it drew "according to n e e d . "16 In 1951, after; obtaining the consent of the United Kingdom, the CBI was ! 16Judd polk, Sterling; Its Meaning in World Finance (New York: Harper and Brothers, 1956), p. 90. 252 permitted to maintain a modest working balance in United 17 States dollars. Consequently, the Bank began building I ! up a reserve of United States dollars which, except in 1954, increased continuously. While the United States dollar holdings of the Bank were only I.D. .7 million at the end of 1951, they had increased fivefold at the close of 1955. During the year 1955 an important change took place j in the composition of the monetary reserve held by the j CBI. That year, the Bank secured the approval of the j 1 I United Kingdom to acquire gold bullion not exceeding five | million dinars to be used as part of the monetary re- j serve.For the first time in the Bank's history, gold bullion valued at three million dinars was added to the monetary reserve. This was a significant departure from the traditional policy of the CBI. It is true that the Bank's holdings of gold bullion in 1955 represented only i 2.6 per cent of money in circulation and current accounts. : ^ Annual Report of the National Bank of Iraq, 1951 (Baghdad: Thomas Press, 1952), p. 51. 18 International Monetary Fund, International Financial News, August, 1955. 253 Nevertheless, the existence of a gold reserve, although / in a meager amount, could mark the first step toward com- | IQ | plete autonomy in Iraq's monetary affairs. ^ I ! Finally, the table displays that the Bank's holdings; of Iraqi Government securities since 1949 had taken an upward trend. From an amount of I.D. 5.6 million on December 31, 1949, they rose to I.D. 15.4 million at the close of 1955. There was, however, no material change in their ratio to the combined value of currency in circula tion and the Bank's current accounts, which ranged from a low of 10.6 per cent to a high of 14.6 per cent. ! Generally speaking, Table XII discloses that in ; its first six years of operation, the CBI continued to j j invest 100 per cent or more of the currency reserve in i sterling securities. Also, the table establishes the I ! fact that the sterling securities were not the only type i | of assets composing the reserve. It is hoped that the i CBI will continue to increase and diversify its holdings j of assets other than sterling. The CBl's goal should be the achievement of an independent monetary system and a 19 This supposition will be developed in the next chapter. Cf. post., pp. 305-310. _ -“254 I 20 flexible monetary policy. I II. THE DETERMINATION OF MONEY SUPPLY As briefly pointed out in Chapters IV and VI, the Currency Board exercised no autonomous influence on the supply of money. In the absence of a fiduciary issue the ; same statement in theory holds true for the CBI. In | addition to other reasons discussed below, the Bank took J j ( limited advantage of the legal possibility of making a I fiduciary issue. This section is an attempt to explain ; i the determinants of the supply of money under the present ! | monetary system. The term “money’1 means coins and bank i i notes and demand deposits with the commercial banks. The determinants of each of these two elements of the money supply will be discussed separately. The Supply of Currency In Iraq, the coins and bank notes are introduced The statistical data available for the third quarter of 1956, however, indicate that the Bank’s holdings of gold, United States dollars and Iraqi Government securi ties remained almost constant in comparison to their values at the end of 1955. International Financial j Statistics, op. cit., p. 134. j i 255 into circulation by the CBI. In this regard a distinction will be made between (1) the legal powers possessed by the I Bank to change the supply of coins and bank notes and (2) the actual manner in which this supply is determined. The increase (or decrease) in the supply of currency is mainly done through the purchase (or sale) of foreign exchange. The foreign exchange procured is added to the i Bank's assets, while the coins and notes expended for j foreign exchange are added to its liabilities. i The Bank may in a legal sense also place coins and notes in circulation by the purchase of other assets such i ias bonds issued by the government, semi-government or i ! ! I private institutions. Similarly, the bank may lend money ! i • ! to the government, semi-government departments or to the jbanks— the commercial banks as well as the state owned j } ] 1 I non-commercial banks. The lending of money by the Bank | i I ! i takes the forms of discounting of treasury bills, the ) j I rediscounting of commercial papers or the granting of i I j overdraft facilities. Here, too, the claims obtained are added to the Bank's assets and the coins and notes loaned ' are added to its liabilities. i i In many cases, however, it is more convenient for the sellers of foreign exchange to receive payment, not in the form of coins or bank notes, but in the form of a deposit with the CBI. In such cases these demand deposits are added to the liabilities of the Bank. Whenever the holders of demand deposits draw on them and are paid in the form of coins or notes, the volume of coins and notes in circulation is increased, whereas, correspondingly, the | demand deposits are reduced. j Conversely, the CBI can withdraw coins and notes | from circulation (or reduce its demand deposits) by selling ; assets to the public or by curtailing its loans and i i ' advances. In these cases both sides of the Bank's balance! ! j sheet are reduced by equal amounts. The circulation of j coins and notes is also reduced if the state or the banks j i ! | place cash for which they have no immediate need on | deposit with the Bank, but here again, its balance sheet ' j is unaffected. The operation merely means that one kind I ■ of liability (demand deposit) is substituted for another i i (coins and notes). But, since the deposits may be con- j , verted again into coins and notes without notice, it j makes little difference to the Bank whether, momentarily, its liabilities are in one form or another. In its i - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 2 5 7 - -J I dispositions, the Bank must always give regard to both of these forms of liabilities. Thus, ostensibly, it is the CBI which decides how i I large the supply of currency shall be; but, actually, the j position of the Bank in this respect is essentially passive. With fixed rates of exchange, people possessing foreign exchange must be able to count upon the Bank’s ! : willingness to buy whatever amounts of foreign exchange | are offered to it at its buying rate. As mentioned before, i | the Rafidain Bank, the foreign banks and the oil companies : 1 i | are able to provide large sums of foreign exchange. On j the other hand, the CBI cannot decline to sell the foreign I exchange demanded for legal purposes at its fixed selling I rate. « ; ! : « 1 ; If the CBI could alter the exchange rates, this I i would, of course, influence the amounts of foreign ex- i I !change demanded and supplied. An increase in the rates i I !of exchange, which normally reduces the demand for and i [ augments the supply of foreign exchange, would mean smaller* i sales and greater purchases of foreign exchange on the part' of the CBI. This increase would tend to expand the 258 volume of currency in the country, whereas a lowering of the foreign exchange rates would tend to have the opposite effect. ^ As to the relation between the fiscal policies of the Treasury and the volume of money supply, it is not unrealistic to assert that, under emergency circumstances, the CBI would yield to the demands of the Treasury. Although the bank is formally independent of the state, it would probably be unable to resist the Treasury requests to buy or redeem any volume desired of government securi ties. The recent experiences of the Federal Reserve Banks in the United States in regard to pegging the prices of government securities point out the validity of such an assertion. t j If the commercial banks were to borrow money from I the CBI, the latter could withdraw coins and notes from circulation (or reduce the demand deposits of the com mercial banks with it) by curtailing these loans through raising its discount rate. But, as mentioned in Chapter ^Needless to say, changes in the rate of exchange have many other effects which should be taken into account when the desirability of such changes is considered. . . 259 | I III, the commercial banks, and in particular, the foreign banks, are virtually independent of the CBI. In order to j maintain this independence, when the foreign banks need ! money, they resort to their head offices in London instead of the CBI. As long as this is the case, the Bank will be equally unable to increase the volume of money in circula tion by offering to lend to the commercial banks on easier j i terms. \ \ If there was a developed capital market in Iraq, . i i ! the CBI could effect the volume of money in circulation f ■ • i i through the "open market operations." In other words, the , l i Bank could reduce the volume of notes and coins in cir- j ! culation (or its short term deposits) by offering securi- i i j ties for sale on the capital market. This would tend to j j i j depress security prices and thereby induce either the j i : public or the commercial banks to purchase the securities. j i | | If the securities are bought by the public they must be ! paid for either in notes or by drawing on the deposits * of the public with the commercial banks. If the latter I : buy the securities, they likewise must pay either with notes or by reducing their deposits with the CBI. In % | i ; whatever way the transactions are settled they result in j a reduction of the volume of money in circulation. Con versely, the CBI might increase the volume of money in j circulation by purchasing bonds in the capital market, i.e.,j either from the commercial banks or the public, paying for ' them either by notes or by adding to the deposits of the i commercial banks. In sum, the CBI is normally in a passive position, i vis-a-vis the foreign exchange market, and with highly | i i liquid commercial banks and underdeveloped capital market I ! it is unable to do much to counteract the changes in the note circulation engendered by the foreign exchange trans- j t actions. It is, therefore, forced to play a more or less passive role except in the extent to which it can persuade j i the government and/or the commercial banks to undertake j a policy which is in line with its own aims. ! i Changing the Volume of Current Accounts in the Commercial Banks .. l The way in which demand deposits with the commercial I banks came to function as a means of payment is in prin- , ciple equal to the one just described in the case of coins and notes. The banks acquire assets from the public and pay-in the first instance--by short term claims on them- j 261 ] selves. The assets acquired m a y be in the form of dis counted commercial papers, advances or overdraft facilities. Also the assets acquired may, of course, be coins and notes handed in by customers. A theoretical explanation of the process of multiple credit expansion is beyond the sphere of this dissertation. i However, below is a simplified exposition of how changes ! I | in the demand deposits are achieved and how, in turn, they | affect the supply of money g e n e r a l l y . 2 2 i If a single bank could feel sure that its customers ' would never demand notes and coins and that they would never pay by way of checks to persons keeping accounts | with other banks, it could grant, in the absence of legal restrictions, unlimited drawing facilities. But this is i i I not the real situation prevailing. ! Every day each commercial bank is confronted with j a demand for cash arising out of its liabilities. It may appear in two different forms, which have, however, virtually identical effects. First, persons having This simplified discussion is mainly based on Charles S. Whittlessey, Principles and Practices of Money and Banking (New York: The Macmillan Company, 1948), pp. 102-138. 262 deposits with the commercial bank may demand full or partial redemption in bank notes or coins; or they may have paid by checks to other persons, who, in turn, demand redemption in cash. These persons may, however, also choose to hand-in the checks to another commercial bank, whose customers they are, and have the corresponding amounts credited to their accounts. The other bank will J then demand that the checks be redeemed in cash or, nor- i | mally, that a transfer of a corresponding amount be made j ! in the books of the CBI from the accounts of the first I ■ i j bank to its own accounts. Since bank notes and demand i deposits with the CBI are completely interchangeable, f j the two ways in which the demand may appear are exactly i i equal in their effects.^3 | j The magnitude of the cash drain, generally speaking, i | depends on the size and the composition of the liabilities j of the bank in the form of deposits or unutilized over draft facilities. 23nowever, a commercial bank can avoid the loss of cash only when the checks drawn by its customers are handed over to customers of the same bank and the latter chose to deposit these checks with the bank rather than cashing them. 263 On the other hand, each single private bank receives cash every day from its customers in the form of new deposits and repayments of loans. The size and t timing of this inflow of cash depends on the number and ' i character of the bank customers, and the kind of business which they carry on,^ as well as the general state of business. As far as the repayments of loans are concerned, - the determining factor is, of course, the conditions agreed upon when the loans were made. I I i ! The commercial banks usually exert deliberate ' » attempts to make the flow of ingoing payments conform to j j I ! the outflow of money. They demand the installments to be j ! j paid on such days, which, according to their experience, j | normally witness large.withdrawals. Since it is impos- I ! I ! sible, however, to make this conformity complete, the * i » 1 i ; | commercial banks must always hold a certain '‘cash reserve” ; i in order to bridge the gaps which may arise between normal ( < ’ in- and outpayments, and in addition, an extra reserve in order to meet abnormal situations. In Iraq, as in many j < I 2^The inpayments from retailers, for example, will normally flow more evenly than inpayments from factory owners. ! 264 I I other countries, the commercial banks are legally required to hold a minimum cash reserve of 10 per cent against deposit liabilities. Thus it appears that, although the private banks 1 i are able to create means of payments, this ability is | limited by their holdings of cash in their vaults and their demand deposits with the CBI. If the commercial banks want to extend their lending operations, they must i themselves possess (or be able to provide) ready cash in ! the form of coins and notes in excess of the legal minimum | reserve. j i ' ! | ! So, if the CBI could determine the amount of coins j ; i | and notes in circulation, the final power over the mone- j ! tary system would rest with that institution. But, as i : previously mentioned, the Bank has only limited influence on the money supply, hence changes in the system are j required before the Bank could be able to perform the i function normally associated with central banking. i i * Having arrived at the conclusion that, for the ! i present, it is not the CBI which really determines the ! I i 25cf. post., pp. 376-377. f 265 supply of money, it may be finally asked: f,How, then, is this money supply determined?'* The answer to this question has already been given at various points above. ! It may be summarized by stating that the decisive factor j I is the foreign exchange market. Here again the two main ! sources of supply are the foreign banks, which may draw on their foreign reserves, and the export of oil. The foreign banks may obtain notes to expand their lending ! ( j activities by selling foreign exchange to the CBI. i | | Similarly, the Government, the Development Board or the | \ j oil companies themselves may acquire notes or bank 1 j j ! deposits by selling foreign exchange obtained from oil to j the commercial banks. For the time being, therefore, the j j ; j supply of money in Iraq is in the main, determined by the ; | Government, the Development Board, the oil companies and | j ! , the foreign banks, rather than by the CBI. This result ! ‘ I . arises, principally, from the present ties between Iraq 1 and the sterling area. i III. CHANGES IN THE IRAQI MONEY SUPPLY, 1949-55 : It was established above that the supply of money in Iraq is determined mainly by the status of Iraq’s holdings of foreign assets. In the final analysis, this I I means that the supply of money is largely dependent on the I status of the balance of payments. j It is the purpose of this section to follow the j actual development of the Iraqi money supply from 1949, when the CBI began its operations until the end of 1955, j for which statistics are available. \ ! j Table XIII shows the relation between changes in the money supply on one side, and Iraq's holdings of j foreign assets and the status of its balance of trade on J the other.^6 in general, the table brings out three i i i significant developments in Iraq's money supply during I 1949-1955. j I The first outstanding development revealed by the j table is the existence of a chronic deficit in the balance j of trade. This deficit, except for the years 1950 and 1951, increased continuously during the period 1949-1955. ^The major reason for comparing the money supply with the balance of trade rather than with the balance of ! payments is to exclude the operations of the oil companies. The oil companies' operations affect the Iraqi economy mainly through the payment of royalties to the Iraqi Government. The impact of the payment of oil royalties can be seen in column 4 of Table XIII. TABLE XXII THE IRAQI SUPPLY OF MONEY DECEMBER 31, 1949 TO DECEMBER 31, 1955 (In thousands Iraqi dinars) Year* Supply of Money Notes & Coins Demand Deposits Total Foreign Assets** Held by the CBI, and the Commercial Banks Status of the Balance of Trade 1949 36.356 14.662 50.918 35.137 ' -16.140 1950 39.096 14.975 54.071 52.192 - 2.910 1951 37.125 22.864 59.989 54.277 -10.140 1952 34.106 22.101 56.207 65.240 -26.080 1953 38.588 24.298 62.886 85.853 -33.870 1954 45.353 27.465 72.918 106.996 -48.020 1955 48.085 30.128 78.213 123.957 -75.000**** I Source: Annual Reports of the National Bank of Iraq, for .the years 1949 to 1954, ! Quarterly Bulletin of the Central Bank of Iraq,.JanuaryMarch, 1956 (BaghdadThomas , Printing Press, 195bJ, and International-Monetary Fund, Balance of Payments Year- ; books, for the years.1947 to 1955 (Washington, D.C.). I ^December 31 of each year. 1 **The great majority is in the form of sterling securities. , ***Excluding holdings of the commercial banks as they are unavailable for the year j ...1949. | ****Preliminary 267 — 268 ! It rose from as low as I.D. 2.910 thousands in 1950, to a I record high of seventy-five million Iraqi dinars in 1955. The least such a chronic deficit in the balance of trade could have led to was the reduction in Iraq's holdings j of foreign assets and in the supply of money. But, as indicated by the table, neither of these consequences took place because Iraq's receipts from oil royalties in the I ( jform of sterling were more than enough to offset the , j 1 i |deficit in the balance of trade. This explains the con- I i ; tinued increase of the foreign assets holdings of the CBI i ■ | and the commercial banks. While those foreign assets were j : i I.D. 35.137 thousands in 1949, they were more than tripled J in 1955. Undoubtedly, this increase of foreign assets holdings was the main contributor to the increase in the j supply of money from I.D. 50.918 thousands at the end of s * I ! 1949 to I.D. 78.213 thousands at the close of 1955. i The second development disclosed by the table is the continuous rise in the volume of demand deposits. At the end of 1949 those deposits amounted to only I.D. ! 14.662 thousands, but by the end of 1955 they became I.D. I 30.128 thousands. This represented an increase of over 206 per cent. The phenomenon of increasing demand deposits; 269 could be related to (1) the addition of new commercial banks to those already operating in Iraq; (2) the increase in the number of expatriate enterprises undertaking public works for the Development Board and (3) the rise in the general economic activity in the country as a result of the Five Year Plan. The rise in the volume of demand deposits, on the other hand, might indicate the increase I, { in the use, by the public, of checking accounts as a means j i of payments. It might further indicate the liquidation j j of hoardings, by the people, as a consequence of the j i i J creation of new investment opportunity in the country. j ; Despite the increase in: ; Iraq's foreign assets J i . j holdings, the table shows that, in comparison to 1950, the I l i i ! | value of the combined notes and coins in circulation i j during the years 1951, 1952, and 1953 declined to a certain I i | ! j extent. This third development was attributed mainly to 1 l the emigration of Iraqi Jews to Israel. The Annual Reports' j i I of the National Bank of Iraq^7 explained the above ; ! phenomenon as follows: The years 1947-1950 had witnessed an exceptional demand for currency notes, particularly of ■ ^ Annual Reports of the National Bank of Iraq, for the years 1950 to 1953. — 275"1 the higher denominations, following the liquidation of the Iraqi Jews* businesses and their smuggling of Iraq bank notes. Consequently, the total volume of currency in circulation during 1947-1950 was out of proportion to the requirements of economic activities and in excess of the actual amount in the hands of the public in Iraq. When the smuggled Iraqi currency notes began to return and | I | | the surplus continued to be withdrawn from circulation, ! j the total volume of currency in circulation began to | decline steadily from 1951-1953. Since the end of 1953, ; ' ' however, the supply of currency began to level put accord- | ing to the normal needs of business. As economic activi- j j ties during 1955 continued to expand, total coins and I | notes in circulation at the end of that year was 25 per I j cent higher than that of 1953. < > | To sum up, Table XIII points to the incontestability I ! i of the above-stated conclusion that the money supply in | i i ; Iraq is largely determined by the foreign exchange market ; I rather than by the policies of the CBI. I i [ IV. CONCLUSION | It was shown above that the most important function 272 of the CBI is the issue and administration of currency. The Bank inherited this function from the Currency Board. However, the monetary standard and monetary system remained, to all practical purposes, almost as they were under the Currency Board. The bulk of the monetary reserve is invested in sterling securities and kept in London, which makes the Iraqi monetary system on the sterling exchange standard. The rate of exchange between the dinar and the pound sterling is fixed at a ratio of one to one. However, unlike under the Currency Board, the CBI keeps a small fraction of the monetary reserve in the forms of Iraqi Government securities, United States dollars and gold bullion. It was further explained that the CBI possesses all the legal powers, usually possessed by central banks, to alter the supply of money according to the needs of the economy. The Bank is empowered to participate in the open market operations, to change the legal reserve requirements and/or to alter its rediscount rate. But, it was concluded that, practically speaking, so far the Bank was unable to efficiently manage the supply of money because of the following reasons. First, the present " 27 3 ’! I nature of the monetary system which ties the Iraqi money with the pound sterling, and therefore, deprives the bank i of altering the rate of exchange. Second, the operations of the oil companies in Iraq which supply the Development Board and the government with great quantities of sterling. Third, the existence of an undeveloped capital market which hampers successful open market operations. Fourth, the reliance of the foreign banks on their head offices i for the supply of sterling. The four above mentioned I I j j factors render ineffective the powers of the CBI to ! control and manage the money supply. They leave the j i latter to be determined by the foreign exchange market j i instead of the domestic market needs. i ! | j There Is no doubt that the present Iraqi monetary j | system endures numerous defects and is liable to inflict : I ; many harmful consequences on the Iraqi economy. This i : leads to the subject of the next chapter which will be a j comprehensive evaluation of the present monetary system I with major emphasis on its relation with the sterling area in general and the pound sterling in particular. CHAPTER IX j i i EVALUATION OF THE PRESENT MONETARY SYSTEM The principal characteristics of the present mone tary system, explained in the previous chapter, could be summarized as follows: j 1. The Iraqi dinar is indirectly linked to the J i pound sterling at a fixed rate of one dinar ’ to each pound. 2. The largest portions of the monetary reserve is invested in sterling securities. I 3. The above two features place Iraq on a full- i i fledged sterling exchange standard, whereby the supply of money is mainly determined, not by the policies of the Central Bank of Iraq, but by the sterling exchange market. ; Undoubtedly Iraq derives some benefits from linking its monetary system to sterling. The same is true in j ! regard to the United Kingdom. The relation between Iraq i and sterling, however, contains many defects which could result (as in the past) in real harm to the Iraqi economy. | 275 I f The analysis of the actual and probable advantages and disadvantages of such a relation between Iraq and sterling ! is the first concern of this chapter. The second concern of the chapter is to discuss, in the light of that analysis the changes required to remove the deficiencies of the present monetary system. I. THE OBJECTIONABLE FEATURES OF IRAQ'S I i RELATION WITH STERLING I j I * j There are two objectionable features of the member- j * 1 i I J ship in the sterling area in general and the sterling i | exchange standard in particular. First, the fluctuations J in the exchange value of the dinar respond to changes in | the value of sterling, rather than to changes in Iraq's ! economic conditions. Second, the investment of the mone- i ■ s / tary reserve in London constitutes a weapon in the hands ; of the British authorities which could be utilized to j i t ■ bring pressure upon Iraq. ' Subservience of the Dinar to Sterling ! The sterling exchange standard remains stable so long as conditions in the United Kingdom, in whose currency i the reserve is held, are normal; but there can be no i 276 certainty that this will always be the case. England may be involved in another war, its currency may become depre ciated and it may establish a tighter control of foreign exchanges, so that the credits or securities held there will fall in value and will not be realizable except after a long delay, or will be disposable only at a great sacrifice. Examples of the failure of the exchange standard, ' | in the past, are many. When, after the First World War, j the pound sterling fell below gold parity, the currencies > ! linked to it fell with it. During the early 1930*s, the I | exchange standard of Egypt, British East Africa, British j I t West Africa, Straits Settlements, Palestine, Jordan and j i Iraq was subjected to similar fluctuations following the I ( I departure, in September 21, 1931, of England from the | i ; gold standard.^- ! | ' ; The recent experience with the sterling exchange j i ! i standard, on the other hand, furnishes a perfect illustra- : ! I i tion of what may happen should England witness an economic j * | I -•-Imre de Vegh, The Pound Sterling; A Study of the ■ Sterling Area (New York; Scudder, Stevens and Clark, j 1939), pp. 20-26. 277 hardship. During and after the Second World War, the financial difficulties of England resulted in the imposi tion of foreign exchange controls and the blocking of 2 sterling assets. Furthermore, on September 18, 1949, Britain devaluated the pound sterling by 30.5 per cent so that it became equal to $2.80 instead of $4.03. Immediately, all the members of the Commonwealth and the countries of the sterling area adjusted their exchange rates with the dollar. While Iraq, India, Australia, i Burma, Ceylon, the Netherlands, South Africa and Sweden I devalued their currencies to the same extent as England, I , Belgium devalued her currency by 12 per cent and Canada i j by 10 per cent. Only two countries of the sterling area j did not follow the course of the United Kingdom, namely i | Japan, which was under American occupation, and Pakistan, i | which, for one reason or another, took no devaluation I action.^ i i One of the main arguments offered in favor of the i ^Cf. ante, Chapter Vf pp. 133-169. Judd Polk, Sterling: Its Meaning in World Finance (New York: Harper and Brothers, 1956), p. 79. exchange standard is that it helps to stabilize foreign exchange, and, therefore, to facilitate foreign trade,4 but obviously in such cases, this purpose is defeated. ;The exchange rates of exchange standard countries will be i stable in relation to the currencies to which they are linked, but not to other currencies. This international valuation of the currencies affected becomes very compli cated, and international trade becomes, in a way, specula tive. Since 1932, such was the case when the Iraqi dinar followed the fluctuation of the pound sterling; at each change there was a new valuation of foreign moneys based on gold or dollars in terms of the Iraqi standard. Impediment of Political Independence i ! As can be seen from Table XII, most of the monetary i reserve is deposited in England. This practice makes Iraq greatly dependent upon England. In case of a serious conflict in the policies of Great Britain and Iraq, it is feasible that the former might freeze the latter's assets invested in London as a means of economic pressure to force Iraq to alter its own stand. The recent experience 4Ibid., p. 119. 279 ■ of Egypt and Iran indicate the possibility of this danger £ Impairment of Iraq's foreign trade and the shaking up of its monetary system could be the natural consequences of the freezing of Iraqi sterling assets. | i II. A CRITIQUE OF IRAQ'S MEMBERSHIP IN THE STERLING AREA i ' j j The advocates of the sterling area argue that, i i i through its membership in the area, Iraq is enjoying the i convenience of its foreign trade, the stability of its 1 foreign exchange and the ability to borrow in the London i , capital market. i j Convenience ; j i At present, Iraq does not need special payments ! j ! agreements with foreign countries nor the operation of a ; foreign exchange market. Iraq can make payments to other ; j countries by using the banking facilities of Great Britain.' This system, whereby weaker or less important ! Great Britain froze the sterling assets of Egypt when the latter nationalized the Suez Canal Company in July, 1955, and froze the sterling assets of Iran after the latter's nationalization of the Anglo-Iranian Oil Company in 1950. 280 countries held balances in stronger financial centers and made most (or all) of their overseas payments through these centers, became formalized as an element of the gold jexchange standard system of the twenties, with London, New i ! ] I |York and, to some extent subsequently, Paris, as the | j | center.6 A second argument which expresses the convenience of the sterling exchange standard concerns the stable exchange rate. It is argued that because the bulk of Iraq's foreign trade is with Great Britain, the dis advantages of continually fluctuating exchange rates would . be intolerable* and even infrequent once-for-all changes would be hard to deal with.^ In contrast to the thirties, Mr. Day, a student of this problem points out that the arguments of convenience ! in favor of sterling area membership are no longer so ; i strong; (hence) a serious blow has been dealt at the j I 8 1 system. In the thirties, exports to Britain were of ^A. C. L. Day, The Future of Sterling (Oxford: The Clarendon Press, 1954), pp. 59-60. ^Carl Iverson, A Report on Monetary Policy in Iraq ! (Baghdad: The National Bank of Iraq, 1954), p. 259. _**Day, ojd . cit., p. 76. 281 predominant importance in the economies of most member countries. This was due to first, the relatively high level of activity and income that was maintained in Britain, compared with the more depressed conditions in Europe and the United States. Second, through Britain*s deport trade great quantities of goods were channeled between outer sterling countries and non-sterling coun tries.^ Moreover, the outer sterling countries owed j large sums to Britain, upon which the interest payments i ' were expressed in sterling. In these years, therefore, t I there was considerable convenience for the non-members | i of the sterling area to keep their exchange rates stable I in terms of sterling. Since the Second World War, | however, conditions have changed greatly, and it is no I ! longer in ”the unquestionable interest of most sterling I j area countries to keep their sterling exchange rate I | stable.*1-^ The heavy burden of sterling debt has been greatly reduced as a result of the war, and has in several cases been replaced by net sterling assets. Although these assets mean that their holders must remain closely ^Polk, op. cit., pp. 249-57. 1() Day, op. cit., p. 75.______________________________ 282 related to Britain, circumstances do not necessarily demand that their value in terms of their holders' domestic currency should be fixed. It would seem that a more significant blow to the sterling area is the relative decline in the importance of British markets for raw materials and foodstuffs and the rise in the relative importance of the United States. To some extent this has arisen because of the decline of British organized produce markets. However, even if the majority of world trade in the major commodities were i again to pass through Britain, the British markets would ; find their prices influenced, to a far greater extent l | than even was the case before the war, by American I 11 ‘ demand. The increase in the economic growth of her economy and from the increase in her prosperity since the thirties, means that American demand dominates the market ' for many, if not most, primary products. This can be the i case even when the volume of American imports is fairly small: "Changes in American price-support policies for ■^Samuel I. Katz, "Sterling Instability and the Postwar Sterling System," The Review of Economics and i Statistics, 31:83, February, 1954. " 283 I grains can have shattering effects on world markets."12 Generally speaking, the above discussed weaknesses of the sterling area lead to the conclusion, “there is no longer unquestionable justification for slavishly follow ing sterling." Stability ‘'Stability1 1 in this respect, means the elimination of economic fluctuations resulting from fluctuations in j ! : foreign trade. ; i , : ! Stability can be bought at the cost of holding } 1 smaller international reserves, or more stability can be j 1 i ! I | bought with given reserves, if these reserves are pooled j I I 1 A i with those of other countries. The main purpose of the I ! possession of reserves of international currency is to ; | l j j : provide a cushion against the immediate or passing effects j I i ! of adversities, which would otherwise demand a fall in ! the exchange rate or some equally drastic remedy each time ! ■^Day, op. cit., p. 76. , 13Ibid., p. 77. ; ^Elliot Zupmick, "The Sterling Area's Central Pooling System Re-Examined,1 1 Quarterly Journal of Economics, ! 69:74, February, 1955. ! _ _ _ 2 8 4 I circumstances turned at all unfavorable. It is obvious, I I then, that an increase in the effective size of a country'sj i reserve is a big contribution to its potential stability, j _ _ I To the extent that the sterling area provides for the pooling of the international reserves of its members, it is said that membership in the area has the advantages of achieving stability. k A fundamental principle of a currency union that is I ! seeking stability is that it should include the largest j i , : j possible part of the world that is seeking stability. The ; | decline in the size of the sterling area in relation to k ; the world economy as a whole since the thirties, therefore, \ _ | gives rise to a doubt about the area being a good insurance! | | premium for stability.^ The decline has occurred partly j i j because a number of countries which were full members in ! I j the thirties have not rejoined since the war. It also > i I arises from the increased economic prosperity and wealth i ; of the Western Hemisphere. The ineffectiveness of the sterling area to achieve i ! stability, however, was recently eliminated, to some ■^Day, op. cit., p. 84. extent, through the European Payments Union^--sterling area relationship. As Britain is a member of the Union, the sterling area in effect is also a member of the Union. According to the arrangements of the Union, the sterling area is not required to make payments in gold or dollars unless the balance of payments of all the area shows a serious net deficit.with the members of the Union combined. j This eliminates the use of the gold and dollar reserves ! of the area and widens the use of sterling in international I | j payments. Nevertheless, it is believed that the sterling | I ! j | area "is not likely to be as satisfactory an instrument J ^The European Payments Union came into effect in 1950. The major objectives of the Union were stated by \ j its Constitution as follows: "The replacement of bilateral j by multilateral trade would be accomplished through a clear* i ing system which would permit each member to offset a ( 1 deficit against any one member with a surplus against any i | other. Countries would not have to settle each deficit ; bilaterally with each other but would settle only their ; I multilateral deficit with the Union, which would generally = j be smaller than the sum of their bilateral deficits. To discourage excessive multilateral surpluses and deficits, the Union would require creditors to settle part of their surpluses with long-term loans to the Union, and debtors j to settle part of their deficits with the Union in gold j i or dollars." Federal Reserve Bank of New York, "The > European Payments Union," Monthly Review of Credit and j Business Conditions, 118-119, September, 1950. I 286' 1 for introducing a higher degree of stability into the i economies of its members as it was in the thirties.” *-7 Access to the London Capital Market Many people argue that the greatest advantage to J the overseas members of the sterling area from their membership is their freedom of access to the money and ' 18 ; capital markets in London, because there is no British I control over capital movements from Britain to the j i 1 : sterllns area- I i i j At present, this advantage is of only minor--if any | j j — importance to Iraq, as Iraq is accumulating sterling j reserves from oil royalties at a faster rate than needed I ■ i i | for the foreseeable future. Professor Iverson, however, | i j argues that, in some time in the future, Iraq might be j ! : I ] ! confronted with the need for foreign loans. It is ! > feasible , he continued, that internal economic expansion ■ i ! I ; in Iraq could become so strong that the foreign exchange reserves would decline below the level considered neces- j I sary to provide a buffer against external shocks. A j i . - - ■ I i *^Day, op. cit., p. 95. 1 i *•8Ibid., p. 104. 287 19 similar need for foreign loans, according to Iverson, might occur if, for example, oil production declines as a consequence of unforeseen circumstances. It seems that Professor Iverson based his arguments on the assumptions that (1) the London capital market is the only source of foreign loans, and (2) the fruits of present economic expansion would not reduce the need for 20 foreign capital. Nothing could be further from the truth. ! i . . ; | Regarding the first assumption, it is necessary to : 1 j |mention that, besides the London capital market, there is j I |the New York capital market. There is no reason why Iraq i |should not be able to raise any capital funds it needs * : |in this New York market. Also, there is the International j j Monetary Fund which supplies foreign currencies to its j members to finance a temporary deficit in their balances ; I 21 : j of payments. Furthermore, there is the International j Bank for Reconstruction and Development which provides ! ' \ i 1 "^Iverson, op. cit., p. 272. j ^ Loc. cit. | ^International Monetary Fund, Articles of Agree- j ment (Washington, D. C.: 1944), Article V, Section (3). long term loans for economic development. Being a member j in these two organizations, Iraq should not have any difficulty in acquiring foreign currencies or long term loans for justifiable purposes. ! Concerning the second assumption, it is believed that the present economic development will, in the future, reduce Iraq’s needs for foreign capital. First, it is expected that the present agricultural and industrial t expansion will reduce, if not eliminate, the deficit in ! i Iraq’s balance of payments aside from oil exports. Second,1 i it is a matter of general knowledge that an increased ! volume of domestic capital accumulation usually accom panies economic progress. Consequently, it is expected ! that Iraq will be able to satisfy most of its capital requirements from the domestic capital market. Aside from the advantages of utilizing the London capital market for borrowing, the supporters of the j sterling area rightfully point out that the London money ; i i market provides opportunities for earning interest on j i the foreign exchange reserves. Again, it should be 1 remembered that the London money market does not possess i a monopoly over this advantage; all developed markets 289 H supply such opportunities. The writer found nothing better to conclude this j section than the statement of Mr. Day: ! The Sterling Area is by no means dead; it is i not even moribund. But there is enough reason j to believe that its justification is waning; wise policies will realize this, both by refusing to treat the Area as a sacred cow which must come before all else, and by considering now whether better arrangements can be made to obtain its advantages without its costs.^ III. THE ROAD TO MONETARY AUTONOMY | The reader may have already sensed that the present I | writer does not have whole-hearted sympathy for the existing link between the dinar and the pound sterling, nor does he approve the prevailing relations between Iraq \ I and the sterling area. Iraq, as noted above, certainly ; enjoys some advantages from membership in the area, but, j 1 as also shown, the costs of Iraq*s membership in the area and the defects of the fixed rate of exchange between the dinar and the pound sterling are, beyond doubt, far more , than those advantages. This leads to but one conclusion, namely, the existing monetary arrangements explained in 09 Day, op. cit., p. 113. 290 the previous chapter must, be revised thoroughly on the basis of changing Iraq's monetary relations with sterling. There are three principal paths Iraq could follow in altering its relations with the sterling area. These are: the abandonment of the sterling area at once; the maintenance of membership, but with a more liberal treat- | ment for Iraqi withdrawings on the area's dollar pool; i . i j and the gradual withdrawal from the sterling area. I The analysis of these different paths will be based on some assumptions, which of necessity must be explained and clarified, before proceeding. i I Assumptions i In order to determine the least costly and the most advantageous path to be pursued in altering Iraq's rela- ; tions with the sterling area, it is assumed here that | (1) there would be an increase in Iraq's dollar earnings I ! and (2) the pound sterling would remain inconvertible. Each of these two assumptions is treated below separately. An increase in Iraq * s dollar earnings. The assumption of an increase in the dollar earnings of Iraq should not be difficult to realize. The increase could be achieved through (1) requiring all oil companies operating in Iraq to pay a certain proportion of oil royalties in i dollars and (2) speeding the development of sulphur j extraction. Today Iraq receives the entire oil royalties in the form of sterling. It is suggested here that the Iraqi Government should enter negotiation with the oil companies j i demanding payment of part of the royalties in dollars and/or gold. The Iraqi Government has every reason to ! justify such a demand. First, although statistics con- I cerning the final geographical distribution of the refined i Iraqi oil are inaccessible and probably are wholly j unavailable, it is not unrealistic to assert that part of ^ the oil is exported to hard currency countries like Canada. This means that the oil companies are acquiring hard currencies against the exportation of the Iraqi oil. Second, if Iraq had granted the oil concessions to American companies, as is the case in Saudi Arabia, the royalties I would have been paid in dollars and/or gold. Nevertheless,j certain American oil companies have an interest of 23.33 j per cent in Iraq Petroleum Company, which is the largest operating oil company in Iraq. This should serve as a - - - - - - 292 1 i warrant for the payment of part of the royalties in I j dollars. The third justification, which.is the most j i tangible and the strongest, is the fact that the Iraqi oil j saves Britain and the sterling area the payments of appre- j i ciable amounts of dollars and/or gold. The mere fact that ! j ! the Iraqi crude oil is at the disposal of the sterling area reduces the dependence of Britain and other members ! o q j | on oil paid in dollars. As a result of oil exportation j to the European countries, Iraq accumulates a considerable ' i j surplus of European currencies which strengthen the inter- ; t national position of the sterling area as a whole and * : reduced the British gold and dollar payments to the t European Payments Union. i In the absence of statistical data in regard to the j I amount of dollars earned and/or saved by the sterling . area from the export of Iraqi oil, it is difficult to i I !calculate the reasonable ratio of oil royalties which should be paid to Iraq in dollars. However, it should not 23^he best example illustrating this fact is the purchase of oil against dollars by Britain and other European countries after the Iraqi pipelines were blown up in October, 1956, as a result of the Anglo-French- Israeli aggression in Egypt. be impossible for the Iraqi Government and the oil com- i panies to work out a certain formula which would be favor- I * able and just to both parties concerned. : The second source of increasing Iraq's dollar earnings is a large scale utilization of the sulphur | 1 * deposits. Again, this possibility is not too remote. The j Development Board has recently decided to build a plant | i j for the production of sulphur from natural gas, a by- j : product of Iraq's oilfields, which is now entirely wasted. ! The output of the projected sulphur plant is estimated at three hundred to three hundred and fifty tons per day. Iraq's sulphur consumption is considerably lower than the i i I output of the proposed plant. Hence, most of the sulphur i 1 i that will be produced will be exported.^ Since sulphur I * is imported by the United States, this can be expected j to be an important source of dollar income to Iraq. The preliminary figures of the annual proceeds from sulphur exports for the first few years is estimated to be 2^The Financial Times, London, England, October 25, 1956. 294 1 ! between ten and twelve million dollars.^ j The pound sterling remains inconvertible. The term “inconvertible" is used here to mean that the pound sterling is unexchangeable freely for dollars and/or any i | other currency. In contrast, the pound sterling would be j i considered convertible when it could be used with complete freedom in any part of the world. At the present time, the world is divided by : I , i ! England into three monetary areas: the sterling area, , l : » 1 the dollar area and "the rest of the world" area. Resi- | _ ! , dents of the sterling area can use their sterling with | i a high degree of freedom for any purpose within the area, j : and with almost as much freedom anywhere, except in the ! ! < ! ; dollar area. The residual countries described as "the j rest of the world" can use their sterling freely in trans- j I > I ■ I actions with one another, almost as freely in transactions with the sterling area, and with considerable freedom in dealing with the dollar world through world financial i i markets. The dollar area holders of sterling can use , ! | ^International Bank for Reconstruction and Develop ment, The Economic Development of Iraq (Baltimore: The j Johns Hopkins Press, 1952), p. 289. j | 295 ! their sterling freely in any currency area and for i virtually any purpose. Despite the recent relaxation of some payments restriction much is left controlled. The general scheme is that sterling payments within the non-dollar world flow freely, but between that world and the dollar world they i flow only when the authorities deem it necessary. In the • controlled flow of payments with the dollar world, the | j ; i central reserves of the sterling area are available, on j i I ‘ a pooled basis, to provide a limited measure of dollar j | convertibility for residents of the area but not for "the ! | rest of the world." The policies of the governments of j i I the sterling countries, however, are aimed at preventing I t i | any net drain of reserves by sterling holders having I O * 7 recourse to reserves. ' How such a drain could be pre- j vented in the case of "the rest of the world" holders of sterling is not spelled out and it is in fact a consider able source of worry when sterling officials think of : establishing greater payments freedom between the sterling | ^Polk, op. cit., pp. 97-98. 27 Commonwealth Economic Conference Communique, j official text released in mimeographed form, December ' 13, 1952, par. 9_.____ _____________________________ 296 area and the dollar area. Against this background, here is the proper place i ! to test the validity of the assumption that the pound j t [ sterling will, for a long time to come, remain inconvert- j t ible. However, as Iraq*s membership in the sterling area is of main concern, it is felt necessary to focus atten tion on the feasibility or infeasibility of unlimited i j convertibility of sterling held by the residents of the j j i i sterling area. ! i , i 9 0 I < It was shown above 0 that, since the Second War, ; i j the pound sterling has lost much of its power as an I | 1 effective international currency. This was attributed, j A-. « j among other factors, to the decline of Britain as a world j i j economic power, the mounting importance of the United : 1 I States in international economics and the reduction in I I j the membership of the sterling area. None of these factors is of a temporary nature; they are expected not only to OQ continue, but also to be magnified.^ The logical 28£f* ante> PP- 279-286. 29 Dennis H. Robertson, Britain in the World Economy (London: Allen and Unwin, 1954), pp. 32-36. 297 consequence is the inability of Britain, in the fore seeable future, to accumulate adequate gold and dollar reserves which are the prerequisite of the return to unlimited convertibility of sterling. Furthermore, there are indications that the British are not in favor of granting sterling convertibility to the members of the sterling area. Mr. Day, a student of the sterling area, once stated: j j I As for the members of the Sterling Area, ' British opinion does not seem to consider that J considerable changes would be necessary to the present position for a reasonable degree of j convertibility to be established. \ | But by no means do the overseas countries share the j above opinion. On the contrary, some of the Dominions' ! delegates to the Commonwealth Conference held in London ; I in 1952, considered that any movement toward convertibility! i should give additional rights to themselves. Converti- j bility, to them implies that sterling area members should be allowed to use their sterling as and how they please, 31 at least for current transactions. There can be little -^Day, op. cit., p. 129. ^Robertson, op. cit., p. 54. 298 j doubt that any substantial extension of the rights pos- i j sessed by holders of sterling outside the area would increase pressure within the area to reduce discrimination i against dollar goods. This pressure.would show itself quite easily, since it would simply be expressed as a reduction in the degree of self-restraint shown by the central banks of the overseas sterling countries. In its i : J effects it could put serious additional strains on the \ liquid reserves of the sterling area. On the other hand, ! I | if this pressure was not satisfied it could create ten- ! j sions and dissatisfactions among the members which could i I i , well force some of them to leave the area. The problem ( j of convertibility therefore, will become more acute and j its solution will be remote. i The conclusion to the discussion of the last few , i I pages is, ”. . . the peak of England*s importance as ; banker to the rest of the Sterling Area has now been passed.The hope of the return to complete sterling , convertibility can now be almost dismissed. I .... . . .. . .... ..... -^Day, 0p, cit., pp. 169-170. . ' Approaches to Alter Iraq's Relation with Sterling Granting the validity of the above assumptions on the one hand, realizing the disastrous effects on the Iraqi i economy from the continued relation with sterling, and jknowing the limitations of the advantages derivedfrom this relation on the other hand, leave no justification for maintaining the status quo in Iraq's present monetary ' | ' isystem. Iraq, therefore, has three alternatives: to ! t leave the sterling area immediately; to retain membership , ; i in the area but after securing better arrangements; and j to withdraw from the area gradually. Relinquishment of the sterling area immediately, j It has been suggested by some quarter, mainly the opposi- ; tion political parties, that Iraq should break the relation I I Q O ; with the sterling area at once. J The advocates of such ! ! ! j a view argued that Iraq had suffered extensively from the j membership in the area, particularly during and after the ! | I ; Second World War. During that period, Iraq experienced ■ t j | hyper-inflationary pressures, frozen sterling balances | •^^Al-Ahali Newspaper, July 10, 1947 and Al-Istiqlal Newspaper, July 8, 1947. 300 and wide fluctuations in the exchange rate of the dinar in response to the fluctuations of the pound sterling.34 Also, they maintained that it is quite possible for Britain to be involved in another war with the recurrence of the l consequences of World War II. In addition, Britain, they i I continued, is no longer in a position to offer Iraq worthy i !substitutes for the latter*s sacrifices by remaining as I a loyal member of the area. Despite the truth of the above arguments, the present writer believes the proposition that Iraq should abandon the sterling area immediately is unwarranted, j ! I economically speaking. The achievement of such a proposi- ' ! tion could result in serious disturbances to the entire I ;Iraqi economy and could bring the operations of the Five- i | Year Plan to a complete halt. | In the first place, Iraq, as a member of the ster- ling area, can import freely from countries other than the hard currency area. As far as the import from the hard currency countries is concerned, the Bank of England is responsible for supplying Iraq with hard currencies ■ I i ^Cf. ante, pp. 133-169. 301 according to need. In case Iraq decided to leave the sterling area immediately, it would still be able to utilize the sterling earned for the payment of imports from the area itself and from "the rest of the world," but not from the hard currency area.^5 Iraq would have to depend on itself for financing the imports from that area. However, the assumed increase in the dollar earnings| of Iraq, discussed above, cannot be realized before some time elapses. In addition, Iraq's present reserve of hard currencies and gold is inadequate to sustain the 36 I normal trade with the hard currency area. Therefore, it j 35cf. ante, pp. 294-296. . Complete data concerning Iraq's receipts and expenditures of the hard currencies are unavailable. Never theless, the value of goods exported from Iraq, other than oil, and goods imported from the hard currency countries | constitute the bulk of such receipts and expenditures. ! The average annual value of goods exported to the hard j currency area since 1950 did not exceed three million j dollars, while the average annual value of goods imported i from the hard currency area for the same period was about thirty million dollars. This left an annual deficit of about twenty-nine million dollars. Comparing this deficit j with Iraq's present dollar and gold reserve of about ; eighteen million dollars, the reader can realize the dif- ' ficulties which Iraq has to face if it decided to leave ! the sterling area immediately. The data are figured from J the Quarterly Bulletin of the Central Bank of Iraq, January- March, 1956 (Baghdad: Thomas Printing Press^ 1956), p. 2 j and pp. 20-22. is believed that the interest of Iraq is better served by ! i I remaining for the time being, as a member in the sterling i i area. I i j In the second place, it is unnecessary, at the I present, for Iraq to either operate a foreign exchange j market or to negotiate payments agreements with other 1 countries. The first service is performed through the ' London money market while the latter service is arranged I by Britain on behalf of the sterling area. If Iraq were to sever the relation with the sterling area, it would be deprived of those services. The consequences would be i for Iraq to assume the responsibility of establishing its i ! own foreign exchange market and negotiating its own pay- I ments agreements directly with foreign countries. As f both of these responsibilities require considerable [ s j experience and technical skill which are not possessed by j i | : Iraq at the present, it would be more advisable to avoid j ^ any hasty decision to abandon the sterling area immediately. In the third place, the present monetary system and i its similar predecessor have been in operation for more ! i - than one-fourth of a century. They established certain j commercial and financial traditions and practices within I ' 303 j Iraq as well as between Iraq and other countries. Besides, j the Iraqi dinar is unknown in the international market. ! To abolish, overnight, all these traditions and practices and to suddenly give an independent international entity I i to the Iraqi dinar would undoubtedly result in chaos in Iraq's financial and trade relations. i I In sum, the immediate breakdown of Iraq1s relation I i i I with the sterling area would certainly remove many of the I ! defects of the present monetary system by freeing the system from the dependence on the pound sterling. However, ; I ' as revealed above, such a step could cause more hardships f than benefits to the economy of Iraq, so it has to be j rejected as being economically unsound. I Securing more privileges from Britain. The second I alternative before Iraq is to maintain membership in the , sterling area and to enter negotiation with Britain for > j the purpose of obtaining as advantageous a position as i , possible within the area. Among the privileges which i should be secured is obtaining the consent of the British j | authorities to allow Iraq to retain its entire dollar earnings for a certain period. Iraq should be allowed, , at the same time, to draw from the central pool the ; - - - 3Q4 _ |dollars currently needed. The retained dollar earnings | should be utilized by Iraq to build up its own dollar and gold reserves. j Iraq, furthermore, should be enabled, as suggested | by Professor Iverson to receive j ! . . . the gold and dollars needed for paying Iraq's j contribution to the International Monetary Fund I and the International Bank for Reconstruction ! and Development. Such payment would widen Iraq's possibility for drawing on the Fund in case that should become necessary in some— but probably ' remote— future period.-*7 | The merits of the second alternative would actually be j I ' I j very limited. It would not go further than creating, at i j some time in the future, an independent dollar and gold ! j reserve. There is no doubt that such a reserve could be i j used as a primary step toward autonomy in Iraq's monetary | affairs. Nevertheless, this alternative would also fail ! I I : to remove the objectionable features of the present mone- j ; tary system which are discussed in the first part of this i chapter. Moreover, with the expectancy of an increase t in Iraq's dollar earnings and the maintenance of the ; ! i status quo of sterling convertibility (the two j 37iverson, op. cit., p. 273. I 305 I assumptions), Iraq would gain appreciably if it followed j an independent course from the sterling. Apart from t ' removing the disadvantages of the link with the sterling | area, the least Iraq could expect by leaving the area is the establishment of independent monetary and foreign trade policies. The exercise of independent monetary and i jforeign trade policies, in addition to satisfying the i national pride, would assist in the formation and execution: 1 1 \ of these policies on the basis of domestic economic condi- I ( tions, rather than on those of the sterling area. ! I ' Gradual withdrawal from the sterling area. The l ! proposal that Iraq should withdraw gradually from the I sterling area constitutes the third alternative facing « jIraq. This alternative means that Iraq for the time being, |should maintain membership in the sterling area, and, at ! :the same time, should prepare itself for leaving the area |in the near future. When Iraq relinquishes the sterling I ! !area, the Central Bank of Iraq should assume the task of : maintaining not only the stability of the Iraqi dinar but i | ;also its free convertibility.38 To maintain both 38Stability implies that all exchange transactions ,must be carried on at or near the legal parity. Converti- i 306 stability and convertibility the CBI must therefore stand ready to buy and sell gold or foreign exchange at or near parity in unlimited amounts. i This alternative is proposed and advocated by the present writer for reasons discussed throughout the chapter. For the purpose of recapitulation, these reasons ! are summarized hereafter. First, Iraq, in balance, would ! suffer more than it would gain from maintaining the present . . relation with the sterling area. Second, even if Iraq : j I could secure more liberal treatment within the area, the j I j j long-run disadvantages to the Iraqi economy and politics > , would remain larger than the disadvantages. Third, Iraq, | | for many reasons, would not be able to immediately with- j j draw from the sterling area. Fourth, Iraq would be ; capable, in the future, of .increasing its dollar earnings I i ; i : ' and, therefore, to establish and maintain its own inter- i ( t national monetary reserve. Fifth, the pound sterling I would continue to be inconvertible, which places some limitations on Iraq's foreign trade. . bility implies that any holder of Iraqi dinars can convert j these freely into foreign currency and that any holder of 1 foreign currency can likewise convert it into dinars. ! ; According to this alternative, a transitory period i must elapse before Iraq could withdraw completely from the l I sterling area. During the transitory period, Iraq should j I j act simultaneously on two fronts: negotiation and train- ! ing. The negotiation aspect of the transitory period j ! requires the Iraqi Government to negotiate with the oil j i companies operating in Iraq and with the British Govern- t ! 1 ment. In its negotiation with the oil companies, Iraq I I i 1 should demand the payment of a certain proportion of oil ! ! j royalties in the form of dollars or gold. The justifica tion and rationalization of such a demand was already i explained and there is no need for repetition. The j i ; ! negotiations with the British authorities should aim to I t , J ; achieve the following. First, while retaining the dollars j or gold paid by the oil companies, Iraq should be per- j | I ' i mitted to continue to satisfy its current dollar needs I from the central pool of the sterling area. Against this ^ privilege, Iraq should abide by the rule of pooling its i ! i earnings of foreign currencies other than the dollars re- ! ! i | ceived from the oil companies, with the rest of the j i sterling area. Also, Iraq, should maintain a portion of iits monetary reserve invested in sterling securities. I |Second, Iraq should secure the approval of the British 1Government to negotiate some payments agreements, par- t Iticularly with some Middle Eastern countries who are not [ jmembers in the sterling area, like Syria, Lebanon, Egypt 39 and Turkey. These independent payments negotiations could serve as training for the personnel of the CBI and i J as a first step to introducing the Iraqi dinar in the international market. : The training aspect of the transitory period involves the preparation of a considerable staff of well- educated civil servants to assume the responsibilities | connected with operating a foreign exchange market and jnegotiating payments agreements with foreign countries. i f ! As the failure or success of leaving the sterling area j depends greatly on the training aspect, the latter should j ! i i be prepared thoroughly and executed carefully. j 9Q | ^The average ratio of exports to Syria, Lebanon, | Egypt and Turkey for the years, 1950-1955 was about 12 j per cent of total Iraqi exports, while the average ratio ! of imports from these countries for the same period was 1 about 2 per cent of total Iraqi imports. Quarterly 1 Bulletin of the Central Bank of Iraq, January-March, 1956, op. cit., pp. 20-25. 309 ! : During the transitory period, Iraq, then, should j remain a member of the sterling area, enjoying its privi- !leges and exercising its duties except for retaining the 1 \ t i dollars received from the oil companies and for negotiating I | independently some payments agreements. But, after having accumulated an adequate international reserve and having trained enough personnel, Iraq should attempt to reach an j I j agreement with Britain similar to those the latter has 1 ! with ’ ’the rest of the world.1 1 Accordingly, while achieving j I its monetary independence, Iraq, as explained before, j | would continue to use its earnings of sterling anywhere I J in the world except in the hard currency area. Iraq’s | needs of hard currencies would be partially satisfied i j from the receipts of exports in those currencies, and J i I j partially from the dollars received from the oil companies . j | In case Iraq’s reserve of foreign currencies becomes I I i ; ! temporarily inadequate for meeting the current needs, j Iraq, to give one possibility, could resort to the Inter- | national Monetary Fund to correct this deficiency. ; l 1 I ; In summary, the most advantageous course for Iraq j i I 1 to follow is to break off its relation with the sterling , I area and to establish its own independent monetary system. ! The changeover from the present monetary settings to the I I proposed should be brought about gradually. Each step j should be studied extensively and examined closely; other- jwise, the changeover might end in a monetary chaos. ! IV. CONCLUSION ! i \ This chapter has established that the major con- i I | tributor to the defects of the present monetary system is the relation between Iraq and the sterling area. Because j I , of this relation, the exchange value of the dinar and the ■ ! i | supply of money are mainly determined by the status of the I j sterling exchange market, instead of economic conditions ; in Iraq. The investment of the monetary reserve in London : i ; ' constitutes a threat to the exercise of an independent ' [ Iraqi policy, due to Britain's ability to freeze these j I ! ; reserves. Most of the economic advantages which the j i i sterling area has offered its members before and during ! i i J the 1930's have either become limited or are no longer ! in existence. Hence, it was concluded that it is in the I interest of Iraq to leave the sterling area; but, as Iraq, ! at the present, lacks the necessary requirements for such ! l a change, it was found that Iraq should withdraw from the ! 311 area gradually. CHAPTER X THE CENTRAL BANK OF IRAQ AS CONTROLLER OF FOREIGN EXCHANGE In general, prior to the First World War, tariffs were the main instruments of foreign trade control. i Exchange control, in the modern sense, was first used by 1 i ! , belligerent countries, as a temporary wartime measure, ! i I after hostilities broke out in 1914. It was adopted mainlyj i : i i to combat the flight of capital and to direct the available ' 1 foreign exchange to the importation of war essentials. During 1931, exchange restrictions were again adopted, -• • ( j this time by distress-stricken countries with the object I i i of curbing the outflow of capital^ and the alleviation of j 1 the economic disturbances created by the depression of the j 1930’s. Exchange control re-emerged as a tool of war I ; ! economy during the Second World War. The mechanism of ; i : i Norman Crump, The ABC of the Foreign Exchanges (tenth edition; London: Macmillan and Company, Ltd., 1936), pp. 26-30. ^League of Nations, International Currency Experi ence (New York: The United Nations, 1947), p. 162. control turned out to be more rigid, and the techniques j became more elaborate and complicated in comparison with j those used during the First World War. At the close of i | the Second World War, exchange restrictions were not abolished, but instead, were adopted on what may be a somewhat permanent basis. Up to 1956 the majority of the world*s nations were still maintaining exchange controls, O | though with some differences in the degree of rigidity. | | Despite the considerable progress made since the end of i ! the Second World War toward greater freedom of trade and j payments, the outlook for complete abolishment of exchange control in the foreseeable future seems gloomy. i This chapter deals principally with an analysis of j ; i I the fundamental characteristics and with an evaluation of j ! Iraq*s foreign exchange controls since the CBI took over j i ' the administration of this function in 1950. However, the ; j analysis is preceded by a short discussion of the important j i | principles of exchange controls and the application of these principles in some leading countries. Such a dis- ! ! cussion is deemed beneficial for the object of comparison. ^International Monetary Fund, Seventh Annual Report ! Exchange Restrictions (Washington, D. C.: 1956), p. 2. 314 I. THE GENERAL PRINCIPLES OF EXCHANGE CONTROL Essentially, the foreign exchange market deals in t the money of the nations of the world. Under conditions of free exchange, importers buy their foreign exchange in the exchange market without restrictions at the pre vailing market rate. The market rate of foreign exchange is determined, generally speaking, by the demand and supply conditions of that particular moment. When restric4 tions are imposed on the buying and selling of foreign exchange, a condition of exchange control is said to exist. Definition of Exchange Control First of all, it is essential to define the term ! i I “exchange control.1 1 On various occasions it is used in I ! different senses, which sometimes lead to misunderstanding.! I I Professors S. Enke and V. Salera define exchange j I control as I . . . a system in which the government intervenes i to require a special disposition of foreign i balances accruing to its nationals or to allocate, ! by means of special criteria, the foregoing funds needed by its nationals to effect various I foreign payments, or to do both.^ According to Dr. Paul Einzig, Exchange control is every form of intervention on the part of the monetary authorities aiming at interfering with the tendencies affecting exchange rates.^ The terms "exchange control" and "exchange restrictions" in the words of Professor J. P. Young refer to "government measures which restrict the purchase or sale of foreign exchange." These definitions all agree that exchange control implies government intervention in the free operation of the foreign exchange market. As far as the objectives, methods and scope are concerned, exchange control varies from time to time and from country to country. The Principal Functions of Exchange Control Although exchange control was originally a stop-gap “ ^S. Enke and V. Salera, International Economics (New York: Prentice-Hall, Inc., 1947), p. 318. ^P. Einzig, Exchange Control (London: Macmillan and Company, Ltd., 1934), pp. 9.10. 6John p. Young, The International Economy (third edition; New York: The Ronald Press Company, 1951), p. 379. r " ” 316 i , means of meeting an emergency situation,^ it opened the i I : way for regulation of the country's entire foreign trade j and other transactions. The original purpose of exchange [ j control was merely to prevent the outflow of capital and I | to see that foreign exchange was available to pay for the 8 importation of essential goods and services. Soon, J however, exchange control was used to make exchange avail- ! able to pay for the importation of essential goods and I j services and to protect exchange rates from depreciation. i j Later exchange control was also used to protect home j markets against imports; to discriminate in favor of or i j against certain countries and for other nationalistic ends. Some governments even utilized exchange control as a source of revenue. Professor Towle pointed out: j The Argentine Government used the profit which resulted from the margin between the official buying and selling [exchange] rates to pay for the operations of crop-control boards, to meet exchange losses on the service of the national j debt, to subsidize exports and to set up an i exchange equalization fund.^ ^League of Nations, Report on Exchange Control ‘ (Geneva, 1938), p. 9-13. O International Currency Experience, op. cit., p. 184. ^L. W. Towle, International Trade and Commercial Policy (New York: Harper and Brothers, 1947), p. 475. r _ " " 317 i i ! However, exchange restrictions are considered today ! ! as the principal means of dealing with an existing balance I t | of payments deficit, and as continuing and regular arrange^ ! ments. The Technique of Exchange Control Under a system of exchange restrictions, the purchase and sale of exchange are subjected to official regulations. The regulation of imports. To administer an I exchange control system, imports and other transactions ! \ j involving foreign payments are classified into various j ■ categories on the basis of their priority. The main j categories are usually subdivided according to particular commodities, such as certain raw materials, machinery, food, automobiles and so on. Each of these groups is treated separately in the allocation of foreign exchange. ' Certain luxury imports may be allowed very little exchange or perhaps none at all, whereas food imports, for example, ' may be granted exchange relatively freely. Licenses are ] issued to applicants either on a discretionary basis on the part of government, according to the estimated merits i i of the individual transaction, or on the basis of i ! 318 ’ established criteria, such as the previous imports of the j applicant, his capital, or some other standard. In effect i | the latter procedure involves the fixing of quotas for i I j individual importers. While this procedure is "definite j | and obviates some of the difficulties of discretionary j i allocation, it lacks flexibility and has difficulties of ! in ! j its own.,,iU Licenses are sometimes issued on the basis i ; j of first come first served, up to the limits allowed for j I I ' the particular category. This method also eliminates some of the difficulties of discretionary allocation, but "does j not assure an equitable distribution of the available i | exchange.Another method is that of a waiting list, which is a form of the quota system and involves post- J j ponement of an application rather than rejection. It similarly does not assure an equitable distribution of J exchange. Tie-in import arrangements require that an | importer, who is allocated exchange must purchase spe- i cified amounts of similar domestic products. Such ; arrangements usually provide partial protection for » I i ^Young, op. cit., p. 384. 1:LLo c. cit. domestic producers. ' The regulation of exports. In order that a system ^ i j of exchange control may operate effectively, it is neces- I | sary not only that purchases of exchange be regulated, j but that the receipts of exchange by exporters and others j either be directed into a central pool or be disposed of i ‘ | according to established procedures.^ Recipients of exchange are thus ordinarily required to sell their ! ! ' ! ! exchange to a government agency in return for domestic j i . I ' ^ I currency. The selling rate which they receive is fixed J j by the government. In order to enforce supervision over i ! receipts of exchange and to minimize evasion of regula- I i tions, governments may require exporters to obtain export ! i | licenses. The government, in granting export licenses, i i ; ! may require that the foreign buyer make payment in a i specified foreign currency. An exporter thus must receive ■ i dollars or some other specified foreign currency from his j ‘ . ! buyer rather than an undesired currency. I Frequently, the recipient of exchange is allowed i to sell a portion of his receipts on the free 1 i _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ i •^Einzig, op. cit., pp. 120-121. j 320 13 , market, J where importers of luxuries or semiluxuries are i J permitted to purchase exchange but at rates above those j i 1 ' | officially determined for other transactions. Invisible ' I i transactions are often carried out legally in this market. i ! In countries which do not have a legal free market, j ; exporters are sometimes allowed to retain a portion of j the proceeds of their exports to the dollar area, and to use the amount retained for such purposes in order to | import goods for which exchange would otherwise not be i j available, or to make payments in the dollar area. The < j proceeds retained, however, are not to be sold for local i currency. They, are usually used to import goods on behalf ! of a merchant who buys the goods at an attractive price. I ' j The government or its monetary authority sometimes i i supplies part or all the exchange that is sold. This is i | : called an auction market because the exchange is sold to j t i 1 the highest bidder and the monetary authority as seller ; I T , receives the profit from the high rates, rather than the exporters, as in the case of a free market.^ ; l \ ^xhis so-called free market is not a broad repre sentative market since the kind of transactions which are 1 allowed access to this market are limited and may be altered by the government. Enke and Salera, op. clt^p. 326., ^Young op. cit., p. 386._____________________________j ; Exchange control systems sometimes provide for what are known as private compensations, wherein certain j categories of exporters or other recipients of exchange j | are allowed to sell all or part of their exchange receipts i | to certain categories of importers or other purchasers of ! : exchange, on a free basis. A single exchange rate tends ; to prevail in such a market. In some instances, receipts ( ; i t [ from a particular type of export may be sold only to j J * , purchasers using them for a particular type of import. j ■ j This pairing of particular exports with particular imports j j I may result in several rates of exchange. I Multiple exchange rates. A distinct technique of | exchange control is known as the multiple exchange rate. j | l 1 According to this technique the government establishes j ' ■ i ; two or more rates of exchange for a particular foreign 15 currency. Thus, imports which are considered essential ; I i i •^A buying rate and a selling rate that are not far ! apart, i.e., not more than 1 per cent apart, are not con- j sidered multiple rates, since a small spread to provide | ! for costs, including reasonable profits, is customary in j i all exchange markets. International Monetary Fund, Articles j of Agreement (Washington, D. C.: 1944), Article IV, Section 3. may be allocated exchange at a low or favorable rate, whereas luxuries must pay a higher rate of exchange. Similarly, it may be required that receipts from exports be sold to authorities at rates which vary according to the kind of commodity exported, a favorable rate being given to commodities the exportation of which the govern ment wishes to encourage. | Exchange Control Practices in Leading Countries 1 The systems of exchange control in different coun- | i j tries are by no means uniform. They differ in their techniques, objectives and scope. For the purpose of comparison, below are the main features of exchange i l control systems in some leading countries which were imposed as a result of the Second World War. 1 Canada introduced control over foreign exchange 1 i in 1939 as a temporary measure to combat the exchange | t difficulties which arose as a result of the Second World j War. However, since 1951, when the system of exchange i control was abolished, Canada has imposed no major | i " ” “ ■ 323 I restrictions on foreign exchange.^ t The foreign exchange restrictions of England were i introduced in September 1939 and are similar to those of |Iraq and the other members of the sterling area. Gener- f ally speaking, exchange control is not imposed on transfers to other countries in the sterling area, but all payments to non-sterling area countries require exchange control i i ’ approval. ^ Export proceeds must be received in the I i ! manner prescribed in the regulations and certain currencies i j i I 1 must be sold to an authorized bank. The French exchange control system was also intro- i j duced in September 1939. The essential features of this i i system are: (A) Almost all imports are subject to indi- : vidual licensing, which is applied more restrictively to hard currency imports. (B) Payments for authorized imports are allowed automatically, while payments for | invisibles relating to trade transactions have to be I ! approved. (C) Residents are obliged to collect and sur- irender amounts due from nonresidents representing the ^A. o. Gibbsons, ’’ Foreign Exchange Control in Canada, 1939-1951,” Canadian Journal of Economics and Political Science. 19:37, February, 1953. ” Cf. ante» PP* 294-5296. proceeds of the sale of goods and services. In the United States there are no exchange restric tions worthy of mention. I In conclusion, the present exchange control emerged 1 i i as a war expedient during the Second World War but has i i i remained in operation in most countries ever since. As I i for the future, many authorities believe, "exchange control^ once instituted, has a tendency to perpetuate itself and j I to make difficult the restoration of a relatively free j multilateral trading systeml'^^ i II. EXCHANGE CONTROL IN IRAQ Exchange control was introduced for the first time j in Iraq on November 24, 1941, by Exchange Control Law \ i Number 71 of 1941, which was superseded in 1950 by i Exchange Control Law Number 18 of 1950.^ Prior to the j • ^Seventh Annual Report on Exchange Restrictions, op. cit., pp. 124-34. ^Young, op. cit., p. 384. ^Al-Waqayi'a Al-Iraqiya, No. 1972 of November 24, 1941, Law of the Exchange Control No. 71 of 1941 and No. 2829 of May, 1950, Law of the Exchange Control No. 18 of i 1950 (Baghdad: The Government Press). ! ! " ~ 325 ! | establishment of the Central Bank of Iraq and up to May i i '1950, the exchange control administration was entrusted to | | a special committee called the ''Exchange Control Commit- | tee.'’2* - At the start of its operation in 1949, the Bank j ! took over unofficially some of the duties of the Exchange j Control Committee, particularly those relating to statis- J j ! ] tics of foreign currencies sold and bought between local j t j banks and between these and foreign banks.22 since May I . 1 1950, however, the Board of Administration of the CBI j i * ; i j is entrusted with all powers and responsibility in con- | ; i j nection with exchange control. In practice, the Board i has delegated most of its administrative authority to t the Directorate of Foreign Exchange of the Bank. All I I I foreign exchange transactions must be effected through j ! | • licensed dealers unless especially authorized by the t , Bank. J Imports and export licenses, where required, are ; I i issued by the Directorate General of Commerce. i 21Cf. ante, pp. 133-139. I ' 22Annual Report of the National Bank of Iraq, July I ' 1949-December 1950 (Baghdad: The Times Printing and | I Publishing Company, Ltd., 1951), p. 9. 2^Law of the Exchange Control No. 18 of 1950, op. J cit., Article III. 326 Main Features of Exchange Control in Iraq The essential features of exchange control in Iraq are similar, with minor exceptions, to those of Britain and other members of the sterling area. Below is a brief account of these features with particular emphasis on import and export regulations. j Exchange rate system. The par value, as noted, is I ll.D. 1 = $2.80 = 3.5813 grams of pure gold. In the offi- j J J jcial market, most transactions are effected in sterling. ! I |For certain specified currencies, licensed dealers are authorized to deal on the basis of London rates. Since 1952, the CBI quotes an official rate for the United States dollar at which it will sell exchange to licensed dealers to cover the excess of their dollar requirements over their purchases from customers or other banks.^ An additional exchange rate arises from the sale of the exchange proceeds of certain exports to neighboring countries (which do not have to be surrendered) to import- | i i J ers of certain goods from soft currency countries. I ^International Monetary Fund, Fourth Annual Report on Exchange Restrictions (Washington, D. C., 1953), p. 203. Prescription of currency. The methods and currency of payment for transactions with most non-sterling area countries are, in general, comparable to those applied in other countries of the sterling area. Payments to and receipts from countries with which the United Kingdom has negotiated monetary agreements,^5 the United States dollar area and Canada are either made in sterling or in the currency of the paying/receiving country or monetary area. Receipts from Transferable Account countries may also be accepted in any specified currency,^6 if freely offered and freely transferable to the United Kingdom. Payments to and from all other countries are effected 25up to the end of 1955 the countries (monetary areas) covered by these monetary agreements were as follows: Belgian Monetary Area, Denmark, French Franc Area, Federal Republic of Germany, Italian Monetary Area, Netherlands Monetary Area, Norway, Portuguese Monetary Area, Sweden and Switzerland. Seventh Annual Report on Exchange Restrictions, op. cit., p. 296. 26These specified currencies, up to December 31, 1955, beside the currencies of the territories and monetary areas listed above, were the following: Canadian dollars, Panamanian dollars, Phillipine pesos and United States dollars. Loc. cit. 328 i j predominantly in sterling. 1 i Nonresident accounts.^ Nonresident accounts con- i ! j sist of dinar accounts belonging to banks, or to private j I I individuals or firms, resident outside Iraq. Payments to i the accounts of nonresident banks for imports, interest, dividends, and allowances may be made by authorized J dealers without prior approval; other payments from resi- | dents to such accounts must be approved by the CBI. The ' I ! nonresident accounts of foreign banks may be drawn on to ! , pay for Iraqi exports and for other payments, if the I : i 1 amount of an individual transaction does not exceed a j certain amount to be determined from time to time by the ! I i ! CBI. For all other credits and debits to the accounts of ; ! I the banks, prior approval of the CBI must be obtained. 1 Dinar balances of banks in other sterling area territories i may be transferred freely from one to another. Those of ; 1 banks outside the sterling area may be transferred freely | , to nonresident dinar accounts of banks belonging to the i , same country or monetary area are also allowed. All other I I " ' I ' " n | i i 2^Law of the Exchange Control No. 18 of 1950, op. j j cit., Article III. j 329 interbank transfers require the approval of the CBI. Nonresident accounts of private individuals or firms may be credited, without prior approval, for pay ments of dividends and interest on securities and proceeds of small checks up to certain limits. They may be debited for such items as payment for insurance premiums, income, ' j limits for each transaction. All other credits and debits require the prior approval of the CBI. Transfers normally are not permitted from the accounts of individuals or firms to nonresident accounts of banks belonging to the j same country or monetary area, unless the items originally i ! credited to such accounts are "currently remittable" in i nature. • i I ' i Imports policy. All foreign transactions are, with ; i 1 certain exceptions subject to exchange control. Imports from hard currency areas are governed by licensing systems and are limited to goods such as agricultural and indus trial machinery, automobiles, trucks and drugs. Up to August, 1952, all imported goods were placed on one of several lists, the two longest consisted of , I "unlimited" and "limited" goods. Each merchant was given r " ' 330 an annual quota in dinars, within which he was able to | import unlimited goods without restriction, provided he , could obtain a license for each purchase. Alternatively, J he was able to spend a small part of his quota on "limited** | goods, but only up to a fixed amount. Unlimited goods consisted mainly of the goods purchased by the common people, such as tea, sugar, and ; cotton textiles, and a variety of other goods considered i , essential, such as drugs and medical equipment, educa- i i tional matter, industrial, electrical and agricultural 1 machinery, transport equipment and raw materials for I local industries such as gunny bags, certain vegetable i oils, tanning extracts and non-ferrous metals. The ! principal object of the system when it was introduced, \ i according to the experts of the International Bank for | - , I Reconstruction and Development, was to "prevent a shortage j i of these necessities--and hence high prices--at a time j I F I ! when imports as a whole had to be restricted to protect ! ^Annual Report of the National Bank of Iraq, 1954 (Baghdad: Al-Najah Press, 1956), pp. 31-36. 331 the country's exchange reserve."^ The goods on the limited list, while not strictly / > luxuries, consisted of goods less essential than those i i in the unlimited list. This included, for example, ready \ J made clothing of various kinds, automobiles, matches, and i j certain types of household utensils and electric ware, i Luxuries, such as bananas, confectionery, cosmetics, I Persian rugs and nylon stockings were placed on a third 1 i ; list of goods "without foreign exchange." These goods i | were purchased only by merchants who held a special | license to import "without foreign exchange," which meant I ! that they acquired foreign exchange through other than the official channels. Such licenses also permitted them I to purchase goods on the other two lists. i ! Foreign exchange was (and still is) acquired with- ! i out official license in a number of ways, of which the « 1 following were (and are) probably the most important: by I ^ undervaluation of imports, especially wool, hides and skins; by the export of dates to neighboring countries in t 29ihe international Bank for Reconstruction and 1 Development, The Economic Development of Iraq (Baltimore: ! The Johns Hopkins Press, 1952), p. 163. ! 332 : small craft (in this case retention of foreign exchange *as i j and is legally permitted as noted); by smuggling, although j there was probably a net inflow of smuggled goods; by j sale of dinar notes to foreign pilgrims to the Holy cities; and by overvaluation of imports. The procedure of granting license to import "without foreign exchange" j was introduced in order to compel merchants to use the [ foreign exchange acquired in one or more of the above ways ! instead of drawing on the national exchange reserves, and also to discourage the imports of luxuries since the i foreign exchange rate in this market is usually higher than the official rate. However, as the International Bank | t i i experts pointed out rightfully, the system, although sue- i ; cessful in its obligation, has encouraged the illegal I j acquisition of foreign exchange. t A fourth list consisted of prohibited goods. This was purely a protective device, almost all of the goods i J in this list being produced in Iraq. These included a \ : variety of agricultural products such as sesame seeds, and i I cotton seeds or their oils. Several of the newer industries ^Ibid., pp. 163-164, 333 i were also protected by prohibiting the import of products similar to theirs. Among these products are: beer, cement, cotton yarn, aluminum ware, alcohol and hides. But, as a result of the improvement in Iraq's foreign ! | exchange situation, most of the above restrictions are now relaxed. Generally speaking, presently, all imports from hard currency countries require licenses, which are granted I » in accordance with an annual program based on the availa- J | bility of hard currency reserve in the dollar pool of the j j i isterling area and the needs of the econoray. For imports J i !from soft currency areas, both the control policy and the j ‘ t I ]licensing procedure are more liberal. The licensing pro- < cedure does not apply to most imports from soft currency I i |countries (except certain listed goods for which an import ! } t ( |license from the Directorate General of Commerce must be i I obtained). The allocation of foreign exchange to importers! i I i |according to the category in which they were classified ! I Ol and registered has been discontinued since 1952. For goods subject to license, the licensed dealer may make the exchange available upon presentation of the I | • ^Fourth Annual Report on Exchange Restrictions, | op. cit., p. 203. 334 I exchange control copy of the import license; for goods not subject to license, exchange is provided on application. The licensed dealers do not, of course, provide for imports' of goods licensed on the understanding that the importer I * will provide his own exchange. Exports policy. Exports of essential goods in short supply are subject to licenses from the CBI. How- 1 ever, since September 1952, the licensed dealers were | permitted to approve certain types of licensing applica- i I * tions without reference to the Bank. The export of certain | commodities is prohibited; they include certain kinds of ! I I livestock; certain foodstuffs in short supply; cereals and fruits; and raw materials in short supply including | ; cement and scrap metals.32 However, commodities on the I | S prohibited list may be exported if specially authorized ! i ; by the High Supply Committee. Generally, goods imported i : in to Iraq may be re-exported, subject to license. The : exceptions being the goods imported from the hard currency j area and such specified goods as cars and agricultural ! 3^Quarterly Bulletin of the Central Bank of Iraq, j January-March, 1956 (Baghdad: Thomas Printing Press, 1956), p. 24. 335 machinery. Exporters must declare their exports to ensure that foreign exchange proceeds are received and surrendered. However, foreign exchange proceeds from exports of dates to India, Pakistan, Syria, Lebanon, Jordan, Saudi Arabia, Kuwait and the Persian Gulf Protectorates are exempt from the surrender requirement. These proceeds constitute one source of exchange for the importation of commodities j ! grouped as goods ’’ without foreign exchange.” Since June | ! I j 1, 1955, special export declarations are no longer required i i ! for exports to be paid for through an intermediary in the j I , United Kingdom, unless the goods were being exported to i ! ( O O ! the dollar area. I i Invisibles policy. All payments for invisibles require permission.^ Exchange granted for invisibles i • normally is restricted to travel, educational and medical i ! expenses abroad, freight on exports carried on a "Cost and Freight” of ’’ Cost, Insurance and Freight” basis, Seventh Annual Report on Exchange Restrictions, op. cit., p. 191. ~ ^Law of the Exchange Control No. 18 of 1950, op. cit., Article XVI, Section H. 336 ' j i insurance premiums, and royalties on certain films. ! Exchange is not however, granted to merchants for the insurance abroad of their imports and exports.Exchange j i is provided for the transfer of interest and profits if | the amounts applied for are considered reasonable by the CBI. Under the system now in force, the licensed dealers are permitted to transfer up to fifty dinars per month ( ■ i | for family maintenance on behalf of foreign nationals I ■ J resident in Iraq, provided the remittances do not exceed i | I half of the resident*s monthly income.^6 por amounts I i 1 exceeding this limit, it is necessary to refer to the j CBI. For residents traveling abroad there is a basic I | ! allowance of one hundred dinars per person per month for ' ; i not more than three months in any one year. Travelers i j may take out up to fifteen dinars in Iraqi currency notes i I or the equivalent of twenty-five dinars in foreign ^^Because the Iraqi Government operates its own insurance company for this purpose. ■^International Monetary Fund, Sixth Annual Report on Exchange Restrictions (Washington, D. C., 1955), p. 203. 337 ! I f currency.37 Pilgrims to Saudi Arabia are permitted to { take out the equivalent of one hundred and fifty dinars in foreign exchange, including up to forty dinars in the form of notes and coins.38 Exchange to meet the cost of j business travel is subject to prior approval of the CBI. As far as the foreign exchange receipts from invisibles are concerned, the law requires the surrender of such proceeds. Foreign currency, including notes, may ' be brought into Iraq by travelers in unlimited amounts ! J | J provided they are declared to the Iraqi customs, and the J unused amounts may be re-exported. Travelers other than ! * i : j pilgrims returning from Saudi Arabia may bring in only ; on fifteen dinars xn Iraqi currency notes. * ( i Policy toward capital movements. In general, all ; transfers of capital abroad require the prior approval of j 1 40 ' the CBI. The transfer of capital abroad by residents 07 Seventh Annual Report on Exchange Restrictions, 1 °P* » P* 189. ; ■^International Monetary Fund, Fifth Annual Report ' on Exchange Restrictions (Washington, D. C., 1954), p. 209: ^Loc. cit. , ^Law of the Exchange Control No. 18 of 1950, op. j cit., ArtXcTe IlTTSection 3. ______ ___j 338 is not allowed. Nonresidents may import capital freely, but they must deposit it with a licensed dealer. Such deposits may be converted into local currency at the official rate, and repatriation to the country of origin is permitted. Foreign investment in Iraq is permitted freely and exchange is provided for the repatriation of reasonable profits upon submission of an audited earnings j statement and proof that local taxes have been paid. I i Interest payments may be made freely, subject to adminis- i trative checking. Payments of a capital nature which are not per mitted to be transferred abroad may be credited to i i "Blocked Accounts." Balance on Blocked Accounts may J be disposed of subject to approval of the CBI.^ I In sum, being a member of the sterling area, Iraq i j has an exchange control system similar to those of the I United Kingdom and other countries of the area. For the I most part, transactions with the sterling area are either ^Al-Waqayi'a Al-Iraqiya No. 2095 of May 1943, Exchange Control Regulation No. 28 of 1943 (Baghdad: The Government Press, 1943), Article I. ^Ibid., Article IV. free from restrictions or subject to minor ones, while payments and receipts from the hard currency area are subject to licenses and quotas. However, as a result of the improvement in recent years in the position of foreign j exchange reserves of the sterling area in general and of Iraq in particular, exchange restrictions are simplified and the payments rigidities are relaxed. i ! III. EVALUATION OF THE IRAQI EXCHANGE CONTROL POLICY ! i | j There is no doubt that any type of exchange i I i restrictions impairs the free flow of international trade, 1 ! j < regardless of whether it is designed to protect the j reserve; to keep imports and exports in balance; to pre- ■ t J vent nationals from exporting their capital; or to ! * I protect the domestic industriesgut the impact of ! j i exchange control on the free multilateral trading system is beyond the scope of this dissertation. On the other hand, part of the evaluation of the present exchange control system, namely, the relation with the sterling ^Paul Bareau, "Exchange and Payments Controls and | Their Influence on Foreign Trade," International Banking and Foreign Trade (London: The Institute of Bankers, 1955), p. 34. 340 ' area and the fixation of the dinar rates in terms of the t i pound sterling, has been already discussed in the previous j « chapter and repetition is unnecessary.44 This section, furthermore, does not deal with the impact of exchange control on the balance of payments, pattern of foreign trade, the foreign exchange reserves or the distribution of income. These aspects were also effected simultane- j ; j ously by the tremendous increase of the Iraqi oil exports, ; I ; J the implimentation of the economic development program j j and trade restrictions other than exchange control. This j I makes it very difficult to separate the impact of exchange 1 i control from that of the other factors. Consequently, the j ! ) evaluation of the present exchange control system is dis- | cussed below in rather general terms with particular i i | stress on the relation between the exchange restrictions = and the current plans for economic development. ‘ i The Need for a Simplified Exchange Control System Although, as noted above, the improvement in the foreign exchange situation has led in recent years to a i relaxation of the quota limitation, as noted, most of the i ___________________ 44Cf. ante, pp. 274-298. 341 other restrictions remain. In particular, import licenses still have to be obtained for imports from the hard cur rency area. Although it is maintained that licenses can now be obtained quickly, licensing appears to act as at least a psychological deterrent to merchants.^ One of the objects of the licensing system is to restrict import- 46 ing to bona fide merchants. But if this is considered necessary, it could, be achieved by the issue of a general importers* license, good for a period such as a year. j As the economy develops and the standard of living J I ' i rises, which it may be possible in the near future, the ; i I demand for goods now imported on a limited basis or pro- i ihibited is likely to increase and restrictions in imports jof these goods, esepcially from the hard currency area, 1 Imight have an inflationary effect on prices. This would I ! ! Ihit the artisan, the clerk and the civil servant and i might increase the cost of the development program. j j A much more flexible instrument would be the customs ! ! tariff, but little coordination of the import licensing sys-; I tem with the tariff seems to have been achieved. At pres- j ent the tariff is primarily a means for raising revenue and,' ! i ^-*The Economic Development of Iraq, op. cit., p. 164.! I ^Einzig, o£. cit., p. 120. j 342 as such, imposes the greatest burden on those who buy bulk commodities. It hardly conforms to the objectives of a licensing system that aims at a plentiful supply of ■ ' these goods at low prices. The principal objection put | i , 1 j forward to higher duties on luxuries is the increased | premium thereby put on smuggling which is difficult to I i ; control even with a large police force in a country with ' 47 a long land frontier like Iraq. On the other hand, smuggled goods can now be purchased quite openly, and it is hard to believe that enforcement could not be made more effective. In any event, outright restrictions of imports could cause prices of foreign as well as domestic goods i | to rise and so put almost as great a premium on sijniggling ! i i i as a high tariff. The government has sometimes tried to prevent excessive mark-ups on certain goods, such as radios, by price control measures, but the control was j i by no means fully effective. Sometimes, the government has supplemented the i exchange control system by entering the market itself. [ --------------------------------------------------------------- I ^The majority of the smuggled goods to Iraq comes through Kuwait, Syria and Iran. 343 For example, arrangement was made under a trade agreement with India, signed in 1952, for the import of cotton j textiles and gunny bags, in part on government account. i I The government has also made direct purchases from abroad I i of its own requirements such as tires. The effect has, i however, not always been as intended, merchants being | hesitant to buy foreign goods with the prospect of large ! ; government stocks hanging over.the market. ^ \ j Furthermore, since Iraq cannot be expected to run | into foreign exchange difficulties during the next few j I i | years to come, there does not seem to be much reason to I j I retain control over payment to other countries to the i same extent as hitherto. On the contrary, payment should I be freed as much as possible in order to facilitate imports I j thus contributing to the evasion of inflationary pressure. The licenses for imports “without foreign exchange,” for example, should be abolished. More power should be delegated to the commercial banks in approving specific payments in order to facilitate the foreign exchange transactions and thus the flow of goods. As it is ^The Ibonomic Development of Iraq, op. cit., p. 165. 344 I necessary to protect certain infant industries against competition from abroad, this can be done through custom duties and other means, rather than exchange restrictions. Beside the necessity of a freer treatment of pay ments for imports, Iraq should relax the restrictions on payments for services such as interest on foreign loans or repatriation of salaries paid to foreigners working in I Iraq. If such transfers are freely allowed, it would probably stimulate the interest of foreigners in invest ment and work in Iraq and thus contribute to increasing the supply of foreign "know-how.’* As far as demanding delivery of most exchange earnings is concerned, the CBI should continue this policy or at least demand that such earnings must be reported. i . :At present it does not matter too much if minor amounts j of foreign exchange earnings fail to reach the CBI. But on future occasions it may become important that the Bank obtains all foreign exchange. Therefore, the system of delivery of exchange proceeds should not be allowed to degenerate by neglect. The above suggestions should not be taken to mean that all controls should be ended at once. The present 345 membership of Iraq in the sterling area requires maintain ing the control over current payments to the hard currency I area. Also, the membership necessitates the maintenance I ! of restrictions on capital payments. Besides it may be “wise to keep the system alive in order that it can be set in function in case of emergency without too much : delay.”49 ! t i However, if Iraq chooses to leave the sterling 1 area, as was suggested in the previous chapter, a thorough I i revision of the present exchange control system would be i ! necessary. The restrictions and regulations of exchange I ! would then have to be based on Iraq*s economic needs, the status of its foreign currencies reserve and its balance of payments rather than the sterling exchange i market and the economic requirements of the sterling area. In summary, as the report of the International Bank i pointed out, a less complex system of exchange control . . . would seem better suited to an economy like that of Iraq, whose requirements are likely to change in composition and to increase quite rapidly. Fewer regulations, more strictly 4^Carl Iverson, A Report on Monetary Policy in jlraq (Baghdad: The National Bank of Iraq, 1954), p. 279. 346 enforced, are likely to serve better the two ends of social justice and public revenue.-*® i IV. CONCLUSION As in other sterling area countries, the Iraqi exchange control is modeled after the United Kingdom, j modified to some extent to suit local requirements. It ! was shown that the system of control is based on the i principle of surrender of foreign exchange receipts (with a few minor exceptions) and their allocation by the control authorities to payments for goods, services, and other transactions on the basis of priority of need and the "hardness*’ of the currency involved. However, the oil companies, under special arrangements, have complete autonomy in their exchange transactions, provided that i they are effected at official rates. Imports from hard currency countries are restricted on the basis of annual quotas but imports from soft currency countries are, with few exceptions, freely permitted. It was further shown that certain exports to neighboring countries are exempt from exchange surrender 5®The Economic Development of Iraq, op. cit.,p. 165. requirements. Also, import licenses are granted for certain goods from soft currency areas provided the importer makes his own arrangements for the amount of foreign exchange necessary to order the goods from abroad. As a result of the improvement in Iraq's foreign exchange reserve and those of the sterling area, the exchange restrictions have been relaxed in recent years. However, the present system of exchange control remains rigid in comparison to Iraq's need for economic develop ment. It is, therefore, deemed necessary to simplify the present exchange restrictions and to move further in the direction of freer trade, particularly with the hard currency area. CHAPTER XI THE CENTRAL BANK OF IRAQ AS CONTROLLER OF COMMERCIAL BANKS Today, there is hardly a country without a statute i for the control and supervision of commercial banks. j However, the earliest complete banking code was that incorporated in the English Joint Stock Bank Act of 1844. The Act included provisions relating to: the control of the number of banks, the publication of balance sheets, audit, minimum capital, returns, restrictions on loans j on a bank's own shares and the like.1 This development j i t was followed by a similar one in Sweden. After prelimi- j | i nary legislation was enacted in Sweden there was published ! I in 1846, a royal decree which could be said to have ! embodied the principal requirements of a reasonably com plete banking code. The English and Swedish codes were ^-This act, however, applied only to a few banks, and from 1857 onwards, banking law liberalized and merged with ordinary company law. A. M. Allen, et al., Com mercial Banking Legislation and Control (London: Macmillan and Company, Limited, 1938), p. 4. 349 followed, though after an interval of twenty years, by the banking laws of the United States in 1863 and Canada in 1871.2 Since then, commercial banking laws have been introduced in practically all countries of the world. In Iraq, the first law designed to regulate and control com mercial banks was enacted in 1938, which was superseded in 1950 by new legislation. So far, two of the principal functions of the Central Bank of Iraq have been discussed; namely, the issue of currency and the control of foreign exchange. This chapter will take over the treatment of the third and final main function, i.e., the control of commercial banks. In order to determine the scope and methods of jcontrol in Iraq, however, a brief account of the com- I t Imercial banks* control in some leading countries will be i ! given first. This will be followed by a critical analysis !of the present system of commercial banks' control in Iraq. The chapter will show that the commercial banks in i_ _ _ _____________________________ ^Loc. cit. • a Jabir J. Abdul-Rahman, Political Economy, Vol. II (Baghdad: The Iraqi Publishing and Press Company, Ltd., 1951), p. 237. 350 Iraq are subject to numerous and detailed restrictions in regard to capital, surplus, deposits, investments and ! other aspects. The objective of most of these restrictions, ! i i as will be noted, is to secure liquidity and solvency of banks. This chapter will deal then, only with the legal { regulations ofcommercial banks. The treatment of the I J application of changing reserve requirements and redis count rate as well as other instruments of credit policy is postponed until the next chapter. | I. COMMERCIAL BANKING LEGISLATION i | IN LEADING COUNTRIES \ ; As yet, there is no universally accepted theory J concerning the statutory regulations of commercial banks. 1 f Nevertheless, certain general principles could be derived J i from a study of the main features of commercial banking i legislation in some leading countries. These principles are practiced either legally or voluntarily in most countries, although in a different manner and with a different degree of emphasis. Following is a brief description of those major aspects of commercial banks* ! activities usually regulated and controlled in Canada, 351 England, France and the United States. They are treated here with the intention of furthering the understanding and appreciation of the regulations applied by the CBI. Canada i According to the last amendment in 1944 of the Bank Act of 1871, the incorporation of any particular bank requires an Act of Incorporation giving the names of the applicants, the amount of capital stock, the name of the bank and the location of the bank’s head office. If the bank meets all the legal requirements a certificate J | will be issued authorizing the bank to start its I operations The Bank Act requires that any chartered bank oust have a minimum capital of half a million Canadian dollars t l | with not less than half of it paid up. Also the Act forbids the banks^ to: first, buy, sell, or barter goods, or engage in any trade or business; second, to purchase, deal in, or lend against, its own shares or the shares of ^Donald Baily Marsh, “Canada," Banking Systems, Benjamin H. Beckhart, editor (New York: Columbia Uni- i versity Press, 1954), pp. 134-33. c I Allen, op. cit., pp. 114-18. i | 352 any bank; third, to lend against mortgages or hypotheca tion of land, houses or other immovable property, ships or i other vessels, or on the security of goods, wares and i | merchandise; fourth, to lend more than one thousand I Canadian dollars to any officer or employee of the bank without the approval of the directors, and with that i approval not more than ten thousand dollars; fifth, to lend more than 5 per cent of the paid-up capital to any i director, or to any company in which the president, general manager, or a director is a partner or shareholder j without the approval of two-thirds of the directors I i present; sixth, to charge interest or discount in excess j I of 6 per cent per annum. On the other hand, the Act entails further restric- i tions on the banks concerning legal reserves, loans and j investments. Chartered banks are required to hold not i less than 8 per cent of deposit liabilities payable in £ Canadian dollars in the form of cash reserves. In addi tion, the chartered banks are required to maintain with 6 Federal Reserve Bank of New York, "Commercial Bank Reserve Requirements Abroad," Monthly Review of Credit and Business Conditions, 131-32, October 1955. i i the Bank of Canada or elsewhere, adequate reserves against liabilities held other than in Canada. Recently Canada introduced the principle of "variable cash reserve" for the first time on its monetary system.7 According to this principle the Bank of Canada is authorized to change, within certain limits, the reserve requirements against deposits. The chartered banks, furthermore, are subject to inspection at any time, occurring at least once a year by the Inspector General of Banks. The Inspector par ticularly inspects the bank’s compliance with the pro visions of the Bank Act, the safety of its creditors and depositors, and the soundness of its financial position. He then reports his findings to the Minister { of Finance. In addition, the banks are required to supply I the Minister of Finance and the Bank of Canada with signed annual, monthly and special returns. i England English banks are subjected to a minimum of legal restrictions, presumably because of the small number of 7Ibid., p. 131. | 354 banks and the tradition of close cooperation between the authorities and the banks making it unnecessary to for- i malize these restrictions. However, some restrictions relating to the banks can be found in the Companies Act i of 1929.® These restrictions are mostly concerned with formation of a bank, its inspection by the Board of i Trade, the personal responsibilities of directors and auditing. From the point of view of economic policy, the banks are usually under a considerable measure of control from both the Bank of England and the Exchequer. As for regulation concerning capital, surplus, reserves, investment policies and the like, the banks have developed their own standards and restrictions. ! , France Up to 1937 no specific banking law existed in France. However, the commercial banks are now regulated and controlled according to banking laws passed in 1941 I t and 1945. The main provisions of these laws are those g regulating capitalization, liquidity and reporting. ®Allen, o£. cit., p. 235. ^Henry G. Martin, '’ France,” Banking Systems, op. cit., p. 286. 355 According to these laws, an incorporated bank should have a minimum capital of five million francs, / while partnerships or single owners should have one million francs. If a bank has more than two permanent offices, the minimum required capital should be doubled. The banks are, further, required to maintain in their i balance sheets a minimum of 60 per cent of their short term liabilities in the form of liquid and easily liquidated assets. The banks are, also, asked to submit to the Bank Control Commission and the Bank of France, their balance sheet, profit-and-loss account and other periodical reports of condition. The United States j ! American banking law and regulations are detailed ; i i and complex; mainly because of the overlapping authority of the Federal Reserve System, the Federal Deposit Insur ance Corporation, the Comptroller of the Currency and the j forty-eight state supervisory agencies. A full explana tion of the powers and functions of each of these author- ! ities would lead to a discussion quite remote from the 356 10 subject in hand. Furthermore, because of the wide range and diversity of state bank supervision^ it is extremely difficult to summarize regulations in this ; short discussion. Hence, this is a brief summary of only the principal aspects of the national banks, regulations i in the United States. ! I A national bank must secure a charter before it can i i operate. The minimum capital requirements for a bank | i range from fifty thousand dollars to two hundred thousand dollars, depending on the number of inhabitants in the ; city in which the head office is located.^ Changes in i i capital stock must meet requirements set forth in the law. i A bank is required to have a paid-in surplus equal to i 20 per cent of capital at the time it commences business ! 12 and to build up a surplus of 100 per cent of capital. 10 For a full discussion of the regulation of the commercial banking system in the United States see R. F. Leonard, "Supervision of the Commercial Banking System," ! • * - n Banking Studies (Washington, D. C.: Board of Governors of the Federal Reserve System, 1941), pp. 189-210 and Allen, op. cit., pp. 377-470. -^Major B. Foster, et al., Money and Banking (fourth edition; New York: Prentice-Hall, Inc., 1953), p. 113. i 12Ibid., p. 139. 357 A bank must neither hold nor buy its own shares, nor make loans or discounts on their security. Second, a bank must not make a loan of more than two thousand and five hundred dollars to any of its executive officers. Third, a bank is subject to legal restrictions in connec tion with loans to one customer. These restrictions are too complicated and involved to be stated h e r e . However, with numerous exceptions, the general rule is that loans to one customer must not exceed 10 per cent of a bank's combined value of paid-in capital and surplus. Fourth, a bank must not own real estate unless it is necessary for i I , its premises. No real estate acquired for any other ! purpose may be held for more than five years. As for ' I I , investments in real estate mortgages, the law requires I that they should not exceed 60 per cent of the bank's time i and savings deposits, or an amount equal to 100 per cent j of its capital stock and surplus, whichever is greater,^ 13 JAn excellent schedule on the limitations and exemptions of loans to one customer could be found in ibid., pp. 208-9. ^Charles L. Prather, Money and Banking (fifth edition; Homewood, Illinois: Richard D. Irwin, Inc., 1953), p. 493. i A bank's reserve requirements against deposits vary according to the classification of the bank into "central reserve city," "reserve city," or "country" bank. Also, 15 it varies in regard to time and demand deposits. A bank is further restricted concerning the interest to be paid on deposits. The payment of interest on demand deposits is illegal, while the amount of interest to be paid on other deposits is subject to limitation and regulation. ■^The percentages of legal reserve requirements in the United States as of April 1957 stand as follows: Class of Demand Deposits Time Deposits Bank In effect Max imum Mini mum In effect Maxi mum Mini mum Central Reserve City 20 26 13 5 6 3 Reserve City 18 20 10 5 6 3 Country 12 14 7 5 6 3 Source: Federal Reserve Bulletin, April, 1957, p. 422 and Prather, op. cit., p. 81. 359 Also, a bank must secure the prior approval of supervisory authorities before opening or closing branches and adding trust-banking functions. Last, but not least, a bank is subject to periodical examinations and audit and it must submit periodical reports on the bank's condition. In summary, although the nature and objectives of commercial banks' regulations vary from one country to another, they, generally speaking, embrace the same aspects of banking organization and activities. They regulate such matters as: the organization and liquidation of banks; the changes in capital or corporate structure; the estab- i lishment of and closing of branches; the ratios and nature of reserves against deposits; the payment of interest on deposits; the determination of permitted and forbidden ! operations and; the submission of reports of conditions, earning and expenses. II. SUPERVISION OF THE COMMERCIAL BANKS BY THE CENTRAL BANK OF IRAQ I The Law of the National Bank of Iraq Number 34 of I 1947 and that of the Central Bank of Iraq Number 72 of j 360 1956 entrusted the CBI with the function of control and supervision of the commercial banks. In order to ful- V fill this function the Law for the Control of Banking Number 34 was enacted in May, 1950 outlining the techniques' and scope of control to be followed by the CBI.^ Hence, while the last mentioned law provides the framework with * which banks have to operate, the actual mechanism of ; control is operated by the Banking Department of the CBI. ! The structure and characteristics of the commercial banking system in Iraq were discussed in Chapter III. Therefore, they will be referred to briefly in the course of the following discussion. The following pages are mainly concerned with the analysis of the aspects of com mercial banks' operations which are controlled and super- j j i j vised by the CBI. Owing, however, to the strategic ; l^Al-Waqayi'a Al-Iraqiya, No. 2499 of July 27, 1947, Law of the National Bank of Iraq No. 34 of 1947 (Baghdad: The Government Press, 1947), Article IV, Section (a) and Al-Waqayi'a Al-Iraqiya, No. 3818 of July 1956, Law of the Central Bank of Iraq No. 72 of 1956 (Baghdad: The Govern ment Press, 1956), Article IV, Section (5). •^Al-Waqayi'a Al-Iraqiya, No. 2833 of May 20, 1950, i Law for the Control of Banking No. 34 of 1950 (Baghdad: 1 The Government Press, 1950). 361 importance of some of these aspects (reserve requirements and rediscount regulations) in credit policy, their regula % tion will be treated in the following section of this chapter. Application of the Law The law applies to all institutions, Iraqi or foreign, carrying on a banking business in Iraq. Banking is defined as the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by 18 j check, draft order or otherwise. A bank is described as an institution engaged in the above activities, even if the institution does not carry the name "bank.1 *^ | The law applies therefore to private commercial banks as i - well as to state-owned commercial banks (at present only lO Law for the Control of Banking No. 34, op. cit., Article I, Section (1). IQ ^ ■^The law applies also to the sarrafs, who are individuals or companies engaging in trading as well as banking activities. However, due to the small volume of their operations and negligible importance in the money market, they are omitted from the.discussions. 362 90 Rafidain Bank). Formation and Liquidation The control of commercial banks plays an important role at the beginning of a bank's life, during the life J of its operation and at the termination of its business. ! j Formation. The banks are required to be organized as limited banking companies "except in the case of public *>21 banks which are established by a special law. The law does not specify, however, that the bank's name must contain the word "bank.5* Also, the law does not state the procedures to be followed if a bank wishes to change its name. Before it could commence business, a bank has to I 9 submit a written application to the CBI for a license. ! The applicants must state the name of the bank, its loca tion, the intended capital and surplus, together with the 20private commercial banks are those owned and managed by individuals, while public commercial banks are those owned and managed by the state. 21 Law for the Control of Banking No. 34, op. cit. Article I, Section (2). 363 22 articles of association. As to the banks established before the enactment of the law, they were also subjected to the same provision. In addition, they were required to state in their application the names and places of their local and foreign branches, their last balance sheet, the last profit and loss account, and a statement i of condition for the month preceding the request for oo application. J A bank is further required to have a minimum paid- up capital of two hundred and fifty thousand dinars. How ever, a license to establish a branch of a foreign bank is not granted unless the CBI is assured that Iraqi banks would receive like treatment in the foreign banks's country.^ t | The necessary license is granted only after the I CBI determines that the designated bank meets the legal requirements and that its formation is in the public interest. Up to 1956, the CBI granted licenses to nine ^Ibid., Article V, Section (1). ^^Ibid., Article V, Section (2). ^Ibid., Articles IV and V. 364 commercial banks with a combined total of twenty-four local branches.25 Liquidation. A bank is liquidated either volun tarily or by an order from the CBI. The CBI is empowered to withdraw the license from a bank permanently if the latter has violated certain provisions of the law (to be discussed in a coming section), or has proved to be incapable of meeting its obligations. There are only two j restrictions in either case of liquidation. First, the i bank in the process of liquidation must return the t deposits and other liabilities in full, or any proportion j ! acceptable to the owners. Second, if the bank can not j locate some of its creditors, the remaining funds must be ! j forwarded to the CBI which will be responsible for locating, i j and repaying those c r e d i t o r s .26 up to the end of 1956, however, there has been no instance of liquidation either i voluntarily or by order from the CBI. j I i j I 25QUarterly Bulletin of the Central Bank of Iraq, January-March, 1956 (Baghdad: Thomas Printing Press, 1956), p. 10. ^ Law for the Control of Banking No. 34, op. cit., Article XXIV. 365 I Regulations During the Operating Life of a Bank It is during the period of active operation that i banks are subject to most phases of regulation and control. The aspect which are regulated during the operating life i of a bank are, surplus, investment of assets, deposits, responsibilities, branches, accounts and the like. i Surplus. Besides the requirement of a minimum paid-up capital, each bank is required to build up a surplus from its undistributed profits. A bank must set aside each year at least 10 per cent of its realized profits until the surplus amounts to 50 per cent of paid- up capital. This surplus must not be used to offset a bank's losses unless authorized by the CBI.^ | The existence of a surplus of substantial propor- j tion is considered as a safeguard for depositors. It is more practical than the provision of double liability of' shareholders, because a paid-up surplus is usually a stronger guarantee than the paper liability of a number j n o j of small shareholders. ° In practice, however, the j ! j ^ Ibid., Article XVI. ; — I I I I —. * \ ^Allen, op. cit., p. 12. 366 strength of the guarantee afforded by a paid-up surplus depends on the form in which it is maintained. As Mr. Allen pointed out: All too often surpluses have been found at times of crises to be as immobilized as capital and deposits, for very seldom is there any legal specification as to the tYPe assets in which they should be invested. i Consequently, if the surplus is to serve its intended objective, the legislature should require that the sur plus be held in a liquid form of asset which would be likely to retain a high proportion of its value even in times of crisis. 30 Restrictions on assets. In order to secure a high degree of liquidity and safety, the banks are for- , bidden to hold certain kinds of assets as well as to ( ! engage in specified activities. 1. A bank is not permitted to acquire real estate beyond what is needed for premises and living ! ) quarters for the employees. However, if any ^^Ibid., p. 13. j o n i JUFor the statistical data concerning the amounts i and composition of the bank's assets as well as liabili ties, cf. ante, Table V, p. 69. 367 real estate over and above this is acquired as a result of foreclosure, the bank must sell it within five years, subject to extension.31 it is evident that the law does not go far enough in this respect, for there are no restrictions against holding shares in real estate com panies. Furthermore, there are no restrictions on the value of real estate to be held for | premises and living quarters for the employees. In the absence of such a restriction, a bank could Invest Its entire capital and surplus or ; I even more in real estate for these purposes, ! i and still be within the limitation of the law. Therefore, it is suggested here that this pro- i vision of the law should be amended to correct \ these deficiencies. j i 2. A bank is forbidden to deal in wholesale or retail trade, including import and export ! trade. The only exception to this prohibition is when a bank is permitted to undertake such t i ------ j ■^Law for the Control of Banking No. 34, op. cit., Article XIII, Section (1). 368 activities by a special l a w .32 otherwise, if, as a result of the settlement of claims, a bank acquired some goods, these must be disposed of within a year, which is subject to extension by the CBI. 3. A bank must not grant loans to any one customer in excess of 20 per cent of the bank's combined capital and surplus. However, there are excep- j ! tions to this restriction. First, the limit can be raised to 40 per cent if the loan is I I secured by gold, government securities or bills j of lading. Second, in special cases, both ! limits can be exceeded upon approval of the l CBI.33 Third, the following are not subject to ; i the limitation: loans to the government and | l semi-government institutions; intrabank loans; i and advances against commercial paper payable abroad for the settlement of Iraq exports. The difficulty with this provision is its inadequacy to prevent the possibility of 32lbid., Article XIII, Section (2). 33 Ibid.. Article XIV. Section (1). subterfuge, i.e., through borrowing by a customer's wife or business associates, or through the discount of bills drawn or accepted by him. Any guarantee given on the customer's behalf, or loans to enterprises in which he is financially interested, should also be taken into consideration. 4. No bank is allowed to grant loans to its employees in excess of the employee's annual salary, except when the loan is secured by acceptable collateral. Similarly, no bank is permitted to make loans in any form to its directors in excess of their shares of stocks in the bank.^ It should be noticed that the latter limitation implies that there is no legal restriction on the banks investments in its own stocks. This practice is contra dictory to the principle of "solvency," particularly if the directors own all banks*s stocks. Because, as Pro fessor Thomas pointed out, there would always be ■^Ibid,, Article XIV, Sections (3) and (4). I 370 . . . a constant danger that stockholders might borrow from the bank the equity they are supposed to have contributed for the protection of the depositors. Such a result would be similar to the effects of the common practice in the days of early banking [in the United States] when stockholders paid for their stock subscription with their promissory notes.^5 Consequently, the law should prohibit banks from making loans on the security of their own shares of stock, i whether the loans are extended to a director or any other stockholder. For the same reasons, the law should also prohibit the banks from accepting the stocks of other banks as security for loans to such banks. j I 5. A bank is prohibited from investing in stocks j or bonds of industrial, agricultural and real | estate mortgage enterprises owned by a foreign i < I ! government or nonresidents or established in a l I foreign country.36 : I I It is evident that this provision is directed first, against the danger of banks becoming too intimately con nected with foreign non-banking enterprises. Second, it ^^Rollin G. Thomas, Our Modern Banking and Monetary System (second edition; New York: Prentice-Hall, Inc., ! 1950), p. 195. Law for the Control of Banking No. 34, op. cit., Article XII. 371 is designed to divert part of the bank's resources to the investment in bonds and commercial papers of local 37 enterprises. Because of the present mounting needs for funds by local projects, the inclusion of this provision in the 38 law is very appropriate. ! Deposits and interest. The law further limits the j i maximum amount of deposits to be accepted by a bank. A bank cannot accept deposits from the public in excess of j i | sixteen times its combined value of paid-up capital and j i j surplus. In the event that the accepted deposits are i j beyond the legal limit, a bank, within five days, must either deposit the excess amount with the CBI or increase | i the capital so as to reach the proportions mentioned ! above. 3 9 i i j Undoubtedly, the purpose of this provision is to achieve some sort of solvency. Actually, this provision ~^Cf. post., pp. 377-379. 38 This point will be further elaborated in the next chapter, cJE. post., pp. 404-405. j ~^Law for the Control of Banking No. 34, op. cit., Article VIII. 372 alone is inadequate to secure the solvency of a bank. Therefore, in order to fully appreciate the value of this provision, it has to be taken in conjunction with other i provisions, particularly the restriction on investment and the ratios of reserves against deposits. The regulation of interest on deposits and loans was not mentioned in the Law for the Control of Banking, Number 34. Today, the rates of interest paid on fixed and saving deposits, as well as interest charged on loans and advances, are determined by a gentlemen's agreement among the banks.4® However, there is a provision in i The Commercial Law of Iraq of 1946 prohibiting any bank i (or any institution or individual) from charging interest ! t exceeding 7 per cent.4' * ' ' For the purpose of a centralized credit policy, it i I seems illogical that the CBI has no control over the J interest rates paid or received. For reasons to be dis- j cussed later,42 the ability of the CBI to influence j i ______________ I 40Cf. ante., p. 76. j 4^Government of Iraq, The Commercial Law of Iraq I (Baghdad: The Government Press, 1946), Article XXV. j 42Cf. post., pp. 410-412. 373 interest rates indirectly is very limited. Therefore, it is not unreasonable to empower the CBI to compel banks to change their interest rates, received as well as paid, where these rates do not correspond to the economic condi tions of the country.^ Some kind of control is essential if a centralized credit policy is to be pursued. | Reports and inspection. Each bank must submit to the CBI, in prescribed form, semi-annual balance sheets and monthly reports of its operation together with any further information that the CBI may require. The balance I sheets must show the position at the close of business j j every six months, and must reach the CBI within four i I months of that date. The monthly statements must show I , the position at the close of business every month and must I , , i reach the CBI within twenty days of that date. Each j bank, moreover, is compelled to publish within two months i ___________________ ■ * ^Such a practice is not strange in the history of j monetary experiences. The best example illustrating this | practice is the Czechoslovakian Banking Law of 1932 which authorized the government to force banks to change their : interest rates, received as well as paid. Allen, 0£. cit.J p. 31. | ^Law for the Control of Banking, op. cit., Articles XVII, XVIII and IXX. 374 after the close of its financial period a balance sheet and profit-and-loss statements, in an approved form and certified by a chartered accountant, j The inspection of commercial banks is entrusted J to a special department of the CBI. The inspectors have i I access to all the books, accounts, and documents of every bank. However, the inspectors are not permitted to check the names of a bank's clients (except borrowers), or the extent of overdraft granted to each of these clients. Any transgressions of the Law for the Control of Banking, Number 34 are to be reported by the inspectors to the Governor General of the CBI who in turn then takes steps to sue the violating bank. All the information acquired by the CBI through j the monthly statement, semi-annual balance sheets or inspection are considered secret. They cannot be pub lished unless the approval of the concerned bank is secured or they are published as a consolidation combining all banks. The detailed information of the activities of each bank which the CBI receives should prove of the utmost benefit in framing and carrying into execution the CBl's 375 policies. Moreover, this information should enable the CBI to take steps to counteract any undersirable tendencies in the investment policies of the banks, before they have time to endanger the stability of the whole banking system. Penalties The law holds the directors, managers and high officers responsible for any violation of the above regu- j i lations and restrictions. The CBI is authorized to sue ! the person directly responsible for the violation. This person may be fined from five hundred to three thousand i dinars and imprisoned for a term up to two years, depending I on the degree and the number of recurrences of the viola tion. In addition, the CBI can cancel the license of the i violating bank either for a limited period or permanently^ ' * III. RESERVE, FOREIGN INVESTMENT AND REDISCOUNT REGULATIONS i I As stated before, this chapter is mainly concerned with the legal regulations of commercial banks’ activities.j It does not deal with policies; it deals with regulations. | ! I 45Ibid., Articles XXVII-XXXII. I 376 Therefore, the subjects of reserve requirements against deposits and the rediscount operations with the CBI are discussed here from the point of view of regulations. The applications, implications and limitations of changing ! the reserve requirements, the rediscount rate, and other related policies will be discussed in the next chapter dealing with the role of the CBI in economic development. 46 Legal Reserve Requirements The liabilities of commercial banks are, to some extent, payable on demand. Consequently, the banks, voluntarily or legally, keep a reserve of cash and liquid j assets on hand as well as with the CBI to meet any demands j , that may be made. The avowed purpose of cash reserves i i t i then is liquidity, although in recent years changing cash j j reserves is considered an instrument of credit control. Each bank in Iraq is required to keep with the CBI a reserve equal to at least 15 per cent of the combined I t total demand and fixed deposits, excluding those of the i government. A minimum of 10 per cent of this balance must be in the form of Iraqi notes and coins and the rest in i ^Ibid., Article IX. 377 the form of Iraqi Government securities and Treasury bills. The CBI is authorized to reduce the 15 per cent require ment to 10 per cent, but it is not authorized to increase it to over 15 per cent. The CBI, also, is required to inform the commercial banks at least two months before effecting the changes. Two points deserve mention here. First, it is unreasonable to exclude government and semi-government I deposits from the reserve requirements. These deposits , ! are as liquid as the private deposits and have the same j i j effect as the private deposits on credit policy. Second, j , it would be more consistent with effective control if the present arrangement of reserve requirement is replaced by one with a wider range. It would be better to authorize | i j the CBI to vary the cash reserve requirements between 30 1 I and 10 per cent of total deposits. This range or ratios would enable the CBI to absorb the excess reserves of the i ! commercial banks more effectively, should this be necessary. The Ratio of Banks* Investments Abroad Aside from the requirement of holding a reserve j r l of 15 per cent with the CBI, a bank is required to invest j 378 the balance of total deposits as prescribed by the law. A bank must hold in Iraq a minimum of 35 per cent of total demand and fixed deposits. These holdings must be j in the form of cash assets,^ Government bonds, Treasury I I ! I bills, as well as bonds and paper of commercial, indus- | i trial and agricultural enterprises. The law places no restriction on the maturity of bonds or commercial, industrial and agricultural paper; although some indirect i restrictions could be found in the regulation of the < eligibility of paper for rediscounting. I The remaining counterpart amount of total demand i and fixed deposits can be held abroad in the form of j government securities, Treasury bills, deposits with I banks, and commercial paper. The law requires that these holdings must be in a currency freely convertible to the j dinar and must be acceptable to the CBI. ! It is evident that the law requires the banks to keep in Iraq at least 50 per cent of the counterpart of i their total deposits. The law further requires that the ^7"Cash Assets" are defined by the law as "Iraqi j securities plus (or minus) deposits with other licensed , banks in Iraq." Ibid., Article I, Section (8). 379 ratio of investment abroad must not exceed 50 per cent of total deposits. However, the CBI is authorized, if / necessary, to reduce any of the.ratios to 30 per cent and naturally to increase the other to 70 per cent. Undoubtedly, authorizing the CBI to change the ratios of permitted investment abroad is very wise, since it helps to channel part of the bank's resources to be j i i invested in Iraq. Similarly, when the funds are not | needed in Iraq, the banks would not be deprived of finding investment opportunities abroad. i Although, as stated before, the application of reserve requirements as an instrument of credit policy [ i will be discussed later, it is found necessary to bring j t i | to the attention one simple conclusion. The discussion i j reveals that the regulation of reserve requirements seems j i to have been intended mainly to secure the safety and liquidity of banks, rather than to achieve an effective credit control. Rediscount Regulations Theoretically speaking, in an emergency a commercial! i i bank may obtain help from the CBI, if the first bank has assets which are acceptable for purchase or rediscount 380 at the central institution. Therefore, banks usually place a substantial part of their funds in assets of this | kind. | 1 The eligibility of paper for rediscount is to be I i 4 8 judged by two standards. The first is the question of ) 1 maturity. Only paper maturing within 90 days is eligible, i : The second test of eligibility is the purpose that gives i rise to the paper. Paper issued to finance commerce and i i t ' a Treasury bill of three months maturity is eligible. On i i the other hand, the paper is ineligible for rediscounting j t if it is issued to finance agriculture or industry, I regardless of the date of maturity. As far as the rate j j of rediscount is concerned, the law authorizes the CBI I i to fix that rate and changes it as often as necessary. In actual practice, however, and for reasons mentioned before, the commercial banks up to 1956, had ! not resorted to the CBI either for rediscounting or borrowing. Therefore, changing the rediscount rate to i i influence the credit policies of commercial banks up to i that time has been of minor importance, if any. 4*8 Law of the Central Bank of Iraq, No. 72, op. cit., Article IV, Section (2). IV. CONCLUSION 381 The control of commercial banks is regulated by the Law for the Control of Banking Number 34 issued in 1950. While this law provides the framework within which banks have to operate, the actual mechanism of control is operated by the CBI. The law required that each bank must secure a license before it commences business or opens a new branch. Other provisions of the law deal with paid-up capital and surplus, cash reserves restric- i i tions of advances and maintenance of percentage of assets. ! All banks are required to submit their accounts, balance | sheets and monthly statement to the CBI. Also, the CBI is empowered to inspect the banks at any time. The person' responsible for a violation committed by a bank may be i ! fined or even sentenced to a prison term, together with , ! the possibility of cancellation of the bank*s license. j * From a general point of view, it seems that the i I main feature of the Law for the Control of Commercial j ! Banking Number 34 is the concentration of control in the | hands of the CBI. The reason for this lies, perhaps, in f the fact that the law is based on English banking experi- [ l ences. The merit of the arrangements is: (a) that j 382 divided responsibility which is weak by its nature, is avoided; (b) that there is no unnecessary duplication in such matters as the making of returns; (c) that no attempt is made to draw what is often a very hypothetical distinc- j tion between qualitative and quantitative control; and (d) that a bank operated more flexibly than could a bureaucratic commission. The second feature of the law is its limited complexity; it is neither complex like that of the United States, nor simple like the regulations in England. The law, as discussed above, restricts and regulates many j i aspects of commercial banking activities. But unlike ; American regulations, the law has: (a) no detailed I ! I control of the management or the directorate of the ' | banks; (b) little regulation of security for loans; and (c) no double liability provisions such as existed in the j - United States prior to 1933. A premium is put on good j internal commercial banks*management coupled with some I { l guidance from the CBI j f I It is still too early to say how successful the law will be, for no major economic disturbances have I taken place since the law was introduced. But, given the spirit of cooperation between the commercial banks and the CBI, together with a few amendments to the law, there is no reason why the banking system should not operate j successfully. The above statement should not be taken to mean that legal control of banks is considered the only answer to eliminate bad banking practices. On the contrary, it is believed that although legal regulation of banks is necessary, the ultimate success and efficiency of the j banking system depends more upon the growth of sound i tradition in the banks themselves than upon external I i control. t CHAPTER XII ROLE OF THE CENTRAL BANK OF IRAQ t IN ECONOMIC DEVELOPMENT i i ! I i | The art of central banking is essentially practical I | and the theory is ’’simply reading of past experience.”* " j In this way the theory of central banking, which is purely empirical, attempts to expound the techniques of central banking. It is usual when expounding the theory or i I principles of central banking to analyze the functions of i { this institution. Such a practice has inevitably led to j a frequent identification of central banking with the J |functions of the bank rate, the open market operations | o j and legal reserve variations.^ Now it is known, however, ^ i that the particular techniques employed by a central bank i are not of any absolute value. Their effectiveness * | R. G. Hawtrey, Art of Central Banking (London: Longmans Green and Company, 1932), p. vii. : i 2 I R. S. Sayers, ’’Central Banking in the Light of i Recent British and American Experience,” Quarterly Journal of Economics, 1X111:211, May, 1949. i 385 depends on certain institutional factors. As these institutional factors vary in different periods and in different countries a central bank's task should not ; consist of following only policies or techniques which | have been traditionally accepted as effective. On the I ! j contrary, the cardinal virtue of the central banker, as I Professor Sayers stated: . . . is not conservation in technique, but rather a disposition to discover novelties and to be versatile in technique. . . . They [the central bankers] must sharpen their insight into the working of the economy so as to see not only where they stand in the trade cycle but also where are the critical sensitive spots in the financial system; and they must be quick to j adapt their methods to suit the changing | economic structure.3 From the viewpoint of controlling any monetary 1 j ' system, discretion on the part of the central bank is of | cardinal importance. The instruments of central banking ; I j policy have their importance insofar as the monetary » authority— the central bank— uses them with discretion j in particular situations. These instruments of central j banking policy are also very closely associated with the economic activities of the community in the period in •^Loc. cit. ■— —— - 3- 8- 6 which they are to be applied. The present experiences of many underdeveloped countries^ are the best proof of the accuracy of the above point of view. These countries recently have been in an t I • economic ferment resulting from the urge for accelerated development. This pressure is having profound effects I ! upon both the policies and techniques of the central banks in those countries. Many of these banks have had to reach out beyond the range of activities traditionally regarded as within the domain of central banking. More over, because the banks have had to operate within rela- | I tively underdeveloped financial environments, considerable experimenting has been necessary even when seeking to Jfulfill traditional responsibilities. ! ! In coping with their varied tasks, the Monthly i i Review of the Federal Reserve Bank of New York pointed out I that only a few of the central banks ' . . . have so far made any appreciable use of traditional credit-control techniques, mostly because of the relatively underdeveloped financial ^Federal Reserve Bank of New York, "Central Banking in Asia: Policies and Techniques," and "Monetary Policy in Latin America," Monthly Review of Credit and Business Conditions, 129-133, September, 1956 and 5-54, April, 1956. 387 setting in which the banks have had to operate. Many banks, however, have endeavored to adapt the traditional instruments to such an environ ment, sometimes modifying them so much as to substantially alter their character.-* The above approach is adopted in the analysis of this chapter, i.e., a central bank should always try to modify the traditional techniques of credit control to suit its own objectives as well as to discover new ones. The purpose of the chapter is to analyse why the Central Bank of Iraq has not used, or used to a limited extent only, the traditional techniques of monetary policy; how these techniques can be made more effective; and the type of instruments by which these techniques should be supple mented. But the type and nature of the existing and suggested techniques of credit control are greatly related to the development expenditures undertaken by the Develop ment Board. Therefore, the analysis of the instruments of credit control is preceded by a brief description of the composition and impact of development expenditures in the hope that the tasks and objectives of the CBI in the process of economic development will be determined. ^"Central Banking in Asia,** o£. cit., p. 130. 388 I. THE DEVELOPMENT PROGRAM, 1955-1960 I The expectation of highly increased income from the ratification, in 1950, of the oil concession agreements, ! led the Iraqi Government to enact Law Number 23 establish- i 6 1 ing a Development Board. As stated in Article III of the law, the Board was assigned, ' i I . . . (1) to prepare a general economic and financial plan for the development of the resources of Iraq and the raising of the standard of living of her people; (2) to undertake a general survey of the exploited and unexploited resources of Iraq; and (3) after the approval of Parliament, to carry out the projects mentioned in the program . . . in accordance with their decided priority.7 In order to finance the development projects, the Board, as noted, was at first endowed with the entire I i oil royalties. However, since 1952, the Board receives i only 70 per cent of these royalties while the remaining 30 per cent is allocated to the general budget of the government. In addition, if necessary, the Board is Government of Iraq, The Development Board, Com pilation of Laws concerning the Development Board of Iraq (Baghdad: The Government Press, 1951), Article I. 7Ibid., Article III. 389 empowered to issue and sell bonds to finance specific projects. So far, the Board has not found it necessary to borrow because the oil revenues were greater than the Board's current expenditures. I [ The first development program of the Board was | approved by Parliament in June 1951. This initial pro- j gram was amended several times to adapt it to the findings i of new studies, past achievements and changes in the revenues of the Board. These amendments are of no con cern here because the purpose of this chapter is to analyze the relations between the CBI policies and the present Six Year Program, 1955-1960. For the same i reason, it is beyond the scope of this dissertation to evaluate or pass judgment on the different projects proposed.8 Consequently, the next few pages are devoted 1 i to the discussion of the composition and financing of the I present Development program as well as its probable I i impact in relation to monetary policy. ^For an excellent account of Iraq's plans for economic development in general and the Six Year Program, 1955-1960 in particular, the interested reader is referred to.Lord Salter, The Development of Iraq (Baghdad: The Development Board, 1955). 390 Scope of the Development Program The development program covers only the public sector of the Iraqi economy; it excludes the private sector of the economy.^ The purpose of the program is to bring about a general increase in productivity so that I the effective national income and hence the standard of j J living will be increased. This is to be accomplished by ! i i i 1 | providing the means for expanded and more efficient pro duction, principally through development expenditures in the public sector. As shown in Table XIV these public expenditures are estimated to be five hundred million t dinars over the six year period. ! Table XIV further shows that estimated development | i ! i expenditures include I.D. 153.8 million for irrigation i 1 i I I and flood control; I.D. 14.3 million for the development j l of animal and plant resources; I.D. 123.1 million for i roads, bridges and communication; I.D. 124.4 million for building and houses; and I.D. 67.1 million for industry. The emphasis on public expenditures is not a conse quence of undue concentration of economic activity in the ^In India, for example, the Five Year Plan, 1951-56 covered the entire economy, both public and private. The TABLE XIV ESTIMATED EXPENDITURES AND REVENUES OF THE DEVELOPMENT BOARD ... MARCH 1955 - MARCH-I960 (In millions of Iraqi dinars) 1955 1956 1957 1958 1959 1960 Total I. Estimated expenditures Administration & organization 3.0 .8 .8 .9 .9 1.0 7.4 Irrigation & flood . control 13.1 24.0 26.9 27.0 29.3 33.5 153.8 Roads & bridges 14.1 17.7 26.8 32.2 20.1 13.5 124.4 Buildings & houses 9.8 17.3 26.4 24.4 23.5 21.7 123.1 Industry 4.1 17.0 16.0 11.0 9.0 10.0 67.1 Development of animal . & plant resources 1.0 3.0 3.0 2.5 2.5 2.3 14.3 Others 1.5 2.1 1.6 1.6 1.6 1.5 9.9 Total 46.6 81.9 101.5 99.6 86.9 83.5 500.0 391 TABLE XIV (continued) ESTIMATED EXPENDITURES AND REVENUES OF THE DEVELOPMENT BOARD ... MARCH 1955 - MARCH I960 . (In millions of Iraqi dinars) 1955 1956 1957 1958 1959 1960 Total II. Estimated revenues Oil royalties Interest and others 59.1 1.9 65.2 .6 65.2 .6 65.2 .6 65.2 .6 65.2 .6 385.1 4.9 Total 61.0 65.8 65.8 65.8 65.8 65.8 390.0 ; Source; Government of Iraq, The Development Board, Development Board Law No. 54, ' for the Year 1956 Amending the Laws of the General Programme of the Proiects of the ! Development Boarh and the Ministry of Development No. 43 for the Year 1955 (Baghdad: ! The Al-Ani Press, ■ m e j r v n s : ----- t * 392 hands of government. Rather, it is a necessary concomi tance of the early stages of development in a predomi nantly agricultural country. Government investment is necessary for irrigation, power, transport and communica- ! tion projects, because it provides the basis for a more highly developed agricultural and industrial economy in I j the future. Certain direct expenditures on agricultural | development, such as provision for fertilizers, better seeds, and livestock improvement, as well as for rural community development through agricultural extension activities and cooperative organization, cannot be under taken under present conditions^ except under government sponsorship. As these primary development needs are better met, it may be expected that the role of private investment in agriculture and industry will become greater. plan set up a detailed blueprint of development expendi tures by the Central and State Governments and a some what less detailed blueprint for forty-two of the larger industries, which provide about two thirds of the total industrial output of the country. •^Cf. ante, pp. 21-28. 394 Financing the Development Program Unlike the majority of underdeveloped countries, Iraq does not have the problem of inadequacy of funds for ' I | financing the development projects. In order to finance j i ' I | their development plans, many countries have to resort to ! deficit spending, credit expansion and/or foreign aid. ! i ! j In Iraq, the Development Program, as Table XIV shows, will be financed by the receipts from oil royalties. This i method of financing should eliminate the need for the incurrence of large domestic and foreign public debts, as well as the possibilities of interruption of the develop- I ment plans due to the lack of foreign exchange. On the other hand, the table shows that the esti- i i mated revenues for the Six Year Program will be three hundred and ninety million dinars, compared to an esti- j mated five hundred million dinars in expenditures. This will leave a deficit of one hundred and ten million dinars. It is believed that this deficit can be covered from an expected increase in the oil royalties. Such an increase has already taken place as a result of increased produc tion. i It is evident from the above description that the 395 CBI will not be called upon to finance the Development Board expenditures. However, as long as the Board will continue to receive its revenues in sterling, the CBI in this respect will have to stand ready to exchange into I Iraqi currency, at the request of the Board, any quantity j of sterling offered by the latter. In other words, as | I long as the present monetary arrangements remain in prac- J i i tice, the function of the CBI in this connection will j i : continue to be a "monetary exchange agency.’1 II. EXPERIENCE OF THE YEARS 1952-1955 The Development Board has been in operation for , more than six years. The available statistics show that the Board, from March 1951 to March 1955, has spent over ! i i forty-seven million dinars on economic development. These j i expenditures, however, have not generated, as Table XV 11 • shows, any serious inflationary pressures. The table 11 Inflation is here used in its simplest sense. It describes the condition when total purchasing power sub stantially exceeds the total costs, at normal prices of the goods and services it seeks to buy, and does so with out bringing in new sources of supply to match the j increased demand. The meaning of inflation here, then, i excludes the increases in particular commodity and factor 1 prices. These relative increases in the prices of scarce factors are necessary for the proper reallocation of available resources. , TABLE XV THE IMPACT OF THE DEVELOPMENT BOARD EXPENDITURES ON THE PRICE LEVEL, SUPPLY OF MONEY AND FOREIGN TRADE . 1952-1955' . ' Year Actual expendi tures of the Development . Board* . ’000, I.D. Cost of living indices Wholesale prices indices Notes 6c Coins in circulation *000 I.D. Demand Deposits .’000 I.D. Imports '000 I.D. Exports *000 I.D. 1949 - 506.0 469.8 36.907 14.661 40.580 11.208 1952 3.131 546.1 498.2 30.033 14.883 61.845 18.771 1953 12.838 470.0 420.1 34.339 18.293 68.377 19.069 1954 12.257 484.7 431.5 40.456 21.792 72.766 17.976 1955 20.868 512.9 455.0 43.175 24.079 97.156 15.918 Source: Annual Reports of the Development Board, for the Financial Years 1952-1955; ; Annual Reports of the National.Bank of“Iraq, for the years 1951-1954; and Quarterly ! Bulletin of the~~CentraT~Bank of~Trag, January-March. 1956 (Baghdad: Thomas Printing ; Press, 1931o) . i ' • *As in March of each year. 397 displays that while the cost of living index was 546.1 in 1952, it declined to 470.0 in 1953. Although the index ! rose in 1954 and 1955, it was still below the level of 1952 when the Development Board had just begun the implimentation of some development projects. The same trend was experienced by the index of wholesale prices. As to the volume of notes and coins in circulation, as well as the volume of demand deposits, Table XV shows that it increased continuously in response to the increase in development expenditures. However, as the same table indicates, the increase in the volumes of currency and deposits was not large enough to exert a violent upward movement on the price level.. The fact that the increased development expendi tures did not lead, as some might expect, to inflation can be related to one or all of three factors. First, the available manpower, capital and natural resources were more than adequate in comparison to the level of development expenditures. The report of the International Bank for Reconstruction and Development in 1952, for example pointed out: . . . considerable unemployment exists in the cities of Baghdad, Basra and Mosul, and there are 398 many people underemployed who would welcome opportunities for full-time work.-^ This undoubtedly helped to expand the economy without driving wages up. Second, on the assumption that the relative prices of imported goods remained stable, the value of imports to Iraq was increased to offset any probable increase in, the domestic market, of the prices I I | j of imported goods. Table XV shows that imports to Iraq had increased from about sixty-two million dinars in 1952 to ninety-seven million dinars in 1955. Third, the volume of exports from Iraq was decreased to offset any possible increase in the prices of domestic goods. As Table XV demonstrates, Iraqi exports decreased from about nineteen million dinars in 1952 to little less than six teen million dinars in 1955. If these considerations are correct, future pos sibilities that development expenditures may become an inflationary potentiality should not be ruled out. First, as Table XIV indicates, the estimated amount of development expenditures for the next five years will be far higher 12lnternational Bank for Reconstruction and Development, The Economic Development of Iraq (Baltimore: The Johns Hopkins Press, 1952), p. 91. 399 than those already spent. As a matter of fact, while total combined development expenditures for the last four years, as mentioned before, amounted to only forty-seven million dinars, future estimated expenditures will exceed this for each of the next five years. These large expenditures, if not well planned, could impose a great general upward pressure on interest, wages and the prices of domestic, as well as imported, goods. Second, and most important, as the development program gets underway, most of the presently unemployed or underemployed resources will probably be more fully utilized. The development program could then face a shortage of available manpower, certain materials and know-how, which in turn could push up their prices. Third, as expenditures by the Develop ment Board rise, and as most of these expenditures will be spent in Iraq, more money will eventually be spent on imports of machinery, equipment and materials required for the development program. On the other hand, if imports by the public should be restricted, an increase in the domestic prices of imported goods would ensue. Fourth, the process of economic development originated by the Development Board will undoubtedly start a chain 400 of expansion on the part of the private sector of the economy. In addition to competing with the Development Board for the available resources, the economic expansion in the private sector, if not well directed, could lead to unnecessary extensive credit expansion which could bring about an inflationary pressure. Fifth, if the commercial banks should continue to finance mainly the import trade, and if the financial resources of the non- ! t commercial banks should continue to be limited, the credit cost for the development of private agricultural and j industrial projects may rise at a time when it is most ! | desirable to supply these projects with cheap credit. This point is loosely related to the problem of inflation; it is rather concerned with the problem of the misalloca- tion of credit facilities. Nevertheless, it is mentioned i here because of its bearing on the CBI*s objectives and techniques in the process of economic development. However, against the danger of inflation, Iraq, as Lord Salter stated, has two safeguards. nHer development resources come to her in foreign exchange and her balance lO of payments is positive.1 t [ l^salter, o p. cit.. p. 27. 401 III. PLACE OF THE CENTRAL BANK OF IRAQ IN THE DEVELOPMENT PROGRAM The CBI*s principal objectives, as stated by the law, are (1) to maintain the stability of money, and (2) to influence credit movements in the public interest.^ I Owing to the fact that a central bank does not operate in a vacuum, and due to Iraq's present endeavor to develop its economic conditions, the above objectives should be directed toward the achievement of a "balanced development with stability." In other words, they should be so arranged as to facilitate the development of agri culture and industry as well as commerce, throughout the country and without running the risk of inflation or con- i traction. In order to fulfill these objectives, the CBI should strive first to supply currency in quantity ade quate for the carrying out of the process of economic development without the danger of inflation or contraction. Second, the CBI should endeavor to channel credit facilities into projects most essential for promoting ^Al-Waqayi'a Al-Iraqiya, No. 3818 of July 1956, Law of the Central Bank of Iraq No. 72 of 1956 (Baghdad: The Government Press, 1956), Article IV. the growth of real incomes. The Supply of Adequate Currency The experience of the years 1952-1955, as noted before, showed that spending on economic development was accompanied by an increase in the demand for and the i supply of notes and coins. This experience was consistent with the fundamental principles of economics, particularly in economies like Iraq, where the use of checks as a means of payments is limited. In the future, the demand for currency for the purposes of transactions, liquidity and speculation, is expected to increase more than ever. i The CBI should then stand ready to satisfy all legitimate demands, yet endeavor to eliminate the unnecessary j demands. The process of the increase in the demand for notes and coins will take the following patterns. Should the original initiator of the expansion be the Development Board, the Board, as noted, will receive the oil royalties in sterling and sell it to the CBI against dinars to be spent in Iraq. If a foreign company should start an investment project it will sell foreign exchange to the CBI and also receive the dinars necessary for the execution of the investment. If the commercial 403 banks decide to expand their activities in Iraq by trans ferring some of their investment abroad to the Iraqi market, they will also sell sterling to the CBI against dinars. In each of these three cases, under the present arrangement of the monetary system, the CBI, as shown before, will play a passive role in increasing the supply of currency. With a fixed rate of exchange the CBI will i not be able to refuse buying any quantity of foreign 1 exchange that is offered.^ Notwithstanding, it is possible that economic expansion in Iraq will lead to the extension of the money economy into areas presently dominated by a household and barter economy. This should result in an increase in the i demand for currency. As a consequence of economic expan- i sion it is expected that some people will speculate in regard to the future movement of prices of different j groups of assets. This could lead such persons to hold large amounts of currency for speculative purposes. In * | /• both of these cases, as will be shown later, the CBI I •^Cf. ante, pp. 251-258. j _ 1 1 } 16Cf. post., pp. 422-427. j 404 could influence, to some extent, the supply of and the demand for currency through the application of selective instruments of monetary control. ) ! j Against these elements contributing to the increase ! in the demand for currency, there is the distinct pos sibility that many people will become accustomed to the t use of checks as a means of payment instead of currency. There is also the probability that the process of dis hoarding, which has already started, will continue for the next few years. Both of these developments will undoubtedly reduce the quantity of currency required to carry on the planned economic expansion. Channeling Credit Facilities It was shown in Chapter III that, first, the com mercial banks in Iraq are restricting their activities mainly to the finance of trade. Second, the noncommercial banks are unable to supply agriculture, industry and real estate mortgage activities with the required funds. Third, the commercial, as well as the noncommercial banks, are concentrating their functioning in the principal cities which is leaving the rest of the country without the necessary credit facilities. 405 As a result of the economic expansion that Iraq is undergoing, it is expected that more credit facilities will be required in fields outside that of trade. When the waves of development reach regions other than the i i !principal cities, it seems certain that loanable funds 1 j will also be needed to supplement and further the invest ments extended by the Development Board. It is possible i that on occasion such credit expansion will be inflationaryj The task of the CBI in this respect, therefore, should be to counteract inflationary tendencies which could originate in the excessive expansion of credit to certain sectors of j i ! the economy. This might be accomplished by (1) directing ; credit into more ‘’ productive’* activities such as industry and agriculture, instead of into speculative or ’’ commercial” t 1 activities, such as the import trade and the holding of I commodity stocks; and (2) by facilitating and helping in the establishment of new branches for both the commercial j and noncommercial banks. The limitation of these instruments to be applied by the CBI in order to achieve these objectives, as well j i as the prerequisites for increasing their efficiency, are I I factors to be analyzed in the remainder of this chapter. 406 IV. GENERAL INSTRUMENTS OF CREDIT Generally speaking, when central banks were being established or re-chartered in certain countries after 1920, emphasis was placed on the power of the central bank | to fix the rediscount rate. Second, importance was attached to the power to buy and sell securities in the open market. This power allows central banks to engage > in open market operations whereby the bank rate policy might be enforced.^ Some time later, a new power was I Igiven to central banks, namely, the variation of legal ! I j 1 reserve requirements. These three powers are usually ; I called "the general instruments of credit control." i However, many countries, and particularly the under- t developed countries, have found it desirable to supplement I the general instruments of credit control with selective ones. The latter are designed to encourage or discourage particular types of bank credit and thus influence the allocation of resources in desired directions. In fact, the monetary authorities in some underdeveloped countries have often been concerned more with selective than with 17 R. S. Sayers, Central Banking in Underdeveloped Countries (Cairo: National Bank of Egypt, 1956), p. 5. 407 general credit controls, especially as long as the finan cial and economic structure of their countries offered little leverage of the effective application of general i |credit measures. The CBI, as shown in the previous chapter, possesses i |the power to change minimum reserve requirements and to i l alter the rediscount rate. In addition, the bank has the i 9 j authority to conduct open market operations and to use I I some selective measures to influence credit movements. jPrinciples of the General Instruments of Credit Control I The fundamental feature of the general instruments j of credit control*- ^ is the effect they have on total com- imercial bank reserves or, in the case of changes in reserve ■^"Central Banking in Asia,” op. cit., p. 131. IQ j These instruments are sometimes called the "indi- | rect," the 1 1 traditional,1' or the "conventional" techniques of credit control. They include, as mentioned before, the rediscount rate, open market operations and minimum legal reserve variations. Rediscount rate means the rate of interest charged by the central bank when, by rediscounting] bills or by making advances, it puts cash reserves at the ■ disposal of commercial banks or7other financial institutions! Open market operations are defined as the purchase or sale of securities by the central bank. Minimum legal reserve variations are the changes by the central bank in the minimum ratios of cash reserves to be held against | deposits. George N. Halm, Monetary Theory (Philadelphia: j The Blakiston Company, 1948), pp. 49-62. I 408 requirements, on the part of the total which is in excess of legal requirements. The discount rate represents the price at which the CBI stands ready to sell or lend reserves to the commercial banks in exchange for eligible paper or for a bank*s promissory note backed by satis factory collateral. A change in the discount rate means, in simplest terms, that the CBI has raised or lowered the price at which it is prepared to sell or to lend. This price change is designed (like changes in any other price) to restrict or stimulate the demand for loanable funds. The significance of open market operations is not j the purchase or sale of securities by the CBI, but the sale or purchase of reserves which is thereby accomplished. 1 Securities are the medium for the purchase or sale of com- 1 j ,mercial bank reserves by the CBI. In summary, the general instruments of credit con- j trol are designed to influence the volume of credit by altering the amount of reserves which commercial banks i are free to use for expanding deposit credit. They are i I general in that they focus not on bank credit itself, but j on the commercial bank reserves on which bank credit is : i based. They rest on the underlying assumption that the volume of bank credit will bear a relationship to the_____ quantity of commercial bank reserves. They attempt to control the volume of bank credit by controlling the volume of bank reserves.^ When the commercial banks, t therefore, possess large excess reserves whether in the CBI or in their vaults, or are in a position to acquire such reserves quickly through liquidating part of their i !investments abroad the impact of these general instruments on the quantity of money will be limited. | On the other hand, monetary policies are made effective "through changes in the amount, availability and cost of loanable funds in the money and capital 2i markets." Consequently, the effective application of the general instruments rests further on the assumption that there are well developed money and capital markets. i The importance of a money market is due not only to a supply of short-term funds, but also to a demand for these ' funds. The money market usually deals in (a) commercial ^Charles Whittlesey, Principles and Practices of Money and Banking (New York: The Macmillan Company, 1948), pp. 256-58. 21 Charles L. Prather, Money and Banking (seventh I edition; Homewood, Illinois: Richard D. Irwin, Inc., 1957), p. 329. 410 bills, which are composed primarily of bankers' accept ances; (b) commercial papers; (c) call loans which arise i .... . from financing the purchase and sale of new securities, ias well as financing the trade in outstanding stocks, bonds and other long term obligations; and (d) short term ! government securities. The capital market, on the other j i hand, is related to the supply and demand for intermediate : i and long term funds. Application of the General Instruments of Credit Control by the Central Bank of Iraq The CBI, as indicated in Chapters VIII and XI, possesses the legal authority to resort to all of the j general instruments of credit control in the pursuit of | i i its objectives. However, due to various reasons, the I Bank up to 1956 was unable to apply these instruments. j These reasons were (and still are): (1) the existing i relation between the Iraqi dinar and the pound sterling; | (2) the high liquidity position of the commercial banks, including the possession of excess reserves; (3) in case of need for cash, the resort of foreign banks to their i head offices instead of the CBI; and (4) the absence of ! well developed money and capital markets. I _ 411 It follows from the above that the CBI through the application of the general instruments would not be i capable of assisting effectively in the process of economic development as long as these obstacles exist. Although, as a result of economic development, some of \ these obstacles may disappear by themselves, deliberate i action on the part of the CBI in that direction is ! i desirable. This deliberate action could bring about the j removal of the obstacles in a more positive manner, as well as in a shorter time. This should not mean, however, that, while waiting i for the obstacles to be removed, the CBI would not effec- | tively participate in the process of economic development. On the contrary, the Bank should first employ what it has ( in the form of selective instruments of credit control. ; I Second, the Bank should be authorized to use some new iinstruments and techniques which are vital for the fulfill ment of the Bank*s objectives. In the words of Professor Sayers, . . . the new central bank [like the CBI] should j . . . avoid a completely passive attitude, waiting < for opportunity to wield the conventional weapons. The central bank must be venturesome in the kind of business it is willing to handle, even at j the cost of making some mistakes. It must be i 412 not only central but also, and very actively, .a bank. [Underlining is not in the original.]22 The ways and means through which the CBI could remove the present obstacles to an effective monetary policy are discussed in the next few pages. This discussion is followed by first, listing some of the selective instru ments of credit control already possessed by the CBI. i Second, an analysis of some new instruments to be added to | ! the powers of the CBI. | ! i Adapting the General Instruments of Credit Control It was concluded above that the CBI will not be I l able to adopt the general instruments of credit control j I unless it removes the obstacles hindering their applicationJ Following is a brief description of how these obstacles , could be removed. I Relation with sterling. The future relation of Iraq with the sterling area in general and with the pound sterling in particular has been discussed in detail in Chapter IX. It was concluded that it would be advisable 00 & Sayers, Central Banking in Underdeveloped Countries, o p. cit., p. 7. 413 for Iraq to take necessary preparatory steps for leaving ! the sterling area at some future time;23 the sooner the ( better. I i I Liquidity of commercial banks. The commercial jbanks* possession of highly liquid assets, and especially J cash assets, is one of the major obstdcles to an effective monetary policy. j Although cash reserve requirements against deposits were only 10 per cent, the commercial banks for the years 1951-1955 maintained an average cash reserve of 28 per O A * cent. ^ This left the banks with average excess reserves j j of 18 per cent in addition to an average 40 per cent kept in their vaults or with other banks in Iraq. Should the !commercial banks desire to expand credit, therefore, they I I lean do so even if the CBI*s policies are directed toward j the contraction or prevention of credit expansion. This is true particularly, if it becomes generally known that i * Cf. ante,pp. 305-310. ^Quarterly Bulletin of the National Bank of Iraq, January-March 1954 (Baghdad: Thomas Printing Press, 1954), p. 12 and Quarterly Bulletin of the Central Bank of Iraq, | January-March 1956 (Baghdad: Thomas Printing Press, 1956), p. 13. 414 under the present legislation the CBI can not raise the cash reserve requirements above 10 per cent.^5 I In order to make the general instruments of credit I { j control more effective, it is necessary, therefore, to amend the present statute so as to authorize the CBI to increase the minimum legal cash reserve requirements to at l least 30 per cent of total deposits.In this way, the CBI will be able, if necessary, to eliminate the excess reserves of commercial banks by "a stroke of the pen.1 5 Commercial banks borrowing from abroad. The ability of foreign commercial banks to borrow from their head offices in London can have the same effect in nulli fying the CBI's policies, as that of possessing excess i f j reserves. This ability of borrowing abroad is largely I facilitated by present monetary arrangements where the commercial banks can, without difficulty, exchange borrowed Al-Waqayi’a Al-Iraqiya, No. 2833 of May 20, 1950, Law for the Control of Banking, No. 34 of 1950 (Baghdad: i The Government Press, 1950), Article IX, Section (1). ^In Colombia, for example, the cash reserve require ments against demand deposits may be varied between 10 and 30 per cent, and in Cuba between 12 1/2 and 40 per cent. 1 ’’ Monetary Policy in Latin America,” oj>. cit., p. 52. i | 415 i I j sterling into Iraqi dinars. The solution of this problem, Jtherefore, is partly related to the question of Iraq's j relation with the sterling area. Yet, the importance of this obstacle could be j ! , i I eliminated through the CBl's encouragement of establishing 97 new domestic commercial banks. 7 The comparative share of foreign commercial banks in banking operations, in this way, would be reduced and thereby decrease their impact on monetary policy. A further possibility, which falls under the selec tive instruments of credit control, is to authorize the CBI, in particular cases, to fix a ceiling on the amounts | ! (or ratios) of foreign borrowing. This is, undoubtedly, a rather drastic measure, hence it should only be employed !when all other means of credit control are exhausted. ! The a b s e n c e of advanced money and capital markets. The money market in Iraq consists of commercial banks, sarrafs (individual money exchanges), private money lenders and usurers. While the first two segments are controlled I I l ___________________ i ! "^Carl Iverson, A Report on Monetary Policy in Iraq ! (Baghdad: The National Bank of Iraq, 1954), p. 193. 416 by the CBI, the last two are uncontrolled. The capital market, on the other hand consists mainly of the state- owned noncommercial banks. There is no doubt that the existence of well i 'developed money and capital markets is of great importance for carrying out the objectives of monetary policy. In i addition, these markets could help to equalize the rates of interest for different kinds of loans; to increase the volume of real investments; and to distribute these investments between the various trade and geographical areas.. The question of developing the money as well as the capital markets requires, not only the efforts of the CBI, i ,but also the commercial banks, the noncommercial banks, i I | ! the Development Board and the government. This development,! i ! furthermore, can not be achieved over night; it may J require many years before its accomplishment. However, a starting point in this direction has to be made and at i i i ;once. I j To begin with, it would not be necessary to set up j a stock exchange as a separate institution. All that is ! t needed, in this respect, is that the CBI could announce | 417 to the public and the other banks that it is prepared to act as an intermediary between buyers and sellers of bonds and shares. The Bank also could begin to publish daily, bi-weekly or weekly lists of (1) bond and share prices at which transactions have actually been carried out, and (2) the prices of particular bonds and shares which the i Bank has offers to sell or orders to buy. In this way the public would be constantly informed about the market j situation and,thereby, the height of the "effective rate of interest." The second requirement would be to provide a suf- | I ; ficiently large number and variety of securities, as well J ! as to create the necessary familiarity and confidence in i ; holding savings in the form of securities. Although the I | matter of confidence is mainly a problem of education and | ! propaganda, the task could be facilitated if care is taken to create such types of securities which are likely to make the greatest appeal to the prospective buyers. { Lottery loans, for example, may prove to be attractive in , the beginning. 28Ibid., p. 206. 418 It is the CBI which should take the initiative in developing the money and capital markets. Nevertheless, in this respect, the support of the commercial banks is essential for the success of this development. They should acquire the habit of holding a larger part of their assets than at present in the form of securities. They should, i i further, assist in developing regular trading in such securities either through the CBI or if preferred, directly over their counters. If they choose the latter case, they should report the prices immediately to the CBI in order ito be included in the above mentioned lists. Gradually, !commercial banks might also float bond issues or assist in j I the formation of joint stock companies. j i In developing the money and capital markets the I I r ;role played by the state-owned noncommercial banks, the 1 Development Board and the Government could be, mainly, to • i supply the rising capital market with securities through borrowing from the public. Noncommercial banks, at ! present, for example, borrow directly from either the j CBI or the Development Board. J 419 V. SELECTIVE INSTRUMENTS OF CREDIT CONTROL As a result of the existing limitations on the adaptation of the general instruments of credit control in Iraq, or in any developing economy, it is necessary i I that credit policy be selective. Monetary management j should not aim merely at a general restraining or spur J i to economic activity; it should also try to influence different economic activities in different ways. A number of devices have to be adopted to provide specific encour agement to certain types of investment and expenditure. Principles of Selective Credit Control 1 Selective credit controls are intended to encourage ior discourage specific types of investment and expenditure I i i iby influencing the lending policy of banks. One of the j i basic problems in an underdeveloped country is to insure that the funds available for investment are directed into socially desirable channels.^ The direction of invest ments toward this end cannot be left for determination by 2^John h . Adler, "The Fiscal and Monetary Implica- I tion of Development Programs," American Economic Review, 1 Papers and Proceedings, XIII:595, May, 1952. 420 the free,operation of the market. There is an institution al bias in underdeveloped countries in favor of investment in trade and construction, to the detriment of more pro- jductive alternatives available in industry and agriculture. ! ! The traditional regard for short-term "self-liquidating” loans on the part of the banks encourage purely commercial activities as distinguished from production. In the absence of adequate facilities for medium-term or long | term credit, some of the existing opportunities for increasing production are wasted. Consequently, a policy of selective credit control may be adopted as an adjunct j i to a well-balanced development program. | j Selective credit control may also be necessary to protect the interests of certain poorly organized sectors I of the economy whose credit needs are not satisfied by I ; existing institutions. A good example concerning the use of selective credit controls in this respect is given by Mr. Patel, an expert in the field of economic development. He stated, . . . attempts to develop an economy are often accompanied by egalitarian measures, such as the j | division of large estates among small peasant 1 proprietors, and such measures often create new | 421 ill-organized areas with special credit needs. ^ Selective credit control, furthermore, may be adopted during a period of active inflation. It is now . generally recognized that inflation creates a large drain i on the reserve of foreign currencies and encourages too much unproductive investment in inventories, luxury con structions and the like. The introduction of selective credit controls may serve to minimize these adverse consequences of inflation. It is not necessary to discuss here the limitations and success potentialities of selective credit control. i It should be noted, nevertheless, that selective credit control has proved highly successful in many Asian and 31 ! Latin American countries. i | E ! | j Adaptation of Selective Credit Control by the Central , Bank of Iraq j The CBI, as shown in the previous chapter already j i i i ■ 30i. g . Patel, "Selective Credit Controls in Under- j jdeveloped Economics," Staff Paper of the International j | Monetary Fund, IV:74, September, 1954. , ^"Central Banking in Asia," op. cit., p. 133 and "Monetary Policy in Latin America," op. cit., p. 54. t 422 has some of the selective instruments of credit control. There is no evidence, however, that the Bank up to 1956, has used any of them to an effective extent. It is true that some time has to elapse before a new central bank can apply an effective credit policy. Nevertheless, an attempt on the part of the bank in that direction has to i be made sooner or later. The CBI is urged, therefore, to use at once the instruments it already possesses in the pursuing of its objectives. Because the present instruments possessed by the CBI have already been discussed in the previous chapter,32 they will only be listed here. In addition to these instruments, it is felt that new ones should be adopted | by the CBI. The nature and importance of these new 1 i i instruments are discussed below. I Existing instruments of selective credit control. The Law for the Control of Banking of 1950 authorizes the CBI to use the following instruments of selective credit control. 1. Put a limit on loans to any one customer. 32cf. ante, pp. 365-370. 2. Vary the ratio of deposits that must be kept in Iraq between 30 and 70 per cent. 3. Require a legal reserve of government securities against deposits. The CBI can vary this reserve between 5 and 3 per cent of deposits. 4. Fix a ceiling on the amount of total deposits that can be accepted by any single commercial bank. The present law prohibits the banks from accepting deposits exceeding an amount sixteen times their paid-up capital and surplus. ! I 5. Prohibit commercial banks from investing part j of their assets in certain fields like real i | estate and commodities. | 1 I With proper modification and cautious application, f j it is believed that these instruments can prove very suc- ! cessful in channeling credit to some desired fields and in halting a mild inflation. i Suggested instruments of selective credit control, i i ; I 1 £ !It would be infeasible to include here all the types of selective instruments of credit control applicable to j i each possible change in Iraq's economic conditions. The following instruments of selective credit control, there- _ - 42' 4 fore, are suggested here as examples. It is hoped that they will be used as temporary correctives during a deter mined effort at stabilization or as long-term devices to i aid the process of well-balanced development. Despite the fact that the government has established specialized institutions to meet the special needs of agriculture, industry and housing construction, the credit i needs of these segments of the economy have not yet been \ l met adequately. It is suggested here, therefore, that j the value of certain types of agricultural, industrial and j real estate mortgage papers should be deducted before cal culating the required cash reserves against deposits. j i i Alternatively, the commercial banks could be required to ! I hold a minimum percentage of their deposits in the form ! i of these papers. In order to compromise between compulsion I | and encouragement, the CBI should be authorized to redis- ■ I I icount noncommercial papers with a maturity of not j ’ i I exceeding, say, one year. : The suggestions under consideration would have the I great advantage of making loanable funds plentiful to agriculture, industry and real estate mortgage. They, further, would have the advantage of developing the money, 425 as well as the capital, market. They would increase the cooperation between commercial banks, noncommercial banks and the CBI.33 * Owing to their inflationary potentialities, the suggestions under consideration should not be introduced J in a period of extensive expansion and when introduced should be preceded by careful study. From the long range i I point of view, however, these suggestions could be effec- J i tive guards against inflation, because they would help to increase the supply of domestic goods and thus minimize ithe danger of inflation. | i During a period of expansion, the import of many luxuries from the sterling area^ is liable to increase j jwith the consequence of exhausting much of Iraq's sterling i ! reserves. The CBI, therefore, should be authorized to O O f Fawzi A. El-Kaissi, "An Analysis of Iraqi Govern- 1 ment Institutions for Agricultural, Industrial and ! Mortgage Banking" (unpublished Master's thesis, The Univer sity of Southern California, Los Angeles, 1954), pp. 94-95. I *^The import of luxuries from other areas is excluded here because they are already subject to quotas and other limitations. Cf. ante, pp. 333-334. 426 require prior deposit for the import of these luxuries. According to this proposal, the importer would be required to deposit with the CBI at the time of his application for an import license, a part of the Iraqi currency equivalent of his imports. The importance of a prior deposit require ment would be to create an artificial need for credit on the part of the importer. The importer may be able to i borrow the sum required from a bank; but insofar as the deposit is transferred to the CBI, there would be an equal decline in the reserves of the banking system. 35 In order to increase the effectiveness of the CBI in combating inflation, Professor Iverson suggested the introduction of the principle of . . . interest payment on deposits with the National Bank [CBI]--especially on deposits exceeding the legal minimum. By raising this rate of interest the Bank— when deemed necessary-- might induce the private banks to increase their lending activities (or prevent them from expanding).36 It should be noticed, however, that this suggestion j I would not be effective unless it is assumed that the 1 35patel, oj>. cit., p. 81. 36Iverson, op. cit., p. 193. 427 commercial banks have no ability to multiple credit expansion. In Iraq where the legal reserve requirement is 15 per cent (10 per cent cash and 5 per cent government securities), the banks could expand credit about seven ! times as much as the amount of excess of free deposits that they receive. Therefore, all banks would be better off by expanding credit than by depositing part of their assets with the CBI. In summary, it is the duty of the CBI to watch closely and diagnose the appearance of any undesirable developments during the process of expansion. The Bank, then, has to decide upon the techniques to be used and their degree of influence in halting the further growth of such undesirable developments. | VI. COORDINATION OF MONETARY AND FISCAL POLICIES The previous discussion has purposely disregarded one aspect of monetary policy, namely, the coordination of that policy with fiscal policy. The main reason for this omission was the fact that Iraq, unlike some other countries, has not yet experienced a serious conflict between the two policies., Owing, however, to the absence 428 of guarantees that such a conflict may not occur in the future, below is a brief description of two suggested approaches to the fulfillment of coordination. t Professor Iverson suggested that the Governor General of the CBI should be appointed as an ex officio member of the Development Board.37 The defect of this suggested approach, as Lord Salter rightfully states, is that the Governor . . . would in that capacity be liable to be both outvoted and yet, by his membership, compromised in the action he might otherwise take. ® The present writer thinks that a modest start in the direction of coordination would be to set up a com mittee composed of three members. One member would repre- ,sent the CBI, the second would represent the Development I Board and the third would represent the Treasury. ’’The Committee for Economic Policy,” as it might be called, would convene once a month or as frequently as necessary. Its task would be to review the economic conditions of i the country and to recommend to the concerned agencies 37Ibid.3 pp. 112 and 242. 38Salter, o£. cit., p. 28. 429 the type of different policies suitable for these condi tions. The recommendations of the Committee would have no power of enforcement on any of the represented institu tions . It is believed that this proposal would achieve more effective coordination than the mere representation of the Governor of the CBI in the Development Board. i VII. CONCLUSION | Like other active institutions, a central bank in the pursuance of its objectives should adapt its techniques to its own environment. For the purpose of monetary i policy, the bank should not rigidly and necessarily j i identify itself with a set of instruments already proved i ; successful in other countries. The bank has to devise I its own instruments and techniques. I I I i The CBI, if it adopts the above approach, could have a much greater potential role in economic development. j The Development Board, up to 1955, has spent over forty- seven million dinars. The estimated expenditures, up to 1960, on the other hand, will be five hundred million dinars. These expenditures could impose on the CBI at least two major tasks. First, to supply enough currency. 430 Second, to channel credit into the most socially desirable types of investment. The objective of the CBI in both tasks should be to achieve a “well-balanced development with stability.” Owing to the obstacles discussed above the CBI will not be able to use the general instruments of credit i control. Some action has to be taken to remove these obstacles. While waiting for the obstacles to be removed, | the CBI should rely heavily on the use of selective instruments already authorized by the present statutes. Moreover, the Bank should be empowered to use some addi tional instruments to supplement the existing ones. ! i i In order to prevent any possibility of a conflict | between monetary and fiscal policies, some measure of coordination seems to be necessary. It is advisable to i I organize a committee charged with this function and composed of a representative from the CBI, the Development Board and the Treasury. CHAPTER XIII j SUMMARY AND CONCLUSIONS I The essential aims of this dissertation were, first, to determine the underlying problems which have prevented the Central Bank of Iraq from pursuing its objectives effectively and secondly, to find the possible solutions to these problems. This appraisal necessitated the study of the Bank's establishment, administration and functions. To appreciate the Bank's significance and to understand its problems, however, it was further necessary to study its economic background and environments, par- I ticularly the existing economic conditions, the character- ! istics of the banking system, as well as the development of the monetary system prior to the establishment of the Bank. The principal conclusion reached is that, despite the possession of all the techniques of a central bank, the CBI, for all practical purposes, has been and is a mere currency exchange institution. The purpose of this chapter is to summarize and to bring together the most important facts, conclusions and findings contained in 432 the previous chapters. Due to the predominant place in this dissertation occupied by the question of Iraq's relations with the sterling area, it will also be given equal importance in this concluding chapter. I. PROBLEMS CONFRONTING THE CENTRAL BANK OF IRAQ I The CBI was established in 1947 and commenced business in July 1949. The management of the Bank is entrusted to a Board of Administration composed of the Governor General, Assistant Governor General and seven members. The Board is assisted in matters relating to general monetary policy by an Advisory Board. The Advisory Board consists of the Governor General, as jChairman, and representative of each of the commercial i I ; !banks. Like the Bank of England, the CBI is divided into i t two departments; the Issue Department and the Banking Department. The Bank is charged with the objectives of manage- I ment of the currency to assure its stability and the redirecting of credit in the public interest. In order to attain its objectives, the Bank is authorized to under-' take the functions usually performed by central banks. 433 The more important of these functions are: note issue, control of foreign exchange and control of commercial banks. For the purpose of attaining its objectives and performing these functions, the Bank is empowered to apply the traditional instruments of credit control, i.e., changing its rediscount rate, conducting open market opera tions and varying the minimum legal cash reserve require- ! ments. In addition, the Bank is authorized to use some selective instruments of credit control such as: (a) limiting the amount of credit to be granted by commercial banks to any one customer; (b) changing the ratio of the j i commercial banks assets to be invested abroad; and (c) j varying the ratio of assets to be invested in Iraqi |Government securities. * i I | i Prior to 1949 when the CBI assumed authority for | l t the note issue, the function of issuing notes was performedl I by a Currency Board which resided in London. After 1931, j i the Board exercised this function with the understanding j that it should cease operation when an Iraqi central bank would be established. The Board was composed of two representatives of the Iraqi Government, one representative of the Bank of England, and two representatives of the 434 commercial banks operating in Iraq. The basic features of the Iraqi currency under the Board were: (1) The "dinar” was the monetary unit. (2) The exchange value of the dinar was fixed at one pound sterling. (3) The monetary t t reserve was composed of 100 per cent or more of sterling securities kept in London. The Board was required to exchange, at the fixed rate of exchange, any amounts of sterling supplied for Iraqi currency and vice versa. This placed Iraq on sterling exchange standard. The Currency Board, therefore, was merely a currency exchange institu tion in a restricted sense; it had no banking functions j f ; I and exercised no control over the volume of money in j circulation. The above monetary system was criticised J i for various reasons: (1) The dinar’s rate of exchange I 1 i with currencies other than sterling was determined by the i status of the latter in the international market rather 1 than by Iraq’s economic conditions. This caused the exchange rate of the dinar to fluctuate with sterling, i (2) The Currency Board variant of the sterling exchange j i standard entailed the absence of any monetary authority capable of influencing the money supply in accordance with the country’s monetary needs. (3) Since the Currency 435 Board acquired assets only passively and was unable to engage in credit operations, the system lacked a local source of liquidity. (4) There was no effective authority concerned with the operations and development of monetary and financial institutions. (5) The investment of the ' ! whole monetary reserve in sterling securities deposited j I f I in London constituted a continuous threat to Iraq’s i political independence. Great Britain was in a position j to freeze Iraq’s sterling assets in case the latter chose i . Jto adopt a position contrary to British interest. In addition, in case Britain was faced with economic diffi- I I culties, it was able to block Iraq's entire sterling mone- ; tary reserve. Most of these defects manifested themselves I clearly during the Second World War. First, during that j i period Iraq witnessed severe inflation, resulting mainly from the method of financing Britain's war expenditures in Iraq. Second, due to economic difficulties during and after the war, Britain blocked Iraqi sterling assets, including most of the monetary reserve. Third, following j Britain and other members of the sterling area, Iraq j imposed foreign exchange control, not in accordance with> ' l its economic requirements, but in accordance with the 436 British war needs. In 1949, when the CBI assumed authority of note issue, the expectation was that this institution would { remove most of the defects of the previous monetary system. I i For all practical purposes, however, the bank proved to be unable to do so. This is mainly due to the incorpora tion in the present monetary system of most, if not all, ! I of the features of the Currency Board, particularly the j | continuation of the relation with the sterling area. It is true that the Bank holds a portion of its monetary j ,reserve in the form of gold, American dollars and Iraqi ! !Government securities, but these holdings are so meager that their effect on the supply of money is negligible. j jit is believed that as long as Iraq remains in the sterling i ' :area the CBI will not be able to effectively maintain the I stability of the currency. j In 1950, the function of foreign exchange control was transferred from the Exchange Control Committee to the CBI. Before and after the transfer, the scope and ! features of foreign exchange control remained practically the same. The only changes made were those warranted by favorable or unfavorable changes in the status of the 437 \ sterling area reserve of gold and foreign currencies. As it stands today, the Iraqi system of exchange control is modeled after the United Kingdom, modified to some extent to suit local requirements. It is based on the principle ! jof surrender of foreign exchange.receipts and the alloca- j tion of these receipts by the CBI to payments for goods, | I | j services and other transactions on the basis of priority j of need and the "hardness1 1 of the currency involved. The * I hardness of a currency is judged by its abundance or scarcity in the sterling area's reserves of foreign cur rencies which is called the "dollar pool." Imports from hard currency countries are restricted on the basis of ! annual quotas, while imports from soft currency countries j are, with some exceptions, freely permitted. Imports i from the sterling area are allowed with no restrictions. i The CBI is required to surrender Iraq's receipts of foreign! currencies to the "dollar pool" of the sterling area j i against the privilege of withdrawing on the pool as i needed. In practice, however, Iraq has to restrict its withdrawals in accordance with the scarcity of a currency in the dollar pool. It is evident, then, that, owing to j Iraq's relation with the sterling area, the CBI was and 438 is restricted in pursuing an independent policy of exchange control. Its policies in that respect are dominated by the economic conditions of the sterling area, instead of Iraq's economic needs. j | Since 1950, the CBI has been performing the function! of control and supervision of the commercial banks. Any institution accepting deposits from the public, withdraw able by check or otherwise, is subject to banking control. Today, the institutions subject to control are composed ! I | of nine commercial banks and fifteen sarrafs (individual | i I money lenders and exchangers). Of the nine commercial | j banks, four are branches of British banks, and two are ; 1 i branches of Arabian banks. Before it commences business | i , or opens a new branch, a commercial bank is required to i 1 i obtain a license from the CBI. A bank has to have a i stipulated amount of minimum capital before it is granted j I a license. A bank, furthermore, is restricted in regard | to the assets it can hold against deposits and the type i I of activities it can undertake. In addition to the sub mission of periodical financial statements and reports to the CBI, a commercial bank is subject to a periodical i i inspection by the CBI. On matters related to the control _of _the_general_credit_ _palicy_of_thec ommerc ial, banks , _____ i j 439 the CBI is authorized to apply the traditional, as well as some of the selective, instruments of credit control. ! So far, however, the CBI has been unsuccessful in the effective use of these instruments. This is mainly I because of, first, the high liquidity of commercial banks, 1 which is also the predominant characteristic of British j j j !banking practice. Second, in case of a temporary need for j | cash, branches of the British banks (which have the largest! share in the banking business in Iraq) usually resort to their head offices in London instead of borrowing from the CBI. This practice is facilitated by the existence j j of a fixed rate of exchange between sterling and the i i dinar enabling the British banks to exchange freely to | ' dinars any desired quantity of sterling. Third, the j fact that the capital and monetary markets in Iraq are > not yet quite developed. j It is clear, then, that in the final analysis, the ! i major problem which hinders the effective functioning of j the CBI is Iraq*s relation with the sterling area. It is the only problem which presents itself as a handicap to every principal function of the CBI. 440 II. THE FUTURE OF THE CENTRAL BANK OF IRAQ Iraq is virtually an underdeveloped country. The country's agricultural and industrial output and produc tivity are quite low. The annual per capita income was ! estimated in 1949 to be eighty-five dollars. Over 88 per i cent of the population is illiterate and many are subject i to debilitating diseases. Like many other underdeveloped countries, Iraq imports most of its needs for manufactured goods from abroad, while it exports mainly primary goods, particularly crude oil. If oil exports are excluded, there is always a deficit in Iraq's balance of payments. This deficit, however, is covered by the royalties received from the oil companies. At the end of the Second World War, Iraq took some t I measures toward development of its economic resources, in l ■ » order to raise the standard of living of its people. Among the measures taken was the establishment of state- owned specialized institutions to extend credit to agri culture, industry and housing construction. Due to their limited financial resources, these institutions contributed little to the economic development in their own fields. In addition, they restricted most of their operations 441 to the capital city of Baghdad and a few other big cities. The most ambiguous measure toward economic develop ment of Iraq, however, was taken in 1950. With the expectation of highly increased income from the ratifica tion, in that year, of the oil concession agreements, the Iraqi Government established the Development Board. The Board is charged with the task of preparing a general I jdevelopment plan that improves the utilization of Iraq's i resources and raises the standard of living of the people. In order to finance the plan, the Board is endowed with 70 per cent of the oil royalties. At the present time, j J the Board is executing a six year development plan, 1955- j ! 1960, which calls for total estimated expenditures of five hundred million dinars. So far, the expenditures I i , of the Board have not yet produced the anticipated hard- j ships on the Iraqi economy in general, and on the monetary aspect in particular. This is mainly due to three factors.j First, actual developmental expenditures of the Board in j the initial stages were far below their estimated level. Second, prior to the execution of the development plan, the factors of production and particularly, labor, were i r substantially unemployed and underemployed. Third, most 442 of the increase in the personal disposable income has been spent on importing consumer goods from abroad. As a I result, the supply of such goods in the Iraqi market has tended to equal the demand, thereby preventing what would j J otherwise have been a rise in prices in Iraq. In the i I : j future, however, it is expected that these conditions will ! i jnot remain constant. As the development plan is more extensively executed, the development expenditures will appreciably increase, the unemployed or underemployed resources will be more fully utilized and the importation i j of goods from abroad will not be allowed to increase j indefinitely. The above expected consequences mean that 1 the CBI*s assistance in the process of economic develop- j i ' ment will be needed more than ever. Without the effective i functioning of the CBI, the fulfillment of a "well-balanced economic development with stability," will be unattainable.! i The CBI will be called upon to achieve at least two impor tant tasks: The first will be to supply currency in a ! quantity adequate for the carrying out of the plans of economic development without the danger of inflation or contraction. The second will be to channel credit facili ties into projects most essential for promoting the growth 443 of real income. Owing, however, to the presence of the above men- i jtioned obstacles, the CBI will not be able to carry out j [these tasks effectively. Therefore, the'"duty of the CBI, i | ! I in cooperation with other governmental agencies, should ! I be to take the necessary positive steps toward the removal j i of these obstacles. , As the removal of most of these obstacles will require time, the Bank should be authorized j i immediately to apply some new ways and means of monetary control. I I jSummary of Recommendations ■ 1 In the text of this study, the writer made numerous reflections and recommendations related to the administra- jtive and functional aspects of the CBI. Below is a summaryj *of the more important considerations. j i i I Relinquishing the sterling area. Iraq should, as j soon as possible, break its present relation with the ; sterling area. There are two groups of reasons which justify such a recommendation. The first group is composed of the economic and political disadvantages suffered by Iraq from the association with this area. The second group! 444 of reasons is related to the disappearance or limitation of the advantages enjoyed by the members of the area before and during the thirties. At that time, membership in the area offered the following advantages: (1) The convenience! i i i i i ! resulting from using the banking facilities of Britain i I for international payments and from the unlimited con- ! ' vertibility of the pound sterling. (2) The stability in ' exchange rates caused by the stability of the pound ster- | i ling and by the pooling of the international currency reserves of a large number of countries who were members | in the area. (3) Due to the absence of British control on capital movements from Britain to the sterling area, l t the members had access to the London capital market to J finance their development plans. Today, however, Britain is no longer the principal commercial center of the world ; J 1 or the major financier of other countries. Furthermore, i the pound sterling is no more the undisputable inter national currency. The number of the sterling area members is declining. In addition, as a result of the increasing oil royalties, Iraq possesses adequate funds to finance its economic developments and is free from the problem of ! i deficit in its balance of payments. ! 445 i But before Iraq leaves the sterling area, she should take the following steps: (1) Enter into negotia tions with the oil companies demanding the payment of a certain proportion of the oil royalties in American dollars !and/or gold. (2) Intensify efforts to utilize the exist- i i ling sulphur deposits. The realization of these steps will jincrease Iraq's dollar earnings. (3) Prepare adequate i ! staffs of well-educated civil servants to assume the responsibilities relating to the techniques of negotiating and executing payments agreements with foreign countries. (4) Develop the foreign exchange market. i i I ; Eliminating the high liquidity of commercial banks. , One of the major characteristics of commercial banks in !Iraq is their holdings of a high ratio of liquid assets ! i to deposits. At the present time, the CBI can vary the i legal cash reserve requirements against total deposits between 7 to 10 per cent. The commercial banks, however, have always maintained an average reserve of about 28 per j cent with the CBI. In order to make the general instru ments of credit control more effective, it is recommended i that the CBI should be empowered to vary the legal cash reserve requirements between 7 and 30 per cent of total 446 deposits. Developing the capital and money markets. The I question of developing the capital and money markets i i i usually accompanies the slow evolution of economic condi- J i tions in general and the financial institutions in par- J ! i ; ticular. In Iraq, the task of developing such markets, ! ' j on the other hand, involves not only the CBI, but also ' the Treasury, the Development Board, the commercial banks, the noncommercial banks, and the public. Nevertheless, a start in this direction lies in the hands of the CBI. I The Bank should announce that it is prepared to act as j i an intermediary between buyers and sellers of securities. i Also it should publish, say, each day, the type, prices, i and quantities of securities actually transacted, as well i as those which the Bank has of offers to sell or orders to buy. A second recommendatipn in this respect is that the CBI should encourage the establishment of new domestic commercial banks. In addition to developing the capital and money markets, this recommendation will reduce the foreign banks' share in the banking business and hence increase the effectiveness of the CBI policies. 447 A third recommendation is that the CBI should be authorized to rediscount certain agricultural and indus- I trial papers of a maturity not exceeding one year. In I the absence of rediscounting, the CBI should be empowered | to require the commercial banks to hold specified minimum | ratios against deposits in the form of commercial and I industrial papers. As a result a stipulated percentage I of the reserve with the CBI would be in the form of industrial and agricultural papers. In order to modify the effect of the compulsory element, the CBI should be empowered to allow the commercial banks to deduct the value of these papers in calculating the required cash reserves against deposits. J It is expected that if these recommendations were ' i | vigorously applied, they could transform the CBI from its j i i I present status as a currency exchange agency to an active j institution of monetary policy. Then, the Bank could live up to its name as a central bank and could assist i more effectively in the process of the economic develop ment of Iraq. I j b i b l i o g r a p h y ( BIBLIOGRAPHY A. BOOKS • Abdul-Rahman, Jabir J. Political Economy. Baghdad: The I Iraqi Publishing and Press Co., Ltd. , 1951. Al-Jalili, Abdul R. Monetary System of Iraq. Cairo: Metba'at Nehthet Misir, 1946. ’ . Lectures on the Economy of Iraq. .Cairo: ” Al-Risaleh Press,' 1955. . ■ i j ' Allen, A. M., et al. Commercial Banking Legislation and ; ; Control. London: Macmillan and Co., Ltd., 193'8.r • I Bareau, Paul. "Exchange and Payments Controls and Their ; Influence on Foreign Trade," in International Banking i ! and Foreign Trade. London:.The institute ofBankers, i 1955.. i ! ; |Crick, W. F. 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The Rationale of Central Banking. London: P. S. King and Son, Ltd., 1936. Stock, Milton L. The Bank of Canada. Toronto: The [ j Macmillan Company of Canada, Limited, 1939. . ■Thomas, Rollin G. Our Modern Banking and Monetary System. I Second edition; New York: Prentice-Hall, Inc., 1950. |Towle, L. W. International Trade and Commercial Policy, j New York: Harper and Brothers,1947. j 452 'Wadsworth, John S. ’'United Kingdom of Great Britain and j Northern Ireland," in Benjamin H. Beckhart, editor, I Banking Systems. .New York: Columbia University Press, ; 1954. jWhittlessey, Charles S. Principles and Practices of Money . and Banking. New York: The Macmillan Company, 1948. ! !Willis, H. Parker, and B. H. Beckhart, editors. Foreign j Banking Systems. London:. Sir Isaac Pitman and Sons, Ltd., 1929. - ;Young, John P. The International Economy. Third edition; J The,Ronald Press Company, 1951. i . ; i Young, Sir Hilton. 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I | Federal Reserve Bulletin, 43:422, April, 1957. ; "French Banking Nationalization Law, ” Federal Reserve I - Bulletin. 32:483-488, May, 1946., . . . j --------------------- ----- ---------------------- — — 453- ~ ! Gibbsons, A. 0. ’'Foreign Exchange Control in Canada, 1939- j 1951," Canadian Journal o£ Economics and Political I Science. 19:35-54, February^ 1953. Harr, L. Ai ’ ’ The Heed for a Central Bank, " Economic Forum. 2:15-22, 1934-1935. ...... Heatherington, D. F. ’’ The Sterling Area, " International Reference Service,.32:20, November, 1945. Jackobsson, P. "A Problem of Convertibility for Western Europe.” International Affairs. 30:137-147, April, 1954. . - | I Katz, Samuel I. "Sterling Instability and Postwar Sterling, 1. . . System," The -Review of Economics and Statistics. : 31:31-87, February, 1950. | 1 _______ "The Future of Sterling," The Journal of Finance,. IoT430t441, December, 1955. . . . . . . j "Monetary Policy in Latin America," Monthly Review of j Credit and Business Conditions. April, 1956, pp. 50-54. i - *■ |Nurske, R. "Problem of Currency Convertibility Today," ' ■ Bibliography of Academy of Political & Social Pro-. i eedures. 25: 3HT-32&7 May, 1953. . . . . . j I Ohlin, B. "Mechanism and Objectives of Exchange Control,” ; The. American Economic Review, 27:12-28, Supplement, i I 9 T 7 : : ’ 1 Patel, I. G. "Selective Credit Controls in Underdeveloped Economics, ’ ’ Staff Paper of the International Monetary j j Fund, 4: 73t94, September, 1954. , ; • "" < • - ! j Sayers, R. S. "Central Banking in the Light of Recent , British,and American Experience," Quarterly Journal of ; J Economics, 63:198-211, May, 1949. I t ' 1 : ,"The European Payments Union," Monthly Review of Credit and Business Conditions. September, 1956, pp. 118-121. j jWilliams, John H. 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Creator El-Kaissi, Fawzi A. (author)

Core Title Critical analysis of central banking in Iraq

Contributor Digitized by ProQuest (provenance)

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag business administration, banking,Economics, General,Middle Eastern Studies,OAI-PMH Harvest

Language English

Advisor Garis, Roy L. (committee chair), Martin, G. Preston (committee member), Phillips, E. Bryant (committee member), Pollard, Spencer D. (committee member), Sultan, Paul E. (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-255720

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