The Impact of Financial Liberalization on Financial Development in Iraq

• zinah AL_lamy

  كلية الادارة والاقتصاد/ جامعة واسط

  Author

Abstract

The financial sector in Iraq has undergone significant transformation, starting from 2003, due to reforms in the Central Bank of Iraq (CBI), private and foreign banks and interest rate liberalization and capital account openness. Even with these positive developments, financial development in context of these economies is still weak in comparison with other economies in MENA region, indicating that structural barriers exist to financial liberalization in oil dependent and post conflict economies.

Financial liberalization is widely believed to have affected financial development in Iraq between 2004 and 2024. This study employs a systematic multi-method econometric approach to look at the financial development of Iraq during this period, particularly regarding the financial sector, and the accompanying liberalization policies. There has been an application of the ARDL bounds testing approach (Pesaran et al., 2001), Johansen cointegration analysis, Vector Error Correction model (VECM) and Granger causality testing (Granger, 1969). Domestic credit to private sector (% of GDP), the M2/GDP ratio, bank deposits (% of GDP) and a financial inclusion index are used as indicators of financial development.

 calculated empirical results provide evidence of positive and statistically significant relationships in the long-run between financial liberalization measures and indicators of financial development (R² = 0.87–0.95), in line with the proposition of McKinnon–Shaw. But the impacts are dampened by the macroeconomic fragility, oil reliance, low institutional capacity, and state-owned bank dominance. The error correction term –0.081 further attests to the process of convergence to the long run. The output of Granger causality results corroborates the "supply-leading" hypothesis. Indeed, as suggested by the financial resource curse, there is evidence of oil revenue dependence. The results highlight aspects of financial sector reform in post-conflict, oil-rich countries with policy relevance.

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