The Iraq’s Budget Bill Misses Some Expected Solutions
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.
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 build Faw 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.