1. Iraq was able to maintain macroeconomic stability in 2010, notwithstanding very challenging domestic and external conditions. With the lower level of oil production, GDP growth in 2010 was modest at about 1 percent. Inflation remained in the low single digits, the exchange rate remained stable, and international reserves increased. Fiscal performance improved, mainly reflecting an under-execution of the capital budget and higher than projected oil revenues. The budget deficit is estimated to have remained well below the original forecast. Nonetheless, both the fiscal balance and current account are projected to remain in deficit in 2011 and 2012. Despite persistent capacity constraints and the long delay in forming a new government, structural reforms progressed in several key areas. These areas include program safeguards, central banking, as well as the oil sector.
2. Notwithstanding these accomplishments, the Iraqi economy continues to face daunting challenges and risks, notably a deteriorating security situation, constraints in administrative capacity, delays in the development of oil fields, and volatility in oil prices.
Economic and Financial Policies in 2011
3. As a result of the increase in oil production, GDP growth is expected to recover strongly in 2011. Non-oil GDP is projected to continue to pick-up slowly as security conditions improve.
4. Fiscal policy. The 2011 budget balances the need to accelerate investment in public services and oil infrastructure with the need to return to a sustainable fiscal position in the coming years. The authorities appreciate the staff’s support for their budget. Iraq’s reconstruction needs remain large, and the authorities aim to accelerate the pace of investment in 2011, within the country’s implementation capacity, to make up for the previous year’s delays. Current spending is also projected to increase in 2011—after being held constant in nominal terms for three years. The main objective is to accommodate higher costs of the in-kind Public Distribution System—stemming from the increase in world food prices—as well as higher security outlays. The budget continues to be based on a conservative assumption for oil revenues.
5. Monetary policy. The Central Bank of Iraq (CBI) intends to maintain its present monetary policy, which aims at keeping inflation in the single digits. The exchange rate remains the CBI’s main policy instrument, given the very low level of financial intermediation. The authorities remain committed to ensuring the independence of the CBI, which they view as critical for maintaining confidence in the Iraqi dinar.
6. Continued capacity constraints, compounded by the difficult security situation and the long delay in forming a government, have slowed progress in structural reforms. Nonetheless, considerable progress was made in strengthening program safeguards—notably with the completion of an external audit of the CBI’s net international reserves and net domestic assets and the strengthening of the internal audit committee that is charged with addressing remaining safeguard risks that were identified in the safeguard assessment update. The restructuring of the balance sheets of the two largest state-owned banks, Rafidain and Rasheed, is ongoing and is expected to be completed by end-June 2011.
7. With regard to public financial management, the review of all bank accounts in the banking system that were classified as central government accounts is nearly completed, with about only 7 percent of the accounts remaining to be clarified. The authorities acknowledge that improvements in cash management as well as fiscal controls and reporting can be made with the introduction of a Single Treasury Account. With support from the World Bank, the Board of Supreme Audit will carry out a review of a number of large 2008 investment projects with a view to distill lessons on how to enhance the quality of investment projects in the future.
8. Continued progress is being made in improving transparency in the oil sector with the installation and calibration of oil metering systems. Moreover, the authorities are working on modeling, in cooperation with the Fund, the implications of the agreements with the international oil companies on government finances. This work would feed into their Medium-Term Budget Framework. They reiterate their commitment to maintaining a single oil export revenue account that is subject to the principles of transparency and accountability that apply to the Development Fund for Iraq currently.
Performance under the Stand-By Arrangement (SBA)
9. The Iraqi authorities have demonstrated a strong commitment to the program’s objectives. They met all the performance criteria for which data were available at end-December 2010. They request waivers of applicability for the end-December performance criteria for which data are not yet available, and for which there is no evidence that these were not observed. Furthermore, they request an extension of the SBA by five months to allow time for an additional review and the implementation of the structural reform measures under the program. Accordingly, and as their financing needs have shifted to 2011, they request a rephasing of the remaining disbursements under the SBA. The authorities intend to treat the SBA as precautionary if oil revenues, irrespective of the combination of volumes and prices, in the first three quarters of 2011 exceed the projection of $46 billion by more than $3 billion or if at the time of the fourth review, the rate of execution of the capital budget is below 90 percent.
10. The Iraqi authorities are grateful for the valuable policy advice and technical assistance they receive from staff in support of their stabilization and reform efforts, as well as for the continued support provided by the Fund and its membership. They see the arrangement as continuing to provide them with a valuable anchor during a period of difficult political transition and considerable global economic uncertainty.