Iraq: First and Second Reviews of the Staff-Monitored Program and Request for a Three-Year Stand-By Arrangement

This paper discusses Iraq's First and Second Reviews of the Staff-Monitored Program (SMP) and Request for a Three-Year Stand-By Arrangement. The oil price decline has resulted in a massive reduction in Iraq's budget revenue, pushing the fiscal deficit to an unsustainable level. The authorities are responding to the crisis with a mix of necessary fiscal adjustment and financing, maintaining their commitment to the exchange rate peg. The authorities started an SMP in November 2015 to establish a track record of policy credibility and pave the way to a possible IMF financing arrangement. Their performance under the SMP has been broadly satisfactory.

Abstract

This paper discusses Iraq's First and Second Reviews of the Staff-Monitored Program (SMP) and Request for a Three-Year Stand-By Arrangement. The oil price decline has resulted in a massive reduction in Iraq's budget revenue, pushing the fiscal deficit to an unsustainable level. The authorities are responding to the crisis with a mix of necessary fiscal adjustment and financing, maintaining their commitment to the exchange rate peg. The authorities started an SMP in November 2015 to establish a track record of policy credibility and pave the way to a possible IMF financing arrangement. Their performance under the SMP has been broadly satisfactory.

Background: Iraq is Facing An Acute Fiscal and Balance of Payments Crisis

1. The economy has been hit hard by the collapse in oil prices and the ISIS attacks. The external environment has worsened since the agreement on the SMP,1 mainly owing to further weakening of global oil prices. The ongoing armed conflict with ISIS continues to strain the country’s resources and is resulting in new waves of internally displaced people. Iraq’s political situation remains volatile.

A. Background

2. Iraqi forces are making progress in retaking territories controlled by ISIS. In January, the Iraqi forces and their allies retook control of Ramadi, west of Baghdad. They have launched a military campaign to recoup the city of Fallujah, 50 km west of Baghdad.

3. The ISIS attacks have boosted the number of internally displaced persons to 4 million and the number of people in need of humanitarian assistance to 10 million (27 percent of the population) including 250,000 Syrian refugees (Memorandum of Economic and Financial Policies—MEFP, ¶3). Refugees, 60 percent of whom are women and children, mostly reside in the north, including the Kurdistan Regional Government (KRG) where they have been granted residency status including rights to work. This refugee inflow is adding to the already difficult internal humanitarian situation faced by the Iraqi government. According to a recent survey, 48 percent of Iraqis, equal to 18 million people, wish to emigrate.

4. In response to escalating protests against the lack of progress to address widespread corruption, inefficiency, and low quality of government services, Prime Minister Abadi has proposed a cabinet reshuffle. Negotiations have been ongoing since March 2016 among political parties to organize a possible cabinet reshuffle.

5. Relations between the federal government in Baghdad and the KRG remain tense. On the one hand, the KRG leadership announced a referendum on Kurdish independence. On the other hand, a high-level KRG delegation recently met with the federal government in Baghdad to discuss the resumption of the budget-sharing agreement between the KRG and the federal government. According to this agreement, the revenue from the oil extracted in the KRG accrues to the federal government and the federal government makes transfers to the KRG equivalent to 17 percent of non-sovereign spending in the federal budget.2 At the level of oil prices in the 2016 budget, net flows would be in favor of the KRG since the oil revenue budgeted from KRG (ID 11 trillion in the 2016 budget) is lower than the transfers budgeted to the KRG (ID 13 trillion in the 2016 budget, Table 3). In order to facilitate implementation of the budget sharing arrangement, both parties are considering netting out the KRG oil receipts, which the KRG plans to have audited by international audit companies starting on July 1st, 2016, with the budgetary transfers to which the KRG would be eligible under the budget sharing arrangement (MEFP, ¶19).

B. Recent Economic Developments

6. In 2015, real GDP contracted by 2.4 percent, in spite of a 13 percent increase in oil production (Text Table 1 and Tables 12). The non-oil economy experienced broad-based economic contraction (−19 percent) as a result of the war with ISIS and the ongoing fiscal consolidation (¶7). In January–May 2016, Iraq produced 4.4 mbpd, of which KRG and North and Midland Oil Companies were estimated to have produce 0.8 mbpd, and the federal government exported 3.3 mbpd, at an average price of $29 per barrel. In 2015, average consumer price inflation (CPI) was low at 1.4 percent, but was likely underestimated because CPI coverage excludes the areas occupied by ISIS, which were inhabited by about 20 percent of the population before the ISIS occupation. In April, the CPI increased by 1.9 percent year-on-year.

Text Table 1.

Iraq: Selected Economic Indicators, 2013–21

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Sources: Iraqi authorities; and Fund staff estimates.

IMF Country Report No. 16/11. Iraq: Staff-Monitored Program.

Adjusted to account for a full year estimate of federal government transfers to the Kurdistan Regional Government in 2014 and 2015, for which actual transfers were made for only 2 and 5 months, respectively.

Half year effects.

Text Table 2.

Iraq: Summary of Central Government Fiscal Accounts, 2013–21

(In trillions of Iraqi dinars; unless otherwise indicated)

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Sources: Iraqi authorities; and Fund staff estimates and projections.

IMF Country Report No. 16/11. Iraq: Staff-Monitored Program.

Excludes interest payments, oil related spending and war reparations to Kuwait from total expenditure.

Adjusted to account for a full year estimate of federal government transfers to the Kurdistan Regional Government in 2014 and 2015, for which actual transfers were made for only 2 and 5 months, respectively.

Difference between non-oil revenue and non-oil primary expenditure.

Table 1.

Iraq: Selected Economic and Financial Indicators, 2013–21

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Sources: Iraqi authorities; and Fund staff estimates and projections.

IMF Country Report No. 16/11. Iraq: Staff-Monitored Program-Press Release; and Staff Report.

Does not reflect KRG production during 2013 and 2014.

Reflects KRG exports through State Organization for Marketing Oil (SOMO).

Adjusted to account for a full year estimate of federal government transfers to the Kurdistan Regional Government in 2014 and 2015, for which actual transfers were made for only 2 and 5 months, respectively.

Reflects the balances of the Development Fund of Iraq which were moved from the Federal Reserve Bank of New York to the CBI as a US$ account (US$ balances from oil revenues) in May 2014.

Includes arrears.

Starting 2014 includes US$ account balances from oil revenues. Starting Q3 2015, SDRs and reserve position in the Fund are excluded from the definition per instruction from the Central Bank of Iraq.

Positive means appreciation.

Table 2.

Iraq: National Accounts, 2013–21

(In percent)

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Sources: Iraqi authorities; and IMF staff estimates and projections.

7. In 2015, the fiscal deficit widened sharply to 14.3 percent of GDP because of the fall in oil prices, in spite of the large fiscal consolidation (Tables 36). Faced with the precipitous fall in oil prices, the authorities cut adjusted3 non-oil primary expenditure by 30 percent in real terms, mostly investment spending, reducing the adjusted non-oil primary balance (NOPB) by 13 percent of non-oil GDP relative to 2014. The resulting deficit was financed mostly by the issuance of Treasury bills subscribed and loans provided by the state-owned banks Rasheed and Rafidain (in an amount equivalent to 9.8 percent of GDP) of which 44 percent was refinanced at the discount window of the Central Bank of Iraq (CBI). The deficit was also financed by the drawdown of government deposits (2 percent of GDP), the accumulation of domestic and external arrears (respectively 2.8 and 2.2 percent of GDP), and two loans of $1.2 billion each from the IMF4 and the World Bank. During the first quarter of 2016, the fiscal deficit amounted to 2.4 percent of (annual) GDP and the non-oil primary deficit to 5.6 percent of GDP as oil revenue was significantly less than programmed owing to the lower-than-programmed oil prices (¶6) and the authorities prioritized the payment of wages, pensions, transfers, and interest to the detriment of spending on goods and services and non-oil investment. Oil investment continued to be executed and was mainly financed by the accumulation of arrears to international oil companies (IOCs, ¶12).

Table 3.

Iraq: Central Government Fiscal Accounts, 2013–21

(In trillions of ID; unless otherwise indicated)

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Sources: Iraqi authorities; and Fund staff estimates and projections.

IMF Country Report No. 16/11. Iraq: Staff-Monitored Program-Press Release; and Staff Report.

For 2013–2014, includes off-budget transfers to SOEs financed by Bank Rafidain.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

See Text Table 3 for more details.

Adjusted to account for a full year estimate of federal government transfers to the Kurdistan Regional Government in 2014 and 2015, for which actual transfers were made for only 2 and 5 months, respectively.

Table 4.

Iraq: Central Government Fiscal Accounts, Quarterly, 2016–17

(In trillions of ID; unless otherwise stated; Cumulative from the beginning of the fiscal year)

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Sources: Iraqi authorities; and Fund staff estimates and projections.

IMF Country Report No. 16/11. Iraq: Staff-Monitored Program.

Includes off-budget transfers to SOEs.

Five percent of oil exports as mandated by U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

See Text Table 3 for more details.