* Also plans to create new forex markets
* Sees return to budget surplus in 2012
(Adds analyst comment, paragraphs 8-9, writes through)
BAGHDAD, March 10 (Reuters) - Iraq expects to step up its treasury bill activity in 2010 to help plug continuing budget deficits and foster a secondary treasury market, the Central Bank and Finance Ministry said in a submission to the IMF.
Iraq, only just emerging from sectarian war but still battling a stubborn insurgency, also wants to develop foreign exchange markets outside the framework of dollar auctions currently conducted by the Central Bank.
That included the establishment of an interbank foreign exchange market and dinar forward market, the submission said.
The country's letter of intent submitted to the International Monetary Fund for a $3.6 billion standby arrangement was dated Feb. 8 and can be accessed here
Iraq, which on Sunday held its second election for a full-term parliament since the 2003 U.S.-led invasion, said it would not return to a budget surplus until 2012.
"As our financing needs in 2010 will still be substantial, we will step up our efforts to mobilize domestic financing through the Treasury bill market," Iraq's Central Bank head and finance minister wrote.
"To that end, we will conduct regular auctions, and refrain from cancellations, while allowing interest rates to be determined by the market. This will have additional benefits by determining a benchmark interest rate, while the development of a secondary market for treasury bills will allow banks to improve their liquidity management."
Iraq's banking sector, for decades dominated by the state, is basic after years of sectarian slaughter that followed the invasion. The Central Bank does issue a form of treasury note to local banks to cover some of the government's financing needs, but it sets the interest rate. There is no secondary market.
"They are going to shift to building a local market, they have ample cash, loan-deposit ratios are very low and they will benefit from oil," said Turker Hamzaoglu, emerging market economist at BoA-Merrill Lynch.
"They have to develop a domestic bond market but it's still baby steps, it's still too early, it's not even a frontier market," he said, adding that Gulf Arab and Lebanese investors could be interested in Iraqi domestic paper.
SALES TAX AND OTHER IDEAS
Central Bank Governor Sinan al-Shibibi and Finance Minister Bayan Jabor said in the letter to the IMF that the country planned to introduce a sales tax, as a precursor to a Value Added Tax, "in the coming years".
Iraq's gross domestic product expanded by 4 percent in 2009 compared with almost 10 percent the year before, their submission reported. GDP growth would rise to almost 7 percent this year and 7.5-8.0 percent in 2011 and 2012, they said.
That improvement would be rooted in an increase in Iraqi oil output to 3.1 million barrels per day by 2012, from around 2.5 million bpd now, and exports of 2.5 million bpd, compared to just over 2 million bpd now.
That outlook might be conservative following the signing of 10 multibillion-dollar deals with global oil firms to develop Iraq's vast reserves. If all the deals work out, Iraqi oil capacity could soar to 12 million bpd in six to seven years.
Amongst other things, the IMF submission said Iraq's Central Bank planned to create a foreign exchange market outside the framework of regular dollar auctions now conducted by the bank. The bank uses the auctions to set the exchange rate, which has been held at 1,170 dinars per dollar for many months.
"To improve the functioning of foreign exchange auctions, we plan to develop organized exchange markets outside the central bank, including an interbank foreign exchange market," it said.
"Our aim is to establish a forward market in Iraqi dinars in the near future."