IMF updates on Iraq economy
IMF updates on Iraq economy
Recent macroeconomic developments have been broadly positive in Iraq. Economic growth in Iraq reached 8.4 per cent in 2012 and is expected to rise to nine per cent in 2013 as oil production increases to 3.3 million barrels per day (mbpd), said the International Monetary Fund. Inflation has declined from about six per cent at end-2011 to 3.6 per cent at the end of last year, and should increase only slightly in 2013. International reserves of the Central Bank of Iraq (CBI) rose from $61 billion at end-2011 to $70 billion at end-2012, and fiscal reserves held at the Development Fund for Iraq (DFI) have increased from $16.5 billion to $18 billion.
Iraq is exceptionally rich in oil, but its economy suffers from severe structural weaknesses, such as a small non-oil sector, a dominating role of the government in all areas of the economy, and a poor business environment. Nevertheless, partly thanks to the increase in oil production since 2003, Iraq has achieved a rise in GDP per capita from $1,300 in 2004 to $6,300 in 2012 in a very difficult security and political context. During this period, Fund programme engagement with Iraq was instrumental in maintaining macroeconomic stability—even though progress on structural reforms and job creation was mixed.
Thanks to higher-than-expected oil revenues and the under-execution of the investment budget, fiscal surpluses reached almost five per cent of GDP in 2011 and four per cent in 2012. However, with a break-even oil price of about $100, fiscal performance is very vulnerable to oil revenue shocks—either from oil price declines or export shortfalls. Furthermore, fiscal discipline weakened over the past two years, with poor budget planning and execution, large off-budget spending, and low investment execution rates. The 2013 budget includes large unfunded commitments, increasing fiscal risks, including the possible depletion of fiscal reserves, if the budget were to be fully executed.
The policy of a de facto peg to the US dollar provides a key nominal anchor to the economy, and the nominal exchange rate in the official market has remained stable since 2010. However, since late 2011, the authorities enforced existing exchange restrictions and introduced new restrictions in response to concerns about money laundering and illegal foreign exchange outflows related to the increased demand for foreign exchange. As a result, the spread between the official rate and the parallel market rate—which had been up to that point below two per cent—started to climb, passing nine per cent in May 2013.
Over the medium term, Iraq’s macroeconomic outlook will continue to be driven by developments in the oil sector. Staff projects that oil production will rise gradually by about 400-500 thousand barrels per day per year, reaching 5.7 mbpd by 2018. Overall, growth is projected to remain above eight per cent and inflation at 5–6 per cent over the medium term.
Risks to the macroeconomic outlook remain high. They include (a) weak policy implementation, particularly in the fiscal area; (b) further deterioration of the political and security situation; (c) a larger-than-projected decline in global oil prices; and (d) delays in developing Iraq’s oil fields and oil export capacity, possibly due to security issues but also insufficient investment in oil infrastructure. These risks can translate into lower oil revenues, deterioration in the fiscal position, pressures to use CBI reserves for fiscal purposes, and higher inflation.
Executive Board Assessment
Executive Directors commended the authorities for maintaining macroeconomic stability in a difficult security and political environment. With risks remaining high, including from oil price volatility, they stressed the need to build fiscal buffers and further strengthen the institutional framework. They urged the authorities to step up reforms to develop the private non-oil sector to help generate employment and inclusive growth.
Directors emphasised the need to implement sustainable fiscal policies and address risks from oil revenue volatility. Rationalising current spending—including public employment, energy subsidies, the Public Distribution System, and transfers to state owned enterprises—is needed to create space for priority social spending and public investment and to accumulate buffers. Enhancing public financial management and avoiding quasi fiscal operations by the state owned banks are also crucial. Directors noted that fiscal rules could provide a framework for fiscal policy over the medium term.
Directors supported the objective of the Central Bank of Iraq (CBI) to liberalise the foreign exchange market and the recent steps to simplify market regulations. Further measures are needed to liberalise fully the supply of foreign currency, with the objective of lowering the exchange rate spread, removing distortions, and complying with Article VIII of the Fund’s Articles of Agreement. Directors considered that strengthening the Anti Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework, in line with the Middle East and North Africa Financial Action Task Force (MENA FATF) recommendations and FATF standards, would be more effective than restricting foreign exchange in curbing money laundering and terrorist financing.
Directors agreed that a stable exchange rate, supported by a high level of international reserves, provides a valuable anchor in an uncertain environment. They agreed that the two tier architecture of prudent management of CBI reserves and use of the Development Fund for Iraq (DFI) as a de facto oil stabilisation fund is appropriate. They urged the authorities to continue to rely on the DFI to help stabilise government spending and ensure oil revenue transparency.
Directors highlighted the importance of a stable financial sector in developing the private sector and diversifying the economy, and were encouraged by recent progress in strengthening banking supervision and restructuring the Rasheed and Rafidain banks. They encouraged the authorities to ensure a level playing field for public and private banks by opening to private banks access to government business.
More broadly, Directors emphasised that fostering growth in the private non-oil sector requires improving the business environment, investing in infrastructure and social capital, reforming state owned enterprises, and enhancing public service delivery. Judicious use of the country’s oil wealth can help address these pressing challenges. Improving the authorities’ capacity to implement reforms will also be critical.