AMMAN, 26 July 2004 — How will the Iraqi economy fare now that power has been handed from the Coalition Provisional Authority (CPA) to the interim government headed by Prime Minister Iyad Allawi? Are the rewards of doing business in Iraq greater than the risks associated with it? Taking stock of what had happened in the past year or so suggests that several laws have been put in place providing a basis to build upon. However, without security, efforts to rebuild the economy will be fruitless.
The persistent targeting of foreign contractors, which started in April this year has significantly undermined progress on key reconstruction work, and has negatively impacted the allocation of funds under the $18.6 billion Iraq Relief & Reconstruction Fund approved by the US in October 2003. Almost $10 billion is yet to be committed to projects and less than $350 million of the total has been spent. As a result, basic services such as power, water treatment and transport have been continuously disrupted.
Iraq’s oil revenues will not be enough to finance the country’s reconstruction. Most of the oil revenues have already been earmarked for subsidies, wages and security costs. Iraq may therefore have to rely on the international community to survive. This together with the ongoing security issues suggest that, despite the transfer of sovereignty, the US will be playing a key role in Iraq’s economy for some time to come. Iraq’s oil production has continuously been disrupted and oil sales have yielded only $11 billion over the last twelve months. Despite last year’s pledges from other countries which totaled more than $15 billion, funds have been released at a very slow pace.
The lack of security remains the missing prerequisite for Iraq’s full economic rehabilitation. Nonetheless there have been some successes in pushing through important structural reforms. Since its introduction at the beginning of the year, the new Iraqi currency has been stable. More recently, Iraq’s stock exchange reopened on June 24 and has been quite active.
Though only 27 companies are listed on the exchange, daily trade has reached over 14 billion dinars ($10million) on some days. Another 100 companies are due to go public in the next six weeks. These firms have the right to list because they were part of the former exchange that was dissolved after the US invasion of Iraq.
The government has issued recently its first post war debt, raising 150 billion dinars ($104 million) in 3 month Treasury bills carrying an interest rate of around 5.5 percent. In theory the equity and debt markets are supposed to be open to foreigners, but settlement mechanisms are not yet in place to make this possible.
Iraq suffers from unemployment rates ranging between 30 percent to 50 percent, and one out of six Iraqis still depends on the rationing system. Yearly per capita income dropped from $3,600 in the 80s to $970 following the Gulf War in 1990 and then to $420 after the 2003 American occupation. It is estimated that close to $36 billion is needed for the reconstruction of Iraq, excluding the oil sector that requires an estimated $20 billion.
Agriculture accounts for 8 percent of gross domestic product and 30 percent of Iraqis still rely on farming and livestock for their livelihood. The poorly thought out decision to disband the Iraqi Army put half a million men on the street without income, supplying a pool of ready recruits for terrorist and criminal organizations.
Iraq’s external debt is put at $120 billion not counting reparation arising from the 1990 Gulf war. About $21 billion is owed to official creditors (Paris Club members), with the heaviest exposure falling on Japan and Russia. Some $30 billion is accounted for by funds extended to Gulf states during the 1980-88 Iran-Iraq war. However, Iraq claims that the money was provided in the form of grants rather than loans. Debt servicing arrears account for almost half of the $120 billion outstanding. While much of this debt may well be written off, no agreement has yet been reached. Until the extent of Iraq’s debt is resolved, the state banks will not be able to do business abroad.
The CPA which was dissolved by the end of June has drawn up a framework of laws and rules that could form the basis for future governance. Some of the laws were done with appropriate consultation, others were model laws imported from abroad and these need substantial domestic acceptance before investors believe they are credible. A law that came into effect in March this year established the Central Bank’s independence and laid down its procedures for everything from the management of foreign reserves to bank supervision. With no electronic banking (there are no ATMs or credit cards) most of the Iraqi economy is still based on cash. It works around, not through, the formal banking sector. Total assets of Iraqi banks are estimated at $2 billion, or only 10 percent of GDP, a low ratio by any standard. Banking transactions are limited to deposit-taking and infrequent loans for which banks require collateral worth up to four times the loan.
In the past eighteen months, trade has been channeled through the Trade Bank of Iraq, run by a consortium of 13 international banks, which provides letters of credit for everything that the country imports. Perhaps the best hope lies with the 17 private banks legalized in the early 1990s, which hold just 5 percent of all bank assets, although their share is growing. None of them has a countywide presence. Bank of Baghdad, the biggest has 20 branches. In January 2004, the Central Bank of Iraq granted bank licenses to three foreign banks: Britain’s HSBC and Standard Chartered, and the National Bank of Kuwait. There is a new commercial bank law that permits other foreign banks to buy up to 49 percent of existing Iraqi private banks. Many of the private institutions are already in discussions with other Middle Eastern banks.
A long, uphill struggle lies ahead for the Iraqi interim government. A number of pressing policy choices need to be made which include creating job opportunities for the unemployed, stimulating the private sector, establishing a social safety net, rehabilitating the agricultural sector and integrating it within the reconstruction priorities, guaranteeing stable food supplies, and finding the adequate funding for all these tasks. This entails an efficient use of the country’s human resources, the potential of which remains widely unutilized. A program must be designed now for the training of the work force. The legal and regulatory environment must accommodate business formation and foreign investment. Privatization must occur at a measured pace to establish business entities that would gradually replace public sector institutions.
(Henry T. Azzam is chief executive officer at Jordinvest.)