* Iraqis still prefer hard currencies for many transactions
* But some foreign speculators see long-term opportunity
* External, budget surpluses could eventually boost dinar
* For now, central bank wants to keep currency stable
* Any major appreciation unlikely before two or three years
By Aseel Kami
BAGHDAD, Oct 3 (Reuters) - Many Iraqis have lost faith in their dinar currency but to some foreign speculators, it promises big profits. The contrast underlines the uncertainties of investing in Iraq as the country recovers from years of war and economic sanctions.
The logic of the dinar bulls is simple. Iraq's oil exports rose to 2.6 million barrels per day in September, their highest level in three decades; the country aims to hit 6 million bpd by 2017, which would put it close to Saudi Arabia's current level.
Even if unstable politics, militant violence and bureaucratic inefficiency prevent that target from being hit, Iraq still seems to be on the threshold of an oil boom that will transform its finances.
Inflows of new oil revenue could give the country big external surpluses and push state finances deep into the black by late this decade - the classic recipe for a strong currency.
"As far as our investors are concerned, when they buy Iraqi dinars they do know it is a long-term investment. You know it takes time for a country to rebuild itself," said Hassnain Ali Agha, president of Dinar Trade, a U.S. dealer of exotic currencies.
Because the dinar is not freely traded by banks outside Iraq, online dealers of banknotes such as Dinar Trade are the only way that most foreigners can invest in the currency. The Las Vegas-based company says it sells as much as hundreds of thousands of dollars worth of dinars daily, shipping dinar notes to thousands of customers in the United States and elsewhere.
Agha said that because of optimism about Iraq's oil wealth, there had been solid demand for dinars since his company was founded in 2004, a year after the U.S. invasion which triggered years of political violence and economic turmoil.
Back in Baghdad, however, Iraqis themselves are not convinced. Many take what opportunities they have to change their dinars into hard currency, and conduct all but small day-to-day transactions in U.S. dollars.
"We have no trust in the Iraqi dinar - we feel afraid to save it. We trust the dollar more. The dollar does not go up and down, it is fixed," said housewife and mother-of-two Eman Saadeldine.
The dinar has endured wild swings over the past three decades. In the 1980s, one dinar bought around $3, but economic sanctions imposed on Iraq around the time of the 1991 Gulf War sent the currency into decline and stoked inflation, which the government fuelled by printing money. By late 1995, $1 bought as much as 3,000 dinars.
After the 2003 invasion, the central bank intervened in the currency market to strengthen the dinar, using its supplies of dollars to manage the exchange rate.
But over the last several years, even as Iraq's oil production has expanded, there has been none of the appreciation for which speculators have been hoping. The central bank now sells dollars in daily auctions at a fixed price of 1,166 dinars, a level barely changed since 2009.
In fact, the dinar has recently faced downward pressure as a result of the international economic sanctions imposed on neighbouring Iran and Syria. Iraqi traders rushed to buy dollars to sell on illicitly to residents and businesses in those countries, which are hungry for hard currency.
The dinar fell as low as 1,280 in the open market this year before Iraqi authorities reacted by allowing two state-run banks and some private lenders to sell dollars, helping push the exchange rate back to around 1,200 currently.
Another factor counting against the dinar is the fact that the largest banknote is only 25,000 dinars. This often makes the currency unattractive to use in an economy where the banking system is primitive and deals are often done in cash.
Saadeldine recalls paying in cash for a new house in 2009.
"If our money had been in dinars, it would have been impossible for us to carry it. It was in dollars and we carried it in a small suitcase," she said.
The central bank has been considering plans to knock three zeros off the nominal value of banknotes to simplify financial transactions. This would not in itself increase the real value of the dinar, since prices would adjust in line with the redenomination, but economic experts say it could improve confidence in the dinar and thus boost its value eventually.
"It would increase trust in the dinar even though its value would not change," said Baghdad-based economist Majid al-Souri. "Indirectly, when trust increases there will be appreciation."
Earlier this year, however, the cabinet decided to suspend the technically complex redenomination plan until further notice, saying the economic climate was not suitable.
The biggest obstacle to dinar appreciation is the fact that for now at least, Iraqi authorities appear content with the exchange rate in its current range.
In a memorandum to the International Monetary Fund on economic and financial policies for 2011, written in March that year, the Iraqi government said it saw benefits in keeping the dinar stable.
"We believe that the policy of maintaining a stable exchange rate continues to be appropriate, as it provides a solid anchor for the public's expectations in an otherwise uncertain environment and in an economy with a still very low level of financial intermediation," it said.
In the long term, however, Iraq's finances and economy may improve so dramatically that authorities feel comfortable allowing the dinar to appreciate under the pressure of flows of oil money into the country.
The IMF expects this year's estimated budget surplus of just 0.2 percent of gross domestic product to balloon to 12.1 percent in 2017. The country's balance of trade in goods and services, in deficit as recently as 2010, is projected over the next five years to shift to a large surplus of 11.3 percent of GDP.
Deputy central bank governor Mudher Kasim told Reuters that he expected redenomination of the dinar to go ahead in 2014 or later, by which time the amount of Iraqi currency in circulation would have increased significantly, making financial dealings in cash even harder.
In the long term, the central bank aims to make 1 dinar equal to $1 with a combination of redenomination and appreciation, although that will take over three years because of instability in the Middle East, Kasim said: "If not for the regional circumstances, we would proceed faster with that plan."
Some analysts think the appreciation could go further. Kamal al-Basri, research director at the Iraqi Institute for Economic Reforms, an independent research body in Baghdad, said he expected the dinar to stay stable for the next three years, but that afterwards it might strengthen beyond parity against the dollar, including the effect of redenomination.
For that to happen, Iraqi politics will have to stabilise, skill and education levels rise and the economy diversify so that it is not so heavily dependent on oil exports, he said.
Speaking at the Baghdad currency exchange shop that he owns, Ahmed Abdul-Ridha said the dinar's stability in the past three years was good, but it did not indicate the long-term trend.
"We wish the dinar's value would go back to what it was like before, when it used to equal $3 in the 1970s and even in the 1980s," he said.
"I expect that day will come. Why not? What we are going through is an abnormal condition...We are an oil country."