Iraq: Staff Report for the 2017 Article IV Consultation, Second Review Under the Three-Year Stand-By Arrangement, and Requests for Waivers of Nonobservance and Applicability of Performance Criteria, and Modification of Performance Criteria
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
09 Aug 2017
eISBN:
9781484314944
Language:
English
Keywords:
ISCR; CR; Iraq; government; GDP; anti-corruption legislation; physical capital; oil revenue; development fund; excl. KRG; Iraqi authorities
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2017 Article IV Consultation and Second Review under the Three-Year Stand-by Arrangement-and Requests for Waivers of Nonobservance and Applicability of Performance Criteria, and Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Iraq

Abstract

2017 Article IV Consultation and Second Review under the Three-Year Stand-by Arrangement-and Requests for Waivers of Nonobservance and Applicability of Performance Criteria, and Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Iraq

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

A. Background

1. Iraq is an oil-dependent and state-dominated fragile economy. Iraq is very well endowed with oil resources: it holds the fourth largest oil reserves in the world with among the lowest extraction costs (Figure 1). Despite volatile security conditions, oil production has tripled since 2003, but little progress has been made to diversify the economy as the non-oil sector was adversely affected by the lack of security and a difficult business environment. The growth of oil production financed a large expansion of public expenditure and civil service employment, which tripled between 2003 and 2014 (Figure 2). The composition of public expenditure is heavily tilted towards wages, pensions and transfers. Despite an oversized public sector, even relative to other oil-exporting countries, the quality of public services particularly health, education and electricity, where power outages are frequent, is sub-par. Violence and a very difficult business environment have stifled private sector and financial sector development (Figure 3). The lack of electricity, political instability, corruption, and the lack of access to finance were identified as the most significant constraints by the World Bank’s latest Investment Climate Assessment.

Figure 1.
Figure 1.

Iraq: An Oil Dependent Economy with Little Progress in Diversification

Citation: IMF Staff Country Reports 2017, 251; 10.5089/9781484314944.002.A001

Note: AGO = Angola, AZE = Azerbaijan, BRN = Brunei Darussalam, BRZ = Brazil, CAN = Canada, CHN = China, COL = Colombia, DZA = Algeria, GNQ = Equatorial Guinea, IRN = Iran, IRQ = Iraq, KWT = Kuwait, KZH = Kazakhstan, LBY = Libya, MEX = Mexico, NGA = Nigeria, NOR = Norway, OMN = Oman, QAT = Qatar, RUS = Russia, SAU = Saudi Arabia, SSD = South Sudan, TTO = Trinidad and Tobago, UAE = United Arab Emirates, UK = United Kingdom, USA = United States of America, and VEN = Venezuela.
Figure 2.
Figure 2.

Iraq: A State-Dependent Economy with Sub-Par Public Service Delivery

Citation: IMF Staff Country Reports 2017, 251; 10.5089/9781484314944.002.A001

Figure 3.
Figure 3.

Iraq: Violence and Weak Governance Deter Private Sector Development

Citation: IMF Staff Country Reports 2017, 251; 10.5089/9781484314944.002.A001

Note: MENAP = Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Malta, Morocco, Oman, Saudi Arabia, Syria, Tunisia, United Arab Emirates, West Bank and Gaza, and Yemen.UMIC = upper middle income countries = Albania, Algeria, Angola, Belarus, Belize, Bosnia, Botswana, Brazil, Bulgaria, China, Colombia, Costa Rica, Dominica, Dominican Republic, Ecuador, Equatorial Guinea, Fiji, Gabon, Georgia, Grenada, Guyana, Iran, Iraq, Jamaica, Jordan, Kazakhstan, Lebanon, Libya, Macedonia, Malaysia, Maldives, Marshall Islands, Mauritius, Mexico, Montenegro, Namibia, Palau, Panama, Paraguay, Peru, Romania, Russia, Serbia, South Africa, St. Lucia, St. Vincent and the Grenadines, Suriname, Thailand, Turkey, and Venezuela.

2. Since 2014, Iraq has been hit hard by the conflict with ISIS and the fall in oil prices. The conflict with ISIS has caused the destruction of infrastructure and assets and boosted the number of internally displaced persons to 3.0 million and the number of people in need of humanitarian assistance to 11 million (29 percent of the population), including over 241,000 Syrian refugees. The oil price decline has resulted in a massive reduction in fiscal and export revenue, pushing the fiscal and balance of payments deficits to unsustainable levels (Figure 4). The authorities are responding to the crisis with large but necessary fiscal adjustment, which is being supported by significant official financing, including a Stand-By Arrangement (SBA) with the Fund,1 of which the Board completed the first review in December 2016.2

Figure 4.
Figure 4.
Figure 4.

Iraq: Recent Economic Developments and Outlook, 2012–22

Citation: IMF Staff Country Reports 2017, 251; 10.5089/9781484314944.002.A001

Sources: Iraqi authorities; Bloomberg; and IMF staff calculations.

3. The Iraqi security forces, with the help of international partners, have made notable progress in the fight against ISIS. They have recently liberated Mosul, Iraq’s second largest city and ISIS’s last stronghold in Iraq.

4. The political situation remains challenging. 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. The Prime Minister is the acting Minister of Finance. In 2016, the federal government and the Kurdistan Regional Government (KRG) did not implement their budget sharing agreement under which the KRG transfers 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,3 which was implemented for two months in 2014 and five months in 2015. The KRG is planning a referendum on independence in September. Parliamentary elections are scheduled in April 2018.

B. Recent Economic Developments

5. Real GDP increased by 11 percent in 2016 owing to a 25 percent increase in oil production, which was little affected by the conflict with ISIS (Text Table 1 and Tables 1–2). Non-oil real GDP contracted by 8 percent because of the ongoing fiscal consolidation and combat in the ISIS-occupied territories. Average consumer price inflation was only 0.4 percent in 2016 in the areas not occupied by ISIS (where 80 percent of the population lived before the ISIS occupation) and 1.0 percent in April 2017, year-on-year.

Text Table 1.

Iraq: Selected Economic Indicators, 2013–22

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Sources: Iraqi authorities; and Fund staff estimates.

IMF Country Report No. 16/379. Iraq: Staff Report for the First Review of the Three-Year Stand-By Arrangement.

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

Includes arrears. The debt stock includes legacy arrears to non-Paris Club creditors on which the authorities have requested (but not yet obtained) Paris-Club comparable relief. Implementing comparable terms will substantially reduce debt (e.g. by 17 percent of GDP in 2017).

Only unidentified financing.

Table 1.

Iraq: Selected Economic and Financial Indicators, 2013–22

(Quota: SDR 1,663.8 million)

(Population: 37.5 million; 2016 est.)

(Poverty rate: 23 percent, 2014)

(Main export: Crude oil)

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

IMF Country Report No. 16/379. Iraq: Staff Report for the First Review of the Three-Year Stand-By Arrangement.

Negative price differential of about $6 per barrel compared to the average petroleum spot price (average of Bent, West Texas and Dubai oil prices) in 2016-22.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

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

Includes arrears. The debt stock includes legacy arrears to non-Paris Club creditors on which the authorities have requested (but not yet obtained) Paris-Club comparable relief. Implementing comparable terms will substantially reduce debt (e.g. by 17 percent of GDP in 2017).

See Table 8, footnote 3, for coverage.

Positive means appreciation.

Only unidentified financing.

Table 2.

Iraq: National Accounts, 2013–22

(In percent)

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

IMF Country Report No. 16/379. Iraq: Staff Report for the First Review of the Three-Year Stand-By Arrangement.

6. Further fiscal consolidation was achieved in 2016, but at a slower pace than programmed mainly because of the inability of the Ministry of Finance to reduce investment expenditure by as much as envisaged but also due to spending pressure stemming from the military campaign against ISIS (Tables 3–5). The non-oil primary balance, on an accrual basis,4 excluding KRG,5 contracted by 1 percent in nominal terms 6 in 2016, reflecting 2 percent real spending growth (following a 25 percent contraction the previous year) and tripling of non-oil revenue (albeit from a very low base). However, this contraction was less than programmed (ID 8.7 trillion, excluding KRG) because of spending overruns in mostly non-oil investment (ID 6.1 trillion), transfers (ID 2.6 trillion) and wages (ID 0.7 trillion), partly because the campaign against ISIS and partly because of weak control by the Ministry of Finance over investment expenditure by line ministries. In addition, the authorities paid about $2.5 billion less external arrears to international oil companies (IOCs) and other external creditors than programmed because of cash constraints. The overall budget deficit increased to 14 percent of GDP in 2016 mainly because of the 22 percent fall in oil prices. The budget deficit was mostly financed by indirect monetary financing from the Central Bank of Iraq (CBI) and donor support catalyzed by the SBA, but also by the accumulation of arrears, of which the total stock amounted to 5.5 percent of GDP at the end of 2016, out of which 68 percent were domestic (¶15). Indirect monetary financing from the CBI could not be avoided as the liquidity position of the state-dominated banking sector is uncertain in the absence of audited financial statements of the main state-owned banks (¶11).

Table 3.

Iraq: Central Government Fiscal Accounts, 2013–22

(In trillions of ID; unless otherwise indicated)

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

IMF Country Report No. 16/379. Iraq: Staff Report for the First Review of the Three-Year Stand-By Arrangement.

For 2013–14, 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.

Includes unidentified financing only.

Adjusted to exclude full year estimates of federal government transfers to the Kurdistan Regional Government. In 2014 and 2015, actual transfers were made for only 2 and 5 months, respectively.

Adjusted to exclude (i) full year estimates of federal government transfers to the Kurdistan Regional Government, and (ii) non oil tax revenues from the KRG to the federal government.

The non-oil primary fiscal balance on cash basis adjusts the non-oil primary balance measured on accrual basis by subtracting the spending financed by arrears’ accumulation during that period, and adding the repayment of arrears from previous years.