Iraq's Fiscal and Economic Situation: DIFFICULT TIMES AHEAD - NOVEMBER 2014
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Iraq’s Fiscal and Economic Situation:
DIFFICULT TIMES AHEAD
NOVEMBER 2014
For more information and feedback please contact Dr. Ashraf Abdelaal abdelaal@un.org
1
Iraq’s Fiscal and Economic Situation:
DIFFICULT TIMES AHEAD
November 2014
Table of Contents 01 Introduction: Iraq’s Slowing Economic Growth PAGE 4 02 Falling Oil Revenue PAGE 7 03 Increasing Inflation PAGE 8 04 Worsening Fiscal Situation PAGE 9 05 Higher Poverty and Unemployment Rates PAGE 10 06 Conclusions and Recommendations PAGE 11 Annex I Updates on the 2014 Budget Law PAGE 13 3
01 Introduction: Iraq’s Slowing
Economic Growth
Iraq is the world’s fourth largest oil exporter, holding the fifth largest 2018. However, the current security
crude oil reserves and the resources to significantly increase its oil situation and the absence of a budget
production, while remaining one of the countries with the fastest law have gravely impaired Iraq’s oil
growth in production worldwide. The oil sector has also naturally production and exports, development
become the main source of revenue for the country; its economy is projects, and foreign investment, limiting
almost completely dependent on oil. economic growth. The current limitations
on economic growth, and its known
01 World crude oil exports by country (million sensitivity to the security context, will
FIGURE
barrels per day, mbpd) lead real GDP rates to likely decrease
Source: OPEC, Annual Statistical Bulletin, 2014 in 2014 and 2015. According to the
IMF World Economic Outlook Report
of October 2014, the projected growth
rates for 2014 and 2015 are lower than
the IMF’s estimate in July, the largest
downward revision of any country in the
Middle East and North Africa region.
A number of specific factors have
been limiting economic growth in Iraq
throughout the year:
• The security situation has led to an increase
of commodity prices, due to the unsettling
of local businesses, the disruption of trade,
supply and delivery chains and routes
throughout the country (both for internal
commerce and for imports). Further, the
In recent years due to positive developments in the oil sector, Iraq’s displacement of populations has disturbed
economic growth rate increased from 6.9% in 2009 to 9.2% in the normal balance of supply and demand in
2012 and was projected to reach 9% on average during 2014- re-location areas.
4
• The absence of a budget law for 2014, 11 months into the fiscal • The humanitarian consequences of the
year, is further destabilizing the economy. This has led to the blocking current conflict for the Kurdistan Region
of investment projects—hindering service delivery, limiting the of Iraq (KR-I)—which hosts close to
development of the oil sector, and making it necessary for Iraqi 50% of the approximately two million
authorities to search for foreign investment. However, while the internally displaced people (IDPs) in
security situation scares off international companies from investing the country—strain its infrastructure
in ‘unstable’ terrain, the lack of a budget hurts Iraq’s image in and ability to deliver services. This
international markets, deterring foreign investment. has a tremendous impact on the local
economy in KR-I. This situation, coupled
with outstanding Federal budget
• This situation is inflated by a significant rise in the budget deficit allocation payments to KR-I, could lead
due to a decrease in international oil prices, coupled with lower-than- to economic recession in what is now the
projected oil production, highlighting Iraq’s oil dependency and poor richest region of Iraq.
budget planning. The lower oil prices, lower production and exports
are therefore likely to lead to a liquidity crisis as the Government of
Iraq (GoI) is unable to respond to current and increasing humanitarian
and military costs.
• The budget deficit has also made an impact on State-owned
enterprises (SOEs), namely in the trading, agriculture, and
manufacturing sectors. They are highly subsidized and supported by
large transfers from the government, which also hinders economic
development.
• The long-lasting disputes between the Kurdistan Regional
Government (KRG) and the GoI over oil management and revenue
sharing continue to hinder the passing of the budget law, and to
block revenue from Kurdistan’s oil exports. This further decreases
overall revenue and increases the budget deficit.
502 Real GDP in Iraq
FIGURE
(Annual % change)
Real GDP (%, IMF estimatesafter 2013)
Source: IMF, World EconomicOutlook, October 2014
As shown in Figure 2, Iraq’s economic growth rates are very sensitive
to the security situation. This is clear from the figures for 2007 and
2014. Clearly, as long as the ongoing conflict with Islamic State in
Iraq and Levant (ISIL) continues to escalate, the implications for the
domestic economy are enormous, leading the economic growth rate
of Iraq to likely decrease in 2014 and 2015. In April 2014, the IMF
estimated a growth rate of around 5.9% and 6.7% for 2014 and
2015, respectively. In October 2014, after the fall of Mosul and the
internationally-witnessed expansion of ISIL throughout the country,
the IMF projected a -2.7% growth in 2014, followed by 1.5% growth
next year. The 2014 and 2015 growth figures are full percentage point
lower than the IMF’s estimate in April, the largest downward revision
of any country in the Middle East and North Africa.
602 Falling Oil
Revenue
In 2014, the oil revenue for Iraq was estimated to reach US$ 122 billion based deficit. The upcoming quarter is likely to
on a budgetary assumption that Iraq would be exporting 3.4 million barrels witness further decreases in oil exports due to
per day (mbpd), at an oil price of US$90 per barrel. However, the ongoing the security crisis, as the constant ISIL attacks
crisis resulted in lower oil revenue for the first three quarters of 2014 (25% have prevented Baghdad from exporting oil
less than the budgeted oil revenue) with clear repercussions in the budget to Turkey via a pipeline and to Jordan by road.
03 Oil Revenue
FIGURE
in Iraq
Iraqi Oil revenue (Billion US$) - 2014
Source: Ministry of Oil, GoI
According to 2014 estimates for the Federal Budget Law, the KR-I was On 12 November 2014, Iraqi Oil Minister
expected to export 0.4 mbpd, mainly through a pipeline from oil fields Adil Abdul-Mahdi and KRG Prime Minister
controlled by the KR-I to Turkey or using fleets of tanker trucks. As of 20 Barzani reached an agreement to unblock
November 2014, however, no oil has been exported from KR-I through the budget process. The agreement requires
the State Oil Marketing Company (SOMO) this year or in the previous year. the Federal Government to contribute to
This has hindered disbursement of budget allocations from the Federal resolving outstanding budget allocations
Government to KRG, leading the region to publicly announce unilateral to KRG by disbursing US$500 million
exports in May 2014 and further stalling agreement on the national budget immediately. In a separate move, the KRG
law. The security crisis has stalled the production and export of oil from will provide 150,00 barrels of crude oil per
areas that fell under ISIL control in June, namely, in the oil-rich Disputed month to the Federal Government for export.
Internal Boundaries areas (DIBs) in the governorates of Kirkuk and Ninewa. This agreement is made on a monthly basis
7and is renewable. This is a very necessary step, as it would allow restoring IDPs from Ninewa and the north-central
Treasury revenue of nearly one million bpd from Kurdistan, Kirkuk and governorates continues to arrive to the
the northern oil fields, amounting to over US$30 billion, much-needed region (approximately one million since
amounts especially with the decline in oil prices and the possibility of their the beginning of the crisis). The KRG might
continued decline through 2015. therefore continue exporting part of its
production of oil directly to Turkey and other
On 19 November 2014, Finance Minister Hoshyar Zebari announced countries in order to cope with its financial
the Government had started disbursing the US$500 million to the crisis.
KRG. Nevertheless, the KRG still faces a financial crunch if the flood of
03 Increasing
Inflation
As a result, Iraq’s current financial situation is clearly deteriorating, commodities, which have already been rising
firstly, through capital outflows following the announcements of many in many cities, and in particular, in Baghdad
international oil companies suspending their activities. These capital as people have begun hoarding amid the
outflows are putting pressure on the exchange rate and resulting in higher violence, but also due to unbalances in supply
inflation. Figure 4 shows that the inflation rate in Iraq declined to as low and demand due to population displacement
as 2% in 2013, after a high of 6% in 2012. However, due to the current (more demand in relocation areas), closure of
crisis, Inflation rates will likely rise to reach as much as 4.7% in 2014 and businesses (less supply in unsafe areas), and
6.2% in 2015, according to the IMF. Projected increases in inflation rates are destabilization of supply chains (as some of
also reflecting higher commodity prices, namely for food and other basic the main routes are under ISIL control).
04 Inflation
FIGURE
Rate in Iraq
Inflation (average annual CPI, %, WDI)
Source: IMF, World Economic Outlook, October 2014
804 Worsening Fiscal
Situation
As mentioned above, the continuously deteriorating security context and help internally displaced families (IDPs),
current budget constraints have gravely impaired the development of most of whom foresee worsening living
Iraq’s oil production and export capacity this year. A number of oil fields in conditions as winter approaches, adds
the north and north central regions have been captured by ISIL militants, pressure to government spending.
blocking production in these areas, while, in the absence of a budget
law this year, infrastructure investments in the oil sector stalled, further Adding to the worrying budget deficit, the
hindering production and exports. Adding to decreases in exports, falling lack of a budget law in 2014 (see Annex
international oil prices (below US$90 per barrel to as low as US$70 per I for updates on the 2014 Budget Law)
barrel) will likely decrease revenue further, while other economic sectors, has hindered the capacity of the GoI to
equally affected by the current security situation (as agricultural land and carry out investment projects, left the GoI
factories have been taken over by ISIL in conflict areas) fail to provide unable to finance economic growth, and
expected revenue and put strain on government expenditures. made it essential for Iraqi authorities to
increase foreign investment.
In this scenario of decreasing revenue, the national budget deficit for 2014
is now expected to reach US$44 billion when the expected budget revenue This security and fiscal scenario damages
is US$88 billion for a total of US$132 billion in expected expenditures. Iraq’s image in international markets,
A financial crisis is therefore likely to ensue if the government does leading to a negative trend in foreign
not cut public spending. Keeping this in mind, the Ministry of Finance investment, which will in turn decrease
recommended to limit all spending to operating expenses (plus military demand for the Iraqi Dinar (ID) and lead to
and humanitarian allocations) until the end of this year. plunging asset prices, which may cause the
foreign exchange rate to soar, disrupting
The government is, however, under increasing pressure to spend. The the already fragile financial equilibrium.
already deteriorating security situation in 2013 had caused an increase
in the budget deficit for that year and a consequent depletion of the Adding to the lack of a budget bill for
Development Fund for Iraq (DFI) from US$18 billion to US$6.5 billion. 2014, the drafting of the federal budget
The DFI may have reached levels as low as US$3.5 billion in the summer bill for 2015 is already experiencing delays.
of 2014. With the continuation of insurgency hostilities, the cost of According to the Financial Administration
security is likely to continue weighing on this year’s fiscal balance at Act and Public Debt No. 95, the Ministry
an alleged cost of US$50 million a day. The GoI will face increasing of Finance should finalize the draft budget
difficulties in financing its ongoing war against ISIL, namely in the and send it to the Iraqi parliament for
reconstruction of the Iraqi Security Forces as well as in the development approval no later than 10 October of each
of the projected National Guards. The allocation of necessary funds to fiscal year.
905 Higher Poverty and
Unemployment Rates
The ongoing crisis (both financial, security and humanitarian) will lead as due to lack of investment in services.
to increased poverty, vulnerability and unemployment, especially in The absence of a budget law has not
the Sunni-majority governorates such as Anbar. The negative economic only hindered the development of Iraq’s
indicators in those areas (e.g., unemployment, inflation, etc.) are oil sector, but also the Government’s
estimated to be twice the national rate. One of the most important ability to deliver services, generate
reasons for the current crisis seems to be a sense that the former Iraqi employment, and initiate investment
government has favoured its Shia population, while ostracizing the projects on infrastructure, namely:
Sunni population from the political process. In addition to concern electricity, transport, health, education,
about political marginalization, the Sunni population has legitimate sanitation and other basic social services
economic grievances, which the ISIL has been able to tap into. essential for poverty reduction and
general development.
Poverty and unemployment are associated with conflict. Rising
unemployment, particularly among men, is making them and any Moreover, as the government and State-
dependents more vulnerable to poverty. According to the 2012 Owned Enterprises (SOEs) employ
Household Survey, Iraq’s poverty headcount index at national poverty nearly half of the labour force, wage
line was estimated at 19.8% in 2012. The unemployment rate expenditures are estimated to have
reached 11.1% in 2012, with a disproportionately high rate among reached 17% of GDP. The GoI will have to
youths at 30% and among women at 32.5%. continue paying the wage bills regardless
of per capita output growth or future
Poverty and unemployment are also expected to continue rising due growth rates. This is causing additional
to the current conflict and ensuing population displacement, as well liquidity challenges.
1006 Conclusions and
Recommendations
Iraq’s current security and fiscal situation has clearly affected its financial structures, namely those dealing
access to investment, liquidity and prospects for economic growth, with revenue management and sharing.
while hindering the Government’s capacity to provide basic services,
develop infrastructure, and expand health, education and social Both the UN and other international
security systems. Further, the current security and fiscal situation organizations have had a modest impact
impair Iraq’s long-term development prospects, hindering national or in supporting the Government in the fiscal
foreign investment for economic diversity and employment creation, and economic fields, namely on budget
crucial to overcoming poverty rates. spending and on the implementation of
national strategies and plans into budget
In this context, Iraq is faced with concerning economic prospects law and procurement.
for 2015 and years ahead. While the previous Government kept the
deteriorating fiscal situation under the radar, the new Government Although their capacity in this field is
under Prime Minister Abadi is coming to terms with the need to find limited, UNAMI and UN agencies could
quick and effective solutions to avoid a possible liquidity crisis or engage in a number of ways:
even an economic recession. The new Government has been pushing
for necessary reforms in the security sector so as to more effectively
counter the current security crisis (through more transparent and UNAMI can continue providing good
efficient spending), which can help cut down expenses and alleviate offices, expanded mediation through
the fiscal deficit. technical expertise, and political advice at
all levels (both at technical working and
In parallel, and aware of the dire fiscal situation it faces, Prime Minister Mission leadership levels) in order to solve
Abadi has redoubled efforts to overcome long-lasting disputes with budget and revenue sharing disputes
the Kurdistan Region, so as to gather the necessary oil revenue to between the Central Government and
make up for the current deficit, and solve issues hindering the passing the KRG.
of the Federal Budget Law, essential for restoring its image in the
international markets, bringing back necessary foreign investment,
and in due course, re-starting crucial domestic investment projects. UNAMI and UN agencies can facilitate
contacts with other international
A third avenue for overcoming the current fiscal and economic situation organizations so as to ensure coordinated
is the necessary revamping of Iraq’s public finance management delivery of expertise to public institutions
systems, both in long-term fiscal planning, and in the preparation and in public finance management,
execution of the national budget, as well as in the strengthening of budgeting and revenue-sharing.
11Specifically, UN agencies could facilitate and support the delivery
of technical expertise and advice to the Oil ministry and financial
institutions, in designing a mechanism for effective revenue
management.
UN agencies could support Iraqi authorities through the provision
or facilitation of technical expertise for conducting a sectorial
expenditure review for more efficient delivery of services.
UNAMI and UN agencies could support development and delivery
of information products and advocacy initiatives on the effectiveness
of public spending in accordance with the National Development
Plan, its translation into the yearly National Budget and the necessary
reflection on both of the needs of the most vulnerable.
12Annex I
Updates on the 2014 Budget Law
In October 2013, the Iraqi Council of Ministries (CoM) approved protest for specific articles pertaining to
the 2014 budget without the consent of the Ministries from the KRG budget allocations, which KA saw as
Kurdistan Alliance. The draft budget bill was then sent to the finance punitive clauses. The federal budget bill
committee in the Council of Representatives (CoR). was therefore deferred to the new CoR.
In November 2013, the finance committee rejected the draft On 23 July 2014, the new CoR created
bill and returned to the CoM requesting that the budget deficit be an ad-hoc finance committee, headed by
reduced and financial problems with the KRG resolved. then Deputy Speaker Haider Abadi (and
former head of the Finance Committee
in the previous COR), who presented a
In December 2013, the CoM amended the bill by reducing the preliminary report on 18 August, with
budget expenditure to US$140 billion from the previously proposed a number of amendment proposals for
US$150 million. The bill was re-approved and sent to the CoR finance the draft budget law. Firstly, the ad-hoc
committee for a second time, again without the consent of Kurdistan committee proposed to eliminate the
Alliance members. so-called “punitive” articles, which made
KRG’s full reception of their allocated
budget (17% of the total budget)
In January 2014, the bill was again amended to respond to oil dependent on reaching their targeted
producing governorates’ demands for further budget allocation, the oil production (400,000 bpd). Secondly,
so called “Petro dollar”, as Governorates requested US$5 per barrel it proposed to re-align the existing
instead of US$1 to make up for use of land and environmental budget ceiling to more realistic revenue
hazards connected oil industries, once again bringing the estimated projections, limiting it to projected oil
deficit up. revenue until the end of 2014. Finally, the
committee proposed to limit spending to
operating expenses, with the exception
The Iraqi Council of Representatives (CoR) failed to agree on the federal of immediate funding needs for security
budget bill for 2014. The draft law was indeed never voted for lack of forces and internally displaced people
quorum, mainly as a result of the withdrawal of Kurdistan Alliance (KA) (IDPs), in response to the present context
members from CoR sessions during the reading of the budget law, in of security and humanitarian crisis.
13On 8 September 2014, the Finance Committee asked the CoR On 19 November, Finance Minister
to resend the draft budget bill to the Ministry of Finance to be Hoshyar Zebari announced that the
amended accordingly and requested the Government to speed up Federal Government had commenced
the completion of the amendments and send the new draft back to the disbursement of US$500 million to
the CoR for approval, indicating as most important recommended the KRG in accordance with the interim
amendments the elimination of the “punitive” articles relating to the deal on oil and revenue sharing. However,
KRG. the expected visit by KRG Prime Minister
Barzani to Baghdad (to finalize budget
and revenue sharing negotiations) was
On 30 September 2014, however, the Council of Ministers (CoM) postponed as Barzani is allegedly waiting
rejected the draft bill provided by the Ministry of Finance and returned until the US$500 million is fully received
it again requesting that the budget deficit be reduced to 15% instead by KRG.
of the present 40%. During the month of October, the CoM refrained
from discussing the federal budget bill in its weekly sessions.
Eleven months into the fiscal year, it is no
longer expected at this point that the CoR
On 5 November, the CoR again discussed the 2014 budget, agreeing will actually pass the Budget Law for 2014,
to stick to 2013 allocations, with adjustments in civil servant salary as all eyes must now be turned to the 2015
grades, while increases in social welfare allocations would be made Budget, which is already suffering delays.
in 2015. The current budget will also include immediate military and According to the Financial Administration
humanitarian expenditures, while only special investment projects Act and Public Debt No. 95, the Ministry of
(previously agreed between the provincial councils and the Ministry Finance should finalize the draft budget and
of Planning) will be allocated. The passing of the 2014 budget law send it to the Iraqi parliament for approval
was again dependent on further negotiations between Erbil and no later than 10 October of each fiscal year.
Baghdad with expectation that KRG would be able to make some
concessions (including re-starting Kirkuk oil exports through SOMO).
On 27 November, Finance Minister
Zebari submitted a proposal to the
On 12 November, Iraqi Oil Minister Adil Abdul-Mahdi and KRG Prime Council of Ministers on the budget for
Minister Barzani reached a breakthrough agreement on Kurdistan oil 2015. Parliament is expected to begin
exports and outstanding budget allocations. The agreement requires deliberations on this proposal in December.
the Federal Government to transfer outstanding budget allocations However, it remains to be seen if it will be
to KRG (a first tranche of US$500 million) while Kurdistan ensures approved by the legislature before the end
the export of 150,000 barrels of crude oil per day through SOMO. of the year.
14Iraq’s Fiscal and Economic Situation: DIFFICULT TIMES AHEAD NOVEMBER 2014 For more information and feedback please contact Dr. Ashraf Abdelaal abdelaal@un.org 15
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