Written and analyzed By
Prof. Dr. Hussein Ahmed Al-Sarhan
Department of Political Studies
March /-2024
Center for Strategic Studies/University of Karbala
Translated By.
Assistant Lecturer : Atheer Makki Al-Shammary
Atheer.m@uokerbala.edu.iq
The structural disequilibrium is still latent in the Iraqi economy, and the decline or fluctuations observed in the macroeconomic indicators are mainly due to these structural imbalances represented by the unilateralism of rent (oil rent), the large contribution of oil revenues to the gross domestic product, the weak contribution of other sectors to it, the weak role of the private sector, as well as the inability of state institutions to impose the law on the entire territory of the state. All of these indicators were not addressed during the Iraqi governments after 2003.
During the period from February 20 to 29, an International Monetary Fund mission met with the Iraqi authorities in the Jordanian capital, Amman, to conduct Article IV consultations for the year 2024. Article IV consultations are bilateral meetings held annually between the International Monetary Fund and member states, after which a team of Fund experts meets with the member country and conducts formal consultations with its officials.
The Fund’s experts expect economic growth to continue, given the expansion in public finances, with a significant increase in exposure to oil price fluctuations in the medium term. Reducing dependence on oil and ensuring fiscal sustainability while protecting critical social and investment spending will require significant fiscal consolidation, centered on controlling the public sector wage bill and increasing non-oil revenues. In parallel, this will require high economic growth to absorb the rapidly growing labor force, boost non-oil exports, and broaden the tax base. Accordingly, the Iraqi authorities should seek to enable the private sector to develop and grow, including through labor market reforms, modernizing the financial sector, restructuring state-owned banks, reforming the pension and electricity sectors, and continuing efforts to improve governance and reduce corruption. As for the non-oil sector, the IMF experts confirmed that “non-oil growth has returned strongly in 2023, with inflation easing. Non-oil real GDP growth is estimated at 6% in 2023, after declining in 2022. Overall inflation has declined from a high of (7.5%) in January 2023 to (4%) by the end of the same year, reflecting lower international food and energy prices and the impact of the revaluation of the Iraqi currency in February 2023. The current account is expected to have recorded a surplus of (2.6%) of GDP, and international reserves are expected to have raised to (112) billion US dollars.
These positive developments were supported by the return of trade finance operations to their normal course and the stability of the foreign exchange currency. After some disruptions following the implementation of new anti-money laundering and counter-terrorism financing (AML/CFT) controls on cross-border payments in November 2022, improved compliance with the new system and the CBI’s initiatives to reduce transaction processing times led to a recovery in trade finance in the second half of 2023. This ensured that the private sector could access foreign currency at official rates for import and travel purposes.
However, public finances have witnessed a significant decline due to increased spending and fluctuating oil revenues. Experts have confirmed that “the public finance position has witnessed a sharp decline. Despite the failure to implement the expansionary budget due to the delay in parliament’s approval of the budget, the public finance balance has declined from a surplus of 10.8% of GDP in 2022 to a deficit of 1.3% in 2023 due to the decline in oil revenues and an increase in spending by (8) percentage points of GDP due to an increase in salaries and contractual pensions by (5) percentage points, given that the Iraqi authorities have begun appointments in line with the budget law.” It is noteworthy that the Finance Committee in the House of Representatives confirmed on Wednesday, March 6, that the 2024 budget is still suspended and that spending is limited only to employee salaries. In terms of economic growth, experts linked this to variables related to oil prices and production cuts. The Fund’s experts expect “total growth to rebound in 2024, with risks tending to increase amid increasing uncertainty. Non-oil growth momentum will continue in 2024. Further declines in oil prices, or extensions of cuts agreed upon by OPEC+ members, could weigh on public finances and external accounts.” The impact of the regional stability variable is not excluded, as economic conditions are affected by the severity of regional tensions, developments in shipping routes, or damage to oil infrastructure, as well as internal security. Experts believe that these variables “may lead to losses in oil production, which could outweigh the potential positive impact of a rise in oil prices. Also, in the event of deterioration in internal security conditions, it could lead to a decline in the level of doing business and the suspension of investment projects.”
The limited role of the private sector and the increase in operating spending will have repercussions on economic indicators, especially financial ones. The Fund’s experts believe that “in the medium term, non-oil growth is expected to stabilize at around 2.5%, given the obstacles that limit the development of the private sector. Moreover, exposure to lower oil prices has increased, as higher spending is expected to push the price of a barrel of oil required to achieve fiscal balance above 90 dollars in 2024. In the absence of new policy measures, the public finance deficit is expected to reach 7.6% in 2024 and to widen further thereafter, with the expected gradual decline in oil prices over the medium term. As a result, public debt will nearly double from 44%) in 2023 to 86% by 2024.
To face these challenges, the Fund’s experts believe it is necessary to follow the following policies:
-Implement an ambitious fiscal consolidation to help stabilize debt over the medium term and rebuild fiscal buffers while maintaining essential capital spending. Much of the fiscal consolidation will come from reducing current spending, particularly controlling the wage bill by reducing mandatory hiring and gradually implementing the attrition rule for public sector workers.
– The Iraqi authorities should also seek to increase non-oil revenues by broadening the personal income tax base and making it more progressive, reviewing the tariff structure, and considering new taxes on luxury items.
– In parallel, efforts should continue to make revenue and customs administration more efficient. Further savings could be achieved by improving the targeting of social support and increasing the level of cost recovery of electricity supply in the electricity sector. These measures could provide scope for expanding the targeted social safety net.
– The Iraqi authorities should also strengthen public finance management and reduce fiscal risks.
– Fund staff welcomed the initial steps taken towards establishing the Treasury Single Account (TSA), which is a critical tool for improving liquidity management. Further progress is also needed in this regard, as well as the importance of close cooperation between the Central Bank of Iraq and the Ministry of Finance. The next steps are to identify options for the design of the Treasury Single Account and complete the census of bank accounts.
– An overall ceiling on guarantee issuances should be set and included in budget laws in subsequent years, with compliance ensured. The use of off-budget funds should be avoided, particularly in light of the potential financial risks associated with them.
– It is imperative to ensure that the Iraq Development Fund has appropriate governance arrangements, including the independence of its board of directors, while ensuring transparency of the Fund’s activities, including by publishing the Fund’s investment plans in annual budget documents and controlling its borrowing capacity.
– The ongoing efforts of the Central Bank must be supported by consolidating unused government deposits in the single treasury account, refraining from pro-cyclical fiscal policy, reducing reliance on cash financing, and improving public debt management. In parallel, efforts to establish an interbank market should continue, supported by technical assistance from the International Monetary Fund. The steps taken by the authorities to accelerate the pace of digitization of the economy, reduce reliance on cash, and enhance financial inclusion should be accelerated.
– Broad structural reforms are needed to enhance private sector development and economic diversification. Iraq needs to sustainably raise growth rates in the non-oil sector to absorb its rapidly growing workforce, increase non-oil exports and government revenues, and reduce the economy’s exposure to oil price shocks. Key reform priorities include adopting a comprehensive employment strategy that aims to gradually eliminate mandatory public sector appointments, align public and private sector jobs, address the gap between educational curricula and skills required in the private sector, and strengthen labor market institutions. The strategy should also aim to reduce informal sector activities and address legal, social, and cultural barriers to women’s participation in the labor force.
– Accelerate reforms in the financial sector to improve access to finance: The Iraqi authorities are committed to modernizing the banking sector and supporting banks’ ability to establish banking relationships with correspondent banks; they have taken steps to merge small private banks.
– Efforts to restructure the two largest government banks should be intensified, including by expediting the approval of past financial statements, implementing comprehensive banking regulations, and strengthening corporate governance in line with best practices.
– Implement comprehensive pension reforms: These reforms are urgently needed to reduce the expected total financial costs of the public sector pension system, improve the alignment of benefits and rules between public and private sector pension systems, ensure adequacy of pensions and equity across generations, and increase the percentage of workers participating in the private sector pension system.
– Combat corruption and enhance governance: especially by strengthening the necessary institutional and legal frameworks to ensure the independence of the Integrity Commission and the Federal Financial Supervision Bureau, enhancing the publication of disclosures of financial assets, disclosures of conflicts of interest of senior officials, and adopting an updated anti-corruption strategy.
– Work should be done to strengthen the rules regulating public procurement and business. The authorities should also continue to strengthen the AML/CFT framework and its effectiveness, including in the banking sector, guided by the priority actions identified by the Financial Action Task Force’s joint assessment of the Middle East and North Africa region, to be completed in May 2024.
– Remove other obstacles to private sector development by implementing electricity sector reforms to improve efficiency, recover costs, and ensure reliable access to electricity; simplify business registration procedures; and modernize critical infrastructure.
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