By Ahmed Rasheed
BAGHDAD (Reuters) -Under pressure from Washington to stem the flow of dollars into Iran, Iraq's prime minister sent elite counter-terrorism forces more accustomed to battling Islamist militants to shut down dealers smuggling the currency to the Islamic Republic.
Saturday's raids in Baghdad represent an early test for Prime Minister Mohammed al-Sudani, who took office in October after more than a year of political paralysis and must now tread a delicate diplomatic path.
The New York Federal Reserve introduced tighter controls on international dollar transactions by commercial Iraqi banks in November.
The move was designed to stop the illegal siphoning of dollars to Iran and apply more pressure along with U.S sanctions imposed over Tehran's nuclear programme and other disputes, leaving Tehran struggling to source dollars.
Aqeel al-Fatlawi, a Shi'ite lawmaker, accused Washington of deliberately using the new regulations as a political weapon.
"Americans are using the dollar transfer rigid restrictions as warning messages to Prime Minister Sudani to stay tuned with the American interests. 'Working against us could lead to bringing down your government' - this is the American message."
A senior banking official said the United States sent a clear message to Iraqi officials: comply with the new regulations or the Iraqi central bank will face fines.
Sudani is reliant on Washington's continued goodwill to ensure his country's oil revenues and finances do not face U.S. censure, and also needs Washington's help in battling Islamic State militants.
But he came to power with the support of powerful, Tehran-backed militias and so cannot afford to alienate Iran.
"Iraqi Prime Minister Sudani is facing an interlocking challenge on how to work a balanced politics with the two old adversaries - Washington and Tehran, who are friends of Iraq at the same time without taking sides. It's too tough a job to handle and Sudani is walking on a tightrope," said Baghdad-based political analyst Ahmed Younis.
The Islamic Republic needs dollars to stabilize its deteriorating economy, hit hard by U.S. sanctions imposed since 2018 after then-U.S. President Donald Trump ditched Tehran's nuclear deal with six world powers.
Iran's troubled currency has lost around 30% of its value since nationwide protests following the death in police custody of a 22-year-old Kurdish Iranian woman, Mahsa Amini, on Sept. 16 that have further isolated the country.
For years, the clerical establishment has used front companies from Iraq to Turkey to obtain the dollars it needs for international transactions and for funding its proxies across the Middle East.
Two advisers to Iraqi private banks who regularly attend meetings with the central bank, speaking on condition of anonymity, said Iran receives about $100 million a month from Iraqi traders.
Iraqi security officials supervised by the prime minister said they had "stark evidence" that smugglers have been buying large amounts of dollars from Baghdad's currency markets and smuggling it through border crossings to Iran, especially since mid-January.
Dozens of smugglers buy dollars from Baghdad's currency markets and use school backpacks to transport it before packing it into four-wheel drive vehicles to the border, under the protection of armed guards, said an Iraqi border police colonel based at the Shalamcheh crossing near the southern city of Basra.
The forces that carried out Saturday's crackdown were targeted pistol fire from unknown gunmen in Kifah, one of the three main currency markets.
Under the new restrictions Iraqi banks must use an online platform to reveal their transactions, disclosing details on the sender and beneficiaries. U.S. officials can object to suspicious transfer requests.
The new system has slowed down dollar transactions, said Nabil al-Marsoumi, economics professor at Basra University.
The anti-smuggling measures have also left a hole in public finances. Banks that abstained from registering on the online platform resorted to the free markets in Baghdad to buy dollars, creating shortages as demand outstripped supply, bank officials said.
Meanwhile the price of consumer goods has increased and the Iraqi currency has taken a beating.
And it has deepened anti-American sentiment among politicians in Iraq, which remains unstable nearly 20 years after a U.S.-led invasion toppled Saddam Hussein.
Dealer Jumaa al-Hilfi, standing inside Kifah, said the supply of dollars to Iran and its sanctions-hit ally Syria was also taking a toll on Iraq's currency.
The Iraqi dinar had been selling at 1,470 dinars against the dollar before the new Fed transfer restrictions, falling in December to lows around 1,620 dinar per dollar before the crackdown began at the weekend.
The Iraqi prime minister replaced the central bank governor after the slide in the dinar, the state news agency said on Monday. Mustafa Ghaleb Mukheef told him he no longer wanted to stay in the job, said the agency.
Sudani has tried to reassure Iraqis that their dinars and economy will be well protected from the crackdown and U.S. regulations.
"We have taken a set of bold decisions to strengthen and stabilise the Iraqi dinar and we warn whoever tries to exploit the crisis," he said at an event on Saturday.
Hadi Ali, account manager at a private bank in Baghdad, was sceptical.
"Following the newly set American conditions means we should wait for ages to get our transfers approved. This is harmful to our business," he said. "Almost all of the dollar transfers end up at parties affiliated to Iranian business. It's not a secret."
(Additional reporting by Haider Kadhim; Writing by Michael Georgy; Editing by Alex Richardson)