International Compact with Iraq

Statement by Mr. Takatoshi Kato
Deputy Managing Director of the International Monetary Fund
Sharm el-Sheikh, Egypt
May 3, 2007

As Prepared for Delivery

Mr. Secretary General, Prime Minister Maliki, Vice-President Mahdi, your excellencies, ladies and gentlemen, it is a great pleasure for me to address this important meeting on the occasion of the launching of the International Compact with Iraq. I congratulate the Government of Iraq, together with the United Nations and Iraq's partners, for their work in developing the Compact. The medium-term framework for political, security, and economic reform endorsed by the Compact aims to secure a better future for the Iraqi people. It is certainly encouraging that the Compact enjoys the strong support of the international community as demonstrated by the large gathering present here today.

The Fund has been closely engaged with Iraq since 2003. Initial work focused on setting up a macroeconomic database, including the preparation of a debt sustainability analysis, and on providing technical assistance and policy advice, mainly on monetary and fiscal policies and key structural reforms. In September 2004 the Fund approved Emergency Post-Conflict Assistance for Iraq, and this—in combination with the debt sustainability analysis—paved the way for the critical November 2004 debt reduction agreement with Paris Club creditors.

The current Stand-By Arrangement was approved in December 2005. It supports the authorities' broad economic reform program, aimed at maintaining macroeconomic stability and improving the conditions for sustainable growth over the medium term. The macroeconomic framework of the Stand-By Arrangement underlies the economic component of the Compact.

Despite extremely difficult circumstances, the Iraqi authorities have continued to implement their economic program. They have taken some courageous measures, including the gradual increase in domestic fuel prices and, starting in 2007, the elimination of all direct budgetary fuel subsidies, except for kerosene. Iraq has also embarked on an ambitious structural reform program, in order to make the transition to a more market-based economy. The government is working to modernize public financial management, streamline the social safety net, and amend the pension law to make it fiscally sustainable. The central bank is overhauling its accounting, reporting and auditing systems, and a modern payments system was established. Steps are also being taken to restructure state-owned banks and to bring the banking supervisory system in line with international best practice. In the oil sector, legislation was enacted to liberalize imports of fuel products and progress is being made in establishing a modern and transparent legal and regulatory framework. In that context, Iraq has indicated that it intends to participate in the Extractive Industries Transparency Initiative.

The sharp deterioration in the security situation during the past year was not foreseen at the outset of the program. As the daily news brings home to all of us, this has precipitated a dramatic increase in human suffering, directly as a result of the violence, as well as through the worsening of living conditions and the displacement of large numbers of people.

The unstable security situation has also exacted a heavy toll on the economy by disrupting its normal functioning and increasing the emigration of skilled labor. It has also hampered the execution of reconstruction and investment projects, and worsened shortages of key commodities, especially fuel products. The shortfall of investments in the oil sector together with the interruptions caused by the insurgency prevented the expected expansion of oil production, keeping economic growth low at 3 percent in 2006. Fuel shortages were a major factor behind the jump in inflation from 32 percent at end-2005 to a dangerously high rate of 65 percent at end-2006.

In response to these developments, and against the background of efforts to improve the security situation, the immediate challenges that Iraq faces in establishing a stable macroeconomic framework are lowering inflation and expanding oil-related investments. To combat inflation, action has been initiated on three fronts. First, the Central Bank of Iraq raised its policy interest rates sharply and allowed a gradual appreciation of the dinar. These measures aimed to de-dollarize the economy in order to enhance the central bank's control over monetary conditions, and also to reduce imported inflation. Second, the government budget for 2007 aims to contain current spending so as to limit inflationary pressures on the small non-oil economy. And third, the government is in the process of facilitating private fuel imports to ease shortages and help reduce black market prices. The first signs of the effects of these policies are encouraging: the annual inflation rate in February and March 2007 has fallen to about 37 percent. Of course, it is yet too soon to know whether this recent outcome represents the beginning of a sustained downward trend, and the authorities remain committed to continued action to reduce inflation further. The 2007 budget envisages a high level of oil-related investments and practical steps are being taken to improve project implementation.

In view of the encouraging progress made by the Iraqi authorities in strengthening economic policies and undertaking structural reforms, the IMF Executive Board completed the third and fourth reviews under the Stand-By Arrangement in early March 2007. At that meeting, the period covered by the arrangement was also extended by six months through September 2007, in order to provide more time for the program to achieve its growth and inflation objectives.

Looking ahead, the discussions on the fifth and final review under the current Stand-By Arrangement and on the 2007 Article IV consultation are scheduled to begin this summer. The Iraqi authorities have also indicated that they intend to request a successor arrangement to cover the period needed to reach the last stage of the Paris Club debt reduction agreement by December 2008. In the meantime, it will also be important to make further progress in reaching debt reduction agreements with non-Paris Club creditors.

I would like to emphasize that with the launching today of the International Compact with Iraq, the country is entering a crucial period in its political and economic recovery. Much remains to be done. It is our hope that this new partnership with the international community will help to improve the political and security situation, which is an indispensable condition for future economic development. The Fund is ready to contribute to the success of the International Compact with Iraq through the medium-term macroeconomic policy framework supported under the Stand-By Arrangement and its possible successor arrangement, as well as by providing policy advice and technical assistance in the areas of our expertise. The medium-term framework and the reviews of the Stand-By Arrangement can provide valuable information on economic developments in Iraq for donor countries subscribing to the International Compact with Iraq.

In conclusion, we wish the Iraqi authorities much success in the implementation of the measures envisaged under the Compact.



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