The document analyzes the determination of the balance of payments (BoP) and the formation of foreign exchange reserves, with a strong focus on resource-dependent economies, particularly Iraq. It begins by outlining the accounting framework of the balance of payments, emphasizing the identity that the current account, capital account, financial account, and changes in reserves must sum to zero. The current account balance is shown to equal the difference between national saving and investment, highlighting how consumption, fiscal deficits, and sectoral saving–investment gaps shape external balances.
A central argument is that foreign reserve accumulation is not an independent central bank process in Iraq but is fundamentally driven by public finance decisions. Oil revenues, owned by the government, constitute the dominant source of foreign exchange, while reserve changes reflect the net outcome of Ministry of Finance foreign exchange sales to the central bank versus central bank sales to the domestic market. Consequently, reserve formation is inseparable from fiscal policy and government spending behavior.
The paper emphasizes the vulnerability of commodity-exporting economies to external shocks, using extensive cross-country data on natural resource rents, export volatility, and current account fluctuations. Iraq is identified as one of the most oil-dependent economies, with exceptionally high export volatility and a narrow export base, which necessitates holding larger-than-average foreign reserves as a buffer against price cycles and geopolitical risks.
Scenario analysis suggests that even under optimistic assumptions about oil prices, export growth, population, and exchange rate stability, Iraq could face balance of payments pressures and potential reserve depletion within the next decade. Borrowing to finance deficits is viewed as unsustainable unless directed toward export diversification.
The study concludes that monetary and fiscal adjustments alone are insufficient. Long-term stability requires a structural transformation strategy centered on export diversification, industrialization, and increased investment in agriculture and manufacturing. Adequate reserves are portrayed as essential for macroeconomic stability, confidence, and crisis prevention, especially in an economy highly exposed to oil market uncertainty.
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