TRIPOLI (Reuters) - In a square behind Libya’s central bank, black market dealers, some of them armed, carry small plastic bags filled with dollars and larger ones with dinars in and out of one of many informal exchanges.

Traders buy food and other goods from abroad at the official rate and sell them at the unofficial one, pocketing vast profits; others make equally large sums by smuggling out heavily subsidized fuel.

In the back streets of the old city meanwhile, ordinary people have resorted to selling jewelry or dollars hidden at home as six years of post-dictatorship chaos take their toll.

“I haven’t been paid for four months,” said Fatima, 40, from the southern city of Sabha as she sold three small gold charms to pay for diabetes treatment for her sister, Hasina, who added: “We’re helpless, there’s nothing else we can do.”

In other signs of rising poverty, elderly women beg motorists for cash on Tripoli’s streets and families queue for charity food handouts. The U.N. estimated that about 1.3 million people in Libya need humanitarian assistance this year.

Their situation took another turn for the worse in the past two weeks after the black market rate of the dinar, which has long languished at record lows, slid again, fuelling inflation that is already around 25-30 percent.

The central bank blamed the audit bureau and the U.N.-backed government for restricting letters of credit that fund basic supplies to a divided country where a security vacuum and smuggling networks have destabilized the wider region.

Officials had come across suspect requests - one to import tuna worth $120,000, more than the country consumes in a year, according to a Libyan entrepreneur who declined to be named, fearing retribution from Libya’s powerful armed groups.

Just $2.5 billion of an expected $7.4 billion of credit has been allocated, the trader said, helping knock the dinar from around 8.5 to 9.25 against the dollar on the black market. Its value has fallen by more than 600 percent since early 2014.

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The economy ministry was not immediately available for comment on a complex credit system that passes through commercial banks and where the audit bureau had documented earlier abuses and lack of oversight.

“We’re talking about an extremely bad economic and financial situation,” Central Bank Governor Sadiq al-Kabir said in a rare news conference on Tuesday. “Everyone, whether legislative or executive, holds responsibility equally.”

ELUSIVE PEACE

Traders and economists say political uncertainty is a major factor weakening the currency, with U.N. talks to broker a deal between rival factions currently suspended.

Libya is struggling to fund food imports and defend its foreign reserves, which the World Bank estimates will stand at $67.5 billion at the end of this year, compared to $123.5 billion in 2012.

International experts say the only way to resolve the issue is to devalue the dinar from the official exchange rate of 1.37 to the dollar, but agreeing an economic strategy in a country dominated by armed factions with rival governments and no budgets is no simple task.

A powerful or well-connected minority who are profiting from a flourishing shadow economy have little interest in change.

The central bank did not comment on devaluation, but economists and diplomats say the bank is reluctant to devalue without a policy plan in place to deal with the resulting shock.

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Libya managed this year to lift oil production to about 1 million barrels a day, but output is stuck well below the levels before the 2011 uprising that toppled Muammar Gaddafi.

Revenues that normally account for about 80 percent of gross domestic product are largely used to pay salaries, including those of armed factions added to the state payroll for their role in the uprising. Subsidies include a $4 billion-plus annual fuel subsidy that is among the most generous in the world.

Premiums on the official exchange rate and subsidized fuel make Libya “a criminal and terrorist cross-border funding paradise”, said Husni Bey, chairman of HB Group, one of Libya’s biggest private firms.

“Most instability in Libya today is of a criminal nature... due to the lack of equitable exchange rate for the Libyan dinar and the subsidies that must be changed from goods to direct cash contributions.”

Last year Libya spent around $26 billion, but earned just $6 billion. “This year we estimate that revenues should increase to around $14 billion, but spending will likely be more than double this,” said Mark Griffiths, Libya Mission Chief for the International Monetary Fund. “This is not sustainable.”

The government has sought to reduce the public salary bill by 5 billion dinars annually, clamping down on abuse by removing some 100,000 people who had been claiming several salaries, according to a finance ministry report.

Libyans became used to plentiful public jobs and state handouts as Gaddafi sought to buy loyalty like other Middle Eastern oil producers. Migrant workers used to do the manual work, now Libyans without contacts have taken their place.

Salman Rashid, a public servant, said he had received just three months-worth of pay in the past year. “It’s not enough for basic needs,” he said. “Now I work on construction sites and in buildings maintenance.”

Entrepreneurs have withdrawn deposits from banks for fear of employees leaking word of them to kidnappers and others also prefer to keep money at home.

In a second shop in the old city, a woman who gave her name as Karima was changing 500 euros. “I need to go to Tunis for surgery and am selling my foreign currency holdings,” she said. “Times are very difficult now.”

Shop owner Salahedin Zarti, 52, said up to 10 people come in daily to sell necklaces, bracelets and rings.

“In the beginning it was every day, but now I think people are starting to run out of jewelry,” he said.