Abstract
This paper reviews Iraq’s Request for Emergency Post-Conflict Assistance (EPCA). The authorities’ main goals under the EPCA-supported program are to improve the general welfare of the Iraqi people and address Iraq’s external debt problem. The authorities’ program is to be underpinned by a prudent fiscal policy that aims to limit spending to available government revenues and external resources, the use of the exchange rate to anchor inflation expectations, and the planning and undertaking of key structural reforms to transform Iraq into a market economy.
Today marks a new beginning in the relationship between Iraq and the International Monetary Fund. It has been some two decades since the Executive Board has formally met to consider economic developments in the country. The Iraqi authorities are very appreciative of the Fund staff and management’s tireless work and their commitment to helping the country in its efforts to establish economic stability and reverse the sharply deteriorating situation that has characterized the past two decades. They would also like to express their gratitude in particular for the substantial technical assistance they have been receiving from the Fund, which has proven indispensable for the rehabilitation of the economic Institutions in the country.
Recent Developments
Years of wars, sanctions, and mismanagement, coupled with the recent conflict have exacted a heavy toll—both human and material—on the Iraqi economy. Given the well-known economic degradation that has taken place throughout these years, I will refrain from detailing it here. Suffice it to say that after enjoying relatively high standards of living in the 1970s, the per-capita income of the Iraqi people experienced a precipitous decline from over $3000 in the early 1980s to $500 in 2003, a level comparable to or even below that prevailing in many of our low-income/HIPC member countries.
The challenges facing the Iraqi authorities today to reverse this deterioration are by any standard daunting. Developments since mid-2003 however have shown a high degree of resolve to take the necessary actions to address these challenges under most difficult circumstances. The ongoing economic rebound and reforms, including in the monetary and fiscal areas, introduced to transform Iraq into a market-oriented economy, have to be viewed against the starting point of the reform process when the economy came to a virtual standstill in the wake of the conflict that started in early 2003. In addition to the decaying institutions and infrastructure, the oil sector, which is the backbone of the Iraqi economy, has suffered serious damage and production was completely halted. Since then, among other positive developments, oil production resumed, a functioning payment system has been put in place, new bank notes were introduced, the trade regime was reformed, a new tax law came to light, and new banking sector legislations were approved. Along with the continuous recovery in the non-oil economic activity, the increase in oil production is likely to lead to a sharp rebound in overall activity in 2004. Underlying this recovery has been a relatively stable macroeconomic environment with inflation kept under control and a stable exchange rate. The accompanying increase in base money is a testimony to the improving confidence in the economy, notwithstanding the security concerns.
As we all know, Iraq continues to suffer from virtually daily attacks within the country which complicate the ongoing reform effort as well as the task of increasing oil production. As they have demonstrated however, the authorities are strongly committed to continue with their reforms in spite of these difficulties. In fact, the recent completion of the first treasury-bill auction and its bi-weekly recurrence since July 2004 is worth noting given its importance for the conduct of both fiscal and monetary policies.
Emergency Post Conflict Assistance
Based on their demonstrated ability to implement difficult reforms and after clearing all Iraq’s arrears to the Fund and consenting to increase the country’s quota under the Eleventh Review of Quotas, the authorities are requesting Emergency Post Conflict Assistance (EPCA). They consider the EPCA to be critical to support their efforts to build on the reforms introduced in recent months and to catalyze and pave the way for additional international support, including in particular debt relief, without which no meaningful reconstruction and rehabilitation can take place. They look forward for prospective negotiations with all their creditors to alleviate the tremendous debt burden accumulated in the period leading to the last conflict. In this regard, they are taking steps to clear arrears with the World Bank and the Arab Monetary Fund. The authorities are grateful to their creditors for agreeing to a moratorium on debt service and for the financing assurances they have provided to facilitate the move to an EPCA. They intend to adhere to the program agreed with the staff with a view to building the necessary track record to move to an upper credit tranche stand-by arrangement in 2005 to support a more ambitious reform agenda.
Economic Program
The authorities’ economic program to be supported by the EPCA aims at maintaining a stable macroeconomic environment while laying the ground for implementing a comprehensive structural reform agenda to transform Iraq into a market-based economy with a larger role for the private sector. The main macro targets include enhancing growth performance while keeping inflation under control, and maintaining a sound fiscal policy.
Fiscal Policy
The conduct of fiscal policy will be shaped by the drive toward prudence on the one hand and meeting the large basic and social needs of the Iraqi people and the reconstruction requirements on the other. Spending will be constrained by the available domestic and external resources. With the primary fiscal deficit projected to decline to around 42 percent of GDP in 2004 and 27 percent in 2005, the authorities would likely be able to finance it with resources available through the United Nations oil-for-food program resources, assets held in the Development Fund for Iraq, and donors’ project financing. The authorities are committed not to borrow directly from the central bank in accordance with the new central bank law. Meeting these objectives hinges to a large extent on a substantially faster disbursements of aid pledges made at the Madrid Donors Conference in October 2003 than has been the case since commitments were made about a year ago. The authorities very much look forward to continuing cooperation of the donor community.
A tremendous effort is being made to keep spending under control. The 2005 budget aims at reducing recurrent spending from 107 percent of GDP this year to 88 percent of GDP. This will be achieved by limiting wage and pension increases to 11 percent and decreasing outlays on goods, services, and transfers. Oil-related spending will be directed at rehabilitating oil production in line with projections.
The authorities are very well aware of the large burden that the price subsidy on domestic consumption of oil derivatives imposes on the budget. Given the high social sensitivity of this issue, they intend to move in a deliberate and gradual manner to avoid a possible detrimental public reaction. They are committed to begin the process of reducing the subsidy by end 2004 with a view to full elimination by 2009.
On the revenue side of the budget, the authorities have put in place a simplified tax regime that includes a 5 percent reconstruction levy, as well as a revised personal and corporate income tax with a maximum marginal tax rate of 15 percent and a higher personal income allowances that introduces progressivity into the system. Moving forward, the plan is to take further measures starting in 2005 to broaden the tax base. A reform of the tax and customs administration will be undertaken and a general sales tax will be introduced most likely in 2006.
More broadly, ensuring fiscal sustainability over the long term will require that the role of the government in the economy be curtailed. The authorities are intent on taking the necessary steps to reduce the wage and pension bill, reforming the state owned enterprises, and replacing the current food ration system with a cash-based distribution system that better targets the needy.
Monetary and Exchange Rate Policy
The introduction of a new currency and a new central bank law that endows the Central Bank of Iraq with independence and accountability are key building blocks for ensuring a prudent monetary policy conduct, with the main objective of price stability. While the exchange rate system for Iraq is still under consideration, the authorities had no means other than the exchange rate to anchor inflationary expectations which has proven to be rather effective in maintaining stability.
Further reforms to modernize the central bank and the financial sector are being pursued. The central bank has introduced a lender of last resort and overnight standing credit/deposit facilities to better manage liquidity. With regard to the supervisory and regulatory function of the central bank, work is underway to implement regulations on loan classification, capital requirements and risk management. The dominance of state banks in the economy clearly suggests that a restructuring plan is warranted to improve their efficiency and governance structure.
Structural Reforms and Capacity Building
In addition to the structural reforms in the monetary and financial areas, the authorities plan during the program period to work towards improving governance in the oil sector, review its financial operation, and prepare a restructuring plan for it which will include the recommendations of the International Advisory and Monitoring Board regarding monitoring and control systems.
On capacity building, I would like to reiterate the Iraqi authorities’ deep appreciation for the ongoing technical assistance provided by donors and the Fund, which is critical for the reform program. They recognize the very difficult conditions under which Fund staff is working to help Iraq build its capacity in the statistical, fiscal, monetary, and financial areas. While substantial assistance has been provided over the past year, the needs of the country are still great. As the First Progress Report on Technical Assistance Subaccount for Iraq clearly shows, weaknesses remain widespread even in those areas where TA has been provided. This underscores the importance of continuity and follow-up training to ensure that initial TA is disseminated throughout the concerned ministries and departments and thus properly implemented. The authorities look forward for continued training and assistance including through the Middle East Technical Assistance Center.
Conclusion
In spite of all the progress made over the past year in reforming the economy and the ongoing economic rebound, the authorities are very well aware of the difficult situation Iraq finds itself in and the many obstacles and risks facing them. They also recognize that in addition to the wide ranging fiscal, monetary, and financial sector reforms planned for the period ahead, placing the economy on the path of sustainable recovery requires the implementation of a far reaching reform agenda to enhance the role of the private sector in Iraq which has been suppressed for many years. In this regard, the preparation of a national development strategy which entails plans to rehabilitate the oil sector, diversify the economy, improve social conditions, and for regional development is nearing completion. The authorities are confident that with the generous support of the international community, their commitment to political, economic, and social reform, and the Iraqi people’s well known resilience, entrepreneurship, and human capital endowment, peace and prosperity will return to Iraq.