IRAQ: First Review of the Three-Year Stand-by Arrangement and Financing Assurances Review, Requests for Waivers of Nonobservance and Applicability of Performance Criteria, Modification of Performance Criteria, and Rephasing of the Arrangement
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
13 Dec 2016
eISBN:
9781475559972
Language:
English
Keywords:
ISCR; CR; Stand-By Arrangement; government; Iraq's economic reform program; SBA approval; Iraq; government import; IMF government Finance Statistics Manual; oil revenue; financial support; GDP deflator; Arrears; Oil exports; Global
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This paper discusses Iraq's First Review of the Three-Year Stand-by Arrangement (SBA) and Financing Assurances Review, and Requests for Waivers of Nonobservance and Applicability of Performance Criteria (PCs). Two PCs at end September appear to have been met on the basis of preliminary unaudited data. One PC at end-June 2016 was missed. One continuous PC was missed. Completion of some structural benchmarks was delayed, but progress is being made for each. Hence, program performance has been mixed, but understandings on sufficient corrective actions have been reached to put the program back on track. The IMF staff recommends completion of the first review under the SBA and the financing assurances review and modification of the PCs and related rephrasing.

Abstract

This paper discusses Iraq's First Review of the Three-Year Stand-by Arrangement (SBA) and Financing Assurances Review, and Requests for Waivers of Nonobservance and Applicability of Performance Criteria (PCs). Two PCs at end September appear to have been met on the basis of preliminary unaudited data. One PC at end-June 2016 was missed. One continuous PC was missed. Completion of some structural benchmarks was delayed, but progress is being made for each. Hence, program performance has been mixed, but understandings on sufficient corrective actions have been reached to put the program back on track. The IMF staff recommends completion of the first review under the SBA and the financing assurances review and modification of the PCs and related rephrasing.

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. Although slightly higher since the approval of the SBA,1 Iraqi oil prices have remained at about one-third of their level in 2013 (Table 1). The ongoing armed conflict with ISIS continues to strain the country’s resources and is resulting in new waves of internally displaced people.

Table 1.

Iraq: Selected Economic and Financial Indicators, 2013–21

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Sources: Iraqi authorities; and Fund staff estimates and projections.
1/

IMF Country Report No. 16/225. Iraq: Staff Report for the First and Second Reviews of the Staff-Monitored Program and Request for a Three-Year Stand-By Arrangement; with the financing gap path modified to reflect unindentified financing only, upon the approval of the three-year SBA.

2/

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.

3/

Includes arrears.

4/

See Table 8, footnote 3, for coverage.

5/

Positive means appreciation.

6/

Only unidentified financing.

A. Background

2. Iraqi forces are making progress in retaking territories controlled by ISIS. After regaining control of Ramadi and Fallujah, the Iraqi army and its international partners have started a major military operation to retake control of Mosul, Iraq’s second largest city.

3. The recent offensive to retake Mosul is expected to increase the need for humanitarian assistance. The war against ISIS has boosted the number of internally displaced persons to 3.3 million and the number of people in need of humanitarian assistance to 10 million (26 percent of the population) including 225,000 Syrian refugees (Memorandum of Economic and Financial Policies—MEFP, ¶3).

4. The political situation remains unstable. Since the SBA approval, the Interior Minister resigned in the aftermath of a terrorist attack that claimed the lives of more than 300 people and Parliament withdrew its confidence in the Defense and Finance Ministers. In the face of such political instability, subsequent to the SBA approval, the Prime Minister decided to reverse the tax increase for senior civil servants that the Council of Ministers had approved as a prior action before the approval of the SBA request (¶14).

5. Relations between the federal government in Baghdad and the Kurdistan Regional Government (KRG) have improved. Both governments are closely collaborating in the offensive to retake control of Mosul (¶2). In August 2016, the federal government and the KRG agreed to resume oil exports by the North Oil Company through the pipeline linking the KRG to Turkey in an amount of 0.15 million barrels per day (mbpd) and to equally split the export revenue until the end of year. Following that decision, 0.095 mbpd of oil was exported through the pipeline in September. Both governments are still discussing changing the modalities of the budget sharing agreement under which the KRG is supposed to transfer the revenue from the oil extracted in KRG and the federal government makes transfers to the KRG equivalent to 17 percent of non-sovereign spending in the federal budget,2 which was implemented for two months in 2014 and five months in 2015 (MEFP, ¶5). At the projected level of oil prices, the budget sharing agreement would lead to a net transfer from the federal government to KRG of ID 0.7 trillion ($0.6 billion) in 2016 and ID 1.5 trillion ($1.2 billion) in 2017 (Table 3).

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.
1/

IMF Country Report No. 16/225. Iraq: Staff Report for the First and Second Reviews of the Staff-Monitored Program and Request for a Three-Year Stand-By Arrangement; with the financing gap path modified to reflect unidentified financing only, upon the approval of the three-year SBA.

2/

For 2013-14, includes off-budget transfers to SOEs financed by Bank Rafidain.

3/

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

4/

Includes unidentified financing only.

5/

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.

6/

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by: (a) subtracting the spending financed by arrears’ accumulation during that period, and (b) adding the payment of arrears during the same period.

B. Recent Economic Developments

6. Nominal GDP was revised upward by 2.8 percent in 2014 and by 13.6 percent in 2015 (Tables 1-2). Two thirds of that revision is the result of an upward revision of the level of construction activity in line with the evolution of public investment in 2015, and the non-oil GDP deflator, explained by the ISIS occupation since mid-2014.3 The balance stems from the full incorporation of KRG oil production, which had only been recorded for 2 months in 2014 and 5 months in 2015 in the national accounts previously, in line with the implementation of the budget sharing agreement (¶5).

Table 2.

Iraq: National Accounts, 2013-21

(In percent)

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Sources: Iraqi authorities; and IMF staff estimates and projections.
1/

IMF Country Report No. 16/225. Iraq: Staff Report for the First and Second Reviews of the Staff-Monitored Program and Request for a Three-Year Stand-By Arrangement; with the financing gap path modified to reflect unidentified financing only, upon the approval of the three-year SBA.

7. During the first half of 2016, overall real GDP growth was robust, on the back of strong oil production, while non-oil GDP continued to contract as a result of the war with ISIS and the ongoing fiscal consolidation. Oil GDP grew by 29 percent while non-oil GDP contracted by 1 percent y-o-y in the first of 2016. In January-August, 2016, Iraq produced 4.478 million barrels per day (4.2 mbpd programmed in 2016). The federal government exported 3.246 mbpd during January-August, 2016 (3.05 mbpd programmed in 2016), at an average price of $32.9 per barrel ($34.5 programmed in 2016) and KRG exported 0.461 mbpd (0.55 mbpd programmed), at an average price of $29.6 per barrel. Additional export gains have materialized since September due to the resumption of North Oil Company exports through Kurdistan (¶5). In September, the consumer price index (CPI) increased by 1.2 percent y-o-y, but was likely underestimated because the CPI coverage excludes the areas occupied by ISIS, which were inhabited by about 20 percent of the population before the ISIS occupation.

8. During the first half of 2016, the budget execution was much lower than programmed due to difficulties in raising domestic financing (Table 3; and MEFP, ¶11 and Table 4). While oil exports revenue, non-oil tax revenue and the CBI’s discounting of Treasury bills were on track, dividends from oil state-owned enterprises (SOEs) and domestic financing of the deficit were much lower than programmed. The oil SOEs transferred only ID 13 billon (compared to ID 1.35 trillion programmed) owing to cash constraints and the authorities could only raise ID 0.6 trillion in bonds (yielding an 8 percent annual interest rate) compared to ID 5.0 trillion programmed. As a consequence, the government prioritized the payment of wages, pensions, goods and services, and debt service. The fiscal deficit (5.7 percent of (annual) GDP) and the non-oil primary deficit (17.6) percent of (annual) non-oil GDP), were much lower than programmed (respectively 10.9 percent of GDP and 26.9 percent of non-oil GDP). While the heavy burden of the fiscal consolidation taken by investment expenditure is clearly suboptimal, it is forced by the lack of financing. Its negative impact on growth is attenuated by the weak quality of such spending owing to severe deficiencies in public financial management, according to the last World Bank Expenditure Review.4

Table 4.

Iraq: Central Government Fiscal Accounts, 2013-21

(In percent of GDP)

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Sources: Iraqi authorities; and Fund staff estimates and projections.
1/

IMF Country Report No. 16/225. Iraq: Staff Report for the First and Second Reviews of the Staff-Monitored Program and Request for a Three-Year Stand-By Arrangement; with the financing gap path modified to reflect unidentified financing only, upon the approval of the three-year SBA.

2/

For 2013-14 includes off-budget transfers to SOEs financed by Bank Rafidain.

3/

Calculated as 5 percent of oil exports as per U.N. Security Council Resolution 1483 to finance war reparations to Kuwait.

4/

Includes unidentified financing only.

5/

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.

6/

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by: (a) subtracting the spending financed by arrears’ accumulation during that period- and (b) adding the payment of arrears during the same period.