Abstract
2020 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Iraq
In the past year, the Iraqi economy faced multi-dimensional challenges arising from the COVID-19 pandemic, the collapse in international oil prices, and the decline in oil production owing to OPEC+ commitments. These shocks compound difficult social and political conditions that have been prevailing for several months. The pandemic led to significant loss of life, while straining the health system’s limited capacity. Moreover, it could push 4.5 million Iraqis, 12 percent of population, into poverty, potentially increasing the poverty rate to 32 percent.1 Real GDP contracted by an estimated 11 percent in 2020 and large fiscal and external deficits emerged, of 20 and 16 percent of GDP, respectively. These adverse economic developments constrained the government’s ability to provide a more comprehensive fiscal response to the crisis.
The authorities’ immediate focus is on minimizing the loss of life from COVID-19 and strengthening social safety nets while ensuring macroeconomic stability. Last December, the Council of Ministers approved and sent to Parliament a draft 2021 budget proposing wide-ranging fiscal consolidation measures, while increasing health spending and targeted cash transfers to the vulnerable. On December 19, 2020, the Central Bank of Iraq announced a 22.7 percent devaluation of the Iraqi dinar/USD exchange rate to narrow the external deficit and mitigate pressures on foreign exchange reserves.
The authorities concur with staff that the pandemic has aggravated socio-economic fragilities that have been building following decades of political, economic, and security shocks. In an effort to address these challenges, the government unveiled a comprehensive economic reform plan in October 2020, the White Paper2, aimed at achieving sustainable and inclusive medium term growth. The authorities’ main objectives are rehabilitating the financial sector; reforming state-owned production sectors; improving key infrastructure; enhancing provision of public services and social assistance; and strengthening governance and the legal environment. The authorities are preparing an action plan to operationalize the White Paper reforms and are working with the World Bank and other bilateral partners on mobilizing donor assistance in support of their implementation. Ahead of the general elections that are planned to take place in October 2021, consensus-building and broad social acceptance will be essential for carrying out the proposed White Paper reforms in the country.
In support of their stabilization and reform efforts, the Iraq authorities have requested emergency financing under the Fund’s Rapid Financing Instrument, which they are currently discussing with IMF staff, and expressed interest in a follow-up Extended Fund Facility.
COVID-19 response
To mitigate the adverse impact of containment measures on non-oil activity, the Central Bank of Iraq (CBI) established a fund to collect donations from financial institutions which raised a total of US$37 million. Although spending was reduced in non-essential areas, the authorities safeguarded budgetary allocations to the Ministry of Health. The Supreme Committee for Health and National Safety introduced a US$254 million cash transfer scheme, targeting the families of workers in the private sector that do not receive salaries or benefits from the government.
On the monetary and macro-financial front, the CBI actively sought to support the recovery while maintaining financial stability. It reduced its reserve requirement from 15 percent to 13 percent. At the onset of the crisis, it also announced a moratorium on interest and principal payments by small and medium-sized enterprises (SMEs) through the “one trillion ID” initiative and encouraged banks to extend the maturities of all loans as they deem appropriate. More recently, the CBI offered additional support to existing SMEs under the “one trillion ID” initiative and reduced the interest rates on loans extended through the scheme. The CBI also encouraged the use of electronic payments to contain the transmission of the virus and instructed vendors to eliminate commissions on such payments for six months.
The Ministry of Health has approved the use of a number of vaccines in Iraq, and the authorities have prepared a draft health plan for the acquisition and distribution of a vaccine. The authorities agree with staff’s proposal to establish a dedicated COVID-19 fund to combine budgetary and donor resources in support of this health plan and have allocated US$0.5 billion to the initiative in the draft 2021 budget. Key ministries and international partners—notably WHO, UNDP, UNICEF and the World Bank—will manage the fund’s resources, and specialized UN agencies will be responsible for procurement to ensure strong governance.
Fiscal policy and reforms
In December, the authorities announced a package of fiscal reforms aimed at ensuring macroeconomic stability and debt sustainability, while strengthening the social safety net. The draft 2021 budget that is awaiting parliamentary approval includes wide-ranging fiscal consolidation measures, including:
a. A nominal freeze of government wages, allowances, and pensions;
b. A hiring freeze;
c. Removal of the exemption of government allowances from the payroll tax;
d. A considerable increase in the domestic price of crude oil;
e. An increase in excise and sales taxes on alcohol, tobacco, car sales, and shopping malls; and personal income tax.
In addition, a 40 percent solidarity tax was introduced on the incomes of the Prime Minister, the President, Speaker of Parliament, and Head of the Judiciary, and a 30 percent tax on the incomes of ministers and their deputies. Fiscal adjustment in the 2021 draft budget that does not come at the expenses of critical social and infrastructure spending, for which the budgetary allocations were increased in the draft 2021 budget.
The authorities acknowledge that while a larger short-term fiscal adjustment may be needed to ensure debt sustainability, due consideration must be given to the country’s fragile security, political, and social situation. They agreed with staff on the importance of maintaining fiscal restraint over a longer period.
Fiscal reforms are among the priorities emphasized in the White Paper. These include a civil service reform, a pension reform, and efforts to automate customs procedures and strengthen administration. The Council of Ministers recently adopted an enhanced framework for vetting and issuing government guarantees in an effort to minimize fiscal risks stemming from off-budget expenditure, government guarantees, and arrears.
Monetary and exchange rate policies
Fiscal adjustment alone would have required a significantly larger upfront effort that may not have been politically or socially feasible. Accordingly, in parallel with the fiscal adjustment effort, the CBI announced on December 19, 2020 a 22.7 percent devaluation of the IRD/USD exchange rate to narrow the external deficit and mitigate pressures on foreign exchange reserves, including by helping to improve the fiscal balance and reduce the need for monetary financing of the budget. Careful planning preceded the devaluation, including contingency planning, efforts to maintain the provision of liquidity to banks, and a clear public communication strategy to explain the exchange rate adjustment. The CBI fully shares staff’s view that a strong fiscal framework is essential to ensure the credibility of the exchange rate peg and minimize future needs for monetary financing of the budget.
Towards more equitable and inclusive growth
The authorities are fully aware of the importance of protecting the most vulnerable groups. Poverty is expected to rise sharply because of a confluence of factors, namely the COVID-19 pandemic, the projected increase in inflation in the wake of the exchange rate devaluation, and the proposed reduction in the public wage bill and pensions.
They proposed an increase in the allocation for cash transfers in the 2021 budget by IRD 2.5 trillion (79 percent) with the aim to (i) expand coverage to all eligible households; and (ii) raise the amount of assistance to shield the vulnerable from the expected increase in inflation.
The authorities also intend to reform the Public Distribution System food rationing program, in terms of implementation and targeting, in order to ensure the protection of the poorest groups.
Conclusion
Iraq faces the serious challenge of maintaining economic stability, while ensuring durable social stability, peace and inclusive growth. The Iraqi authorities would like to express their deep appreciation for the Fund’s Executive Board, management, and staff for their continued support. They particularly appreciate staff’s hard work and constructive engagement, as well as the valuable capacity development they are receiving in support of their stabilization and reform efforts.
UNICEF Iraq, The World Bank, Oxford Poverty and Human Development Initiative and the Ministry of Planning in Iraq, Assessment of COVID-19 Impact on Poverty and Vulnerability in Iraq, July 2020, https://www.unicef.org/iraq/reports/assessment-covid-19-impact-poverty-and-vulnerability-iraq#:%7E:text=Highlights&text=4.5%20million%20(11.7%25)%20Iraqis,%25%20from%2020%25%20in%202018.