* Iraq economy booms, increasing savings
* But much money sent abroad or saved unproductively
* Capital flight believed to remain substantial
* Large flows going into real estate
* Interest in stock, bond investment still minor
By Aseel Kami
BAGHDAD, April 3 (Reuters) - When a recent lecture for a group of Baghdad university students started with the question, "What is the Iraq Stock Exchange?", only one young participant put up her hand to respond, and got the answer wrong.
Last month's scene at the headquarters of the Baghdad bourse revealed the struggle which Iraq faces to modernise its financial system: it must overcome primitive, ultra-conservative savings habits born of decades of war and political instability.
Thanks to a partial improvement of security and an oil boom, Iraqis' average incomes are rising sharply, and they are able to save more. But many of these savings are not being channelled into the stock market, where they could earn returns, or even into bank deposits, where they could be lent on to companies for fresh investment.
Instead, they are going into real estate, where a large proportion of the money becomes tied up unproductively, or being hidden in people's homes in the form of cash - sometimes hard currencies such as U.S. dollars - or jewellery.
"Other countries have political and security stability but we do not," said local economist Majid al-Souri. "So people tend to put their money under the pillow."
Iraq's economy grew about 8 percent last year and is projected to exceed that performance in the next five years, the International Monetary Fund says.
Such growth is supporting a big, if uneven, rise of incomes. Since the U.S.-led invasion that ousted Saddam Hussein in 2003, Iraqi government salaries have jumped from the equivalent of a few U.S. dollars a month to a minimum of around $200 - though some of that increase is due to appreciation of the local currency against the dollar. Government figures show the per capita annual income in Iraq is now about $4,000.
Official, comprehensive data are not available, but the IMF estimates Iraqis will save about a third of their national income this year - a rate about 10 percentage points higher than many wealthy countries in Europe, and 20 points higher than the United States and Britain. Iraq's gross domestic product was about $130 billion last year.
But guiding the savings into productive investments within the country is proving difficult. The political and security situation is one big obstacle.
Although Iraq is much safer than it was during the sectarian bloodletting that killed tens of thousands in 2006-2007, Sunni insurgents tied to al Qaeda still carry out major attacks. Bombs hit Shi'ite Muslim mosques in Baghdad and the northern Iraqi city of Kirkuk last week, killing at least 19 people.
The two-year-old civil war in neighbouring Syria is straining Iraq's shaky sectarian and ethnic balance, and over a year after the last U.S. troops pulled out of the country, its power-sharing government has lurched from crisis to crisis.
In this environment, savings continue to get funnelled out of the country to Jordan, Dubai and other destinations. Timely, comprehensive data is not available, but Iraqi central bank figures from 2011 show a net $6.4 billion left the country that year in the form of "portfolio investment".
"A large amount of money is being smuggled outside Iraq to be invested there," said Souri.
Such transfers appear to be conducted largely by the richest businessmen; smaller business owners, with less access to safe international payments networks, are generally keeping their money in the country, Souri said.
Some funds are going into bank deposits. At the end of 2012, total deposits at Iraqi commercial banks had climbed to around 64 trillion dinars ($55.2 billion), around 22 trillion dinars of which were from the private sector rather than the government, said Abdul-Aziz Hassoun, executive director of the Iraqi Private Banks' League.
But analysts and government officials say that relative to the large volumes of savings which Iraq's fast-growing economy is generating, the amount of money going into bank deposits remains fairly small.
This is partly because of concern that it could be hard to withdraw money in the event of another major security crisis, and partly because Iraq's banking sector failed to develop in the final, difficult years of Saddam's rule. State-owned banks are large but criticised for indifferent customer service.
Privately owned banks have top-class technology but their networks are still relatively small. Trust in them was hurt in March last year when Iraq's central bank placed Warka Bank under guardianship to supervise it through an insolvency process.
"The number of people putting their money into banks is small in comparison to the size of the population. We do not have a specific figure but this is the general sense," said Abdul-Zahra al-Hindawi, spokesman for Iraq's planning ministry. "We do not have banking awareness" in the country, he added.
That leaves real estate as a major destination for Iraqi savings. In the last several years, money has poured into the sector; a lot has gone into houses or apartments in the Kurdistan region, where security is better than many other places in the country, but Baghdad and other provinces have also attracted funds.
"Real estate and land are the only guarantee for Iraqis," said Zainab al-Azzawi, a civil servant who bought a flat in Kurdistan and land on the outskirts of Baghdad for $20,000 four years ago. She estimates the market value of her holdings has now increased by about 50 percent.
"There is nothing without risk in Iraq, but real estate is the best among investments," she said.
Much of the land bought for investment remains undeveloped, however - an inefficient use of economic resources. And Hindawi noted that the rise in real estate prices could have a negative side, by making it harder for ordinary Iraqis to buy homes.
He said many Iraqis still preferred to keep a substantial amount of their cash at home as a safe, accessible option. There is little thought of putting their money into equities or other tradeable financial instruments.
"Generally, there is no awareness of the stock market so we try as much as possible to educate people through advertisements, meetings or lectures," said Firas Mechael, a member of the stock exchange's board of governors.
It was at such a lecture last month that the Baghdad university students struggled with the definition and the functions of a stock exchange.
The exchange mounted a big public relations drive in January to promote a $1.27 billion offer of shares by Iraqi mobile telephone firm Asiacell, the country's largest-ever flotation and the first big one since Saddam was ousted.
The offer was a success - the listing doubled the bourse's capitalisation to $9.2 billion. But foreign investors, including parent Qatar Telecom, bought about 70 percent of the offer, and it was not seen as signalling the arrival of an equity culture in Iraq.
"The trend to buy shares or bonds is still almost non- existent, except when Asiacell sold shares because people trust that company," said Mudher Kasim, a former deputy central bank governor.
"People are uncertain. There are no decisions about future investments in an unstable environment. People are afraid."
One way to channel savings into financial markets would be to develop a private sector pension industry, to complement the state pensions which government employees receive.
The reform has been discussed inside and outside the government, but no official decision has been made, and Iraq's political instability makes legislation on the issue difficult.
"What is needed now is to include the private sector in the pension law," Souri said. "There are many suggestions."