1. On behalf of the Iraqi authorities, we would like to thank staff for their constructive engagement, as well as the valuable capacity development provided to Iraq in support of its policy and reform efforts.
2. Since the last Article IV discussion for Iraq, several elements contributed to improved political and economic conditions in the country: The formation of a new government, the recapture of territories previously held by ISIS, and a gradual recovery in oil prices. Millions of people displaced by the war against ISIS returned home, and negotiations around trade agreements with neighboring countries have progressed. Nonetheless, hundreds of thousands remain internally displaced and reconstruction efforts are delayed by many factors, including implementation capacity.
3. The economy is gradually recovering following the deep economic strains of the last four years. Growth is expected to be robust in 2019, reversing the contraction seen in the past two years, thanks to a notable improvement in security conditions and higher oil prices. The non-oil economy is projected to grow at more than 5 percent, due to better rainfall, a rebound in electricity production, and the fiscal stimulus. Inflation remained low in 2018 and the fiscal balance turned to a large surplus of about 8 percent. Higher oil prices have also supported a steady increase in international reserves to US$65 billion, helping to rebuild solid buffers to external shocks and retire domestic debt, including unwinding about US$1 billion of indirect monetary financing. Growth and the positive fiscal balance contributed to reducing public debt-to-GDP by about ten percentage points in 2018 and the government has adopted a framework to control the issuance of guarantees, in cooperation with the Fund. Higher oil prices and the improvement in the underlying fiscal position also contributed to a marked improvement in the external position, as reflected in the large current account surplus (about 7 percent of GDP). At the same time, the spread between official and market foreign exchange rates has narrowed to below 2 percent in recent months.
4. The authorities are fully aware that Iraq is facing the challenge of maintaining economic stability, while ensuring durable peace and inclusive growth. This entails rebuilding much needed infrastructure, addressing the legacy of conflict, ensuring the provision of services and job opportunities for all Iraqis, particularly the youth, and modernizing the economy. To address these challenges, the newly formed Government of Iraq has launched an ambitious reform and reconstruction agenda, outlined in the Recovery, Reconstruction, and Development Program and National Development Plan. In February 2018, in Kuwait, the international community committed to supporting Iraq’s reconstruction and development and pledged US$30 billion in the form of loans and guarantees at the International Conference for the Reconstruction of Iraq. A small portion of the needed reconstruction effort has, however, taken place to date, mainly due to limited absorptive and implementation capacity, as well as slow disbursement of pledged donor financing due to the heavy documentation requirements and project procedures.
Fiscal Policies and Reforms
5. The authorities are faced with pressures to increase employment in the public sector to address unemployment, achieve justice for some groups that were affected by past fiscal consolidation efforts including militia forces that helped defeat ISIS, and meet legal requirements to absorb graduates of certain specializations. Accordingly, tightening the fiscal stance in the short run is politically and socially difficult. Nonetheless, the authorities fully agree on the need for reforms over the medium term, particularly in the areas of non-oil revenues, subsidies, and civil service. Parliament recently adopted a new civil service law as part of their effort to conduct a comprehensive review of the public sector functions and size. The reform of the electricity sector ranks high on the authorities’ agenda and priority has been given to increasing generation capacity to address power outages. Work in this area has resulted in increased electricity generation by about 25 percent in mid-May relative to the year before. Work to settle electricity-related cross-liabilities is ongoing. The authorities acknowledge that important challenges in the electricity sector remain, as outlined in paragraph 30 of the staff report.
6. The authorities also concur with staff on the need to adopt a risk- and rules-based approach to fiscal policy as part of broader fiscal reforms to manage oil revenue more effectively, and they appreciate staff’s analytical work on the subject. In this connection, Parliament adopted a new General Financial Management Law in May 2019 that strengthens the legal framework for public financial management. The law defines general government for the first time, establishes the need for a medium-term fiscal framework and enshrines fiscal transparency requirements. It also limits parliament’s capacity to amend the budget, as well as the scope for spending to be authorized outside budget processes.
7. Public financial management (PFM) reforms continue to rank high on the authorities’ agenda. They have adopted tight procedures for the approval of government guarantees, kept arrears under control, and enacted a new PFM law in May 2019. They are also designing and implementing a commitment control system for budget execution to avoid the emergence of new arrears. Moreover, budget transfers to the Kurdistan Regional Government were progressively restored during 2018 and have been included in the 2019 budget. The Ministry of Finance is planning to implement an Integrated Financial Management Information System with the support of the World Bank, for which the adoption of an updated budget classification and a chart of accounts is a prerequisite. Work in these areas is progressing, with the support of Fund technical assistance.
Monetary, Exchange Rate, and Financial Sector Policies and Reforms
8. The authorities remain committed to the peg to the U.S. dollar as it continues to provide a key nominal anchor to the economy.
9. The authorities are taking measures to enhance the stability of the banking sector. The two largest state-owned banks, Rasheed and Rafidain, are being restructured. The authorities have made progress in procuring suppliers for core banking systems and have segregated legacy assets and liabilities into “bridge branches.” The Bureau of Supreme Audit is working on finalizing their accounts for 2014 and subsequent years. Once the core banking systems are fully operational, the authorities intend to have the two banks audited to international standards, which would allow their capital needs to be assessed accurately.
10. At the same time, the Central Bank of Iraq (CBI) is pursuing its efforts to strengthen the regulatory framework and improve prudential regulations in banking supervision to align them with Basel II Committee on Banking Supervision standards and guidelines. In this connection, supervisory guidelines on bank internal audit and compliance functions were prepared in the fall, with Fund technical assistance. Work is progressing on early identification of bank risks and the way to deal with weak banks, including early intervention of supervisors, corrective actions and their enforcement, banking crisis management and the supervisor’s role, as well as techniques for liquidating unviable banks. The CBI also intends to develop a deposit insurance scheme, which would help level the playing field across the banking sector. To promote financial development and inclusion, the CBI is working on strengthening payment systems and encouraging deposits, including public salary payments directly into bank accounts.
11. In June 2018, the Financial Action Task Force (FATF) welcomed Iraq’s significant progress in improving its AML/CFT regime and noted that “Iraq has established the legal and regulatory framework to meet the commitments in its action plan regarding the strategic deficiencies that the FATF identified in October 2013.” FATF thus considered that Iraq was no longer subject to the FATF’s monitoring process under its ongoing global AML/CFT compliance process. The authorities will continue to work to strengthen the AML/CFT framework. They consider that continued progress on AML/CFT will also help them address the transfer of illicit gains.
12. Good progress has been made in implementing the recommendations of the 2016 safeguards assessment of the CBI. Amendments to the Law on the Central Bank of Iraq to strengthen CBI governance have been enacted, and the revised audit committee charter now prohibits CBI executive representation on the committee. Work is ongoing on strengthening the capacity of internal audit and financial reporting.
13. The government is prioritizing anti-corruption efforts, with a focus on strengthening public institutions. A new High Council on Combatting Corruption, chaired by the Prime Minister, was established in February 2019. A Commission on Integrity was established in 2011 with the tasks of corruption prevention and enforcement, and it has investigated several high-profile corruption cases. Legislation to criminalize illicit enrichment, trading in influence, embezzlement, and all forms of bribery has been drafted. Iraq has also developed a system of asset declarations, and a large number of public officials are currently required to disclose their assets. The authorities agree with staff that streamlining the anti-corruption framework would make it more effective and less onerous for economic activity.
14. Notwithstanding an improvement in security conditions and oil prices, Iraq faces the serious challenge of maintaining economic stability, while ensuring durable peace and inclusive growth. The Iraqi authorities very much value the Fund’s policy advice in addressing its economic challenges, and they would welcome a Post-Program Monitoring engagement. Continued Fund capacity development would be essential in the period ahead. The authorities have been calling on the Fund to resume visits to Baghdad, similar to the practice of other international institutions. They welcome the recent lowering of the Fund’s security rating for Baghdad to a medium level of residual risk and look forward to welcoming Fund staff again.