Political Crisis in Iraq: The Things Must Change [Part 2, the economic side]

Por Elbay Alibayov, analista invitado a La mirada a Oriente, colaborador de un servidor entre 2002 y 2004 en la Misión de la OSCE en Sarajevo (Bosnia y Herzegovina) y experto en Iraq donde trabajó como asesor internacional del gobierno central de 2011 a 2014.

En esta segunda parte dedicada a la dimensión económica de la crisis de Irak, Elbay Alibayov analiza principalmente los desafíos derivados de la dependencia del petróleo, la ausencia de un entorno favorable a las empresas, el endeudamiento y el coste astronómico de la reconstrucción de las infraestructuras después de casi dos años de guerra contra el DAESH.

 

140615000716_mapa_irak_grupos_etnicosEconomy and Economic Institutions

Oil dependency

The Iraqi economy is struggling. It fully depends on oil & gas industry and, thus, is exposed to market volatility and highly vulnerable. Today, oil exports comprise 99 percent of the country’s exports. This, combined with the old-fashioned central planning, strict market regulation, and outdated methods of management only makes the problem insurmountable. In charge is the Ministry of Planning, which also happens to be very influential due to holding the economic and social sphere information in their hands (and keeping it close to chest), a replica of (Soviet) socialist-style central planning committee.

As across the Middle East, diversification of economy is a fancy word in Iraq, but: first, as shown elsewhere in the region, it is easy said than done, especially in a short time span (considering the external factors of harsh competition, but also internal human factor and the quality of physical and social infrastructures); and second, it requires not only well written strategies but concerted efforts and leadership by political elites (something that the United Arab Emirates have demonstrated in turning their economy from oil-driven to service-based, but Iraq, as some other oil-dependent economies, struggles to do).

oilwelldesert

 

Non-hydrocarbon industrial production (or what is deemed as such) is concentrated in the Iraqi public sector. While comprising a tiny one-and-half percent of the country’s industrial units, state-owned enterprises (SOEs) are producing over 90 percent of the sector’s output. But even these SOEs are non-profitable: in 2012, almost 80 percent of them were functioning on the government subsidies. They use obsolete equipment, do not follow international technological standards, and are managed in outdated ways. Except for cement, fertilizers and transformers, the Iraqi industrial products from state-owned, private and mixed-ownership enterprises are not competitive at either domestic, regional or international markets.


Business enabling environment

In spite of these striking deficiencies, there have not been any serious attempts undertaken towards market economy and deregulation, let alone privatisation. Economic reform plans have been developed by the Government (mostly with the assistance of international actors) but never transformed into action. The examples are numerous, from Integrated Energy Strategy, Industrial Strategy, to the Roadmap for Restructuring the SOEs and the Strategy for Supporting the Private Sector. Here, again, it was more about rivalry, vested interests of political blocs and lack of trust between them rather than inability or unwillingness of Government technocrats that did not allow making even initial steps towards deregulation or introducing mixed forms of ownership in key sectors.

Business enabling environment in Iraq has been long neglected and as a result, remains largely underdeveloped and market-unfriendly (the Government’s ambition for and on-going negotiation on the acceptance to WTO notwithstanding). Private sector is weak and not supported by the effective policy, legislative and regulatory framework; to the contrary, there are thousands of laws, regulations and improvised circulars which only confuse and slow down the entrepreneurial activity, while creating conditions conducive for Iraq’s systemic corruption to thrive. It does not come as surprise then that Iraq is consistently at the bottom of the global ranking for Doing Business report: in 2015-2016, it ranked at 160 and 161 among 189 surveyed countries, respectively. Importantly, even within one year, it fell dramatically in a central category of ‘Starting a Business’ by 10 points. Otherwise, successful businesses are closely linked to political elites, thus feeding further the systemic corruption (such as those enterprises providing off-grid electricity to residential areas across the country, from their privately owned generators).

The result is that extractive economic institutions feed on the country’s rich resource base, but do not reinvest into its growth (typical rentier economy, some would say). Moreover, instead of incentivising and enabling, they constrain the free choice of people to undertake entrepreneurial activities and to invest into their country’s economy—thus, constraining the Iraqi talent and money of strengthening the country’s economy and creating a strong middle class as the society’s backbone. Friedrich Hayek, one of the most influential economists of the last century, has well described the contradiction of this kind economic thinking: ‘It is often said that political freedom is meaningless without economic freedom. This is true enough, but in a sense almost opposite from that in which the phrase is used by our planners. The economic freedom which is the prerequisite of any other freedom cannot be the freedom from economic care which the socialists promise us and which can be obtained only by relieving the individual at the same time of the necessity of the power of choice; it must be the freedom of our economic activity which, with the right of choice, inevitably also carries the risk and the responsibility of that right.’ [1]

Financial Situation and Sovereignty Crisis

Budget

About 95 percent of Iraq’s Government budget comes from oil revenue. Even at better times, any unfavorable fluctuation in oil prices had immediate and very painful implications on the country’s financial standing. As in many other areas, the Government and its Oil Ministry (another bastion of power and vested interest by elites) had been unprepared to the market shocks, because it had continuously failed to introduce modern planning and decision making processes (one such planning support tool, oil resource management system equipped with industry data software, was envisaged by the Integrated National Energy Strategy adopted in 2013 but by that time it was too late—ISIL was knocking at the door). In the last couple of years, the Government’s revenues have dried out due to record-low oil prices at the global market and the excessive spending from public budget, on the administration’s running costs, the war with ISIL and its humanitarian consequences.

The budget has been approved for 2016 at $100 billion, with predicted deficit of about $25 billion. But even this grim outlook is unrealistic: the budget calculations were based on oil price of $45 per barrel, while so far Brent prices have been hovering around $30 to $40 (they are expected to average $42 per barrel in the second and third quarters of 2016, before rising to $44 in the fourth quarter). This means billions more added to the deficit. Five years ago, in 2011 the deficit was projected by the Budget document approved by Parliament at 16.2 percent ($13.4 billion to $82.6 billion budget, respectively), and this was at the time of oil prices keeping high at $76.50 per barrel.

Sovereign debts

In a rather frantic move, the Government has recently resorted to using its foreign reserves (under a pretext of short-term measure) to cover its daily expenditures—and thus has taken a dangerous route which may head towards eventual insolvency. This will make the reserves fall from $59 billion in last October to about $43 billion this year. But that is not all. In the meantime, the Government is seeking yet another loan from the International Monetary Fund (IMF) in an attempt to regulate its financial situation. This is at the top of receiving $1.24 billion emergency loan last year (through the Poverty Reduction and Growth Fund). With another international lender, the World Bank Group (WB), the Government signed an agreement at the end of 2015, for a $1.2 billion loan. This also comes atop of other liabilities to the WB: by the end-March 2016, there were four active loans, through the International Bank for Reconstruction and Development (IBRD) and five credits through the International Development Assistance (IDA) – altogether about $3.1 billion already disbursed. Governments have stepped in, too: the United States has offered a $2.7 billion loan for military spending, and Germany has lent Iraq over $550 million for reconstruction.stock_market_oil_crash

Looks like a lot money, but it is not. Altogether, these loans would barely cover the Government’s one-month administrative expenditure under the current circumstances, but instead will make Iraq more indebted, under mounting liabilities while with no repayment prospects on the horizon. The Iraqi Government simply cannot afford intensively borrowing. The borrowing from international lenders is always conditional, and it is proven helpful only in a short term as cash injection to maintain the equilibrium; while in the situation when government fails consistently to perform structural reforms, the financial discipline and austerity measures (let along being under the pressure of war and destruction of infrastructure and assets) the additional liability may turn disastrous and lead to the bankruptcy and the loss of sovereignty. What these attempts tell is more about the Government being desperate and confused rather than about well thought-out financial policy.

The cost of reconstruction

Another problem is that in order to get back on track and restore the normal economic activities, along with liberating the territories captured by ISIL, the Government will need hundreds of billions to be invested in the reconstruction of physical infrastructure (to revitalize what has been destroyed in the course of the last two years, by now). The cost of reconstruction has not been calculated yet. According to Iraqi economists, the country will need about $60 billion to recover. I think it is a very modest estimate: just recall how the U.S. Government initial estimate of $50 to $60 billion on the Iraqi war and reconstruction turned into $2.2 trillion by 2013. The international organisations and bilateral donors would step in, and so will do various public and private foundations and donor conferences, but the host government has to take its share of responsibility and match those reconstruction funds, which would be yet another challenge to the cash-stripped authorities. The question is, if the things (in this instance, the Government’s economic policies and practices) don’t change, can they stand to the task when the time comes?

@ElbayPolicyLabs

 

[1] F.A.Hayek, The Road to Serfdom (London: Routledge, 1997 [1944]), p. 75

 

About the author: Elbay Alibayov is an international development professional specialising in state building and political processes in post-conflict countries. In 2011-2014, he worked in Baghdad assisting the Iraqi Government’s central executive offices and key ministries on a range of administrative initiatives and policy reforms.

Acerca de La mirada a Oriente

Me interesa entender qué ocurre fuera de nuestras fronteras, analizar por qué ocurre y proyectar escenarios sobre qué puede pasar. Mis áreas de interés son Irán, Oriente Medio y Norte de África, China y la política exterior de Estados Unidos en esas zonas. Mi formación es multidisciplinar. Tengo un Grado en Ciencias Políticas y Relaciones Internacionales por la Universidad de Londres - London School of Economics and Political Science. También soy licenciado en Derecho y Master en Estudios Europeos por el Colegio de Europa. Desde 2008 pertenezco al Cuerpo Superior de Administradores Civiles del Estado y trabajo para la Administración General del Estado. Anteriormente trabajé más de ocho años en la OSCE, la Asamblea de la OTAN y varias misiones de Naciones Unidas, principalmente en los Balcanes y alguna en África.
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