For months, the United States has restricted Iraq’s access to its own dollars, trying to stamp out what Iraqi officials describe as rampant money laundering that benefits Iran and Syria. Iraq is now feeling the crunch, with a drop in the value of its currency and public anger blowing back against the prime minister.

The exchange rate for the Iraqi dinar has jumped to around 1,750 to the dollar at street exchanges in some parts of the country, compared to the official rate of 1,460 dinars to the dollar.

Must meet the requirements 

In Baghdad, exchange houses were closed on Thursday, while the Kurdistan Regional Government banned exchange companies in Sulaimaniyah from making transfers.

Mustafa Al-Karawi, a member of the parliamentary budget committee, told the state news agency that the Central Bank “must meet the requirements of the Federal Reserve to...reduce the scarcity of hard currency in the country." He said new domestic procedures would be rolled out to improve access to currency, while a delegation of Iraqi officials will travel to the U.S. for negotiations next Friday.

The devaluation has already sparked protests. If it persists, analysts said, it could challenge the mandate of the government formed in October after a yearlong political stalemate.

The dinar’s deterioration comes even though Iraq’s foreign currency reserves are at an all-time high of around $100 billion, pumped up by spiking global oil prices that have brought increasing revenues to the petroleum-rich nation.

But accessing that money is a different story.

Since the U.S. invasion of Iraq in 2003, Iraq’s foreign currency reserves have been housed at the United States' Federal Reserve, giving the Americans significant control over Iraq’s supply of dollars. The Central Bank of Iraq requests dollars from the Fed and then sells them to commercial banks and exchange houses at the official exchange rate through a mechanism known as the “dollar auction.”

In the past, daily sales through the auction often exceeded $200 million per day.

Ostensibly, the vast majority of the dollars sold in the auction are meant to go to purchases of goods imported by Iraqi companies, but the system has long been porous and easily abused, multiple Iraqi banking and political officials told The Associated Press.

U.S. officials confirmed to the AP that they suspected the system was used for money laundering but declined to comment in detail on the allegations or the new restrictions.

For years, large quantities of dollars were transferred out of the country to Turkey, the United Arab Emirates, Jordan, and Lebanon through “gray market trading, using fake invoices for overpriced items," a financial adviser to the Iraqi prime minister said, speaking on condition of anonymity because he was not authorized to discuss the matter publicly.

The inflated invoices were used to launder dollars, with most of them sent to Iran and Syria, which are under U.S. sanctions, leading to complaints from American officials, he said.

In other cases, the currency is smuggled across land borders under the protection of armed groups that take a cut of the cash, said Tamkeen Abd Sarhan al-Hasnawi, chairman of the board of Mosul Bank and first deputy of the Iraq Private Banks League. He estimated that as much as 80% of the dollars sold through the auction went to neighboring countries.

“Syria, Turkey, and Iran used to benefit from the dollar auction in Iraq,” he said.

A member of one of Iraq’s Iran-backed militias, who spoke on condition of anonymity because he was not authorized to speak publicly on the subject, said the majority of Iraqi banks are owned indirectly by politicians and political parties that have also used the dollar auction to their benefit.

Late last year, the Fed began imposing stricter measures.

Among other steps, at the request of the U.S., the Central Bank of Iraq started using an electronic system for transfers that required entering detailed information on the intended end-recipient of the requested dollars. One hundred Central Bank employees were trained by the Fed to implement the new system, the prime minister’s financial adviser said.

“This system started rejecting transfers and invoices that used to be approved by the central bank,” he said. “Around 80% of transactions were being rejected.”

The amount of dollars sold daily in the auction plummeted to $69.6 million on Jan. 31, from $257.8 million six months earlier, according to Central Bank records. Far fewer of the dollars are going toward buying imports as well, down to around 34% from 90%.

Even when transactions are approved, it takes banks up to 15 days to get the funds rather than two or three days, Hasnawi said.

Unable to get dollars at the official price through banks, he said, traders turned to the black market to buy dollars, causing the price to rise.

In November, the Central Bank of Iraq added four new banks to the list of those banned from dealing in dollars. Two U.S. officials confirmed that the Fed requested the four banks be blocked because of suspected money laundering. They spoke on condition of anonymity because they were not authorized to comment on the case.

A spokesperson for the New York Fed declined to discuss the specific measures taken with regards to Iraq. But the Fed said in a statement that it enforces “a robust compliance regime” for the accounts it holds. The statement said that this regime “evolves over time in response to new information, which we gather in the regular course of monitoring transactions and events that may impact an account and in communication with other relevant U.S. government agencies.”

The system of keeping Iraq’s oil revenues at the Fed was originally imposed by U.N. Security Council resolutions after the 2003 ouster of Iraq’s Saddam Hussein by the U.S-led invasion. Later, Iraq chose to maintain the system to protect its revenues against potential lawsuits, particularly in connection to Iraq’s 1990s invasion of Kuwait.

The new U.S. restrictions come at a time of increased tensions between the U.S. and Iran. Negotiations over a nuclear deal are floundering. Washington has imposed new sanctions and condemned Iran for cracking down on protesters and providing drones for Russia to use in Ukraine.

Also, in Iraq, allegations came to light in October that over $2.5 billion in Iraqi government revenue was embezzled by a network of businesses and officials from the country’s tax authority.

Within one year, most banks will declare bankruptcy

The case “brought (U.S.) attention to the scale of corruption in Iraq” and how the corruption can benefit Iran and other parties hostile to the U.S., said Harith Hasan, head of the Iraq unit at the Emirates Research Center, an Abu Dhabi-based think tank.

The new Iraqi prime minister, Mohammed Shia al-Sudani, who came to power via a coalition of Iranian-backed parties, does not have a strong relationship with the U.S. that could have enabled him to soften the implementation of the new financial measures, Hasan said.

Al-Sudani has downplayed the current devaluation as “a temporary issue of trading and speculation.” He replaced the Central Bank governor and instituted measures intended to ensure a supply of dollars at the official rate.

Al-Hasnawi said the government's recent measures will not stop the financial bleeding. If the current situation persists, he said, “within one year, most banks will declare bankruptcy” and there is likely to be mass civil unrest.

“This U.S. pressure impacts the Iraqi street in a clear manner, and we do not see clear solutions until now,” he said.