Since 2004, Iraq has successfully completed three economic reform programs supported by the International Monetary Fund (IMF): one under the Emergency Post Conflict Assistance (EPCA) facility and two (precautionary) Stand-By Arrangements (SBA). During this period, Iraq has made considerable progress under very difficult circumstances, including a very challenging security situation. Iraq has successfully reduced inflation, showed fiscal discipline, and started rebuilding our economic institutions. These achievements have helped us to obtain generous debt relief from Paris Club and other creditors that has substantially improved our external position.
These hard-won gains of recent years could be undermined, however, by the large drop in oil prices from their peak levels of mid-2008. After reaching a high in July 2008, when Iraqi crude oil sold for $124 per barrel, prices fell to a low of $35 per barrel in January 2009, before slowly recovering to a level of around $68 per barrel in the second half of 2009. The average export price in 2009 was $57 per barrel, well below the average export price of $92 per barrel in 2008. In addition, due to dire infrastructural problems, the volume of oil exports in the early months of the year fell below 2008 levels (to 1.75 million barrels per day (mbpd) in the first five months). Iraq has been working to address these problems and oil exports reached 2 mbpd towards the end of 2009, bringing the average for the year to 1.88 mbpd.
As the proceeds from oil exports account for the bulk of our total export receipts, and for the majority of government revenues, the lower oil prices are posing considerable challenges to our internal and external economic stability. To maintain macroeconomic stability, and foster growth and employment, Iraq has adopted an economic adjustment program for 2010–11 for which it seek support from the IMF under a new 2-year SBA, as well as financial assistance from other international institutions and countries. This Memorandum of Economic and Financial Policies (MEFP) describes our economic objectives and policies, including the structural reforms, for this period.
Due to the temporary drop in oil production, real GDP growth is estimated to have slowed to 4 percent in 2009, from almost 10 percent in 2008. There are indications, however, that the improved security situation has supported economic activity in the non-oil sector. The Central Organization for Statistics and Information Technology (COSIT) estimates that real non-oil GDP grew by about 5½ percent in 2008 and that the pace of non-oil growth remained broadly unchanged in 2009.
The Central Bank of Iraq (CBI) has been successful in keeping inflation under control, by managing the exchange rate and by keeping the policy interest rate positive in real terms. When inflationary pressures emerged in 2008, the CBI stepped up the rate of appreciation of the dinar vis-à-vis the U.S. dollar (to about ½ percent per month until late 2008), which also helped counter dollarization. As a result, headline inflation fell to 6.8 percent by end-2008. Inflation remained well below the target of 6 percent in 2009, with prices falling by 4½ percent, mainly because of a further decline in fuel prices. Food price inflation has picked up more recently, however, and core inflation (excluding fuel and transportation) ended 2009 a 6 percent, down from 12 percent at end-2008.
With headline and core inflation low, the exchange rate has been stable since the beginning of 2009. The policy interest rate has been reduced gradually to 7 percent. Net international reserves increased to $50.2 billion at end-2008, but have fallen to $44 billion at end-2009, reflecting the drawdown of the government’s deposits with the CBI.
The government budget recorded a modest surplus in 2008 (almost 2 percent of GDP). Higher-than-expected oil revenues enabled us to increase spending. Particularly, and due also to our efforts to improve the execution of the investment budget, Iraq was able to substantially increase capital expenditures in 2008, compared to the previous year.
With the drop in oil prices, the external current account is estimated to have moved into a large deficit in 2009, of over 20 percent of GDP. And as oil revenues account for the bulk of government revenues, the government budget is also estimated to have shifted into a large deficit, of over 20 percent of GDP in 2009. The 2009 budget, which was adopted at a time when sharply lower oil revenues were expected, was designed to support as much as possible our investment program and the required security outlays, while containing current spending. The bombings of the Ministry of Finance in August and December of 2009, however, affected our capacity to fully execute our investment plans. Despite this, the 2009 budget deficit, based on preliminary financing data, is estimated to have recorded a deficit of over ID 17 trillion. This deficit was covered mainly by drawing down the balances the government had built up in the CBI and by mobilizing domestic resources through the issuance of Treasury bills.
The global financial and economic crisis has worsened Iraq’s external outlook significantly. The drop in oil export revenues, in particular, presents a major challenge in view of the country’s vast reconstruction and rehabilitation spending needs. Under these circumstances, Iraq is determined to strengthen fiscal discipline to better ensure that the reduced public resources are used more efficiently and that fiscal sustainability is preserved.
Iraq has adopted a budget for 2010 that aims to further reduce non-priority current outlays and align the investment budget with our national priorities and implementation capacity. Iraq seeks to reduce the government’s budget deficits during 2010 and 2011, with a view to returning to a budget surplus in 2012. In addition, Iraq aims to maintain a financial buffer in our accounts equivalent to three months of government wages. Appropriate management of the exchange rate and an interest rate policy aimed at keeping the policy interest rate positive in real terms will continue to be the main instruments to keeping inflation under control. Iraq will also continue to advance our structural reform agenda, with a particular emphasis on public financial management and financial sector reforms.
By continuing to pursue sound economic policies and intensifying our efforts to boost oil production, Iraq aims to accelerate the pace of economic growth. Iraq seeks to increase average crude oil production and exports to 3.1 mbpd and 2.5 mbpd, respectively, by 2012. As a result, Iraq expects real GDP growth to increase to almost 7 percent in 2010 and to 7½-8 percent in 2011 and 2012. Iraq will also strive to keep inflation at around 5–6 percent in the coming years.
As oil prices and production are expected to rise in the medium term, the current account deficit would narrow markedly in the coming years. Since the decline in oil revenues is expected to be temporary until oil production reaches higher levels, Iraq intends to secure adequate financing to avoid a major economic contraction. The international reserves held in the CBI and the DFI (excluding the FMS subaccount) are expected to fall from $55 billion at end-2009 to $46 billion by end-2010 and to broadly remain at that level in 2011 and 2012, before increasing in the following years.
The 2010 Budget
The 2010 budget aims to contain current spending to limit the deficit and create room for higher investment outlays. In this regard, Iraq will contain the government’s wage bill by refraining from granting new wage increases following the large catch-up in salaries in 2008, which carried over into 2009. In addition, net hiring of non-security personnel in 2010 will be limited to new teachers and doctors, until the civil service census is completed. To limit spending related to the in-kind Public Distribution System (PDS), Iraq has initiated reforms that seek to target the benefits of the program to the poorest Iraqis. In addition, Iraq has decided to reduce the number and volume of goods distributed under the PDS system. At the same time, Iraq plans to expand the new targeted cash transfer system. Generalized transfers, in particular to state-owned enterprises, will be sharply reduced, reflecting the improved financial position of many of these enterprises. As a result of these measures, current spending will be curtailed at ID 62.9 trillion (in the IMF’s presentation). By doing so, Iraq has been able to increase the capital budget to ID 25.8 trillion, with an increased focus on electricity, water and sanitation, health, and agriculture. The overall deficit will be limited to ID 17.9 trillion (19 percent of GDP) in 2010 (in the IMF’s presentation).
As our financing needs in 2010 will still be substantial, Iraq will step up our efforts to mobilize domestic financing through the Treasury bill market. To that end, Iraq 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. Also, to ensure integrity in our payment and budget systems, Iraq will refrain from accumulating domestic expenditure arrears.
Global Arab Network
Extracted from letter of Intent of the government of Iraq, which describes the policies that Iraq intends to implement in the context of its request for financial support from the IMF. (IRAQ: MEMORANDUM OF ECONOMIC AND FINANCIAL POLICIES FOR 2010–11)