Iraq Institute for Economic Reform Iraq Economy: the challenges & Opportunities Dr. Kamal Al-Basri 26 th Apr, 2006

Iraq Institute for Economic Reform

Iraq Economy: the challenges &

Opportunities

Dr. Kamal Al-Basri

26th Apr, 2006


1. Security and Economic Welfare

2. Diversity of Revenue Generation

3. State Owned Enterprises

4. Agriculture

5. External Public Debt

6. The Unemployment and the Infra Structure

7. Unstable Economic Policy

8. Reforming the Subsidies System

Iraq Economy: the challenges


Security & Economic Welfare

Security continues to be a challenge to reconstruction. The issue is expected to be serious as “Multi Nation Forces” are going to be dropped off.

The challenge for the coming years is to ensure sufficient financial resources.

The problem is rapid expenditure on security (in short period of time) could not reduce violence and disruptions (law of diminishing return may apply).


As complementary policy, Iraq needs to spend on activating civil society organizations. Community participating will help in establishing law and order.



Community participation can be achieved by relating the country resources and assets to ownership of the citizens, and any damage to them will affect their economic welfare in negative way,

It is important that for the government to demonstrate it real attention for not discriminate against the citizens, whether they are in the north or in the south,

An effective way to demonstrate these policy, is through equal direct distribution of oil’s revenue to citizens.



Security & Economic Welfare Economic reform can not be achieved in absence of law and order, which is badly need it.

There is serious disruption to economic reconstruction and employment generation programmers. This can not be allowed to continue (because of possible large population revolt).

As alternative, while the political process is evolving, International communities should put the necessary pressure on the politicians to form a technocrat based committee to mange establish law and order and ensure efficient use of resources.


Diversity of Revenue Generation


% Contribution of elements of GDP over time

0%

20%

40%

60%

80%

100%

1968 1978 1988 1998 2004

Social Services

Housing

Banking & Insurance

Sale and Retail

Transport & Communications

Electricity & Water

Constructions

Industry

Mining

Agriculture

The Economy very much dependent on oil production

Agriculture, Industry& construction sectors are all shrinking more than ever.


Nominal GDP and Oil Exports (US$ Billion)

0

10

20

30

40

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

GDP at market prices Oil Exports

In Recent Years Iraq Economy become Depended on

Oil Export


Agriculture 7.3

Electricity and Water

0.5

Transformation Industry

1.7

Building and Construction

1

Social and Personal

Development Services

10.2

Money and Inssurance

1.4

Wholesale and Retail Trading

6.4

Transportation & Communication

6.7

Mining63.9

Gross Domestic Product 2005


Expenditures 50,963 Revenues

45,392

Deficit5,571

0

10000

20000

30000

40000

50000

60000

2006

The Budget 2006: Expenditure, Revenue & Defects

Billion I.D


Project investment expenditures (18%)

Operating expenses (82%)

0

10

20

30

40

50

60

70

80

90

2006

Percentage of operating and Investment Expenditures 2006


Government revenue is very much limited to oil exports, currently Iraq cannot produce more than 2.3 mbd and export 1.6 mbd.

This export makes more than 90% of total Iraqi revenue.

Revenue Generation


Crude Oil Production and Exports ('000b/d)

0

500

1000

1500

2000

2500

3000

3500

May-98 Dec-98 Jul-99 Feb-00 Sep-00 Apr-01 Nov-01 Jun-02 Jan-03 Aug-03 Mar-04 Oct-04 May-05 Dec-05

ProductionExports

There is a need to reduce rate of change in the production


Revenue Generation

rates of estimated revenues planned for the year 2006 budget according to their sources

Other taxes & duties 1.08

Ttransfers from SOFs

0.40Interestincome 0.16

Excise duty 0.37

Pension contribution

0.32

Income tax (staff) 0.19

Services fees 0.07

Construction1.32

Income tax (personnel)

0.20

Income tax on corporation

3.13

Oil revenues 92.76

In Budget of 2006, 92% of the revenue is from export oil


Iraq is facing a huge bill for financing reconstruction at a time where donated grants are declining.

a) to increase the production and the export rates:

There is a need for massive investment (to bring current field up to standard and develop new fields),

Improve the competency and capacity at the management level, The national state oil company is to be re-established (without monopoly),

There is a need to remove the confusion in the constitution about authority in policy making. In some paragraph grant authority to central government, but in other paragraph authorise the regions (see, paragraph 108 &109)

Revenue Generation


b) to increase diversity of income generation.

The current strategy is to is:

to invest in oil sectors to the permitted limit by capacity of expanding, and

to implement other measures to increase income generation through various type of taxations.

Revenue Generation


Industry


State Owned Enterprises

Most enterprises in the industry are State Owned Enterprises,

In the past, SOEs used to contributions to GDP by $12 Billion

( before the ware with Kuwait )

Prior to 2003, many SOE’s earned profits, a portion of which was transferred to the national budget, but since 2003, this contribution has ceased.

Currently, SOEs are inefficient: employing over 580 thousand employees, and

receiving ( I.D 1.26 Trillion or USD 840 M ) as subsidies.


0123456789

101112131415

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

(200

2 $B

)

The State Owned Enterprises

Contributions to GDP by $12 Billion



Opening Iraqi markets to import competition, and opening government procurement to more private firms, has made many SOE’s “non-profitable”, so that they face a “bleak future.”

Even the good enterprises (e.g.; Leather) ceased producing because of their inability to compete.



The challenge, is to make concise policy on what should we do:

1) Is it possible now to privatising the SOEs? If not

2) Shall the government invest to improve their performance?


Privatization & State Owned Enterprises

The effort to privatize state-owned enterprises (SOE’s) in Iraq has suffered from

a) lack of commitment on concise strategy,

c) Investment Law: Current investment law opened Iraq-based enterprises to up to 100 percent foreign ownership. Its weakness, however, is that it does not permit foreign individuals or enterprises to own land. The clause was initially intended to restrict direct foreign investment in real property, but has been interpreted to prohibit even indirect foreign investment, such as foreign purchase of shares in Iraqi companies that own real property. The effect has created a formidable barrier to any but small and informal capital inflows.

d) Strangely, some advocates of privatization have tended to view it as a one-step solution, rather than as part of a process of economic reform.


The Agriculture Sector


Structure of the Land in Iraq

Desert الصحارى

41.90%%

Mountains

8.04 %

Land Suitable for Cultivation

ال

24.68%

Forest

2.58%Swamp & Marshes

(Ponds )

4.54%

Rivers And Lakes والبحيرات األنهار

3.37%

Pasture مراعي

14.88%

Agriculture is the second important sector in the economy


Improving Agriculture Productivity

In the past Iraq used export agriculture products, but now this is not the

case and currently, Iraq import even what used to export,

In general, the challenge to improve productivity & efficiency is through:

1. Improving Irrigation system,

2. Utilizing fertilizers,


Productivity in Agriculture

050

100150200250300350400450500

Year1990

Year1991

Year1992

Year1993

Year1994

Year1995

Year1996

Year1997

Year1998

Year1999

Year2000

Iraq

Syria

Jordan

Egypt

Iran

Turkey

America

Canada 1990 1995 2000

Fertilization usage in different of Countries, by Hectare


1990 1995 2000 0

20

40

60

80

100

120

Year 1990 Year 1991 Year 1992 Year 1993 Year 1994 Year 1995 Year 1996 Year 1997 Year 1998 Year 1999 Year 2000

Iraq

Syria

Jordan

Egypt

Iran

Turkey

America

Canada

Numbers of Tractors (1000 Hectare)120

100

80

60

40

20

0

Productivity in Agriculture


International Debts


Structure of International Debt

Iraq: External Public Debt as of December 31, 2004

Italy2.5%

Russia3.3%

Saudi Arabia and Kuwait41.5%

Other Non Paris Club

20.8%

Commercial creditors13.9% Germany

3.6%

France3.6%

Multilateral Organizations

0.8%

Japan4.7%

Other5.2%

Paris Club


International Debts are a major issue in Iraq economy, the total amount is approximately $195 billion.

Iraq successfully negotiated with Paris Club & IMF to reduce the debts by 80% for members of Paris Club and Iraq had already signed two important agreements with IMF, these are: EPCA and SBA in 2004 and 2005, respectively.

These agreements requires Iraq to restructure the economy toward reduce government control of the economy in ordered improve efficiency and reduce waste as in the subsidy system.

External Public Debt


Each agreement had enabled Iraq to reduce debts with members of Paris Club by 30%. After three years, and if Iraq satisfied IMF’s requirements in restructuring the economy towards free market economy, Iraq will be entitled for the remaining 20%.

The agreement with Paris Club is now taken as an important guideline for Iraq’s negotiations with other, non Paris Club governmental creditors.

For members of non Paris Club, Iraqi Government has achieved considerable success in its foreign debt resolutions, these include:

International Debts


A) Resolution of the debt of the large private creditors (those with over $35 million in claims)

For this group, Iraq proposed issuing bonds, together with a

possible alternative syndicated loan, that will be used to satisfy these

claimswithin the terms of the Paris Club deal. The bonds will have a

face value of 20% of the claim, will carry a fixed coupon slightly above thebest credits, and will have an average term of nearly 20 years at

fixed interest rate 5.8%.

International Debts


B) Resolution for small private creditors (those with less than $ 35 million in total claims):

For this group a cash alternative offering the creditor 10.25% of the total reconciled claim value.

C) Non Paris Club government creditors: Iraq is now in advanced negotiation with these group of governments. There are strong indications that a satisfactory outcome to a number of these claims can be concluded in 2006.

International Debts


D) Resolution with GCC creditors:

There is a strong indication from GCC creditors that they are willing to

resolve their debt issues after the establishment of the new government and

after some evidences of political stability.

The reduction of Iraq’s foreign debt will create the necessary climate for

investment and economic recovery.

International Debts


Unemployment


The Unemployment

Unemployment rate is currently between (27 - 30)%. This creates both human and security costs.

Distribution of Employments & Contributions of Sector to GDP

0% 25% 50% 75%

Petroleum

Agriculture

Manufacturing

Services %Labor

%GDP


A potential solution to this problem is to expand in spending on building (housing) the damaged infra structure overall the country,

In this investment will create incentive for the rapid growth in all sector of the economy and reduce the rate of unemployment,

The government needs to set up priorities of projects.

The Unemployment


Creating Secure Zones over all the country, will encourage business development and then reduce unemployment rate.

The Unemployment


Unstable Economic Policy


From past years evidences have shown that members of successive governments have different priorities and different policy this hampered the processes of reconstruction and make it more costly.

For example: considerable work has been on privatization, Allawi’s government established a commission for privatizations. The new government of last year demolished without any warning the commission. Such a action created confusion and a waste.

Unstable Economic Policy


Reforming Economic Subsidies


0

10

20

30

40

50

60

Food Basket Fuel PricesSubsidies

Electricity Farmers SOEs Al-Hajj SocialSafety net

Type of Subsidies

Value in $ per month

The Cumulative Distribution of Subsidies per Capita

Per Capita per month the value of food basket and fuel subsides is $ 49.

Is it in the advantage of the citizen to monetise these subsidies?

These subsidies create waste and corruption and distortion of resource from market

values


Subsidies System

Type of Subsidies

Cumulative Subsidies per

capita per monthIn $

Cumulative Distribution per Family per Month

in $

Food Basket 10 49

Fuel Prices 49 244

Electricity 50 249

Farmers 50 252

SOEs 53 266

Al-Hajj 53 266

Social Safety net 54 272

If 50% of the Oil revenue distributed directly to the population, then the per capita and per family and per month dividend is $37 and 185

(Based on 2005 oil returns)


Subsidies System

Direct distribution of Oil’s return will have impact on the following:

1) Politically: will show there is no different treatment for member of the population,

2) Security: there will be a feel of ownership of resources and motivation to protected,

3) Economically: reduce the waste of administration and corruptions


To reduce inefficiency, the government started to reforming the untargeted subsidies programmes and to begin the process of replacing their welfare implications with a well-prepared and efficient system of income transfers. The major two policies here are the food basket and fuel price subsidies.

The strategy is to reduce subsides gradually and as form the budget year 2006. Therefore, government for 2006 reduce the budget for both of importing fuel and for the food basket by 25%. Iraq currently spending 17% of the total budget on two subsidies (8.1% for fuel and 8.9% for food basket).

Reforming the Subsidies System


The following actions have been recommended:

A) Fuel subsidies: increase full prices and introducing for the first time a new system ‘Social Safety Net’ to target the poor families and compensate them.

b) Food basket: The government anticipated that some time during this year to start experiment with monetising the food basket in three provinces

Reforming the Subsidies System


This reform is at present time attracting considerable This reform is at present time attracting considerable attentions. The government is already announce new prices. attentions. The government is already announce new prices. This action, as it is expected create unrest, the citizens of Iraq This action, as it is expected create unrest, the citizens of Iraq start asking the question:start asking the question:

Why is a country with rich oil reserve (such as Iraq) can not Why is a country with rich oil reserve (such as Iraq) can not afford cheap fuel?afford cheap fuel?

To address this important question, let us look to the following To address this important question, let us look to the following slides. slides.

Reforming Fuels Prices


3.3

41

24 24 24 29 27

12.05

101

0

20

40

60

80

100

120

العراق سوريا الكويت السعودية االمارات مصر البحرين ايران تركيا

Super Benzeneالبنزينالممتاز

Iraq Syria Kuwait KSA UAE Egypt Bahrain Iran Turkey

Prices of the improved Benzene (gasoline

$


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

البنزينالعادي البنزينالممتاز النفطاالبيض زيتالغاز السائل اسطوانةالغاز

Regular Benzene Super Benzene White Oil Gas Oil Liquid Gas Cylinder

Consumer Contribution

Government Contribution

Percentage of Government and Consumer

Contribution to the Cost of Fuels

%100

%0


Subsidies for Locally Produced

(5)

Subsidies for Imported Fuel (6)

Crude Oil Price

Component of Fuel Subsidies (in Trillions ID)


Expenditures35,981

Revenues28,959

Budget Deficit7,023

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

The Deficit in the 2005 Budget (in Billions I.D.)


Allocation of the Budget on Select Items

Budget Allocation/ Actual Spending

( for 2005 (Trillion .D

Per Capita)Thousand ID(

Items

12 477 Fuels

4 144 Food Basket

2 59 Heath

2 70 Education

0.5 18 Public Work


Fuel Food Basket Education Health Public Work

Budget Allocation to Fuels and other Items


Thank you

Documents

Iraq Institute for Economic Reform Iraq Economy: the challenges & Opportunities Dr. Kamal Al-Basri 26 th Apr, 2006