After a full year of political stalemate and fierce power struggles, Iraq’s ruling elite have finally managed to form a government led by Mohammed Shia’ al-Sudani. Thanks to the surge in international crude oil prices, Sudan’s new government has inherited a rather large oil bonanza, with the potential for huge revenues if handled well. However, the government’s ability to properly invest in this opportunity, taking into account its development and reform plans, is highly questionable due to the very political settlement that gave birth to the new government.
Locally known as the ‘Muhasasa’ system, this settlement dictates the ethno-sectarian power-sharing divisions that have plagued the Iraqi government since 2003. Indeed, the system is widely blamed for rampant corruption, structural imbalances, the weakening of state institutions, and the failure of the government to deliver services to the Iraqi people. Case in point, the national poverty rate in Iraq is above 25%, and the unemployment rate is higher than 14%.
Given the outcomes produced by the Muhasasa system in the past, it seems unlikely that Sudani’s government will function any better than its predecessors or be fully able to seize on the oil market windfall to improve Iraqis’ welfare instead of further enriching the ruling elite. As was the case in 2008, Iraqis will miss out on this opportunity to address some of the country’s most pressing concerns unless the government can tackle several key economic and political barriers.
Nevertheless, the rising oil revenues provide great resources to address Iraq’s dire needs to improve its infrastructure and enable a safer physical environment. Both are preconditions to revitalizing the country’s undeveloped private sector and ultimately diversifying its oil-dependent economy.
The Oil Bonanza and Iraq’s Structural Challenges
Iraq’s federal government is expected to gain $114 billion USD in oil rents by the end of 2022, a clear spike from $75.651 billion in 2021 and $41.948 billion in 2020. The government’s additional cumulative oil revenues in 2022—without independent oil sales from the Kurdistan Region of Iraq (KRI)—is expected to reach $38 billion USD. Moreover, the previous government in Iraq was able to achieve fiscal surpluses in 2021, and the country’s GDP growth is projected to reach 9.3% in 2022, up from 3.6% in 2021 and significantly higher than the projected global average growth of 3.2%. The government’s current account has boosted gross international reserves of the Central Bank of Iraq to $94.6 billionUSD, the highest since 2003.
Lacking any active sovereign wealth fund—one of the means through which other regional oil rentier states manage surpluses—however, the rising oil revenues have generated many debates and arguments among Iraqis as to how these revenues can best be deployed. On the one hand, populist MPs and political blocs are focusing on the distributive side of Iraq’s import-based economy. These figures argue for a depreciation of the value of the Iraqi Dinar (IQD) in a bid to reduce inflation and increase purchasing power of low-income citizens. On the other hand, many economic experts have warned about the danger of devaluing the IQD.
A higher IQD value would raise production costs for Iraqis, while reducing domestic goods’ competitiveness in favor of cheap Iranian and Turkish imports. The devaluation would also undermine the country’s macroeconomic stability and cost the Iraqi government at least $15 billion USD given that the government sells its crude oil (about 99% of all the country’s exports) in USD while accruing most of its expenses in IQD. Therefore, keeping the foreign exchange rate at its current level is necessary to preserve macro-stability and best facilitate using the oil revenues on upgrades for services institutions, infrastructure improvements, and foundational economic reforms to tackle the country’s structural imbalances.
No matter how the debate ends, transforming this opportunity into truly constructive outcomes will require a lot of work from the Sudani government—a government supported by the Iranian-backed Coordination Framework. Already, this government is enduring constant demands for an increase in investments in the country’s underdeveloped infrastructure and dysfunctional service institutions. Iraq’s meager private sector desperately needs to be revitalized, and its oil-dependent economy needs to be diversified.
Likely the best way to spend these oil revenues would be to fund neglected public infrastructure projects. More than 1,450 public projects—including hospitals, roads, schools, bridges, and more—have been halted due to a lack of funding, corruption, and bureaucratic impediments, with many lying abandoned since the 2014 financial crisis. Funding these projects would further enhance service institutions, improve the business environment, and ultimately stimulate the private job market.
In addition to these usual challenges, water scarcity and drought have exposed Iraq to a new set of crises. Ranked as the fifth most vulnerable country to climate breakdown, Iraq’s loss of water from key rivers, including the Tigris and Euphrates, might turn vast areas of the country into desert. Government officials estimated losing 50% of Iraq’s water reserves from 2021. Environmental degradation and poor water management pose grave threats to the sustainability of food security for Iraq’s 42 million citizens.
Internal displacement, loss of livelihood, and excessive urbanization—all connected to these environmental issues—have emerged as new domestic crises. Water scarcity also raises significant questions about the capability of the Sudani government to safeguard Iraq’s agriculture, which employs one-fifth of the country’s labor force without concurrently addressing the country’s water management issues and limited water flow from Iraq’s riparian neighbors.
Pathways Forward
Even if Iraq’s new government decides to break from the status quo, how Sudani and his cabinet will actually respond to ongoing challenges remains the hardest question to answer. If they want to spend the funds of the oil bonanza on development, perhaps Iraq’s lauded but unimplemented 2020 White Paper for Economic Reforms can serve as a blueprint. This report provides a clear vision about how to tackle the country’s most dire economic challenges, from its bloated public payroll to poor water management and national power shortages.
Starting with the 2023 budget law, the new government can take serious steps in the right direction by scaling up infrastructure investments, upgrading service institutions, and removing barriers to private sector development. These efforts would lay the foundation for even more structural reforms.
Moreover, activating Iraq’s sovereign wealth fund (SWF) would help in properly saving and utilizing the oil revenues. The SWF is set to deposit 1% of the country’s oil rents in order to build up cash reserves for future generations and create buffers to withstand the shocks of international oil price fluctuations. Since crude oil accounted for 99% of Iraq’s exports, 85% of the government’s budget, and 42% of the country’s GDP over the last decade, this shock protection is crucial. The SWF’s potential deposits could also be used to finance renewable energy projects, addressing the chronic power shortages that Iraq has faced since the 1990 Gulf War. Nevertheless, the sad reality is that the government is unlikely to move forward on any of these reforms.
Mounting Challenges and No Proper Equipment
The Sudani government likely lacks the tools to handle the myriad obstacles on their path to implementing such investments effectively. Rampant corruption and anticipated intra-elite conflicts—especially between followers of Shia Cleric Muqtada al-Sadr and the Coordination Framework—are some of the largest of these hurdles. The fear of wasting Iraq’s oil windfall to intra-elite conflicts is not entirely outlandish. Just months ago, Sadr’s followers stormed the Green Zone and caused immense political paralysis in the wake of Sudani’s initial government formation, and they are likely poised to do so again if they feel that they are being snubbed by the new government.
Nor would it be the first time that Iraq’s oil rents were fraudulently used up in the last two decades. The most recent manifestation of this country’s endemic corruption was the disclosure of a 3.7 trillion IQD embezzlement scheme (about $2.3 billion USD) which took place over the last fourteen months within the state-owned Rafidain Bank via a network of public officials and five shady companies. Despite rhetoric claiming otherwise, Sudani’s government is expected to sustain Baghdad’s ‘business as usual’ approach to the corruption of the ruling elite unless grass root pressures resurface to combat corruption and back reformist forces within and outside the government.
Just as its predecessors did, Sudani’s government is likely to try to pump up the economy through the oil windfall before the planned snap elections in late 2023. If reformist forces, NGOs, and media join together to pressure the Iraqi government to allocate part of the oil revenues to public infrastructure investments, most Iraqis will be better off. Here, the 2023 budget law is a golden opportunity to focus on key services sectors such as education, health, and electric power rather than increasing military and security expenditures.
Obviously, it is not easy to balance the demands of the ruling elite that back Sudani against the needs of the millions of Iraqis who took to the streets to demand better governance. Sudani’s trade-off is whether to appease the ruling elite or increase infrastructural investment to deliver better services and revitalize the private job market—passing on part of the oil revenues to the low-income citizens who work in the informal economy. Failure to handle this trade-off would expose his cabinet to the previous governments’ challenges and likely prompt a return of civil unrest that has roiled the country in previous years.
The Article is published first by Fikra Forum of Washington Institute.
The Kurdistan Regional Government (KRG) stepped into 2022 with not enough cash to pay the December salaries of civil servants and pensioners; delayed to January 2022. Now, at mid-March, civil servants are going on strike and taking to the streets of Sulaymaniah to demand their February salaries.
The evidence on the ground shows that the government developed a clear set of reform policies, and a special law was passed to reform public finance management (PFM) that has been followed in recent years. Nevertheless, there is no evidence that these reforms were implemented. The government did not demonstrate its following of better practices although there have been an observable opportunity and available political and institutional capacity to do much better. As a result, the government is still struggling to meet growing demands for services and allocating resources according to policy priorities.1
This article aims at evaluating the KRG’s PFM in 2021 and estimating the economic consequences of neglecting the reform of law and policy.
Conventional objectives of PFM are known as aggregate fiscal management (making sure not to accumulate too much debts); maximizing the mobilization of resources and allocating them according to policy priorities; ensuring the value of money in services-delivery with the best combination of efficiency, effectiveness, and economy; and finally financial governance that has transparency and accountability by putting rules, procedures, and practices in place to achieve the entire four goals (Parry). Each government has a different strategy in prioritizing any of these objectives. However, successful PFM basically pursues all of them simultaneously. Thus, the article assesses the KRG’s PFM from the perspective of the aforementioned objectives.
The Setting
The last time that the KRG had a budget law was in 2013. The government has been struggling with continuous financial and economic crises since 2014, when the ISIS war started, crude oil price crashed, and the region’s national budget-share was cut off by the Federal Government of Iraq (FGI) as a result of their oil disputes. Therefore, the KRG’s PMF is faced with a set of political, security, and economic challenges. To tackle the challenges, the region’s leadership has been advised to reform thePFM by several international organizations such as the World Bank, USAID, and EU. It was also offered technical support to do so (World Bank).
The Kurdistan Parliament passed Law Number 2 (2020) to reform the region’s payroll and revenue streams on January 16, 2020 (Kurdistan Parliament). The law mandated the government to reduce wasteful expenditures, unify pensioners’ directorates, resume pensioners’ fund and financial entitlements. However, the law has neither been fully implemented nor has it led to any tangible results due to political constrains. The KRG still struggles with the same challenges as it has prior to 2020.
As in December 2021, ghost employees still take a large portion of the payroll funds, some revenue sources are controlled by deep state power networks of the ruling parties. Border ports such as Peshkhabir and SairanBand are controlled by networks belonging to Masud Barzani’s Kurdistan Democrats Party (KDP) and Bafel Talabani’s Patriotic Union of Kurdistan (PUK). By June 2021, the public debt of Kurdistan Region of Iraq (KRI) increased to $31.6, unfinanced public expenditures are estimated at 300 billion Iraqi Dinar (IQD), about $205 million. Also, the government was
not able to pay December salaries till January 2022 due to lack of liquidity. Even if the crude oil price is bounding and COVID-19 restrictions on economic activities are relaxed, the fiscal situation still poses many threats to the stability of the region. The World Bank projected Iraq’s GDP growth (including KRI) at 2.6% in 2021 and over 6% in 2022-2023, but it has pointed out that “Nevertheless, without accelerated economic reform, unforeseen domestic and fiscal risks could cause reverses.”(World Bank)
The pitfalls of the KRG’s PFM played out in many areas, posing multiple political and security challenges. Civil servants’ protests for unpaid salaries and increasing public debts are the most reported consequences. Moreover, less reported but most effective is the underfunded infrastructure. The fiscal trend has reduced investment and development spending under pressures of bloated payroll and operational expenditures. The payroll took 83% of the region’s revenues in 2021. Only 4% of the total government spending was allocated to infrastructure and development projects as Figure 1 demonstrates. Public debt rose to $31.64 billion (Zhyan News Network), which is more than 119% of the region’s GDP2.
Contrary to the frequent announcements made by successive governments, the economy is still far from being diversified as crude oil revenues and transfers from FGI comprise 64% of total public revenues as Figure 1 demonstrates. Thus, the PFM inform policy makers for immediate reform-actions.
Figure 1: The KRG’s total spending in 2021
Source: The figures are not verified by any formal institutions in KRG. They are collected from members of Kurdistan Parliament’s finance and natural-resources committees, two employees at the finance ministry. They show the trend rather than deep econometric analysis.3 They are unlikely that they were updated on a regular basis. The KRG sometimes gets private firms to finance certain development projects in exchange of awarding them certain services or construction contracts. The costs of these privately funded projects are not counted in these data
Fiscal policy, which is a clear outcome of the ruling elites’ short-term gains, has led to underfunded infrastructure but extremely bloated
payroll. Nearly one fifth of the region’s population (about 1.2 million people) is on the public payroll. That is certainly at the expense of development projects and infrastructure investment. For instance, a road construction project (between Sulaymaniah and Kalar) started in 2012 but still not completed due to lack of finance. Only 56% of the project is completed as promised funds have not been delivered (Radio Deng).
On the revenue side, the KRG still wastes huge amount of resources on poor management and illicit activities. The KRG’s revenue streams including, but not limited to, independent oil sales, taxes on goods and services, fees and fines, property income, monthly transfer from FGI, customs duty, and financial support for the Peshamrga from Anti-ISIS Coalition, as Figure 2 demonstrates:
Figure 2: KRG’s total revenues in 2021
Source: The KRG’s oil revenue for the first half of 2021 is taken form Deloitte reports. The other figures are not verified by formal institutions of KRG. They are collected based on interviews with members of Kurdistan Parliament’s finance and natural resources committees, two employees at the KRG’s finance ministry, and several employees in the border ports of KRI. The figures show the trend rather than any econometric analysis. They are taken from various institutions and it is unlikely that they are updated on a regular basis. Revenue calculation does not include any forward oil sale that the KRG usually does due to lack of formal data. It probably is underreported in the government’s total net oil revenues. To have a unified monetary unit, revenues in USD are converted to IQD based on the official exchange rate at $1=1460 IQD, which is very close to the market exchange rate that is still about $1=1480.
Evaluating the KRG’s PFM in 2021
The KRG’s 2021 PFM is a good indicator to assess the region’s leaders’ commitment towards their declared reform agenda although the whole economy is yet to recover from COVID-19 implications and the oil price downturn in 2020. On its website, the KRG’s ministry of finance and economy announced an ambitious reform agenda to reduce public debt, encourage investment, and diversify the economy. It also aims to develop key job-creating sectors such as industry, agriculture and tourism in addition to improving the business enabling environment (Kurdistan Regional Government). The government’s 2021 spending and revenue- management shows no political commitment towards these goals. No public debt was reduced and no payroll reform was properly implemented. Although it is not realistic to expect fixing the region’s fiscal issues in one year, but the 2021 PFM (which is aligned with the region’s fiscal trend over the past 19 years) shows how the leadership approached the challenges from the perspective of the conventional objectives of PFM.
First, starting from aggregate fiscal management, the KRG’s debt management tells how the government’s aggregate fiscal discipline is poorly managed. The increased oil price in 2021 created expectations among Kurdistan’s citizens for gradually reducing debts; though by the end of the year more debts were accumulated especially arrears to the private power producing companies which increased to almost $5 billion (PORTER).
The KRI’s debt to GDP ratio is about 119%4. There are no official reports and data on debts, that are mostly internal, including $5 billion of the private power producing companies, about $12 billion of unpaid salaries of civil servants and pensioners (over the past 7 years), $4 billions of local banks. The rest are financial dues of local contractors, international oil companies, and oil traders.
The burden will be high on the future generations. Every baby born today in the KRI owes more than $5273 (equal to 7.6 million IQD) in the KRG’s debts. Additionally, the government, again, rolled back in paying December salaries due to lack of liquidity5. Studies show that in emerging markets the threshold of debt to GDP ratio should not exceed 64%. Any percentage point higher than this threshold would lead to a loss in annual real growth by 2 percentage points (Mehmet Caner).
Second, another indicator to assess the KRG’s PFM in 2021 is the way the public resources are allocated to deliver services and address the KRI’s overall development deficit. The 2021 data shows that 426 billion, of approximately 11 trillion IQD (only 4%), of public spending is allocated to infrastructure and development projects. This allocation cannot help lifting the economy out of its structural imbalances. Furthermore, it would not help improve the basic infrastructure needed to develop the region’s business enabling environment.
The fiscal trend did not support, but rather contradicts, the government’s reform agenda for diversifying the economy and making the private sector create jobs. The policy on the ground as well as the reform agenda needs a sound business enabling environment and supportive infrastructure to attract investments. It requires spending more on the underfunded infrastructure rather than the bloated payroll. It is also one of the reasons that led to the bloated payroll since the private job market does not afford enough opportunity for youth. The government had to absorb unemployed youth by offering public jobs.
Third, ensuring the value of money in service delivery is another area where the KRG’s PFM performance should be examined. One way to see how the KRG’s services are delivered is examining the government’s policy for outsourcing some services. The government has more than 800 thousand employees on its payroll, but it hired an international accounting firm, Deloitte, to produce financial reports on its oil sector. Of this number on the payroll, more than 300 thousand are armed men (including members of Peshamrga, police, and other types of security forces,) but the government has hired various private security companies to protect oil fields and facilities.
In the financial sector, similar to the rest of Iraq, the KRI’s public banks deliver no digital services to better meet consumers’ expectations and needs. The economy is still heavily cash-based, and most of the transactions are taking place through money transfer offices in the informal market.
Finally, with the above-mentioned issues, not surprisingly, the KRG has not done well in term of financial governance. No statistical data are available on the government’s public spending and revenues. It has been 8 years during which the government functions without a budget law. Neither the Kurdistan parliament nor Kurdistan’s Board of Auditing receive data or statistical reports on the government’s total spending and revenues.
Additionally, the government has no rules, procedures, and practices to ensure transparency and accountability that could help achieving the entire PFM objectives. It has no published data on the whole government’s revenues and spending; access to information is very poor even compared to what FGI has provided. For instance, the FGI’s ministry of finance regularly publishes basic statistical reports on its revenues, expenditures, and allocations. However, the KRG has never published any similar report.
Good PFM requires some level of transparency and accountability more than what KRG has afforded. It needs real public access to key fiscal information on different aspects of budget performance as a measure of fiscal transparency. It basically means increasing visibility of what the public entities do and how they do it. It also means full information to be available about public expenditures, revenues, and debts. However, the KRG’s performance is the opposite.
Partial Reforms Turned Unfruitful
Facing the dramatic twin shock of oil price downturn and COVID-19 implications in 2020, the KRG’s leaders promised to take anti-corruption measures and diversify revenue streams of the government to move away from oil dependency. Usually, with each cyclical oil price downturn, fiscal pressures push FGI’s and KRG’s leaders to promise ambitious reform actions such as diversifying the economy and rationalizing expenditures. When oil price goes up, they leave reform promises undelivered and come back to the same business as usual. This trend, which has dominated Iraqi and Kurdish politics since 2003, might not work anymore for the KRG due to its relatively limited oil revenues. The region is in dire need to reform the PFM; otherwise, civil unrests and general strike is going to be the most expected scenarios based on past records.
Given the KRG’s structural PFM issues, some challenges can be handled with the available resources and conditions. Some immediate reform actions would yield substantial results. There has been discussion among politicians about ghost employees and illegal pensioners on the public payroll. This led to a biometric registration system introduced by the government in 2017 to reform the payroll and remove the ghost employees and illegal pensioners. However, the payroll reform has been too slow and faced huge political constrain since most of the ghost employees are members of the ruling parties’ cadres. The payroll waste in 2021 is estimated at more than 1 trillion IQD as the following graph shows.
Figure 3: The KRG’s 2021 spending, compared to projected spending (Counterfactual) after taking some reform actions
Source: The KRG’s oil revenue for the first half of 2021 is taken form Deloitte reports. The other figures are not verified by formal institutions of KRG. They are collected based on interviews with members of Kurdistan Parliament’s finance and natural resources committees, two employees at the KRG’s finance ministry, and several employees in the border ports of KRI. The figures show the trend rather than any econometric analysis. They are taken from various institutions, and it is unlikely that they are updated on a regular basis. Revenue calculation does not include any forward oil sale that the KRG usually does due to lack of formal data. It is probably underreported in the government’s total net oil revenues. To have a unified monetary unit, revenues in USD are converted to IQD based on the official exchange rate at $1=1460 IQD, which is very close to the market exchange rate that is still about $1=1480. The projected spending is based on the scenario that removing ghost employees and illegal pensioners would reduce payroll spending by nearly 12%.
In addition to the payroll reform, there are other reform opportunities in the revenue streams that can yield immediate results. Taking some procedures to manage the oil sector better is likely to increase the KRG’s net oil revenues by approximately 18%6. For instance, the KRG have undersold its crude oil at $9 per barrel (pb) less than Iraq’s oil price and $11 pb less than the Brent benchmark oil price in the first half of 2021. The KRG’s discount is a clear outcome of its political disputes with the FGI over the oil sector management. Iraq’s 2021 budget law laid foundations to resolve these disputes and put Iraq’s ministry of oil in charge of selling KRI’s oil. That could have been an opportunity to add more than 1 trillion IQD to KRG’s oil revenues just by reducing this discount by half.
Figure 4: Actual 2021 revenues, compared to the projected revenues (counterfactual)
Source: The figures are not verified by official institutions of KRG. They are collected based on interviews with members of Kurdistan Parliament’s finance and natural resources committees, two employees at the KRG’s finance ministry, and severalemployees in the border ports of KRI. The figures show the trend rather than any econometric analysis. They are taken from various institutions and it is unlikely that they are updated on a regular basis. Revenues calculation does not include any forward oil sale that KRG usually does due to lack of official data. It is probably underreported in the government’s total net oil revenues. To have a unified monetary unit, revenues in USD are converted to IQD based on the official exchange rate at $1=1460 IQD, which is very close to the market exchange rate that is still about $1=1480.
Likewise, there is an opportunity to increase customs revenues of KRI’s border ports by approximately 26% if illicit activities and smuggling operations are prevented in the border ports. Overall, the revenue differences, as a result of the above-mentioned reform actions, are estimated at more than 2 trillion IQD in 2021 as Figure 4 shows.
Reforming the KRG’s revenue streams and public spending basically implies a set of actions starting with improving capacities of law enforcement institutions, public finance inspectors, and introducing components of e-governance. Improving revenue collecting capacity is viable once it is associated with a strong political willingness to fight corruption. Taking partial measures to improve PFM in certain areas but exempting illicit activities in other areas proved unfruitful over the past 3 years.
For instance, the government introduced a sophisticated computerized system to replace the old manual system for calculating customs duty and facilitate trade exchange in the KRI’s border ports. Technically, the system works well in three major KRI’s border crossings (Parwezkhan, Bashmakh, and Haji Omeran); however, it has not been introduced in the other 7 border ports (official and unofficial ones from Peshkhabir and Ibrahim Khalil in Duhok to Pshta in Sulaymaniah).
The computerized tariff calculation system works well in reducing losses arising from petty corruption and some forms of bribery. But, the entire system is bypassed when the smuggling cartels (belonging to the ruling elite) are involved in letting in imports without paying tariff. It cannot stop powerful political and security officials from smuggling operations and taking in imports beyond the tariff calculation system. This is a stark example to show how useful tools for reform cannot yield good results if there is no political willingness to back it. The literature shows that similar issues happened in many middle income countries where technology innovations that led to the creative destruction of existing technology are subdued as they harmed the interests of influential ruling political figures (WANG).
There are technical solutions for most of the KRG’s fiscal and economic weaknesses. Several international entities and development agencies such as the World Bank, UNDP, USAID, EU have advised the government to better handle its PFM. However, political constrains have hindered the required reform actions. One of the most resilient challenges is the political economy of KRI. The way the political dynamics have played out hampered efforts to reform the PFM. Like the chicken or the egg causality dilemma, it is not clear whether this political economy created the poor PFM, or vice versa.
The region’s economy has been strictly controlled by two patronage networks of Masud Barzani’ Kurdistan Democrats Party (KDP) and Bafel Talabani’s Patriotic Union of Kurdistan (PUK). The two rival parties control economic activities in the private sector and manipulate public jobs to keep their domination. They monopolize construction and service contracts to politically linked companies that usually bypass competition in exchange for sharing some profits with the key figures in the ruling parties, which have governed the KRI since 1991.
Moreover, the patronage networks have a few cartels to conduct illicit and extortion activities that clearly undermine the KRG’s ability to collect revenues. Some leaders of the parties facilitate imports without paying tariff in the border ports of KRI (Skelton). The smuggling activities (conducted by the cartels belong to the same parties) still take huge part of the customs revenues. According to one of the border ports’ directors, 80% of customs revenues go to some companies and not the KRG’s treasury (Wali).
Apart from the high level of corruption, KDP’s and PUK’s deep-state networks of power have divided KRI into two zones (yellow and green zones respectively) according to their parties’ military influences. They monopolize extortion activities and other gains from the revenue streams. This political economy that basically generated the fiscal challenges always hinders reform efforts. Therefore, technical and fiscal solutions might not yield desired results unless they are backed by strong political willingness to address these challenges.
Estimated Losses to the Neglected Reform Policies
Figure 5: KRG’s 2021 revenues & spending, compared to the projected revenues & spending (counterfactual)
Source: The KRG’s oil revenue for the first half of 2021 is taken form Deloitte reports. The other figures are not verified by formal institutions of KRG. They are collected based on interviews with members of Kurdistan Parliament’s finance and natural resources committees, two employees at the KRG’s finance ministry, and several employees in the border ports of KRI. The figures show the trend rather than any econometric analysis. They are taken from various institutions and it is unlikely that they are updated on a regular basis. Revenue calculation does not include any forward oil sale that the KRG usually does due to lack of formal data. It probably is underreported in the government’s total net oil revenues. To have a unified monetary unit, revenues in USD are converted to IQD based on the official exchange rate at $1=1460 IQD, which is very close to the market exchange rate that is still about $1=1480.
The expected reform actions could have yielded both short and long- term gains. The estimated return of reforming the KRG’s oil sector management, payroll, and customs regime is projected to be more than 3 trillion IQD in 2021. This is about one fourth of the region’s annual expenditures. The following graph estimates the differences between the actual 2021 spending and revenues, compared to the projected revenues and spending (counterfactual) after implementing the above-mentioned reform actions
Again, the KRG’s challenges cannot be handled by only economic and financial tools while political commitment is absent from the ruling elites to take the needed reform measures. In the absence of real pressures and within the same political economy, partial and sectorial actions to address the impediments remain ineffective. Therefore, the region’s leadership needs to think outside the box and move with a set of sharp actions that can address the fiscal issues in 2022.
Recommendations
Effective government needs to deliver sound PFM and high-quality services as pre-conditions for a stronger and fairer economy. The KRG’s leadership needs to consider the following policy actions to address the PFM challenges if it wants to stop struggling with the same issues in 2022 and the coming years.
For the KRG’s financial institutions
1- Introducing an annual budget law aligned with a multi-year budgeting framework that considers development needs of KRI would help the government better manage its public finance. The framework could be a comprehensive 10-year development plan including sound policies to direct annual budget laws according to the government’s articulated reform goals. It would help moving out of the vicious circle of the above-mentioned political economy and rationalizing public expenditures in favor of development.
2- Apart from the usual budget laws, some expenditures can be structured to meet sectorial needs of the economy by certain development programmes. This can be part of a whole national plan or sector-based programmes according to the needs of each specific sector especially the job creating sectors such as tourism, agriculture, manufacturing, and transportation. The annual budget discussions and laws should be constrained by the development plans.
3- The government needs to put a ceiling on payroll and operational expenditures to reallocate funds for infrastructure investment. Funding infrastructure projects is the key pre-condition for any sustainable economic growth.
4- Introducing performance-budgeting tools to measure adequacy of public expenditures (what they are achieving, not just what they are spent on) is crucial. There should be an input/output calculation for spending and improving the efficiency of public institutions.
5- One way to address the KRG’s PFM is to improve productivity in the public sector. While the productivity issue has not been addressed yet, the KRG outsources some services to politically linked companies. This has brought public private partnership (PPP) to policy discussions. Indeed, PPP can be a useful mechanism in some areas and sectors but not for the low skilled services where the government already has a large number of civil servants to do it. For instance, privatizing the bill-collecting process in the electricity sector would be beneficial as the governments have failed to manage it whereas sonar and health checking at border ports are not something beyond the technical capacity of the public institutions.
6- Sharing statistical data and financial reports on the revenues and expenditures would help improve transparency and accountability. Hundreds of media outlets, NGOs, and international organizations could be involved in the discussions and debates needed to help reforming the financial sector if the KRG provides access to the financial data and reports. Reforming the KRG’s PFM would be easier once it becomes part of policy discussions and public debates.
7- Revenue enhancing measures are doomed to fail if the entire government is not involved, especially security forces to limit smuggling and extortion activities in the border ports. Similarly, the wasted revenue in the oil sector is also another area where the whole government should be involved to negotiate with Iraq’s oil ministry to allow the State Organization for Marketing of Oil (SOMO) to sell Kurdistan’s oil and limit the waste to the disputes driven discounts. Furthermore, to cut unnecessary spending on private security services and deploy the Peshamrga and security forces, the whole government is needed as well.
For the KRG’s Political Leadership
8- Bypassing the deep state power networks, the KRG’s leadership can separate their policy goals from the demands of their political parties’ patronage networks. It is not an easy trade-off but not impossible too if they want to have a more stable financial situation. For the KRG’s leaders, dealing with their political parties’ members is always easier than cracking down onthousands of civil servants protesting for their unpaid salaries or youth taking to the streets to demand employment opportunities.
9- Improving the control of the border ports to decrease smuggling and reduce extortion in the region’s market is highly necessary to let economic activities grow and KRG’s revenues increase. Without protecting the revenue streams in the border ports and limiting the extortion in the private sector, reform is unlikely to happen in the KRG’s PFM.
10- Looking at the privet sector as engineer of growth, the KRG’s leadership has to move against the extortion activities of the same deep state networks. The networks have strictly controlled the market and prevented it from growing and expanding. They prevent investment, limit competition, and ultimately distort the economy. Such an environment is the main reason to keepKurdistan’s job market poor and pushing the region’s youth to look for opportunities broad.
11- Sustainable economic growth is not an achievable goal without reducing inequality, especially gender inequality. It implies enhancing the role of women in the economy and increasing female labor participation.
12- Reforming the power sector is crucial for private sector activities and the whole economy. Any reform measure in this sector needs to start with the bill collecting mechanism and making the sector self-financing; otherwise, the KRG will be further indebted to the power producing companies. Also, it has to introduce some regulations to privatize services in the sector and maximize the availability of power in addition to getting rid of the expensive and polluting private neighborhood power generators.
*Mohammed Hussein is an Iraqi economist specialized in the political economy of Iraqi Kurdistan Region. He is fellow of the Iraqi Economists Network and policy director at ICPAR.
**This article is first published on the website of Iraqi Economists Network.
Footnotes:
1 The KRG’s finance ministry announced on its website a reform agenda that includes reducing debts, diversifying the economy, and improving business enabling environment; https://gov.krd/english/the- governments-mission/reforms/
2 The KRG’s GDP was estimated at $26.5 Billion in 2016; there is no annual GDP figure in the region. The debt to GDP ratio is based on the total debt in 2021/ 2016 GDP. ($31.64/26.5 (total debt/GDP). The calculation does not account for inflation and the new foreign exchange rate, in which the Iraq’s Dinar is deprecated by more than 23%.
3 The KRG does not publish monthly/annual financial reports. Kurdistan parliament’s committees and other public institutions have no detailed reports on the region’s total revenues and spending. No media outlets and any financial organization have published complete reports on the region’s spending and revenues. Deloitte’s reports on oil and gas sector are good to show oil and gas sector revenues in the first half of 2021, but the rest of the revenues are not reported by the government institutions.
4 The KRG’s debts reached $31.637 billion by June 2021. The debt to GDP ratio calculation is based on dividing this debt by the region’s estimated $26.5 billion GDP. Although there is no regular GDP counting in KRG and the figure dates back to 2016. https://zhyan.co/En/news.aspx?id=1429&mapid=1 5
5 The per capita debt is based on dividing all the KRG’s $31.64 billion debts on the region’s 6 million population.
6 This number changes according to the international oil price fluctuations. Usually, the KRG’s net oil revenues increase as oil price increase and vice versa. Due to the nature of the KRG’s production sharing contracts the government’s net oil revenue approaches zero when price of a barrel of oil goes down to any number below $15.
References:
Bank, World. World Bank and EU to Help Iraq Strengthen Public Financial Management Oversight & Accountability. 24 January 2021. 27 2021. <https://www.worldbank.org/en/news/press- release/2021/01/24/world-bank-and-eu-to-help-iraq-strengthen- public-financial-management-oversight-accountability>.
Kurdistan Parliament. Law Number 2 (2020). Erbil, 16 January 2020. یاسای-ژمارە-2-ی-یاسای-/6146/https://www.parliament.krd/media چاکسازی-لەموچەو-دەرماڵەو-بەخشی-وئیمتیازاتەکان-وخانەنشین-لەهەرێم- .2021 pdf. December.کوردستان-ــ-عێاق
Kurdistan Regional Government. Ministry of Finance and Economy, Mission, Reform. n.d. Ministry of Finance and Economy. December 2021. <https://gov.krd/mofe-en/>.
LIZZIE PORTER, RAWAZ TAHIR AND STAFF OF IRAQ OIL REPORT. $4+ billion debt compounds Kurdistan’s electricity challenges. 12 December 2021. Iraq Oil Report. December 2021. <https://www.iraqoilreport.com/news/4-billion-debt-compounds- kurdistans-electricity-challenges-44277/>.
WANG, YIKAI. “The Political Economy of the Middle-Income Trap: Implications for Potential Growth.” vol.33.vol.33 (2016): 167–181. <https://watermark.silverchair.com/adev_a_00077.pdf?token=AQ ECAHi208BE49Ooan9kkhW_Ercy7Dm3ZL_9Cf3qfKAc485ysgAAAsI wggK- BgkqhkiG9w0BBwagggKvMIICqwIBADCCAqQGCSqGSIb3DQEHATA eBglghkgBZQMEAS4wEQQM6tcTXzUpJfR7xSJJAgEQgIICdcSeNe3LG xSqyGHiHIShtTtEsqc_tJyQJoS7DiXzt5>.
World Bank. Iraq: Rising Fiscal Risks, Water Scarcity, and Climate Change Threaten Gradual Recovery from Pandemic. 24 November 2021. World Bank. December 2021. <https://www.worldbank.org/en/news/press-
Washington DC, August 05, 2021—The World Bank Group has renewed its commitment to the continued support of Iraq, approving a new Country Partnership Framework (CPF) to form the basis of its 2022–2026 partnership with the country. The framework lays out the main development goals the World Bank Group aims to support in Iraq and proposes a series of strategic interventions to help Iraq respond to the ongoing pandemic crisis, reform the economy and rebuild human capital.
The new framework comes against a background of highlighted fragility in Iraq, where the impact of the COVID-19 crisis, volatility in oil prices, and growing climate risks have compounded existing challenges. Such challenges could lead to more instability but also provide an opportunity for a new government to realign the country’s priorities by moving forward on economic reform and tackling deep structural issues.
“With its inherent flexibility, the CPF will serve as a platform for the World Bank Group to address immediate needs of the poor and most vulnerable, and work on the causes and drivers of Iraq’s fragility and crises,” said Saroj Kumar Jha, World Bank Mashreq Regional Director. “The Bank Group is ready to support the people of Iraq by contributing to tackling corruption, building transparent and accountable institutions, and a more enabling public sector for improved business environment in Iraq.”
The CPF has been drawn up in keeping with the World Bank Group’s 2020–2025 Strategy for Fragility, Conflict and Violence. The Strategy allows the World Bank Group to continue to engage with countries during periods of conflict and violence in order to help them transition out of crises more successfully. The CPF is aligned with Government of Iraq (GOI) reform priorities listed in their programs and national strategies, and promotes the renewal of the social contract between citizens and the state, as well as fostering a healthy local private sector and strengthening the legitimacy and capacity of core institutions.
“This CPF’s foundations are aimed at improving governance, public service delivery, and private sector participation, and at strengthening human capital,” said Ramzi Afif Neman, Head of World Bank Iraq Office. “In this way, we get to mainstream our priorities—citizen engagement, gender equality, and responding to climate change.” Added Merli Baroudi, MIGA’s Director of Economics and Sustainability, “Indeed, the Iraq Country Partnership Framework offers a strong opportunity to promote green, resilient and inclusive development in Iraq, leveraging the World Bank Group Climate Change Action Plan 2021-2025 and placing the country on a more sustainable pathway to a lower carbon future.”
Having maintained its engagement and an uninterrupted field presence in Iraq since 2003, the World Bank Group has built a strong active portfolio in the country. This has resulted in important initiatives, notably in multi-sector emergency reconstruction programs in areas liberated from ISIS occupation, reforms of the public financial management (PFM) and social protection system among others, and private sector investments of more than US$1 billion.
“As Iraq rebuilds its economy, the private sector will have a critical role to play in creating jobs and more opportunities for young people. This CPF provides the framework for the World Bank Group to focus on advisory and investment engagements with the business community in priority sectors, as well as to support improving the enabling and business environment to pave the way for Iraq’s private sector to lead the country’s future and generate shared prosperity,” said Abdullah Jefri, IFC’s Manager for the Levant.
Furthermore, the sustained WBG engagement in Iraq has resulted in an accumulation of a wealth of experience on the country’s economic and political context. Key lessons include the importance of national ownership, building the capacity of public institutions for sustainable development, working in partnership with international partners to drive governmental reforms, adopting flexible and adaptable approaches in mobilizing resources, improving the business environment and ensuring access to finance for and the thriving of small and medium-sized enterprises, and adopting innovative approaches to progress in the implementation of the portfolio in the field under challenging political and security situations.
The framework of the CPF will be implemented in two phases to allow the flexibility to adapt to changes over the five-year period. A first phase will cover roughly the period until a new Iraqi government is in place, with a focus on protecting the poor and vulnerable and on supporting initial government reforms. During a second phase, the Bank Group will support medium-term reforms to help shape a more diversified economy by creating a more enabling environment for the private sector and by developing human capital.
Acknowledgment of the World Bank Group’s role in supporting Iraq’s development has been prominent over the years, especially in supporting the implementation of the GoI’s reform plan, rebuilding damaged vital infrastructure from conflict and violence, improve basic service delivery, and mitigating the risks of COVID-19 pandemic by launching a 100 million immunization project. The CPF program will build on this trust to support Iraq’s efforts in addressing its challenges towards a more stable and prosperous future for all Iraqis.
Washington DC, August 05, 2021—The World Bank Group has renewed its commitment to the continued support of Iraq, approving a new Country Partnership Framework (CPF) to form the basis of its 2022–2026 partnership with the country. The framework lays out the main development goals the World Bank Group aims to support in Iraq and proposes a series of strategic interventions to help Iraq respond to the ongoing pandemic crisis, reform the economy and rebuild human capital.
The new framework comes against a background of highlighted fragility in Iraq, where the impact of the COVID-19 crisis, volatility in oil prices, and growing climate risks have compounded existing challenges. Such challenges could lead to more instability but also provide an opportunity for a new government to realign the country’s priorities by moving forward on economic reform and tackling deep structural issues.
“With its inherent flexibility, the CPF will serve as a platform for the World Bank Group to address immediate needs of the poor and most vulnerable, and work on the causes and drivers of Iraq’s fragility and crises,” said Saroj Kumar Jha, World Bank Mashreq Regional Director. “The Bank Group is ready to support the people of Iraq by contributing to tackling corruption, building transparent and accountable institutions, and a more enabling public sector for improved business environment in Iraq.”
The CPF has been drawn up in keeping with the World Bank Group’s 2020–2025 Strategy for Fragility, Conflict and Violence. The Strategy allows the World Bank Group to continue to engage with countries during periods of conflict and violence in order to help them transition out of crises more successfully. The CPF is aligned with Government of Iraq (GOI) reform priorities listed in their programs and national strategies, and promotes the renewal of the social contract between citizens and the state, as well as fostering a healthy local private sector and strengthening the legitimacy and capacity of core institutions.
“This CPF’s foundations are aimed at improving governance, public service delivery, and private sector participation, and at strengthening human capital,” said Ramzi Afif Neman, Head of World Bank Iraq Office. “In this way, we get to mainstream our priorities—citizen engagement, gender equality, and responding to climate change.” Added Merli Baroudi, MIGA’s Director of Economics and Sustainability, “Indeed, the Iraq Country Partnership Framework offers a strong opportunity to promote green, resilient and inclusive development in Iraq, leveraging the World Bank Group Climate Change Action Plan 2021-2025 and placing the country on a more sustainable pathway to a lower carbon future.”
Having maintained its engagement and an uninterrupted field presence in Iraq since 2003, the World Bank Group has built a strong active portfolio in the country. This has resulted in important initiatives, notably in multi-sector emergency reconstruction programs in areas liberated from ISIS occupation, reforms of the public financial management (PFM) and social protection system among others, and private sector investments of more than US$1 billion.
“As Iraq rebuilds its economy, the private sector will have a critical role to play in creating jobs and more opportunities for young people. This CPF provides the framework for the World Bank Group to focus on advisory and investment engagements with the business community in priority sectors, as well as to support improving the enabling and business environment to pave the way for Iraq’s private sector to lead the country’s future and generate shared prosperity,” said Abdullah Jefri, IFC’s Manager for the Levant.
Furthermore, the sustained WBG engagement in Iraq has resulted in an accumulation of a wealth of experience on the country’s economic and political context. Key lessons include the importance of national ownership, building the capacity of public institutions for sustainable development, working in partnership with international partners to drive governmental reforms, adopting flexible and adaptable approaches in mobilizing resources, improving the business environment and ensuring access to finance for and the thriving of small and medium-sized enterprises, and adopting innovative approaches to progress in the implementation of the portfolio in the field under challenging political and security situations.
The framework of the CPF will be implemented in two phases to allow the flexibility to adapt to changes over the five-year period. A first phase will cover roughly the period until a new Iraqi government is in place, with a focus on protecting the poor and vulnerable and on supporting initial government reforms. During a second phase, the Bank Group will support medium-term reforms to help shape a more diversified economy by creating a more enabling environment for the private sector and by developing human capital.
Acknowledgment of the World Bank Group’s role in supporting Iraq’s development has been prominent over the years, especially in supporting the implementation of the GoI’s reform plan, rebuilding damaged vital infrastructure from conflict and violence, improve basic service delivery, and mitigating the risks of COVID-19 pandemic by launching a 100 million immunization project. The CPF program will build on this trust to support Iraq’s efforts in addressing its challenges towards a more stable and prosperous future for all Iraqis.
Q1: As an economist who is familiar with Iraq, what is your view on the currency devaluation? Is it the right step taken at the wrong time? How do you see the overall effects of the devaluation? FG: I think that the primary motivation for the devaluation was the 2020 budget crisis. With the collapse of oil prices, GoI revenues were insufficient to pay current expenditures – primarily salaries and pensions – even with a sharp cut in investment expenditures. The almost 23% devaluation of the dinar to 1450 ID/$ in December 2020 will result in an estimated 11 trillion increase in government dinar revenues. However, the net increase will be about one-third less due to government expenditures for imported goods that are unaffected by the devaluation. Of course, this devaluation will also have the effect of increasing import prices – fueling an acceleration of inflation – as well as improving the competitiveness of the country’s small amount of non-oil exports.
Q2: How did we get here, and more importantly, what is the way forward? FG: According to the theory of optimal currency areas, a country whose national income is dominated by foreign trade and where most of that trade is dominated by one foreign currency then this country can maximize its economy by adopting a fixed exchange rate. Iraq is heavily dependent on dollar-denominated oil exports and imports large quantities of agricultural products which also tend to be denominated in US dollars. Shortly after the US-led invasion of Iraq, the GoI fixed the dinar to the US dollar. And the relative stability of the dinar/dollar exchange rate has been one of the great unexpected successes of Iraqi macroeconomic policy. However, this fixed exchange greatly limits Iraqi monetary policy. Or to be more precise, with a fixed exchange rate, monetary and exchange rate policies are the same. This has severely constrained the ability of the Iraqi financial system to facilitate private sector economic growth. The primary danger of attempting to maintain a fixed dinar/dollar exchange rate is riskless speculation. Declines in the international reserve holdings of the CBI motivate speculators to borrow dinars and exchange them for dollars in either the daily currency auction or in the secondary market. This speculation leads to a further decline in reserves stimulating more speculation. Eventually, the loss of reserves will force the GoI to further devalue the dinar providing a profit for speculators. The loss of Iraq’s international reserves is also exacerbated by the collapses of the Iranian rial and Syrian pound that have led to large amounts of dollars being smuggled out of the country. The CBI can try to reduce reserve loss by keeping dinar interest rates high. This will, of course, discourage private sector growth. In addition, the CBI could once again attempt to reduce the rate at which dollars are leaving by restricting access to the daily currency option. Both options are short-term solutions to a long-term problem. One option that would maintain the advantageous fixed exchange rate while eliminating speculative attacks on the dinar would be for Iraq to return to a currency board such as the one that enabled Iraq to have a stable currency from 1930-1949 despite severe internal conflict and chaos of World War II. In a currency board, the GoI would commit to a fixed exchange rate for paper currency only and maintain 100% reserves. These commitments would eliminate the chance of a successful speculative attack on the dinar and allow lower interest rates for loans to the private sector.
Q3: What are the opportunities and challenges facing Iraq in increasing the competitiveness of local products? FG: While the December 2020 dinar devaluation should – in theory – make Iraqi exports more competitive, I think that there will be a little real impact. The key problem with the country’s international trade is that Iraq currently suffers from extreme regulatory hostility towards its private sector especially with respect to foreign trade. According to the 2021 World Bank Ease of Doing Business, Iraq ranks 181st out of the 190 countries surveyed. To legally export a product from Iraq is an expensive and complex process. For example, documentary compliance alone requires an estimated 500 hours. The expense of complying with these regulations or paying bribes to avoid them is a high implicit tax on exports. This export tax resulting from the current regulatory hostility towards international trade substantially explains the current low level of non-oil exports such as agricultural products and textiles. On the import side, there is widespread corruption at the border entry points with Iran and Turkey. Combined with extensive smuggling, import tariff collections are de minimus and Iraqi markets are swamped by imported goods that are often cheaper than products produced in Iraq.
Q4: On top of the protesters’ demands for employment opportunities and better access to public services came the currency devaluation: how do you see the social and security implications of this? FG: Beginning in the 1980s and continuing through about 2014, the government of Iraq has acted as the “employer of first resort”. Each year, government employment was increased in an attempt to create enough new jobs for Iraqis entering the labour market. However, as a result of the 2014 collapse of oil prices combined with the expenses of the anti-ISIS fight, the GoI lacks the needed revenues to create enough new public sector jobs for the estimated 350,000 young Iraqis who enter the labour market each year. While the data is difficult to interpret, I think that about 80% of young Iraqi males are currently unemployed or underemployed. This will be an increasing source of political instability. The devaluation was a temporary fix that allowed the GoI to maintain its existing employment and pensioner levels. However, with an expected decade of oil prices of $60 a barrel or less, the GoI will not be able to return to massive public sector job creation. As a result, political stability will depend upon job creation in the private sector. Currently, private sector growth is constrained by the associated problems of regulatory hostility and corruption.
Q5: During your recent seminar, you suggested that all the subsidies (such as food, fuel, and farm-support programs) should be removed, even though the devaluation reduced purchasing power for most Iraqis. Given Iraq’s high poverty rate (over 31 % by July 2020), what could be done to support the impoverished segment of the Iraqi population? FG: Iraq’s heavy subsidies of energy, water, food, education, etc. suffer from four related challenges. First, in a future of low oil prices, Iraq can no longer afford the subsidies. The World Bank estimated that such subsidies amount to about 12% of the country’s GDP. Second, these subsidies severely distort the data necessary to correctly evaluate government programs. For example, subsidized energy, water, etc. make determining the viability of SOEs almost impossible. Four, subsidies that result in zero or very low official prices lead to substantial waste – if something has a zero price, people treat it as if it has a zero cost. When the grid is providing electricity and air conditioners are operating, shop owners leave their doors in hopes that the cool air will encourage customers to enter. Finally, these subsidies lead to corruption. The amount demanded of these products and services is much greater than the amount supplied. Iraqi families are competing against each other to obtain these products/services using political, family, religious connections, or, most commonly, by paying bribes. The subsidies should be eliminated. As implied in the question, this would cause severe hardships for Iraq’s poor. That is why the elimination of subsidies must be accompanied by a direct dinar transfer to Iraqi’s poor. This transfer payment should be sufficient to allow them to purchase essential services, food, etc. at unsubsidized prices. There will be a budget-saving from eliminating subsidies for Iraqis who are not poor. Also, there should be a reduction in petty corruption since the prices should be sufficient to cover the cost of production – officials will not have less of an economic rent that they can sell for bribes. In addition, it will allow poor Iraqis to make their own decisions on spending priorities rather than having a member of the Baghdad bureaucracy decide on what each poor family wants or needs.
Q6: Do you think the Public Food Distribution Program, if properly reformed and limited to low-income citizens, is an efficient mechanism to support the Iraqis who are already living below the poverty line and the IQD devaluation just exacerbated their situation? FG: No. The PDS is extremely inefficient. The cost of the food basket is a multiple of the value of the food actually provided to the recipient. In addition, the PDS is corrupt. One survey showed that over 80% of the food “baskets” were lacking one or more of the promised items. The Ministry of Trade purchases the needed quantities but, somehow, large quantities are diverted before the baskets reach the recipients. Finally, much of the food is imported rather than obtained from domestic farmers and agricultural businesses. A much-discussed alternative is to replace the PDS with direct dinar transfers to the poor. While this option would probably reduce the problems mentioned above, there is a cultural issue to be dealt with. In traditional families, food is the responsibility of women while men handle money. If the PDS is replaced by direct dinar transfers, this may reduce family food consumption as males uses funds for non-food expenditures.
Q7: Given Iraq’s heavy red-tape procedures and poor enabling business environment, do you think it is realistic to expect any bureaucracy reform to address the impediments? FG: Reducing the regulatory hostility towards the country’s private sector is a necessity. Although some progress has been made, the further movement towards a rational commercial code faces two challenges. First, the complex and expensive regulatory barriers to private businesses in Iraq are no unloved artefacts from the Saddam era. Rather, each rats’ nest of regulations is carefully preserved and protected by the bureaucracy since the more difficult it is to legally follow a regulation, the greater the bribe that will be offered by a businessman or woman. Second, in a future of low oil prices and rapidly rising numbers of unemployed or underemployed young men, Iraq doesn’t have a decade to gradually reform its commercial code before the country faces another severe period of political instability. One option would be for Iraq to rapidly adopt the commercial code of another Arab country such as the UAE. While far from perfect, the UAE commercial code is much more favourable to the private sector. While Iraq is ranked 172nd by the World Bank on the overall ease of doing business, the UAE is ranked 16th.
Q8: On the challenges of endemic corruption, do you think this issue can be addressed at the level of the public administration (where it is considered as grand corruption)? or it can be at the level of petty corruption? FG: An interesting question! Although I think that Saddam and his family and supporters stole more of the country’s wealth,current corruption is doing more damage to Iraq’s economy and society. Under Saddam, corruption was more structured and predictable whereas current corruption is more competitive and uncertain. As a result, while grand corruption – also known as state capture – is a serious problem and gets a great deal of media attention, I think that petty corruption – paying small bribes to an unending queue of officials – is doing more damage to both households and private businesses not only because of the costs of the bribes but also because of increased uncertainty. Even if one pays a bribe for an accommodation from an official, one cannot be confident that the accommodation will actually be provided. What is needed are not new government programs intended to “help” the private sector but for the GoI to get out of the way. In conversations with young Iraqis, I have been surprised that so many of them express their desire to be entrepreneurs, not government employees. If the GoI can give these young people, the space they need to create their own businesses, the resulting job creation should improve political stability. The many failures and few successes of anti-corruption efforts throughout the world have some lessons for Iraq. An anticorruption strategy composed of arrests of a few high-level officials and displaying anti-corruption posters in government offices will fail. What is needed is a multi-faceted anti-corruption strategy that reflects Iraq’s unique characteristics. It is especially important that the anti-corruption strategy seeks to reduce both the supply of corrupt acts by officials as well as the demand for such acts by private individuals and businesses. Since 2005, Iraq’s efforts have focused on the former with little attention to the latter. Two necessary components of reducing the demand for corrupt acts are to change the culture of corruption in Iraq and rationalize the regulatory environment of the country’s private sector. Education starting at a young age is probably the most straightforward of changing attitudes toward corruption. As an example of the effect of excessive regulation on corruption, consider the 167 days currently required to obtain the necessary permits to build a warehouse. To avoid this delay, a business might be willing to pay a substantial bribe to speed up the approval process. However, if the regulations were rationalized so that a business could obtain permits in 30 days then the business owner will only be willing to pay a smaller bribe or no bribe at all.
Q9: You know how the structural issues and imbalances resulted in the current unemployment crises because of the political economy, before and after the 2003 regime change. Is there any way to address the unemployment crisis apart from a proper and comprehensive private sector development program? FG: No. Decades of the government of Iraq acting as the “employer of first resort” has led to spending on salaries and pensions crowding out needed essential services and infrastructure spending. It has also corrupted the country’s political culture since ministries are operated primarily as welfare programs for government workers. In addition, it has facilitated the corruption that is the most serious challenge facing Iraq. Iraq could barely afford massive government job creation when oil prices were over $100/barrel, with the expectation of a decade or more of sub $60/barrel oil, further expansion of government employment is impossible. What new programs should the government of Iraq fund to develop the private sector? I think that this is the wrong question. With the current budget crunch, widespread corruption, and limited competency of the bureaucracy; any new program can be expected to be a costly failure that will probably make the situation worst. What is needed is for the government to do less – to allow space for the private sector to create and operate profitable businesses that will increase employment. While the government in its 5-year plans states that the private sector is critical to Iraq’s further development, the same documents severely constrain the private sector’s operation. As one of many examples, a GoI 2010 plan discusses the severe housing shortage in Iraq and notes that home construction is within the capability of small and medium private firms. But, at the same time, the GoI proposes that certain customers receive priority (civil servants), certain construction materials are used, that homes be built in certain areas, and that a specific complex system of funding is utilized. All of which will require “an expansion of the housing legislative framework” (GoI 2010, National Development Plan: 2010- 2014, pp.124–7). This combination of complexity, uncertainty, and arbitrary bureaucratic decision making seems specifically designed to discourage private-sector home building. It is interesting to note that among the hundreds of persons involved in developing the National Development Plan: 2010–2014, all or almost all were government officials; representatives of Iraq’s private sector were not at the table when the topic for discussion was increasing the role of the private sector. What is needed are not new government programs intended to “help” the private sector but for the GoI to get out of the way. In conversations with young Iraqis, I have been surprised that so many of them express their desire to be entrepreneurs, not government employees. If the GoI can give these young people, the space they need to create their own businesses, the resulting job creation should improve political stability.
Iraq’s Central Bank (CBI) depreciated the Iraqi Dinar (IQD) by nearly 18 per cent from IQD1,180 to IQD1,450 against the US Dollar (USD). This devaluation negatively impacts millions of “losers” – i.e., those who are most affected by inflation resulting from the decision – with no obvious “winners” except for the Government of Iraq (GoI) and the Kurdistan Regional Government (KRG) whose expenditures are mostly paid in IQD while receiving USD for their exports, of which more than 98 per cent is crude oil. This article will attempt to assess the inflationary impact of a devalued IQD on vulnerable Iraqi groups and will suggest some policy actions to mitigate the negative impacts of the decision. Following Iraq’s regime change in 2003, the IQD was valued at IQD1,500 to USD1. This valuation was based on a number of factors, including Iraq’s foreign reserves, external debts, employment rate, and population, and on the price of crude oil. Later, when the price of crude oil reached USD120 per barrel, the value of the IQD appreciated by CBI to 1180 IQD for 1 USD. The parallel informal exchange rate had always stayed lower than 5% to the formal one. The subject of devaluing the IQD was raised again in 2014 when Iraq faced twin crises of a decreasing oil price and a war against the Islamic State of Iraq and Syria (ISIS). In 2020, the COVID-19 global pandemic and negative oil price shock resulted in the GoI implementing desperate policy actions such as devaluing the IQD to deal with several structural challenges, including the nation’s balance of payment deficit.
Ahmad, 45 years old man with special needs, started a small business as a mobile blacksmith with the support of the ICRC. Photo Credit: ICRC
Six years passed since the Iraqi government launched its Private Sector Development Strategy 2014-2030, aiming to reform regulatory frames and market conditions towards private sector-led growth. Several international partners (including UNDP, World Bank, GIZ, and USAID) also attempted to help realize some goals of the strategy. Along with the strategy, Iraqi leaders have always been advised to diversify the rentier economy to cope with their challenges of unemployment (at 13 per cent) and poverty (at 31.7 per cent), but things are not moving forward. The economy is still heavily state-dominated and crude oil-dependent, whereby oil revenues constitute more than 98 per cent of exports, 63 – 67 per cent of GDP, and up to 93 per cent of Federal Budget revenues.
What has hindered the private sector development (PSD) strategy remains as a set of institutional challenges. Although most of the challenges are technical, they can be addressed once a reformist political leadership is in charge. This article is an attempt to find out how the institutional challenges hindered the PSD strategy, assuming that institutions enforcing laws and regulating the private sector matter for economic growth. It also suggests some policy recommendations that could help to tackle the challenges given the current potentials and political constraints.
Mohammed Hussein
is policy director and political-economy analyst at ICPAR. He holds a master’s degree in specialized economic analysis: Economics of Public Policy, from the Barcelona Graduate School of Economics.
The Iraqi government’s PSD goals were outlined as reforming the legal and regulatory framework, improving access to finance, and providing financial stimulants and incentives to private sector growth. It also affording programmes to pave the way for public-private partnership (PPP) by integrating private firms with state-owned enterprises (SOEs), which are mainly out of business. The overall aim of the strategy was to strengthen the private sector and improve its productivity to become more competitive.
Currently, Iraq’s economy is struggling with multiple challenges and imbalances, suffering decades of chronic conflicts, poor management, and continuous institutional decay. The GDP contracted by 11 per cent in 2020, and the national poverty rate raised to 31.7 per cent from 20 per cent in 2018 as a result of the recent multi-faceted shock of COVID-19 pandemic and oil price down. The political leadership, represented in the Federal government of Iraq (GoI) and Kurdistan Regional Government (KRG) still operate within the same rentier dynamics, by which their duties are shortened in selling crude oil and then distributing its revenues through bloated payrolls. All the issues and structural imbalances kept the Iraq’s business environment unfriendly and repulsive even compared to the regional and neighboring peers as Figure 1 demonstrates. Figure 1. Iraq’s Score in World Bank’s 2020 Ease of Doing Business Index, Compared to Its Neighboring and Regional Peers
Source: The World Bank’s Ease of Doing Business score is an average of scores for each of the Doing Business topics as the Figure 1 shows: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, and enforcing contracts. Source of the data is World Bank’s Doing Business Index https://bit.ly/3rU8Q3e.
Looking for PSD in the Aftermath of the Shock
The multifaceted shock of COVID-19 pandemic and the global oil price drop exacerbated the economic and political environment that have hindered the PSD strategy. Luckily, the shock worked as a wake-up call and made several state leaders ask for economic reform and PSD programmes. The Iraqi Government’s reform-agenda known as White Paper was the right step in this direction. It properly outlines what needs to be done for reviving job-creating sectors such as tourism, industry, agriculture, and transportation and ultimately diversify the economy. However, key ideas and reform spirit of the White Paper were not reflected in the 2021 budget law. It was the first test for the integrity of the state leaders who called for reform and also a big disappointment for those who wanted to take the shock as an opportunity to reform.
Before the shock, Iraq’s private sector was too weak and somehow dependent on public expenditures. More than 90% of private and public factories were out of work. Some of them bankrupted during the 2014 double shock (oil-price crash and war against the so-called Islamic State of Iraq and Al Sham-ISIS), and others could not compete cheap imports after the 2004 open-door policy. The unemployment to population ratio, at ages 15-24 years was already 21.5 per cent for men and 61.6 per cent for women. Plus, limited access to finance, endemic corruption, and poor law enforcement was significantly obstructing local and foreign investments. The impediments have kept many start-ups, self-employees, and small businesses informal. The informal economy (usually associated with low productivity and misallocation of resources) is estimated to be livelihoods of more than half of the labour force (and more than 5 million workers) without child labourers that have crowded Iraqi streets and recently raised concerns of UNICEF and ILO.
Figure 2: Sectoral Labor Division in Iraq
Source: ` (World Bank Group 2020) and (Center for Future Studies 2020). The total number of the labour force is taken from World Bank’s open data. The number of private workers insured by Iraq’s Ministry of Labour and Social Affairs is taken from the ministry’s website: https://bit.ly/2C9H4vT. The number of the KRG’s insured private workers is taken from Kurdistan Labour Syndicate.
As elsewhere in the region, the recent shock diminished non-oil economic activates in tourism, retail, and services (where most of the Iraq’s private economic activities take place). It also wiped out the majority of the informal jobs in the first phase of the pandemic (March to April 2020). After April 2020, with the second phase of the COVID-19 containment measures, some businesses opened and started to recover. Some micro, small, and medium enterprises (MSMEs) went bankrupted and others reduced their work. A recent panel study shows that the pandemic disruptions have lowered production and sales by 50 per cent in the 822 surveyed firms. Besides, The shock dramatically reduced Iraq’s oil revenue from $6.195 billion in January to $1.423 billion in April 2020.
In addition to the direct impacts on the already weak private sector, the aforementioned economic challenges pushed the governments to cut from some very needed public spending. GoI lowered investment spending in 2020 to 4 per cent of the total spending. The KRG stopped financing the majority of its infrastructure projects after slashing its payroll by 21 per cent. The reduced investment spending is vital for the private sector not because it is needed for the underfunded infrastructure; it rather provides a market for many private firms that work as technical contractors in the services and construction sectors. This spending is much needed this year given the COVID-19 economic implications.
Landing another blow against the climate needed for any recovery and then PSD programme, the Central Bank of Iraq (CBI) depreciated Iraqi Dinar (IQD) against USD by nearly 23 per cent. According to the White Paper, one of the key goals of the devaluation was to increas competitiveness of local products, while there are no enough products to compete with some very basic imports. The devaluation lowered real incomes for at least 7.7 million Iraqis who depend on GoI’s and KRG’s payrolls. It would prolong recovery from the multifaceted shock and further weaken SMEs and informal businesses working in retail and services sectors. The devaluation was an attempt to increase public revenues since the governments sell oil in USD but make expenditures mostly in IQD. Theoretically, a slow and gradual IQD-devaluation could have decreased production costs and ultimately increased competitiveness, but this cannot be a realistic dream before fixing the key the structural issues and imbalances and improve the enabling environment for the private sector.
How the Institutional Challenges May Play Out?
Many factors prevented implementing the PSD strategy, but lacking a reformist willingness is always the core issue. The post-2003 ruling elite is known for being good at designing strategic development and reform plans but not implementing them. Since 2003, 73 development documents have been prepared to help Iraq, but none of them has been properly implemented. The leadership is overwhelmed with inter-elite conflicts and security challenges.
Besides, the quality and functionality of state-institutions have deteriorated over time. Lacking law enforcement institutions to protect people’s lives and livelihoods from extortions and illicit activities is always a challenge. The institutional deficit, with all its symptoms such as fragile security, the spread of non-state armed groups, and weak law-enforcement increased pre-existing barriers to market competition. They have created an unbalanced playing field in favour of corrupt business people to bypass competition, benefiting their links to the political parties and armed groups. As a result, they have kept the investment climate very unfriendly and the private sector too weak.
For instance, one of the lasting challenges that have hindered PSD and contributed to the tough business environment is getting a business license to kick-off investment projects. Although Investment Law Number 13 (2006) is supposed to facilitate a single-window system and provide the investor with a business license within two weeks, the reality is different. The law contradicts several other laws and the investor still needs a business license from investment offices of all relevant ministries. Eventually, getting the business license might take months/years, or it might not be granted at all since the allocated land for the project would be occupied by political parties’ militias.
Besides, the recently increasing oil revenues is also important to be under radar as it is very determinant for any PSD programme. The revenue usually has dual effects either to hinder or foster the PSD strategy. As the recovered demand in the international oil market pushed crude oil above $60 pb, it released part of the fiscal pressures facing GoI and KRG. Meanwhile, it may reduce politicians’ incentive to reform. The politicians tend to keep the current business as usual rather than pursuing PSD that cannot yield short-term electoral gains. The increasing oil revenues could provide resources to pursue counter-cyclical approaches and foster post-COVID-19 recovery. Supporting SMEs and the people who lost their livelihoods due to the pandemic also needs oil revenues. Either way, the rising oil revenues have always had a positive correlation with non-oil private economic activities in Iraq. Most of Iraq’s private firms depend on public spending and work as contractors of the governments. Data shows that non-oil economic activities in Iraq increase, or decrease, parallel to international crude oil price fluctuations as Figure 4 demonstrates.
Figure 4. Iraq’s annual percentage change of the non-oil GDP growth (the lower curve), increases or decreases, parallel to International crude oil price fluctuations (the upper curve) after 2010.
Given the political constraints and challenges that have hindered the PSD strategy, designing a realistic approach is very much needed. Any reform or PSD programme should start with practical steps from where the interests of the ruling elite do not contradict development goals. This practicality is needed for a while at least to bypass the current political complications. Otherwise, the anti-reform backlash would deter many needed preliminary steps. For instance, creating agricultural rural jobs and fostering food-processing industry is where nobody opposes. It is good for farmers, investors as well as the ruling elite because this is where they can find a market for local products and non-oil public revenues increase. It also helps reducing poverty and unemployment that currently posing multiple political and security threats. This target is not that difficult as domestic consumer’s taste is already in favour of Iraqi products. Currently, the price of one KG of Iraqi lemon is between 3500 to 4000 IQD, while one KG of imported lemon is between 1000 to 1500 IQD. Similar price differences exist for most of the Iraqi food products.
Moreover, restoring order and implementing customs duty in border entry points is also another area where the majority of Iraqi people and the ruling elite can get together to support reform. The customs duty is normally expected to provide 7-8 trillion IQD for the state treasury, but the GoI receives one trillion IQD. The issue is not only the lost revenues wasted on untaxed imports and corruption; it’s affecting local products by opening smuggling doors for cheap imports. Here, lack of law enforcement and policing undermines public revenues and hurt private businesses. However, any attempt to clean state institutions from patronage networks of the ruling political parties would create more obstacles than supporters for reform.
To improve the business enabling environment, GoI and KRG can take some actions today with their available resources as part of a tailored Iraqi PSD programme. Starting with reforming business registration procedures, there needs to be a new and easy single-window system to absorb the informal workers and incentivize them. The governments can afford to have a strong labour inspection mechanism to make sure informal labourers have contracts and economic activities are going within legal frames. The governments and CBI can encourage investment in technology to grow productivity to revitalize fast job-creating sectors. There are some success stories to learn from. Over the past 10 years, local aluminium and iron manufacturing projects boomed to the level that can meet local demands. Iraq Aluminum Extrusion, an example of this factories, employs around 100 skilled workers. They invested in technology to grow productivity until becoming competitive enough to replace Turkish imports, depending on their competitive advantages, not monopoly or customs duty to safeguard them.
In addition to the business enabling environment, reforming the financial sector is also a key step to push for the PSD strategy. Most of Iraq’s banking sector and financial institutions are fragile, incompetent, and short-term profit-oriented. They are not in the position to support any reform or PSD programme. Regardless of the number of commercial banks operating in Iraq, (more than 70 banks), the economy is heavily relying on cash transactions. This is another factor preventing GoI and KRG from implementing the Pension and Social Security Law of Workers that made the private job market undesirable. Therefore, upgrading and digitalizing the banking sector can provide a great foundation for any economic reform.
Figure 5. Iraq’s Financial Infrastructure, Compared to the Neighboring Countries
Source: IMF Open data sets.
Such a poor banking sector can’t help observe the informal economic transactions, enforce labour laws, and detect money laundering. For instance, if CBI would attempt to expand its SMEs-loans to include the rural cash-based informal businesses, this banking sector is unworkable. Benefiting international partners and donors, the governments can facilitate technical assistance and coaching to both private and state-owned banks and financial institutions to build capacity and increase their scale and productivity. They can help linking educational institutions and other skills-development programs to the financial sector. Some universities, like Al-Nahrain University in Baghdad and private universities in the Kurdistan Region of Iraq (K.R.I) already have private sector linked programs.
What Can be Done Now?
Again, the PSD strategy could be a realistic dream whenever it is backed by a reformist political willingness. Although economic solutions, sometimes, play out slowly and longer than expected, Iraq’s tourism, agriculture, and the light food industry hold great potentials. It could be a medium and long-term realistic goal once policy and regulatory actions pursued to address the impediments. It is indeed the most rational solution to the current economic and job market challenges but neither a short-term and nor an easy one. It needs to start what can be done today and pave the way for what should be done in the medium and long term. The increased oil revenue can serve this purpose by providing loans to MSMEs instead of increasing military and security spending as GoI and political blocs did in the 2021 budget law. Given Iraq’s socio-economic challenges, any economic reform and PSD programme needs to be inclusive and pro-poor. It should include, in short and medium-term, unemployed youth and women in impoverished rural areas. With the loans already provided by CBI, the reform programme could revitalize fast job-creating sectors (agriculture, tourism, and construction) even during the current financial strains. Encouraging agripreneurship and startups in tourism and services could be a fast rural job-creating strategy.
Regarding the PSD strategy, there are dire needs to address the business impediments and create a friendly enabling environment. It only needs a reformist political willingness to reduce some heavy red-tape procedures. It is not hard to amend the existing labour law and make it more inclusive towards informal workers. Making the CBI loans accessible for young start-ups by easing eligibility conditions is also something achievable today. Likewise, restoring order in border ports and reforming customs duty to safeguard domestic products, resolving Erbil-Baghdad oil and financial disputes to come up with a unified national customs duty are steps that can be done now.
Preparing the ground for the PSD strategy or any reform programme, Iraq’s institutionalized corruption must be addressed. GoI and KRG need to mobilize all the supports they get from NGOs, international entities, and local religious and cultural figures in battling the corruption. They need to establish various decentralized mechanisms to detect illicit activities and promote transparency. Here, they have supports of thousands of activists, journalists, and professionals who have been taking the streets and voluntarily speaking up and struggling against the endemic corruption. They are the best ally for any reform programme once a proper mechanism is designed to organize their supports. Besides, opening up state institutions for NGOs and media overseeing directly improve the performance of the institutions, which is very much needed to improve the business environment and promote PSD or any economic reform programme.
Making Iraq’s private sector gender-inclusive can help addressing the low female labour participation (about 12 per cent). It is a symptom of the weak private sector but also a reason for keeping nearly half of the population idle and not contributing anything to the economy. In some areas, there are cultural barriers for women to apply for private jobs because the private sector is perceived as an unsafe environment, unsecured job, and low-paid; while the perception is different for public jobs that are seen as safer with life-long security and other benefits. Government protection through formalization can help to change the perception. Any microfinance can address this priority. Special regulations to protect them from gender wage gap, manipulation, sexual harassment, and to promote affording child care in the private sector might directly reduce barriers they face to enter the private sector job market.
Policy Recommendations:
Any economic reform or PSD programme depends on how law enforcement institutions work adequately (in all national, provincial, and district levels). Protecting people’s lives and livelihoods from all sorts of extortions and illicit activities is the pre-condition for any meaningful reform.
In a line with the White Paper, privatizing some of the state-owned enterprises (S.O.E) or engaging the private sector with a viable public-private partnership (P.P.P) may strengthen market forces, increase competition, and revitalize the enterprises.
Removing bureaucratic impediments, introducing policy reforms to strengthen the accountability of the public sector, and granting on-arrival visas for foreign investors are steps that can be taken now. Given the corruption-associated risks, the bureaucracy-reduction steps need the direct engagement of local and international NGOs and media.
In the medium and long term, GoI needs to gradually incentivize members of the armed groups towards the private job market contrary to what the 2021 budget law encourages. The ultimate goal is to attract segments of Iraq’s armed men into economic activities in the private sector, and it can happen only if the private sector affords opportunities better than what they gain from armed groups.
The currency depreciation in Turkey, Iran, and Syria have exposed Iraq’s market to very cheap imports that pushed thousands of producers out of business. Given Iraq’s high production cost due to the tough business environment domestic products cannot be price competitive without protection by tariffs, subsidies, import quotas, and other sessional restrictions placed on certain food imports.
In a line with the 2021 budget law, GoI can finance the on-halt investment projects, especially infrastructural, agricultural, and services projects; The projects improve the needed infrastructure for private economic activities. For the next budget laws, GoI and KRG need to put a ceiling on current spending and scale-up investment spending to improve infrastructure and reconstruct the war ruined areas.
Regarding the rising poverty rate, reforming the current Public Food Distribution programme is highly required. GoI should improve the quality and increase the quantity of the food items after imposing an eligibility criterion to make it accessible only for low-income people, not everyone, including those who may not need it.
Addressing the rising unemployment, a specific Iraqi tailored microfinance programme in tourism, agriculture, dairy and other agro-industry businesses would create viable market opportunities for millions of impoverished Iraqis in rural areas. It will have great multiplier effects and restore the value-chain that links up the rural economy to urban centres. The CBI’s already programme to lend SMEs should be restructured towards this purpose by easing the conditionality of the loans.
From the Labor Market Perspective
In any medium and long-term plans, GoI has the incentive to prioritize fast-growing sectors such as agriculture, services, tourism, construction, and small industries. The timely achieved improvement is needed to release the ongoing demographic and political pressures.
Setting up vocational training on market activities, skills, and small business management is a key strategy to improve productivity and develop the vibrant private sector for enterprises already struggle with the tough business environment.
Connecting universities and schools to the labour market, GOI’s relevant ministries should prepare to supply the private sector instead of over-crowding security and military forces. The policy shift requires renovating curricula to focus on applied sciences and technical skills needed for the current labour market.
Designing new marketing tools, organizing periodical fairs, workshops, and conferences for start-ups to demonstrate their products and services might improve the competitive environment. GoI’s ministries of planning, agriculture, industry, and culture can help conduct these marketing strategies and facilitate inter-sectoral cooperation and exchanges. For instance, they can lead farmers to invest in the type of tomatoes that are commercially viable for canning factories.
To create some balances between public and private job markets, Iraq’s tax-policy needs to be addressed to increase tax rates for public employees and decrease for private ones, given the benefits public employees enjoy (as a pension, paid maternity, sick leave, and lifetime job security), but not available in the private sector.
Iraq’s informal workers’ needs, challenges, and concerns require medium and long-term solutions, but they should be considered in most of the policy actions to deal with immediate economic issues. The informality is usually associated with high poverty, low productivity, under-employment, and misallocation of resources. Optimal policies should be designed soon to incentivize the registration process by ensuring informal firms and workers and adding them to the tax-paying lists, a win-win solution for both GOI and the informal workers.
Center for Future Studies. “hkumati ney Iraq w Qayrany Abwri Haremy Kurdistan: Lamparw synaryokan [The New Iraq’s Government and Economic Crisis in Kurdistan Region: Hinders and Sceinaros. 2020. Accessed June 18, 2020. https://www.centerfs.org/future-ranges-no-4-of-year-2020-ku/#_Toc33192903.
Jaafar, Razaq. June 15, 2020. Razaq Jafar is secretary general of Iraqi Federation of Industries. He was interviewed for this study by phone.
Policy discussions associated with Iraq’s 2021 budget bill so far ignored the challenges facing the country’s informal economy. The initial budget draft prepared by the Iraqi Finance Ministry, as well as the amendments proposed by Parliament’s Finance Committee have failed to properly address the structural challenges facing the country’s informal economy, which accounts for a large chunk of the private economic activities. Hence, the informal economic activities would fall outside proper regulatory and policy actions that Iraq needs to recover from the recent multi-faceted shock of the Covid-19 pandemic and international oil price drop.
The Covid-19 implications have left a significant effect on the informal sector. Most of the reported job losses, work-reductions happened in this sector. Informal workers such as vendors, small shopkeepers, daily-wage workers and self-employees are extremely vulnerable to any economic crisis;
Mohammed Hussein
is policy director and political-economy analyst at ICPAR. He holds a master’s degree in specialized economic analysis: Economics of Public Policy, from the Barcelona Graduate School of Economics.
they are the segment of the population who have been affected most since the early days of the health crisis; they were left behind by the Government of Iraq (GoI) and Kurdistan Regional Government (KRG) because they didn’t exist in the databases, and consequently failed to include them in the financial support programmes and food-basket distribution supposedly designed to help them.
The informal economy is broadly defined as businesses, workers, and activities that operate outside of the tax system and regulatory frames. Nearly 70 per cent of all private economic activities in Iraq are informal[1]. Most of Iraq’s labour force working often without any contract although they are involved in the production, value-chain, distribution system, and social services. A survey of the International Labour Organization, in a sample size of 714 employees (686 men and 28 women) in the Kurdistan Region of Iraq (KRI) and Iraq’s northern provinces found that only 34% of them have written contracts, 40% of the works are based on oral agreements, and 26% have neither.
Challenges and Opportunities within the Informal Economy
To set an institutional frame for any economic reform plan in Iraq, this informality needs to be addressed. It is a huge cause of the misallocation of resources and goes beyond the taxing system. The Iraqi Government’s White Paper tended to be a reform agenda to address economic imbalances and structural issues, barely addresses the key regulatory and policy issues that have kept the majority of private economic activities informal. The Government’s recent policies, reflecting through the currency (IQD) devaluation and the 2021 budget draft, only contribute to the repulsive environment that has led to this informality. For instance, in the 2021 budget bill, the government increased funds for the military and security institutions by almost 15 trillion IQD (compared to the 2019 budget law). This is 16 per cent of the total spending and equal to the amount allocated for capital investment and development. The budget allocations show that the government is still pursuing the same pattern of militarizing the population instead of organizing and reforming the economy to include informal firms and workers.
Iraq’s private sector provides jobs for more than 53 per cent of the country’s labour force, about 5.4 million workers. Of this number, only 5% are insured (208,000 by GoI and 80,516 by KRG)[1] The rest are not registered and neither recognized by the country’s tax and insurance systems.
Source: (World Bank Group 2020) and (Center for Future Studies 2020), and the source. The number of private workers insured by Iraq’s Ministry of Labour and Social Affairs is taken from the ministry’s website: https://bit.ly/2C9H4vT. The number of the KRG’s insured private workers is taken from Kurdistan Labour Syndicate.
Even before the COVID-19 pandemic and recent oil price drop, informal employees did not work and live in a safe environment. They have no access to finance and do not enjoy the retirement and job security public sector workers have. In Iraq, the social protection system in pension, health, and disability benefits are provided only for public employees. The informal workers were the biggest challenge for Iraqi governments, while they were the most vulnerable segment of the population. Many informal workers fear hunger more than Covid-19. Their risk assessment is probably different from the policy makers’ calculations that led to lockdown decisions. Although working in over-crowded streets make them vulnerable from a health perspective, they also become a risk for the whole population as they disobeyed public health directives. They started protesting a KRG’s order to impose another week of lockdown on June 6th, so they forced the government to retreat from its lockdown decision. For them, it was difficult to sit at home while they must earn their income daily.
Organizing and formalizing informal economic activities is one of the preconditions of any structural reform programme. The informal sector evolved through multiple conflicts and changes over the last five decades and in the absence of an adequate regulatory frame; from the Ba’ath Regime’s “socialist” economic policy to the post-2003 limited access-order regime. Now, it is the largest part of the country’s private sector by far but operating outside of any coherent policy. A study by United Nations Educational, Scientific and Cultural Organization (UNESCO) estimated, “two-thirds of all workers in Iraq work informally (over 7 million people).”[2] It also found a strong correlation between youth, working informally, and low levels of education. Meanwhile, returns on investment in education are relatively poor in this sector compared to the public.
For any economic reform, the GoI needs to look at the informal workers as a source of popular support. The informal economy is the livelihood of millions of impoverished Iraqis whose support can make a big difference; otherwise, they might be attracted to radical ideologist groups and militias that already have resources, media, and organizations to exploit them.
The informal workers and employees are the majority in Iraq’s labour market, but they are not politically visible. They have no political party, interest groups, and media to advocate their rights. Their issues, rights, and concerns have barely brought to any policy agenda because they are not well-organized and mostly exploited by populist politicians. They have no parliamentarian representatives and political blocs to bring their demands and needs to policy agendas.
Within any economic-reform planning, NGOs, unions, and advocacy groups that can represent informal workers should be included in policy discussions. Their perspectives and needs should be considered in any regulatory projects that will be introduced to enhance Iraq’s private sector.
Casual Construction Labour Market
Part of the informal economy is the construction labour market. Most of the construction workers, in the first phase of the COVID-19 containment measures, were forced to stay at home with no compensation for their lost wages although they need to go out-earning their income on the daily basis. By late April 2020, when the lockdown restrictions relaxed, day labourers could attend their workplace and gather in the crowded bazaars or streets to find employers, but the market is barely holding any opportunity. “Too many day-labourers are competing over a few opportunities.”[2] The causal labour market yet to recover and return to the pre-pandemic level.
Wages and opportunities of the construction labourers have significantly been reduced in this market. Although casual workers had no fixed payments before the Covid-19 pandemic, they used to work for daily wages between IQD 25,000-35,000 in Baghdad and 35,000-40,000 IQD in Sulaymaniyah. In late June 2020, their daily wage was between 20,000-25,000 IQD in both provinces except for refugees, IDPs, and foreigners who tend to work for even less.
Moreover, the frequency of their working days per week also changed. Before the pandemic, they used to work between 4-5 days per week on average, but in late June they barely get 2-3 days working, according to rough estimations of relevant labour syndicates[3]. Workers who lost their jobs in other sectors have oversupplied the construction labour market.
The majority of construction workers do not opt to be in this labour market, and they do not see it as a decent job. They are not granted with work-safety, and they often do not have the required personal safety equipment. They tend to work for whoever hires them in the allocated urban labour-places without any contract. No statistical data is available on this segment of Iraq’s labour force, which is mainly male-dominated.
Different labour laws enacted to organize the construction labour markets in KRI and the rest of Iraq. Instructions and regulations issued by the Ministry of Labour and Social Affairs to ensure casual labourers, but only 5% of them are insured. Foreign workers’ exploitations have been reported by NGOs and news outlets in various instances. Rudaw, a local Kurdish TV, reported that “Migrant workers in the Kurdistan Region are vulnerable to exploitation, abuse, and trafficking because of limited oversight by the Ministry of Labour and Social Affairs, a minister has acknowledged.”[4]
Turning this issue into an opportunity, both GoI and KRG need to organize this labour market. Recognizing the casual workers as legally registered employees for retirement and tax contribution is the first step. They should be included in Iraq’s tax and insurance systems. This can be the first step to incentivize private sector employment and reduce pressures on the public sector. It requires governments’ and law makers’ immediate actions to initiate a legislation project that could be beneficial for both workers and the state since the existing law and directives do not work well. According to the Pension and Social Security Law of Workers, the retirement system guaranteed by a fund that depends on contributing 17 per cent of labourers’ wage; 5 per cent to be paid by the worker and 12 per cent by the employer. The issue is most of the construction labourers do not have a stable employer to pay the 12 per cent contribution. Many companies also underreport the number of their employees and the bulk of employees’ salaries just to reduce their contribution. To make Iraq’s private sector job desirable and bring back some of the lost contributions to the fund, the issue should be addressed.
Needed Policy Actions
Given mounting risks and challenges associated with any economic reform programme, GoI and KRG need to get popular support for any intended reform policy. Most of the required immediate actions (resorting to ordering in the border-ports, reducing wasteful public expenditures, cutting illegal public salaries and pensions) are going to hurt some segments of the population who have been fed on the public fund. Therefore, the governments need strong popular support to kick off any reform programme. This support could be found within the millions of Iraqis who work in the informal sector. For this purpose, informality should be addressed now, although it is a long-term achievable goal.
1- Iraq’s informal sector is the livelihood of more than 5 million workers. Most of the informal workers have interests in reducing corruption, reforming dysfunctional regulations, removing bureaucratic impediments, and limiting outlaw armed groups that conduct extortion and elicit activate. Thus, the informal workers have incentives to be the best ally for any reformist political leadership.
2- Addressing informal workers’ needs, challenges, and concerns requires medium and long-term solutions, but it should be considered in most of the policy actions required to deal with immediate Iraq’s economic issues. Their concerns and demands should be considered in all the regulatory actions taken to reorganize market activities and the private sector in Iraq.
3- Informality is usually associated with high poverty, low productivity, under-employment, and misallocation of resources. It has created a situation in which informational asymmetric prevents banks from lending to MSMEs due to the absence of credit history, poor financial reporting, and eventually fearing of insolvency. As a result, banks and viable projects can’t meet. Optimal policies should be designed soon to incentivize the registration process by ensuring informal firms and workers and adding them to the tax-paying lists, a win-win solution for the governments and the informal workers.
4- Benefiting the recently rising international oil price, the GoI and KRG need to allocate some funds to support the SMEs and small informal businesses to recover the multi-faceted shock.
Studies show that microfinance and business-training programmes can improve the efficiency, productivity, and earning-potential of the informal sector. The financial support could be designed as an incentive to formalizing all the small firms and businesses. Again, this is another place where a win-win deal could be brokered. The governments’ financial support can save the SMEs and small businesses from bankruptcy; in return, they can be also added to the list of tax-payers.
References:
[1] The number of private workers insured by Iraq’s Ministry of Labour and Social Affairs is taken from the ministry’s website: https://bit.ly/2C9H4vT. The number of the KRG’s insured private workers is taken from Kurdistan Labor Syndicate.
[2] The statement was made by Othman Zindani, head of Construction Labour Syndicate, Sulaymaniah Branch, in a recorded interview for this study.
[3] Three Labours’ Unions’ leaders Adnan Safar, (member of the executive bureau of Federation of Iraqi Labor Unions), Othman Zindani (head of Construction Labor Syndicate, Sulaymaniah Branch) and Marwa Saad (Female Labour Activist) confirmed the numbers in three Interviews.
[1] TRT. “One on One: Interview with Iraq’s Deputy PM and Finance Minister Dr Ali Allawi.” August 18, 2020. Accessed August 22, 2020. https://bit.ly/3hDCLZo
[2] UNESCO. “Assessment of the Labour Market & Skills Analysis: Iraq and Kurdistan Region-Iraq: Informal Sector.” 2019. Accessed June 12, 2020.
The Iraq’s 2021 budget draft was submitted to the Parliament amid a nationwide outcry and anger. The budget bill is definitely explosive and largest in the history of Iraq in term of allocated funds, but it looks like an austerity budget to slash the payroll and impose implicit tax by devaluating Iraqi Dinnar (IQD). As usual, it allocates too much to running expenditure (IQD 120 trillion) but less to public investment (IQD 27 trillion). Although it is still in the line with the country’s fiscal policy, it certainly unexpected to those who had some hopes in reforming the country’s oil-depended economy and restructuring the imbalanced fiscal policy.
Facing a multifaceted shock of low oil prices and COVID-19 Pandemic lockdowns , Iraq is struggling with huge fiscal deficit and political uncertainties. The economy is expected to contract by 11 percent in 2020. Iraqi state leaders have promised to restructure the rentier economy and deviate from the heavily depending on crude oil exports , which still generate more than 90 percent of public revenues.
The Iraqi cabinet recently published a comprehensive reform plan called the White Paper, in which it set several short and medium-term plans to diversify the economy by revitalizing key sectors such as agriculture, trade, and industry towards a sustainable private sector led growth. However, the White Paper plans remained as great ideals on paper and poorly reflected in this budget draft.
Mohammed Hussein
is policy director and political-economy analyst at ICPAR. He holds a master’s degree in specialized economic analysis: Economics of Public Policy, from the Barcelona Graduate School of Economics.
According to the 2021 budget draft, total spending is estimated at IQD 164 trillion, while the revenues is IQD 93 trillion. The government is planning to depend on internal and foreign borrowings to address the IQD 71 trillion of deficit. In 2020, the government depended on two borrowing laws to finance its budget-deficit. Based on the laws, it borrowed more than IQD 27 trillion from local banks, which ultimately came from the Iraqi dollars reserved by Central Bank of Iraq (CBI). Therefore, the CBI’s foreign reserves decreased from $68 billion in 2019 to $57 billion in 2020, and it is expected to further decrease to $36 billion in 2021, according to an IMF estimate. Although the federal reserve is still in adequate level, but it will not be if the government keep borrowing from it. Keeping the same fiscal pattern, the cabinet will end up with depleting the reserves CBI needs to keep the value of IQD stable.
Furthermore, the budget draft mostly ignores what the cabinet needs to do in 2021 to lay foundations for any meaningful private sector development (PSD) by investing in Iraq’s under-funded infrastructure. It lowered public investment expenditures to 17 percent of the total spending, while it was 25 percent in the last budgetlaw, in 2019.
Addressing the unsustainable fiscal trend, the PM Al-Kadhimi’s government made CBI devaluate IQD by nearly 23%, while it has not reduced its wasteful current expenditure, not cleared up its payroll from ghost employees and double/triple recipients, and also not taken any steps to stop armed groups from controlling border-ports and looting custom’s revenues. In addition to the devaluation, which is expected to reduce purchasing power of most of the Iraqis’ poor and middle-class, the cabinet has planned to impose income tax on the civil servants and pensioners whose salaries are more than IQD 549 thousand. All these issues are going to be flashpoints in the upcoming parliament’s sessions to discuss and then ratify the budget draft.
The Dinar Devaluation is expected to save about IQD 7.8 trillion (changes based on oil price fluctuations), as the government sells its oil in USD but makes internal expenditures in IQD. CBI changed its fixed exchange rate from IQD 1182 = $1 to IQD 1145 = $1. The newly imposed income-tax is also expected to increase the non-oil revenues by more than IQD 9 trillion, according to the budget bill. However, the deficit is still there as the increased revenues is counted for in the both revenues and expenditures sections of the budget draft.
Keeping the Business as Usual Is Not Sustainable Anymore
All the aforementioned figures show that the current economic policy is just not sustainable. The post 2003 Iraqi governments constantly have increased running spending at the expenses of the development projects and infrastructure investments. The ruling elite has manipulated public funds and institutions to create employment opportunities for their followers and constituents without any economic viability. As a result, the number of civil servants hiked from 1.91 million in 2006 to 3.95 in 2020. The public hiring has been used as a political mechanism to expand the ruling elite’s patronage networks and then translate it to electoral gains. That has been a common policy trend over the past 17 years, but certainly it can’t keep ongoing as the Iraq’s public revenues (oil and on-oil) have slashed to almost half of what is needed to keep this business as usual.
Again, similar to the previous budget laws, allocated fund for the military and security institutions is too much and increased by almost IQD 15 trillion, compared to the 2019 budget law. It is 16 percent of the total spending and equal to the amount allocated for capital investment and development. The increasing military and security spending goes opposite to the reform vision established in the White Paper, which basically requires increasing infrastructure investment not current spending.
The Gloomy Future
The problematic economic policies are unlikely to lead Iraq towards any planned recovery from the perfect storm of the oil-price down and COVID-19 implications. It would rather raise concerns about disastrous political and economic implications. In the best-case scenario, the country is heading toward the planned national elections in June amid high unemployment, youth’ protests, and pressures from impoverished population.
The government approaches and actions, including this budget bill, so far have showed that nothing will be done to address the Iraq’s long-term needs to help private sector development and create job opportunities for the youth. Neither this government nor the upcoming one can address the economic and financial difficulties unless the economic and fiscal patterns will be restructured in a way to end oil dependency and using public resources as tools for election ends.
The economy cannot make enough employment opportunities for the young population that annually add about 800 thousand new entrants to the labor market. The IQD devaluation would exacerbate the already high national poverty rate, estimated at 31% by Iraq’s Ministry of Planning in July. The devaluation certainly hurt poor and lower middle-class people by its inflationary impacts. It will push a great portion of the middle class under the poverty rate.
Contrary to what Finance Minister Ali Allawi expected, the devaluation is unlikely to help achieving any economic goal and increase the local products’ competitiveness for some basic and very simple reasons;
First, the Iraq’s tough business environment, ranked as 172th (out of 190 countries) by the World Bank’s Doing Business Index, is actually what makes production cost too high and local products’ prices uncompetitive against cheap imports from neighboring countries. The devaluation unlikely ease the tough business environment if not farther deteriorate it.
Second, most of the local products, including agricultural ones, depend one imported input and raw materials. The price of the input already increased as they are bought in USD. This is a key factor to increase price of local products as well and counterbalance the small gain of the devaluation.
Third, as the devaluation is not associated with some crucially needed counter-corruption measures and regulatory reforms to improve the business environment, its effects will be limited to few sectors. The inflationary effects and lowered purchasing power force the consumers to depend on low quality imported products. The absent of proper enabling environment and market conditions do not allow the domestic products to compete cheap imports from neighboring countries. As long as, the investors face all the paperwork and many levels of extortion, they will not shift to production; therefore, the devaluation will only make the low income work-force in the market to get poorer.
Generally, the only gain from this devaluation is raising the value of Iraq’s oil revenue when exchanged from USD to IQD. As the Iraqi government makes big portion of its expenditures by USD (such as International Oil Companies’ payments, imports for government institutions), the gain will be limited and less than IQD 8 trillion for the whole year if Iraq’s oil price, production, and public imports will remain in their current levels.
Non-Oil Revenues
The non-oil revenues are estimated at IQD 20 trillion in the 2021 budget draft, while it was IQD 11.8 trillion in the 2019 budget law. Increasing non-oil revenues is a step forward in the right direction to reduce the oil-dependency, but it is not clear how much the government will succeed in achieving this goal given its poor performance in regard to border-port control over 2020.
In addition to customs-revenues, income tax, services-fees and bill collection operations, Iraq seriously needs to revitalize its local industries and key economic sectors such as agriculture, energy, industry, transportation, and tourism. This is how it can reduce the unemployment and poverty pressures on the government. Even though the government lacks enough resources to support these sectors by infrastructure investments and micro-finance programmes, there are some steps that do not need financial resources. In fact, they can be taken today if the populist blocs and political parties in the parliament will allow for it. It just needs to improve regulatory conditions and provide security for investors; like the recently signed deal with South Korean Company Daewoo Engineering & Construction Company to buildFaw Port in Basra. Iraq has huge potentials to attract investors in the country’s energy and agriculture sectors. It basically needs setting right planning and polices to start what the government can do today and lay foundations for what needs to be done in medium and long terms. For instance, promoting investing in food processing industry does not need anything rather than providing better security and protecting the investors from militias’ and political parties’ extortion activities.
The cabinet was supposed to open doors for private sector to participate in the economic activities and services where the government has poorly performed. For instance, bill-collecting operations (in both electricity and running water sectors) can be managed better by private sector, benefiting smart meter technologies. According to a 2019 World Bank report, 50 percent of energy billed gets lost due to the lack of proper billing mechanism, effective metering, and an adequate commercial management system. Involving private sector can fix much of this issue.
As the budget draft shows, the PM Al-Kadhimi’s cabinet is pursuing some easy reform steps (like IQD devaluation and income taxes) for which civil servants and poor Iraqis are paying for. However, it could not pursue policies and steps by which Iraq needs to reduce corruption, rebalance the economy, revitalize key sectors, and ultimately recover the 2020 shocks of oil price down and COVID-19 pandemic.
Recommendations
a. Any deviation from the established goals and articulated vision in the White Paper is going to shorten the distance that keeps Iraq from total economic and political chaos. In a line with the White Paper goals, the budget draft should be modified. The funds allocated to military and security sectors should be reduced by 50 percent at least, or minimum to the level that was allocated in the 2019 budget law. (the highlighted part does not make sense.)
b. The investment allocations should be increased up to 25 percent of the total spending to address the country’s huge need to infrastructure investment and development projects. The government should be encouraged to invest in the infrastructure projects and complete the on-halt projects also. Thousands reconstruction and infrastructure projects have been put on halt due to lack of financing. Funding these projects will improve the whole infrastructure and create employment opportunities.
c. Addressing the rising poverty rate, there should be more funds for the Public Food Distribution Programme. The government needs to reform the program immediately and introduce new criteria to keep it available only for low income people as it can’t keep it semi-universal. This is the most efficient way to reach out to the impoverished Iraqis who are certainly the losers of the IQD devaluation.
d. The funds allocated to both Shiite and Sunni Endowment Offices should be reduced at least by half. It would be rather spent on the infrastructure projects around holy religious sites that attract tourists. Or, it is better to spend on creating livelihoods for the Iraqi citizens. The offices should depend on donations and self-financing activities rather than public funds.
In his recent article “Iraq’s Government Investments: Between Ambitions and Stumbling,” Dr. Mudhr Mohammed Salih, former Deputy Governor of the Iraqi Central Bank and financial adviser of the Iraqi Government, fairly described the political and administrative dynamics that prevent investment in infrastructure; basically showing how endemic corruption, institutional limitations, and red-tape groups take away resources from infrastructure investment. As a result, the article suggests that Iraqi government’s direct dealing with international partners as the most likely feasible option to keep some investment in the underfunded infrastructure, assuming that direct dealing with international partners would help bypass impediments. Certainly, this can be one of the options, but it cannot be neither a sustainable and nor an easy one. Download PDF
This article is an attempt to touch on some other approaches that could help address the investment deficit before the one suggested by the Dr. Mudhr’s article.
The same challenges that have brought Iraq to the current investment deficit are likely to hinder the international partners’ engagement as long as the challenges are not tackled in their roots. The ruling elite and political parties’ patronage networks that have created the tough investment climate can ruin whatever the approach the Oil for Reconstruction Deal with China might achieve. As the challenges are so systemic and institutionalized, it is unlikely to find a solution by engaging international partners to bypass the impediments.
Mohammed Hussein
is policy director and political-economy analyst at ICPAR. He holds a master’s degree in specialized economic analysis: Economics of Public Policy, from the Barcelona Graduate School of Economics.
Dr. Mudher’s article realistically shed light on the ongoing fiscal challenges and how they have limited the resources for public investment. Additionally, it described how the investment management is not based on economic calculations but rather on political deals. Therefore, direct government to government deal with international partners is the only available option. This approach is understandable, but for how long can Iraq depend on it? One of the big challenges is tackling the obstacles that prevent the Iraqi government from scaling up infrastructure investment. The obvious answer is to blame the ruling elite and populist blocs that manipulate public funds to feed their patronage networks and satisfy constituents rather than considering the whole economic needs and infrastructure.
So, who can help addressing the investment deficit, which certainly can’t be short-term and neither an easy solution? The governments are too weak. The Iraqi parliament is overwhelmed by populist MPs. The private sector, as in any other conflict-ridden economy, is too weak and mostly informal. Non-state armed groups starkly use public resources for their ends and sometimes to challenge state institutions. This tough reality shows why there is neither a reformist leadership to start tackling the root causes of the investment deficit nor a leadership that can resolve problematic issues through bypassing them and working with international partners.
Looking at the government move to change the status quo; the cabinet is trying to get the parliament ratify another borrowing bill in late October to authorize more internal borrowing and finance public spending. It withdrew the 2020 budget draft bill, in which total spending is set to increase by 10 trillion IQD compared to the 2019 budget law, but investment allocations decreased by almost 2 percent. Moreover, the reality is much worse than the figures in the budget laws. Usually, Iraqi governments spend less than the allocations in budget laws. Till July 2020, investment spending was about 1.7 percent of the total spending, while it is about 23 percent in the proposed budget draft. Similarly, actual investment spending in 2019 was 15.3 percent of the total spending but nearly 25 percent in the budget law, according to Iraq’s Finance Ministry accounts. Figure 1 reports both investment and current spending in the past three years up to July 2020.
Figure 1illustrates all the investment and current spending of the federal government according to the published data on the website of Iraq’s Finance Ministry
Where to Navigate for Sustainable Solutions?
As Dr. Mudher’s article links the investment deficit to the structural economic and political impediments, the poor investment management can’t be addressed without structural institutional reform. Here, institutions refer to all the regulatory and policy actions that shape law-enforcement, property rights, competitive open market, and general stability that create a proper environment to allocate scarce resources. Such a reform certainly can’t be short-term. Even the recently published government White Paper set three years expectation to tackle some of the impediments. However, many crucial reform steps can be taken now.
In the short-term, some impediments can be addressed to revitalize part of the non-oil economic activities in the fast-job creating sectors such as agriculture,tourism, and services sectors. It just needs to shift the current fiscal policy towards investing more in the infrastructure. It does not need to wait for the oil price recovery if the cabinet, alongside with the parliament, work together on changing the fiscal approach and reforming the regulatory frameworks to restructure the current fiscal approach. Allocating more funds for infrastructure right now does not need waiting for oil price recovery. It needs slashing the bloated payroll to fund public investment that makes taxi drivers and farmers benefit from better streets and bridges. It is not going to be an easy trade-off in the 2021 budget law, but it is doable. If there is no political leadership to take the risk for the needed reforms and no parliament blocs to help with the needed regulatory reforms, no international partner can help.
In addition to the fiscal approach, Iraq’s unwritten social contract also plays a big role in allocating public resources to short-term political gains rather than capital investment. The core of the impediments is systemic. It is an evolutionary result of several decades of “Socialist Political Economy” of the Baath Regime and then the post 2003 Muhasasa System, where various groups compete over public resources to satisfy constituents by oil rents and public jobs. Therefore, the investment barriers are institutional and political. They are located in parliament as well as state institutions controlled by the red-tape groups. Simply, they are politically devised man-made problems, and their solutions can be found only within the same arena. Again, it is not something the international partners are willing (or able) to resolve.
To set realistic expectations, the investment deficit, as well as most of the other economic issues, can be addressed with a comprehensive reform programme, similar to the White Paper. The reform programme needs to design a new transitional social contract based on which the economic role of the state, relationship between government and private sector, and the whole market dynamics should be redefined. It needs to start with reforming what can be fixed today (as the aforementioned solutions) and then lay foundations for other medium–and long-term solutions. However, changing or establishing a new social contract means a long social and political process.
Iraq’s oil rent can’t satisfy a 40 million population, so the old (unwritten) social contract in most rentier states can’t work anymore. Even the agreed Iraqi Constitution in 2005 is apparently not working properly with regard to the distribution of oil wealth by Iraqi governments, including the Kurdistan Regional Government (KRG); both cannot provide jobs and subsidized services (health, schooling, food distribution, electricity, and refined oil products) as they used to do. In return, citizens are not keeping their voices quiet towards whatever the ruling elite does. They do not give up their rights in exchange for having public jobs and subsidized services that are not available anymore. Iraq cannot afford a rentier model similar to the Arab Gulf States. The ongoing salary protests in the KRG and the recent anti-corruption protests in the major Iraqi cities highlight the new dynamics. It emphasizes the need for a new social contract as well as a new governance-model that can deliver services and provide jobs.
Taking the Challenges as Business Opportunities for the Private Sector
The investment deficit and underfunded infrastructure would not be addressed only by the Iraqi government given the fiscal constraints of low oil price. Involving the private sector in smartly designed solutions is very much needed. Policies should be designed to take most of the current challenges as business opportunities. For instance, transforming neighborhood-generator owners and employees to private bill-collector firms would help fix much of the shortages in the electricity and running water sectors in addition to providing more money for investment in these sectors. With some smart electric and water meters, they can collect the bills better than state employees. They, ultimately, reduce some of the public funds wasted in these sectors and help the government increase revenues for infrastructure investment. Under such arrangements, private generator owners keep their jobs guaranteed while the state gets rid of the polluting deiseal generators. Such a solution makes citizens, the government, and generator-owners better off at a time when 50 percent of energy billed gets lost due to the lack of proper billing mechanism, effective metering, and commercial management systems, according to a 2019 World Bank report.
Besides, until the fiscal deficit will be eased land for reconstruction can be another option. Iraqi governments can give valuable urban and commercial lands to private companies in exchange of building roads, bridges, schools, and hospitals. Such a deal will improve the underfunded infrastructure and revitalize the construction labour market as well. Here, local and international companies might be involved to compete on viable deals directed to improve the neglected infrastructure.
Likewise, the high poverty and unemployment rates can be taken as an opportunity to supply cheap labor force provided the public sector stops the competition with the private sector by offering attractive salaries and benefits. This is what Iraq’s private sector needs, in addition to other protectionist measures, for being price competitive against imports. Here, the role of government to provide enforcement and parliament to afford suitable regulatory frame are needed. A reformist leadership is needed to translate the ongoing food security concerns into an opportunity for food processing factories and provide market for agricultural products.
Some of the aforementioned solutions can be taken now. They need a functional government and reformist leadership rather than oil money or international partners’ engagement. They can lay foundations for some of the solutions Iraq needs to revitalize its fast-growing sectors like agriculture, tourism, services, construction, and small industries. Even to address Iraq’s vulnerability towards external shocks (oil price fluctuations) these solutions are crucially needed as they increase non-oil economic activities.
What would prevent the current cabinet and parliament to address the investment deficit in the 2021 budget draft, to put aceiling on current spending and increase infrastructure investments? Why parliament does not initiate some regulatory reforms that are needed to ease business registration process, stimulate local and foreign investments, and reform the financial sector? These questions should be discussed and answered in public in a transparent manner. Problems and solutions are located here, and this is where public debates should start. If Iraqi citizens and civil servants are convinced of the harmful effects of double payroll recipients, ghost employees, and armed groups in the border-ports that take much of the public funds needed to pay salaries and provide services, they would have an incentive to be involved in any proposed reform effort. They would defend their interests against the corrupt ways of manipulating public funds. Here, a smart leadership would involve most of the Iraqis in the battle of corruption.
Lack of investment in non-oil infrastructure is an outcome of wrong fiscal policies which have been focusing on current expenditures and neglecting monitoring and evaluation of public investment projects. The issues are apure outcome of political and regulatory mismanagement. They have to be addressed by the same means. The Iraqi economic and policy challenges are properly identified in most of the reports by Iraqi economists and international institutions that have been published as well as development plans like Vision 2030, National Development Plan 2018-2022. However, they are not reflected in the investment strategy of the post 2003 governments, neither in most of the policies that have been made to organize the economy.
To sum up, this article is not to overlook the role of international partners that certainly can play a vital role in funding infrastructure investment. However, they cannot help that much if Iraqis do not take the lead in reforming the economy and addressing the investment impediments. Only addressing the root causes of the investment deficit can put Iraq on the path of sustainable development.
Chronic conflicts and wrong economic policies have pushed most of Iraq’s industries and producers out of business. They faced great losses at the local market and could not compete with cheaper and better-quality imports. Now, the market is import-dependent to the extent that the Iraqis producers are left with a small share in the local market. The chronic instability and endemic corruption have kept them from addressing the import-dependency. Crude oil exports, comprising more than 98 percent for the country’s exports and 93 percent of the public revenue, have been used to cover the import dependency. However, the oil revenue is not available anymore in the same bulk, and revitalizing the country’s private sector and economy basically needs robust protectionist policies such as tariff, import quota, and subsidies.
Since 2018, the Federal Government of Iraq (FGI) has placed tariffs on some products and put quota on some industrial and agricultural products. It has a farm-support program to buy grain products (wheat and barley) in prices higher than their market prices. As a result, some local food producers and industrial sectors have recovered. Now, Iraq is near to self-sufficiency in wheat and barley. Local soft drink factories recovered, and Iraqi cement and aluminum products also compete with imported products. Wheat production in 2020, in spite of the COVID-19 disruptions, is estimated to be 6 million metric tons (MMT), while the total consumption is estimated at 8.8 MMT.
Beside the structural economic, political, and security issues in Iraq, currency depreciation in Iran, Turkey, and Syria has made Iraq the dumping ground for neighboring countries cheap imports. The cheap imports could be favorable for Iraqi consumers, but they will put most of the Iraqi producers out of business unless some anti-dumping measures will be taken given the fixed value of Iraqi Dinar (IQD) against USD and relatively high production cost due to unfavorable business environment.
These policies have already shifted the dynamic of some of the Fast Moving Consumer Good (FMCG) product competition landscape in the market. It might be the early to start forcing the importing companies to bring in their operation into the country or replace them with locally produced products. However, it is clear that the current government’s agenda and loud voices in the mainstream would continue to expand the existing protectionist policies to safeguard local products. This will lead to significant changes in the market share of many products and competition of many FMCG products.
A Sizeable Market Outside of International Corporation’s Map
Iraq’s tough business environment and instability did not only keep the import-dependency but rather pushed out local investors to look for outside opportunities. The country looks like a funnel that can’t circulate the oil revenues within the economy, and most of the Iraqis’ income directly is spent on imported goods. Despite increasing oil revenues and bringing in heavy cash into the economy for the great part of the last 17 years, Iraqis’ general well-being did not improve. Youth unemployment is about 36 percent and national poverty rate is expected to reach 38.7 by the end of this year, under a high moderate forecast scenario of the World Bank Group.
The structural issues have pushed many well-known FMCG brands and companies away from directly engaging in Iraq. They have left the market at the hand of local traders who mostly overlook sustainability of the market and building long term success for short-term wins. With the consumer behavior adopted on the cheapest products, the market has been full of low-quality products despite the income growth for many Iraqis. This caused many local businesses to think about production as the quality of the consumed products has lowered down by most of the competing importers to take a greater market share. The local businesses adapted by functioning as packaging factories and competing imported FMCG in many sectors.
Leaving Iraq for local traders by most of the international FMCG corporations and not investing in a 40 million population market directly allowed the rise of many packaging companies in the neighboring countries such as Turkey and Iran. It also led the local businesses to shift to production since there was no need for a history of any sectors. The market becomes full of packaged products from many companies with no background or expertise. The local businesses could not only compete with foreign production, but also provide better services and products since they are more aware of the consumer demands.
According to an interview with Dolphin Sea CEO, “As Iraq goes through constant crises, many businesses moved into trading and especially FMCG; however, the competition got so tight, so it is hard to make any money while the risk is much higher compared to the past because every company looks for cheaper products. Consequently, a lot of new players enter the market, but only few remain.” The high level of competition and risk has forced many to think about producing from Iraq, where some market incentives are available. Here, they have leverage to pressure governments to assist them more and limit the access of the foreign brands into the market.
The Government Support
For years, Iraqi Governments promised to support the local products, but the support was never provided properly due to pressures from the neighboring countries or interests of politically linked traders and importers. The political elite who is mainly in the import business have played a big role in canceling out the government support until 2018, when great youth pressure for employment appeared. The Iraqi government started to impose customs-duty on products that have local substitutes such soft drink products, snack products, fresh foods, and agricultural products.
Unemployment rate, which is estimated at 17 percent, along with the youth protests made the FGI implement the new tariff code. It also pressured the Kurdistan Regional Government (KRG) to follow the same tariff-code, which was severely neglected to promote trading and make Iraq slowly become a hub for regional companies.
However, it is clear for the both politicians and businesses that the current situation is not sustainable and Iraq has to support local productions; otherwise it will face more social and political unrests not just from the young generations but also farmers and low-income people.
In Oct 2019, when young people took the streets of the Baghdad, it was clear that big changes were coming, and the status quo must change sooner or later. They were not just protesting to change the political structure but rather the whole economic regime in favor of local producers. The banner of “Made in Iraq” was visible among the young protesters as a sign of supporting local producers against neighboring countries’ cheap imports.
Aside from pressuring the government to make economic changes, Iraqi market is one of the biggest markets in the region with good consumption capacity. This has given the Iraqi Government an upper hand to implement its rules on all the companies not only FMCG ones.
Companies Are Bowing Down
As FGI increased taxes or banned imports like potato chips and soft drinks, some companies have faced tough choices of whether losing their market share or bring in their operation into Iraq. Previously, the market was dominated by the Iranian and Turkish brands. Extra tariffs revived local brands but also pushed many players to start setting up their production lines inside the country, and it also pushed some others to think about bringing in their operation into Iraq.
Brands like Lays started its production plant in Iraq motivated by high rate of the consumption in the market and trying to avoid the high taxes. Lays now has around 25 percent if not more of the potato chips according to industrial sources working in the snack market. In the long run, the market is expected to be fully covered by the local brands as new products are starting operating across the country. In addition, with a new protectionist strategy, the local producers for the first time have a chance to compete not just with the imported products but also with the other local brands.
Dramatic oil revenue crash as a result of the COVID-19 impacts in the international oil market has exposed FGI and KRG to huge fiscal deficit, but it also forced them to look for increasing their non-oil revenues and address the increasing public pressure for job opportunities and more stable economy. Leaders in the both governments have showed that revitalizing the private sector is where change needs to start. The new economic reality has pushed Baghdad and Erbil ruling elites to discuss various strategies to develop Iraq’s private sector in order to cope with the risen unemployment and poverty rates. Finance Minister Ali Allawi is expected to come up with his white paper regarding the economic issues by the end of this month.
Also, the Iraqi Government extended its support for the soft drink industry too. The sector was majorly dominated by the local water production companies for bottled drinking water, and Coca Cola and Pepsi which both have production plants in the country. But unlike the snack industry, the soft drink market is much bigger especially considering many factors such as improper water distribution in Iraq and hot weather that encourages a high level of soft drinks consumption across the year for many of the consumers.
According to an ICPAR estimate which are based on interviewing many stakeholders across the country, the market volume of the bottled water in 2020 is around 2 billion liters. The estimated carbonated drinks are also around 1 billion liters. These estimates make Iraq one of the biggest countries for soft drinking consumption in the region. With the current installed industries in the country and the protection from the government, this can be the threshold for the current local players to expand their operation for many other sectors and create a health competitive environment that benefits the consumers and the economy.
Currently, the local brands are trying to use the government protection to fill the gap in juice market. Previously, the Aujan Group Holding’s Rani was dominating the market, but with high taxes and import-bans the brand hardly survives in the market. According to an ICPAR source, the size of their sales in Iraq was over 250 million units annually, and losing this market has pushed the brand to work on setting a production plant in Baghdad. With the competitiveness from Rani, the local brands will need to keep up their productions and fight for their shares in an over 1 billion liter market.
Protectionist Policies and long-term Growth
There are many examples in modern history to show how protectionist policies boost or hinder economic growth; however, what is essential is these policies should be limited to certain timelines, not for long term periods that might destroy the competitiveness in the market and eventually harm consumers. There are many sectors in the economy that need protection from the government, but this should be to help these businesses to set their work and find a fair ground to compete with the imported and cheap products from Iran and Turkey.
Regardless of what will be the best scenario for an economy like Iraq, opening more businesses in many diverse sectors, mostly in the FMCG sector, will pressure the government for their protection. Such a created pressure would shape the market for the long term, favoring the local brands over the imports. This could create an important opportunity for investment and therefore reshape the whole economy in the long run.
The ongoing political and economic dynamics has the risk of leading the market towards more protectionism which is likely to create a path to large scale stagnation of the Iraq’s economy. It might leave consumers with no choice but to use inferior local products. Thus, protecting the local production should be understood in its long run effects and benefits not just blindly implemented which can easily make the consumers the hostage of the local producers.
