## _cr04325 — IMF Staff Report (Executive Summary & Appendices) ## Source details **Canonical URL:** [_cr04325 — IMF Staff Report (Executive Summary & Appendices)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04325.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04325.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04325.pdf.json) --- ### Program purpose, scope, and Fund support - Objective of EPCA request: begin economic recovery from recent conflict and past mismanagement; improve general welfare and address Iraq’s external debt problem. - Requested Fund financing: SDR 297.1 million (25 percent of quota). - Program coverage: remainder of 2004 through end-2005 (duration: November 1, 2004 through end-December 2005). - Sequencing: satisfactory EPCA performance envisaged to allow consideration of an upper credit tranche stand-by arrangement in the second half of 2005, contingent on institutional capacity and security improvements. ### Recent developments and macroeconomic context (2003–mid-2004) - Conflict impact and production: - Nominal GDP estimated to have fallen by about 35 percent in 2003. - Oil production averaged 1.2 mbpd in 2003 (from almost 2.0 mbpd in 2002); recovered to about 2.0–2.1 mbpd by end-July 2004 with exports around 1.5–1.6 mbpd. - Oil constitutes about three quarters to more than 75 percent of the economy in various sections. - Prices, exchange rate, monetary indicators: - CPI increased by 5.7 percent in the first eight months of 2004. - Exchange rate largely unchanged at around ID 1,460 per US$ since mid-January 2004; program exchange rate used: ID 1,460 per U.S. dollar (as of August 31, 2004). - Base money increased by about 60 percent in the first six months of 2004 (currency issued increased by about 53 percent since end-2003 in same interval). - Gross international reserves: about US$4.4 billion at end-August 2004 (other references: US$4,273 billion at end-July 2004 noted in one appendix entry; program targets below). - Labor and social: - Unemployment close to 28–30 percent; more than 60 percent of the population rely exclusively on the government’s food distribution system. - Structural and institutional advances: - Currency reform completed (banknote exchange Oct 15, 2003–Jan 15, 2004; issued about ID 6.1 trillion of new dinars). - New central bank and commercial bank laws approved; Trade Bank of Iraq established. - First treasury bill auction completed July 18, 2004; auctions conducted bi-weekly thereafter. - Technical assistance program active; METAC to start operations in late October 2004. ### Program design, policy pillars, and conditionality - Policy pillars: - Prudent fiscal policy: limit spending to available government revenues and external resources; avoid reliance on domestic financing. - Exchange rate stability to anchor inflationary expectations. - Structural reforms: price liberalization, banking sector restructuring, state-owned enterprise (SOE) reform, social safety net development, debt relief negotiations. - Monitoring and benchmarks: - Quantitative and structural indicators through September 2005; Technical Memorandum of Understanding defines indicators and reporting. - Key program quantitative targets include a floor on CBI net international reserves and ceilings on currency issued, CBI lending to government, primary fiscal deficit (cumulative), and contracting of new nonconcessional external debt. - Currency issued stock (6/30/04): 7,003 (range targets provided in Table 1). - Net international reserves (NIR) stock 6/30/04: 3,193 (millions of U.S. dollars); program floors: 4,000 (12/31/04), 4,250 (3/31/05), 4,500 (6/30/05), 4,750 (9/30/05). - Lending to government by CBI stock 6/30/04: 3,986 (ID billions); ceilings set for subsequent dates. ### Fiscal framework, projections, and key fiscal measures - Fiscal objectives: - Limit 2004 overall government fiscal deficit to US$9.0 billion (43 percent of GDP). - Overall government fiscal deficit projected at US$6.7 billion in 2005 (28 percent of GDP). - Primary fiscal deficit decline: from 41.9 percent of GDP in 2004 to 27 percent in 2005; primary surplus of 1.3 percent of GDP by 2007 (staff projections). - Revenue and expenditure figures: - Government revenues budgeted to increase by 14 percent from US$17.1 billion in 2004 to US$19.5 billion in 2005 (including US$0.9 billion from oil-related SOEs). - Revenues & Grants (medium-term table): 19,153 23,745 31,777 32,216 32,967 34,998 (In millions of U.S. dollars across projection years). - Expenditures (medium-term table): 28,217 30,471 39,030 38,511 39,808 42,657 (In millions of U.S. dollars). - Government recurrent expenditures contained at US$21.4 billion (88 percent of GDP) in 2005, down from projected US$22.6 billion (107 percent of GDP) in 2004. - Wages and pensions expected to be US$3.7 billion in 2005 (an 11 percent increase). - Non-oil capital spending projected to increase from US$4.3 billion in 2004 to US$6.1 billion in 2005 (41 percent increase), conditional on donor disbursements projected at US$4.7 billion in 2005 (including US$3.7 billion from the U.S. supplemental Budget on Iraq). - Oil sector fiscal assumptions and subsidy reform: - Oil export price assumption for 2005: US$26 per barrel (noted as US$6 lower than 2005 futures implied price in September and US$4.5 lower than average oil export price in H1 2004). - Oil exports projected to increase from 1.5 mbpd to 1.8 mbpd in 2005. - Authorities decided to raise US$1 billion in 2005 by reducing domestic price subsidy on oil derivatives (starting by end-2004). - Domestic price subsidy on oil derivative products estimated at about US$7 billion or 34 percent of GDP in 2004; commitment to full elimination of the subsidy by 2009. ### External sector, debt, and financing assumptions - External debt and debt relief: - Iraq’s total external debt as of end-2002 estimated at some US$125 billion (also presented as US$124.9 and US$126 billion in different tables). - IMF staff DSA indicated Iraq would need substantial debt reduction (in the neighborhood of 90% to 95%) to reach external and fiscal viability. - Paris Club and non-Paris Club creditors provided financing assurances for the EPCA period; many non-Paris Club bilateral creditors indicated willingness to substantially reduce claims. - Program assumes a deferral on external debt service due through end-2005 based on financing assurances. - Balance of payments and reserves: - Current account projected deficits: examples in tables show -3,768 -4,428 -6,637 -7,157 -8,071 -9,034 (In millions of U.S. dollars across years). - Central bank reserves (total reserves by table): 5,691 8,289 9,305 8,944 8,392 7,879 (In US$ million across years). - CBI net international reserves targets: at least US$5.0 billion by end-2004 and US$6.0 billion by end-2005 (program objectives). - Donor pledges and disbursements: - Madrid Conference pledges: more than US$33 billion in grants and loans for 2003–2007; contributions into IRFFI to date: about US$1 billion. - Reconstruction and investment program (medium-term): US$68 billion over 2004–2009. - External financing assumptions include disbursement of US$22.2 billion in grants pledged at Madrid and US$6.4 billion in multilateral and bilateral loans. ### Monetary policy, CBI reforms, and financial sector priorities - Monetary framework: - Exchange rate stability used to anchor inflation expectations; program prepared to reassess if shocks warrant more flexibility. - Vigilance triggers for flexibility: reserves below a minimum acceptable level of $4 billion or signs inflation could exceed forecast. - CBI institutional measures: - Creation of lender-of-last-resort (LOL) and overnight standing credit/deposit facilities. - New reserve requirement regulations and ceiling on vault cash usage. - Introduction of treasury bill auctions to enable open market operations. - Plans for external audit of CBI 2004 financial statements by mid-2005. - CBI to disseminate monthly balance sheet and results of daily currency auctions; expand transparency and publish policy statements after board meetings. - Banking system condition (Box 5 highlights): - System comprises six state-owned banks and 17 private banks. - Rafidain and Rasheed account for nearly 90 percent of banking sector assets and together own more than 400 branches out of 550; state banks operate effectively on a unit banking system. - Aggregate banking system assets about US$2 billion (less than 10 percent of 2004 GDP). - Asset composition heavily tilted toward treasury bills; limited credit extension to private sector; payments system requires serious revamping. - Program actions: issue regulations on licensing and prudential ratios (deadline: December 2004); strengthen supervisory capacity; adopt plan for restructuring state-owned banks by end-June 2005. ### Structural reforms, governance, and transparency measures - Fiscal and public financial management commitments: - Adopt regulations related to the financial management law by end-2004; financial management law approved in June 2004. - Develop monthly fiscal accounts for general government and the oil sector by end-2004; introduce a treasury single account by September 2005. - Implement FMIS reporting and control modules nationwide by June 2005. - Strengthen Supreme Board of Audit and implement KPMG and IAMB recommendations; publish final consolidated fiscal accounts by June of the following fiscal year starting June 2005. - SOE and oil sector reforms: - Complete analysis of SOEs by end-2005 to produce restructuring/privatization plans. - Review fiscal regime for oil sector and prepare overall restructuring plan by end-2005; implement IAMB recommendations on monitoring and control systems. - Social safety net and subsidy reform: - Prepare to monetize the food basket and transform food ration into cash distribution targeted at the poor and unemployed over the medium term. - Monetization preconditions: efficient payment system, enabling state trade entities to act commercially, public information campaign, continued transfers to regions/local governments. - Tax and customs reform: - Plan to overhaul tax and customs administrations by June 2005 with external assistance. - Potential 2006 measures include introducing a general sales tax (10 percent) as precursor to VAT, converting the 5 percent import duty into a uniform import duty with reduced exemptions, and other excise and visitor fees. ### Technical assistance, statistics, and capacity building - TA program approved September 2003 through June 2004, with seminars largely outside Iraq for security reasons; TA areas: public expenditure management, tax policy and administration, central bank organization and reporting, banking supervision, payments system reform, and statistical missions. - METAC in Beirut to start operations in late October 2004; Iraq to be a major beneficiary. - Statistical shortcomings and priorities: - CSO uses 1968 SNA; national accounts, CPI, monetary, balance of payments, and external trade statistics have significant coverage and methodological gaps, including exclusion of northern region in many series. - STA provided missions and workshops since 2003; RAP includes follow-up missions in FY 2005. - Data reporting commitments: CBI weekly and monthly reporting, monthly CPI with up to one-month lag, balance sheets for Rafidain and Rasheed quarterly, and other deadlines specified in the technical memorandum. - Donor coordination: - World Bank ITF commitments and planned emergency operations; IMF–World Bank shared responsibilities enumerated for macro, fiscal, financial sector, and social areas. ### Risks, safeguards, and staff assessment - Main risks: - Security situation not under control; significant political risks around elections and constitution drafting. - Unsustainable external debt; creditors’ agreement on debt resolution not finalized. - Usual external economic risks, notably oil price uncertainty. - Adequacy of safeguards under the Fund’s Articles and unusual lending risks given unresolved creditor positions. - Creditor assurances and financing mitigants: - Consultations indicated recognition of IMF preferred creditor status; bilateral creditors signaled willingness to make best efforts to provide debt relief and confirmed a deferral for obligations falling due during program period. - Program staff and management sought assurances from official creditors for program and repayment period. - Staff appraisal: - EPCA judged appropriate vehicle for initial Fund support; program stabilizes economy and lays groundwork for structural reform. - Staff recommends continuation of exchange rate stability while monitoring money supply growth and preparedness to sterilize or allow more exchange rate flexibility if needed. - Urgent implementation of fiscal, monetary, and data reporting reforms critical for rebuilding administrative capacity and enabling progression to an upper credit tranche arrangement. ### Selected headline projections and indicators (selected from program tables) - Growth and prices: - Real GDP growth: 51.7 16.7 14.6 5.9 5.5 10.0 (percentage changes across projection years shown in table). - Nominal GDP growth: 74.4 15.0 28.6 9.4 9.7 11.8 (percentage changes). - Real GDP growth targets (explicit program targets): 52 percent in 2004; 17 percent in 2005; average 9–10 percent per annum over 2006–09 in various statements. - Oil production (mbpd): projected 2.1 2.4 2.8 2.9 3.0 3.3 (table sequence); program narratives target 2.1 mbpd in 2004, 2.4 mbpd in 2005, and 3.5 mbpd by 2009 in some sections. - Consumer price inflation: 7 percent in 2004; about 15 percent in 2005; projected to fall to 7 percent by 2009 in medium-term scenario. - Fiscal and external: - Primary fiscal balance (percent of GDP): -41.9 -27.3 -1.9 1.3 1.2 0.2 (table series). - Overall fiscal balance (including grants): -42.9 -27.7 -23.2 -18.4 -18.2 -18.3 (table series). - Oil export revenues (In US$ millions): 16,543 17,597 21,390 21,239 21,096 22,866 (table series for exports of goods). - Reconstruction and investment program: US$68 billion over 2004–2009. - Debt stock examples: Debt Stock (In US$ billion): 124.3 131.5 138.8 145.5 152.2 159.9 (table series); estimated external debt stock end-December 2002: Non-Paris Club official bilateral creditors 67.4; Paris Club creditors 42.0; Private creditors 15.0; Multilateral obligations 0.5; Total external debt stock 124.9. ### Key structural deadlines and operational tasks (selected) - By end-2004: - Adopt regulations related to financial management law; develop monthly fiscal accounts for general government and oil sector; issue bank licensing and prudential regulations; enact payments systems law. - By June 2005: - Implement FMIS reporting and control modules nationwide; establish automated payroll system for all government employees; adopt plan for restructuring state-owned banks. - By end-2005: - Prepare overall restructuring plan for oil sector; complete SOE analyses to produce restructuring/privatization proposals. - Reporting commitments: - CBI gross foreign exchange reserves (weekly, within 2 weeks); CBI monthly balance sheet (1-month lag); CPI monthly (1-month lag); trade and quarterly indicators within specified maximum lags. ### Concluding assessment - The program aims to stabilize the economy, provide minimum social support, kick-start reconstruction, and begin institutional reforms while recognizing that progress is tightly linked to security improvements and donor support. - Staff views EPCA as an appropriate initial instrument to catalyze additional assistance, including debt relief, and to provide a platform for subsequent, broader Fund-supported arrangements if implementation and security permit. *Italicized: Content derived from the IMF staff report text provided in the content unit.* ### Executive Summary ...................................................................................................... ### Executive Summary ### Policy efforts and recent developments - Important policy reforms implemented to facilitate progress toward a more market-oriented economy, including: - completion of a banknote exchange; - approval of new banking sector and central bank legislation; - enactment of a new tax law; - simplification of the trade regime. - Macroeconomic stability achieved despite security challenges: - inflationary pressures have remained relatively subdued; - the exchange rate has remained largely unchanged; - gross international reserves have increased by about US$3 billion since end-2003. - Real economy and labor market: - The 2003 conflict brought about an almost complete halt in economic activity. By end-July 2004, oil production (about three quarters of the economy) had recovered. - Non-oil activity has been recovering, driven by reconstruction and a (partial) revival in the agricultural sector, although many enterprises are not fully operational yet. - Commercial activity at the retail level is brisk, but unemployment remains high. - Security and political context: - Repeated insurgent attacks against government officials and police officers, and sabotage of crucial infrastructure, continue to severely hamper recovery. - Political transition milestones: Governing Council actions and the Transitional Administration of Iraq (TAL) framework culminating in an interim government taking over administration on June 28, 2004; the new constitution is expected to be approved by a national referendum no later than October 15, 2005, with further elections to take place by end-2005. ### The Program for 2004–05 - Objectives: - improve the general welfare of the Iraqi people; - address Iraq’s external debt problem. - Policy pillars: - prudent fiscal policy aimed at limiting spending to available government revenues and external resources; - use of the exchange rate to anchor inflationary expectations; - planning and undertaking key structural reforms to transform Iraq into a market economy. - Fund support: - proposed purchase under the Fund’s EPCA policy: SDR 297.1 million (25 percent of quota). - EPCA is expected to help catalyze additional international support (including debt relief) for reconstruction. - Risks and mitigants: - Significant risks: security situation not under control; unsustainable level of debt; official creditors have yet to agree on debt resolution. - Staff and management sought to allay lending risks by seeking assurances from Iraq’s official creditors for the program period as well as the repayment period. ### Context and role of the Fund - Historical and socioeconomic background: - Iraq was a founding IMF member but had little official contact with the Fund between 1983 and 2003. - Severe economic mismanagement and over a decade of international sanctions led to a collapse in living standards: GDP per capita fell from over US$3,000 in the early 1980s to as low as US$200 in the early 1990s; recovered to an estimated US$800 in 2001; fell again to about US$500 in 2003. - Human development indicators are now among the lowest in the region. - Unemployment is running close to 30 percent; underemployment is pervasive. - About 60 percent of the population is thought to depend exclusively on the government’s food distribution system for subsistence. - Purpose of EPCA request: - The Iraqi authorities request a purchase under the Fund’s Emergency Post-Conflict Assistance (EPCA) to begin economic recovery from recent conflict and past mismanagement. - Fund financing would help meet urgent balance of payments needs arising from reconstruction and recovery, and approval of EPCA should facilitate negotiations on urgently needed debt relief. - Engagement to date: - Since June 2003, Fund staff engaged in dialogue with Iraqi officials and the CPA on macroeconomic policy, monetary and fiscal stance for 2004–05, and medium-term structural reforms (price liberalization, banking sector restructuring, state-owned enterprise reform, social safety nets). - Staff worked on an external debt sustainability analysis (DSA). - Fund management represented on the International Advisory and Monitoring Board (IAMB), an audit oversight body for the Development Fund for Iraq (DFI). ### Selected policy actions and operational details (2003–04) - Early restoration of government functions: - Salaries of all public employees began to be paid in late May 2003, including employees in state-owned enterprises (SOEs). - Several SOEs resumed operations by the second half of 2003 and began receiving modest budget transfers for working capital and operational costs. - Financial and monetary initiatives: - Currency reform: a three-month program between October 15, 2003 and January 15, 2004 exchanged all existing Iraqi banknotes into new ones; involved shipping and distributing about ID 6.1 trillion of new dinars and destroying the old currency. The new dinar has six denominations (instead of two) and improved security features; the Saddam dinar had effective available denominations of only ID 250 and ID 10,000 banknotes. - Approval of new central bank and commercial bank laws; liberalization of interest rates; establishment of the Trade Bank of Iraq. - On July 18, 2004 the ministry of finance completed its first treasury bill auction; auctions have since been conducted on a bi-weekly basis. - Oil sector status and prospects: - Iraq has estimated petroleum reserves of some 100–130 billion barrels (about 11% of the world total). - Historical production: at the eve of the first Gulf War, production was 3.5 mbpd (3.2 mbpd exported); output recovered to 0.6 mbpd in 1996; about 2.5 mbpd by end-2002. - Post-2003: oil production facilities were badly damaged; production recovered to its pre-war level in 2004; expected to reach 3.5 mbpd by 2009. - With adequate investment and modern technology, crude oil production could reach over 5 mbpd in the long run. - Refining capacity is inefficient; Iraq is expected to continue importing oil refined products worth over US$2 billion annually in the next few years. ### Program design and sequencing - Program coverage and forward plans: - The proposed EPCA program covers the remainder of 2004 through the end of 2005. - Authorities indicated intent to seek further Fund support in 2005 via an upper credit tranche stand-by arrangement (SBA), contingent on progress in institutional capacity and significant security improvements. - Structural reform priorities identified for the medium term include: - price liberalization; - banking sector restructuring; - state-owned enterprise reform; - social safety net development; - debt relief negotiations to address an unsustainable external debt stock. *Source: EXECUTIVE SUMMARY (provided content).* ### 13. In addition to providing policy advice, Fund staff has also provided Iraq with much ### _cr04325 - 13. In addition to providing policy advice, Fund staff has also provided Iraq with much ### Technical assistance and coordination - A TA program approved in September 2003 for the period through June 2004, implemented largely through seminars outside Iraq owing to security concerns, includes training in: - public expenditure management, tax policy and administration; - central bank organization, accounting procedures and financial reporting, banking supervision, support for the banknote exchange program, and payments system reform; - joint training on macroeconomic policies by INS and the Arab Monetary Fund (AMF); - a series of statistics missions. - Fund staff coordinated TA efforts of other providers (at their request) in macroeconomic policy areas with the World Bank, U.S. Treasury, USAID, DFID (UK), and the Bank of England. - The World Bank implemented a capacity-building project funded by the European Union covering macroeconomic and financial management, procurement, social safety net issues, and investment regimes. - A technical assistance center in the Middle East (METAC) was established in Beirut and will officially start operations in late October 2004; its principal objective is to provide TA in the Fund’s core areas to improve institutional capacity and facilitate regional integration. Iraq is expected to be one of the major beneficiaries. ### Role of the international community - An International Donors’ Conference on the Reconstruction of Iraq was held in Madrid on October 23–24, 2003 with representatives from 73 countries and 20 international organizations. - Pledges announced during the conference: more than US$33 billion in grants and loans for the period 2003–2007. - An International Reconstruction Fund Facility for Iraq (IRFFI) was established with two windows administered by the World Bank and the UN; disbursements are on a grant basis. - Contributions into the IRFFI to date: about US$1 billion. ### Recent economic developments (2003–mid-2004) - 2003 conflict impact: - Nominal GDP estimated to have fallen by about 35 percent in 2003. - Oil production contracted to an average 1.2 million barrels per day (mbpd) in 2003 from almost 2.0 mbpd in 2002. - By end-July 2004: - Oil production recovered to 2.0 mbpd. - Exports were up to 1.5 mbpd. - Oil constitutes three quarters of the economy. - Monthly production and export levels have fluctuated due to sabotage and unreliable infrastructure. - Non-oil activity recovering (reconstruction, partial revival in agriculture), but many state-owned enterprises and private businesses not fully operational; unemployment remains high. - Inflation and monetary indicators: - CPI increased by 5.7 percent in the first eight months of 2004. - Exchange rate largely unchanged at around ID 1,460 per US$ since the end of the banknote exchange in mid-January 2004. - Base money increased significantly in the first six months of 2004 (by about 60 percent). - Gross international reserves of the central bank: about US$4.4 billion at end-August 2004. ### Elements of the economic program — Overview and targets - Main goals under the EPCA-supported program: improve general welfare, enhance social stability, address external debt problem. - Key challenges: restoring security, preparing for elections, strengthening administrative capacity, stepping up reconstruction, promoting private sector development. - Authorities’ intentions: implement a sound macroeconomic program and structural reforms to transform Iraq into a market economy; recognize implementation is linked to restoration of security and political reform. - External debt: - Iraq’s total external debt as of end-2002 estimated at some US$125 billion, or around six times GDP. - Growth and macro targets: - Growth in real GDP: 52 percent in 2004 and 17 percent in 2005. - Oil production targets: 2.1 mbpd in 2004 and 2.4 mbpd in 2005. - Inflation: could reach 7 percent per annum in 2004 and about 15 percent in 2005. - CBI net international reserves targets: at least US$5.0 billion by end-2004 and US$6.0 billion by end-2005. ### Macroeconomic policies — Fiscal policy - Fiscal stance: limit spending to available government revenues and external resources; avoid reliance on domestic financing of the budget. - Staff fiscal projections: - Primary fiscal deficit declining from 41.9 percent of GDP in 2004 to 27 percent in 2005. - Primary fiscal surplus of 1.3 percent of GDP by 2007. - Debt-service assumptions: program assumes creditors will grant Iraq a deferral on external debt service due through end-2005 based on financing assurances provided in September 2004. - Overall government fiscal deficit projected to reach US$6.7 billion in 2005; financing sources: - US$2.1 billion from letters of credit issued by the UN under the oil-for-food program; - US$4.2 billion from assets accumulated abroad held in the Development Fund for Iraq; - US$0.3 billion from project loans financed by donors. - Government revenue assumptions for 2005: - Revenues budgeted to increase by 14 percent from US$17.1 billion in 2004 to US$19.5 billion in 2005 (including US$0.9 billion of revenues from oil-related state-owned enterprises). - Any revenue windfall prioritized for reconstruction or financing future budgets; off-budget expenditures forbidden; additional spending must be integrated into a revised budget. - Oil price and export assumptions for 2005: - Export price of Iraqi oil assumed to be US$26. - This is US$6 lower than the 2005 Iraqi price implied by the oil futures market in September and US$4.5 lower than the average oil export price obtained in the first half of 2004. - Oil exports projected to increase from 1.5 mbpd to 1.8 mbpd in 2005. - Subsidy and revenue measures: - Authorities decided to raise US$1 billion in 2005 through a reduction in the price subsidy on domestic consumption of oil derivatives (starting by end-2004). - Domestic price subsidy on oil derivative products estimated at about US$7 billion or 34 percent of GDP in 2004. - Commitment to full elimination of the subsidy by 2009. - Expenditure projections for 2005: - Government recurrent expenditures contained at US$21.4 billion (88 percent of GDP) in 2005, down from projected US$22.6 billion (107 percent of GDP) in 2004. - Wages and pensions expected to increase by 11 percent to US$3.7 billion in 2005. - Goods and services, and transfers projected to decrease from US$16.3 billion in 2004 to US$14.5 billion in 2005. - Oil-related spending to increase from US$3.1 billion in 2004 to US$4.3 billion in 2005. - Non-oil capital spending projected to increase by 41 percent from US$4.3 billion in 2004 to US$6.1 billion in 2005, assuming acceleration of donor disbursements projected at US$4.7 billion in 2005 (including US$3.7 billion from the U.S. supplemental Budget on Iraq). - Revenue administration and tax reform steps: - Plan to overhaul tax and customs administrations by June 2005 with external assistance. - Related tax measures potentially adopted in 2006 include introduction of a general sales tax (precursor to a value added tax) and changing the existing 5 percent import duty into a uniform import duty with reduced exemptions. - Structural reform intentions: - Reduce wage and pension bill to 11 percent of GDP from current 16 percent over the medium term. - Establishment of a payroll covering all civil servants and government workers; implementation of an automated payroll system in 2005. - Complete analysis of state-owned enterprises by end-2005 to produce restructuring or privatization plans. - Prepare to transform current food ration system into a cash distribution system targeted at the poor and unemployed (monetization of the food basket). ### Government fiscal operations (Box 3 — structural features) - Components of fiscal operations under EPCA: - (i) government budget covering all recurrent and capital spending except those directly financed by donors; covers Baghdad and Iraq’s 18 governorates; three northern governorates relatively autonomous; - (ii) letters of credit (LCs) under the oil-for-food program managed by the UN, financed by past oil exports, covering purchase of recurrent and capital imports mostly in 2004–05; - (iii) expenditures financed by donors, mostly capital projects; some recurrent expenditure in security and oil sectors financed by the US Supplemental Budget for Iraq; some foreign donor grants managed by the IRFFI; U.S. Government oversees use of U.S. Supplemental Budget funds through its embassy; - (iv) operations of oil-related state-owned enterprises not included in the budget (mainly domestic oil sales and some oil-related operating expenditure). - All Iraqi external assets held in the Development Fund for Iraq (DFI), an account managed by the Central Bank of Iraq at the New York Federal Reserve on behalf of the Iraqi Ministry of Finance; the DFI receives Iraqi assets frozen abroad during the period of sanctions, outstanding balances from the oil-for-food program, and 95 percent of Iraq’s oil export sales. ### Governance, transparency, and fiscal management reforms (Box 4) - Commitments to enhance efficiency and transparency: - (a) Budget preparation and coverage: adopt regulations related to the financial management law by end-2004; adjust budget appropriation only through mid-year budget reviews (extra-budgetary expenditure forbidden); financial management law approved in June 2004. - (b) Budget execution: develop monthly fiscal accounts for the general government and the oil sector by end-2004; introduce a treasury single account by September 2005; implement reporting and control modules of a financial management information system (FMIS) nationwide by June 2005. - (c) Budget control: strengthen the operations of the Supreme Board of Audit; implement recommendations of the KPMG audit and of the International Advisory and Monitoring Board (IAMB), including ensuring oil export sales are in line with international standards and strengthening governance through effective metering of oil production; publish the government’s final consolidated fiscal accounts by June of the following fiscal year, starting in June 2005. ### Monetary and exchange rate policy - Exchange rate stability used as the framework for monetary policy to anchor inflationary expectations and establish confidence in the new currency given limited post-conflict data. - Authorities remain open to reassessing the framework if structural change or external shocks warrant greater flexibility (including excessive downward pressure on the exchange rate or unfavorable inflation developments). - CBI institutional and operational developments: - Creation of a lender-of-last-resort (LOL) facility and an overnight standing credit/deposit facility approved by the CBI Board. - New regulations on reserve requirements: made uniform and set a ceiling on vault cash usage to meet them. - Introduction of an auction for treasury bills to enable open market operations. - Agenda to strengthen regulatory and supervisory capacity: preparing regulations on loan classification, capital requirements, related party lending restrictions and risk management; restructuring the banking supervision department; intensifying training of personnel. - Plans for restructuring state banks to improve governance and enhance market value. - Development of legal and monetary elements of a systemic safety net to prevent bank insolvencies from impairing confidence. - Strengthening institutional capacity for payments to ensure recovery is not inhibited by a weak payments system. *Italicized: Content derived from the IMF staff report text provided in the content unit* ### Box 5. Iraq: Banking System ### Box 5. Iraq: Banking System ### Banking system structure and condition - The banking system comprises six state-owned banks and 17 private banks. - The two largest state-owned banks, Rafidain and Rasheed, account for nearly 90 percent of banking sector assets. - Rafidain and Rasheed together own more than 400 branches, out of 550 in the system; however, the state banks effectively operate on a unit banking system. - Aggregate banking system assets are about US$2 billion (less than 10 percent of 2004 GDP). - Asset composition is heavily tilted toward treasury bills, reflecting limited extension of credit to the private sector. - Credit culture is limited and the payments system needs serious revamping. ### Central Bank and government obligations - The government and the CBI are negotiating an agreement on restructuring government obligations held by the central bank. - Staff was advised that the agreement should not negatively affect the capital of the CBI. - The CBI law will be amended to require the CBI to transfer to the ministry of finance any excess realized profits, but only as long as the CBI’s capital remains at or above its required regulatory minimum. - The intention is to formally close the government overdraft facility at the CBI. ### External sector and debt - Authorities committed to an open trade and exchange system: avoid restrictions on payments and transfers for international transactions; not introduce or intensify trade restrictions for balance of payments purposes; and not resort to multiple currency practices. - Iraq has not yet accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF’s Articles of Agreement. - Iraq has been granted observer status in the World Trade Organization. - Paris Club and non-Paris Club creditors have provided financing assurances for the period of the EPCA. - Authorities aim to conclude discussions with bilateral official creditors on a final solution to external debt problems by late 2004. - Staff view: the current level of debt is unsustainable; staff did not make a recommendation on the magnitude of debt reduction needed. - Several non-Paris Club bilateral creditors have indicated willingness to reduce substantially their claims on Iraq. - Authorities taking steps to clear arrears with the World Bank and expected to reach agreement with the Arab Monetary Fund to resolve outstanding obligations. ### Structural reforms and medium-term macro-framework (Box 6 highlights) - Planned reforms during 2004–2005: - Modernize the central bank and strengthen supervisory capacity. - Increase transparency of CBI operations, including regular dissemination of monetary statistics. - External audit of the CBI’s 2004 financial statements by mid-2005 according to international standards. - Improvements to the payments system. - Review the fiscal regime for the oil sector and prepare an overall restructuring plan by end-2005, including implementation of IAMB recommendations on monitoring and control systems. - Interim national development strategy near finalization to outline structural reforms for transition to a market economy; draft to be presented at donors’ meeting on October 13–14 and to the elected National Assembly early in 2005. - Medium-term macro-framework projections and key figures: - Reconstruction and investment program: US$68 billion over 2004–2009. - Real GDP: increase by 52 percent in 2004, by 17 percent in 2005, and average 9 percent per annum over 2006–09. - Oil output: 2.1 million barrels per day (mbpd) in 2004 to 3.5 mbpd by 2009. - Non-oil real GDP: projected to grow 34 percent in 2004, slowing to 10 percent by 2009. - Consumer price inflation: 7 percent in 2004, rising to 15 percent in 2005, then falling to 7 percent by 2009. - Oil export revenues: US$16 billion in 2004 to US$22 billion in 2009. - Domestic oil derivative price subsidies: equivalent to some US$7 billion in 2004, expected to be eliminated between 2005 and 2009. - Tax effort: rises from 3 percent of non-oil GDP in 2004 to nearly 9 percent over 2006–09. - Government recurrent expenditures (excluding interest and war reparations): decline from about 102 percent of GDP in 2004 to around 54 percent of GDP in 2009. - Public investment: rise from 26 percent of GDP to 37 percent of GDP in 2005, then decline to 27 percent of GDP by 2009. - Primary fiscal balance: improves from a deficit of 42 percent of GDP in 2004 to a small surplus over 2007–09. - External financing assumptions: disbursement of US$22.2 billion in grants pledged at Madrid, and US$6.4 billion in multilateral and bilateral loans. - Iraq’s external debt estimated at US$126 billion (preliminary); assumed rescheduled over 20 years with a 10-year grace period, but no debt reduction (Houston terms); a deferral applies through 2005. - Medium-term scenario shows large financing gaps from 2006 through 2009, reflecting unsustainable external debt; excluding debt service, scenario shows small financing surpluses. ### Donor coordination, technical assistance, and statistics - Fulfillment of Madrid Conference pledges critical for reconstruction; less than 3 percent of those pledges have been disbursed. - TA needs remain significant in areas within the Fund’s mandate: fiscal policy (customs and tax administration, fiscal federalism, tax regime for the oil sector, and expenditure and treasury management), banking sector reform, statistics, and social safety net design. - Work plan to finance TA activities by Fund staff revised and extended to June 2005. - World Bank’s second capacity building project (funded by bilateral donors via the IRFFI) close to approval; will focus on market reforms, subsidy reform, poverty assessment and alleviation, social safety net design, private and financial sector development, public finance and governance, and financial management and procurement. - Statistical base limited after years of institutional isolation and weakened by conflict and looting. - Staff now receive monthly data on the central bank balance sheet, price statistics, government exports and imports, and quarterly fiscal data, though fiscal coverage needs expansion. ### Program issues, access, financing, and risks - Proposed purchase under the Fund’s EPCA policy: SDR 297.1 million (25 percent of quota), or about ID 633 billion. - The authorities intend to keep the total purchase in their SDR account at the Fund. - Iraq cleared its arrears to the Fund (SDR 55.3 million) on September 22, 2004. - Iraq consented to increase its quota under the Eleventh Review of Quotas and is in the process of making the increase effective. - Main risks: - Unusual risks to the Fund because official creditors have not reached agreement on debt reduction to address external indebtedness unsustainability; doubts exist over Iraq’s capacity to repay amounts provided under EPCA. - Adequacy of safeguards under the Fund’s Articles is a concern. - Consultations with official bilateral creditors indicated recognition of the Fund's preferred creditor status and willingness to make best efforts to provide debt relief on appropriate terms to ensure timely repayment to the Fund; creditors confirmed a deferral will be in place with respect to obligations falling due to them during the program period. - Significant political risks due to insecure security situation; political pressures around legislative elections in January and the drafting of a new constitution later in the year may compromise reform implementation. - Usual external economic risks, especially related to oil prices. ### Monitoring and conditionality - The MEFP includes structural and quantitative indicators through September 2005 (definitions for financial indicators described in the technical memorandum of understanding). - Assuming satisfactory performance and strengthened implementation capacity, an upper credit tranche stand-by arrangement could be considered in the second half of 2005. ### Staff appraisal and policy recommendations (summary) - The Fund’s role is to help rebuild Iraq’s economy and institutions and facilitate reintegration into the international community. - EPCA is the appropriate vehicle for initial Fund financial support given the dislocation and damage to institutions. - EPCA could facilitate negotiations between official creditors and Iraq on external debt. - The economic and financial program for 2004–2005 aims to stabilize the economy and lay groundwork for longer-term reforms; budgets designed to provide minimum adequate social support and begin urgent reconstruction. - Authorities committed to prioritizing higher-than-programmed oil revenues for additional investment and/or to help defray future budgetary expenses in 2006 and beyond. - The 2005 budget will incorporate an upward adjustment in the price of domestic petroleum products as a first step toward eliminating subsidies by 2009. - Staff recommends continuation of exchange rate stability for the time being, while monitoring money supply growth and preparedness to sterilize or allow more exchange rate flexibility if needed. - Urgent implementation of fiscal, monetary, and data reporting reforms is critical to rebuild administrative capacity and program monitoring and to enable a move to an upper credit tranche arrangement. *Source: Box 5. Iraq: Banking System (from the provided IMF content unit).* ### 54. The key areas of reform on which progress must be made in 2005 are in the fiscal, ### _cr04325 - 54. The key areas of reform on which progress must be made in 2005 are in the fiscal, ### Major reform priorities (paragraph 54) - Fiscal, public sector, and financial sector reforms are the key areas where progress must be made in 2005. - Tax reform must be an early item on the successor program agenda because the tax effort in Iraq is currently minimal. - Public sector reforms needed include enhancing governance and transparency of the oil sector. - Financial sector reform is essential to promote recovery and private sector growth. - A plan for the state banks will need to be developed. - The CBI’s balance sheet will need to be restructured (taking into account the transformation of the government’s overdraft accounts) so as not to compromise its capital base. ### Risks and creditor issues (paragraph 55) - Fund financing to Iraq under present circumstances is subject to a considerable degree of risk. - Additional to usual program implementation and external-factor risks, Iraq has an unsustainable level of debt. - Official creditors have yet to agree on how to resolve this debt burden, raising questions about Iraq’s capacity to repay the Fund. - Staff and management sought assurances from Iraq’s official creditors that they will respect the Fund’s preferred creditor status by committing to make their best efforts to provide debt relief on appropriate terms to ensure timely repayment to the Fund of the amounts provided under EPCA. ### Staff recommendation (paragraph 56) - The described economic and financial program would be an important step toward rebuilding the Iraqi economy. - The program merits financial support from the Fund in the form of EPCA. - Staff believes that the criteria for EPCA have been met and recommends the program to the Board. ### Selected economic and financial indicators (key statistics from Tables) - Economic growth and prices: - Nominal GDP in US$ (percentage change): 74.4 15.0 28.6 9.4 9.7 11.8 - Real GDP in US$ (percentage change): 51.7 16.7 14.6 5.9 5.5 10.0 - Nominal non-oil GDP in US$ (percentage change): 35.6 26.5 17.4 16.4 14.4 12.3 - Nominal GDP per capita (In US$): 780 870 1,087 1,156 1,234 1,343 - Nominal GDP (In US$ million): 21,132 24,295 31,252 34,203 37,518 41,941 - Oil production (In mbpd): 2.1 2.4 2.8 2.9 3.0 3.3 - Oil prices (US$ pb): 30.4 26.0 26.8 26.0 25.3 24.8 - Population growth: 3.0 3.0 3.0 2.9 2.8 2.7 - Domestic consumer Price Inflation (year-on-year): 7.0 15.0 12.0 10.0 8.0 7.0 - Libor (In percent): 1.6 4.3 5.5 5.5 5.5 5.5 - National accounts (percent of GDP or levels as shown): - Gross domestic investment: 34.9 44.8 38.5 34.0 32.8 31.6 - Of which: public: 26.4 37.4 33.8 29.7 27.9 26.7 - Gross domestic consumption: 91.2 90.7 78.3 79.1 78.5 76.6 - Of which: public: 50.5 45.2 35.3 30.6 27.5 26.7 - Gross national savings: 17.0 26.6 17.3 13.1 11.3 10.1 - Of which: public: -16.4 9.7 10.5 11.2 9.7 8.4 - Public finance (selected): - Government revenue and grants: 90.6 97.7 101.7 94.2 87.9 83.4 - Government oil revenue: 76.7 74.4 77.8 75.2 72.2 71.5 - Government non oil revenue: 1.4 2.1 3.4 3.7 3.9 4.0 - Grants: 9.7 17.5 7.4 12.3 8.9 5.5 - Expenditure: 133.5 125.4 124.9 112.6 106.1 101.7 - Recurrent expenditure: 107.1 88.0 91.1 82.9 78.2 75.0 - Capital expenditure: 26.4 37.4 33.8 29.7 27.9 26.7 - Overall fiscal balance (including grants): -42.9 -27.7 -23.2 -18.4 -18.2 -18.3 - Gross borrowing/use of external assets: 45.3 27.7 3.5 3.5 4.0 3.3 - Amortization: 2.4 0.0 0.0 3.6 6.7 9.7 - Financing gap (+)/Surplus (-): 0.0 0.0 19.7 18.6 20.9 24.6 - Memorandum: Tax revenue/non oil GDP (In percent): 3.0 3.7 8.8 8.8 8.8 8.9 - Primary fiscal balance: -41.9 -27.3 -1.9 1.3 1.2 0.2 - Non oil primary fiscal balance: -103.7 -80.5 -60.3 -54.2 -51.9 -51.6 - Balance of payments and external sector (selected, In millions of U.S. dollars): - Current account: -3,768 -4,428 -6,637 -7,157 -8,071 -9,034 - Trade balance: -5,137 -7,878 -4,327 -3,759 -3,673 -3,065 - Exports of goods: 16,543 17,597 21,390 21,239 21,096 22,866 - Imports of goods: -21,680 -25,475 -25,716 -24,998 -24,768 -25,932 - Income and services: -363 -747 -7,502 -7,380 -7,743 -8,171 - Of which: interest payment: -1 -13 -6,572 -6,636 -7,185 -7,638 - Of which: oil profit remittances: 0 0 0 0 0 -161 - Transfers: 1,731 4,197 5,191 3,982 3,345 2,203 - Financial account: 8,973 7,026 1,502 431 -320 -1,809 - Direct investment: 200 300 400 500 679 861 - Gross borrowing/use of external assets: 9,565 6,726 1,102 1,161 1,504 1,401 - Amortization: 0 0 0 -1,230 -2,503 -4,071 - Overall external balance: 5,204 2,598 -5,135 -6,726 -8,391 -10,843 - Financing: -5,204 -2,598 5,135 6,726 8,391 10,843 - Central bank reserves (increase -): -4,624 -2,598 -1,016 362 552 513 - Financing gap (+)/Surplus (-): 0 0 6,151 6,364 7,839 10,330 - Total reserves (In US$ million) 1/: 5,691 8,289 9,305 8,944 8,392 7,879 - In months of goods and services: 2.6 3.7 4.3 4.2 3.8 3.6 - Debt Stock (In US$ billion) 2/: 124.3 131.5 138.8 145.5 152.2 159.9 - Medium-term fiscal projections (Table 2 selected levels, In millions of U.S. dollars): - Revenues & Grants: 19,153 23,745 31,777 32,216 32,967 34,998 - Revenues: 17,111 19,492 26,347 28,007 29,609 32,696 - Crude oil export revenues: 16,200 17,113 20,778 20,531 20,262 21,979 - Oil products domestic revenues from reduction in price subsidy: 0 1,000 3,539 5,185 6,813 8,002 - Grants: 2,041 4,253 5,430 4,208 3,358 2,301 - Expenditures 1/: 28,217 30,471 39,030 38,511 39,808 42,657 - Operating expenditures 1/: 22,632 21,384 28,483 28,358 29,326 31,476 - Salary and pension payments: 3,360 3,733 3,733 3,733 4,095 4,578 - Interest payments 1/: 213 100 6,661 6,727 7,281 7,742 - Domestic interest payments: 213 100 102 104 106 109 - External interest payments: 0 0 6,559 6,623 7,174 7,634 - Investment expenditures: 5,585 9,087 10,548 10,152 10,482 11,181 - Balance (including grants but excluding accrued and deferred interest): -9,065 -6,726 -7,253 -6,295 -6,841 -7,659 - External financing: 9,065 6,726 1,102 -69 -999 -2,670 - Financing gap: 0 0 6,151 6,364 7,839 10,330 - Memorandum: Primary fiscal balance: -8,852 -6,626 -593 432 440 83 - GDP: 21,132 24,295 31,252 34,203 37,518 41,941 - Central Bank of Iraq's balance sheet highlights (Table 3, In billions of Iraqi dinars unless indicated): - Net foreign exchange assets 2/: 1,600 1,887 2,701 2,353 3,000 3,892 4,404 7,532 11,419 (monthly program sequence shown) - Foreign exchange assets (selected months): 1,916 2,134 2,952 2,606 3,251 4,150 4,661 8,309 12,196 - Base money (levels shown monthly): 5,638 6,547 7,158 7,199 7,630 8,351 9,042 12,235 16,252 - Currency outside banks: 2,606 3,803 4,965 5,461 5,778 5,976 6,512 9,522 12,648 - Banknotes and coins issued 6/: 4,586 5,676 5,927 6,282 6,414 6,674 7,003 10,014 13,301 - Exchange rate (program): 1,690 1,460 1,460 1,460 1,460 1,460 1,460 1,460 1,460 - Inflation (12-month): 36.3 ... 7.0 15.0 - Non-oil real GDP growth (in percent): -3.4 ... 5.0 10.0 - Gross foreign exchange assets (millions of U.S. dollars): 1,134 ... 1,569 2,072 1,829 2,258 2,843 3,193 5,691 8,354 - Net foreign exchange assets (millions of U.S. dollars): 947 1,388 1,895 1,651 2,084 2,666 3,017 5,159 7,821 - Balance of payments detail (Table 4 highlights, In millions of U.S. dollars): - Trade balance: -5,137 -7,878 -4,327 -3,759 -3,673 -3,065 (In percent of GDP: -24.3 -32.4 -13.8 -11.0 -9.8 -7.3) - Government Imports: -14,790 -17,197 -16,707 -15,676 -14,950 -15,583 - Private sector imports: -6,890 -8,277 -9,009 -9,322 -9,818 -10,348 - Transfers, net: 1,731 4,197 5,191 3,982 3,345 2,203 - Current Account 1/: -3,768 -4,428 -6,637 -7,157 -8,071 -9,034 (In percent of GDP: -17.8 -18.2 -21.2 -20.9 -21.5 -21.5) - Financial Account, excl. CBI foreign position: 8,973 7,026 1,502 431 -320 -1,809 - Overall Balance 1/: 5,204 2,598 -5,135 -6,726 -8,391 -10,843 - Central Bank Reserves: 5,691 8,289 9,305 8,944 8,392 7,879 - Non-oil GDP: 4,173 5,661 7,161 8,408 9,787 11,191 - Indicators of Fund credit (Table 5, In millions of SDRs unless otherwise indicated): - Clearance of arrears: 55.3 0.0 0.0 0.0 0.0 0.0 - Obligations from prospective drawings: 0.4 9.2 9.2 9.2 155.9 151.2 - EPCA repayments: 0.0 0.0 0.0 0.0 148.6 148.6 - Total obligations: 55.7 9.2 9.2 9.2 155.9 151.2 - Outstanding Fund credit: 297.1 297.1 297.1 297.1 148.6 0.0 - Projected disbursements (memorandum): 297.1 0.0 0.0 0.0 0.0 0.0 - Estimated external debt stock (Table 6, end-December 2002, In billions of U.S. dollars): - Non-Paris Club official bilateral creditors: 67.4 - Paris Club creditors: 42.0 - Private creditors (including commercial banks): 15.0 - Multilateral obligations: 0.5 - Total external debt stock: 124.9 - Memorandum item: Unpaid awarded claims, UN Compensation Commission: 29 *Source: Program projections agreed with Iraqi authorities through 2005; Fund staff projections for the medium term. (Content unit: _cr04325 - 54.)* ### APPENDIX I ### APPENDIX I ### Introduction - Iraq faces the aftermath of decades of conflict, state control over economic and political activity, lack of investment in critical social areas, and over a decade of international isolation. - Human development indicators are described as being "among the lowest in the region." - Government objectives: improve welfare of the Iraqi people, enhance political and social stability, and achieve a sustainable external debt position. - Political timeline and commitments: - Preparing for legislative elections "early next year" (interim government preparing for transition). - Elected National Assembly to prepare a new constitution, leading to election of a constitutional government "by the end of next year." - Request to IMF: - Government requests access to the IMF’s policy for emergency post-conflict assistance (EPCA) in the amount of SDR 297.1 million, described as "the equivalent of 25 percent of quota." - Government commits to retaining the full amount of this assistance in the country’s SDR account at the IMF. - Forward program sequencing: - Satisfactory implementation of the EPCA-supported program should allow movement next year to a more ambitious reform program that could be supported with a stand-by arrangement, contingent on a positive assessment of planning and policy implementation capacity. - Information sharing: Government will provide the IMF with any information requested on program progress. ### Recent economic and policy developments - Output and production - Real GDP contracted "by about 35 percent in 2003." - Oil production contracted to an average "1.2 million barrels per day (mbpd)" in 2003 from "almost 2.0 mbpd in 2002." - Real GDP projected to rebound "by about 50 percent in 2004." - By end-July 2004, oil production rose to "2.1 mbpd" and exports were "1.6 mbpd"; expected averages for 2004: production "2.1 mbpd", exports "1.5 mbpd." - Oil constitutes "more than 75 percent of total economic activity." - Labor and social conditions - Unemployment estimated at "about 28 percent in mid-October 2003." - "More than 60 percent of the population continue to rely exclusively on a commodity-distribution system for their basic needs." - Prices, exchange rate, and money - Exchange rate "at around ID 1,460 per US$" since mid-January 2004. - Currency issued increased "by about 53 percent since end-2003" in the first six months of 2004. - Consumer prices "have remained relatively stable so far this year." - Fiscal developments - In the first six months of 2004, budget execution with total spending amounting to "US$10.5 billion (100 percent of GDP)" and in line with the budget. - Budget pressures from rising security costs and reconstruction needs. - Revenue-side reforms implemented: - A 5 percent reconstruction levy on imports introduced in April 2004. - Personal and corporate income taxes revised to include "a maximum marginal tax rate of 15 percent," with increased personal income tax allowances, and a wage withholding tax on higher-income civil servants. - Pension contributions introduced for civil servants. - Expenditure-side reforms limited to wage structure: new 13-tier wage scale introduced and average wage level increased; pensions revised. - Costly subsidy policies retained in 2004 budget: subsidies on domestic price of oil refined products, transfers to state-owned enterprises, and the commodity distribution system. - Budget framework and donor coordination - Adoption of second half of 2003 budget and the 2004 budget integrated operating and investment expenditure and covered general government operations across governorates. - Expenditures financed by donors not yet incorporated into the budget; Iraqi Strategic Review Board created to ensure consistency with Iraqi priorities and budget. - Fiscal transparency and institutions - Achievements: - Establishment of a fiscal policy unit in the ministry of finance. - Establishment of the Development Fund for Iraq (DFI) to account for oil export sales and government assets held abroad and to channel them through the budget. - Establishment of the International Advisory and Monitoring Board (IAMB) as an audit oversight board for DFI. - Strengthening of external controls by Iraq’s Supreme Board of Audit. - Monetary and financial sector reforms - New central bank law provides independence and accountability of the Central Bank of Iraq (CBI) and prohibits CBI from extending credit to the government. - CBI governing board composition established: nine-member board consisting of the governor, two deputy governors, three senior managers, and three full-time outside directors; first meeting occurred on August 16, 2004. - CBI conducting daily foreign exchange auctions; strategy led to low inflation and accumulation of gross international reserves amounting to "about US$4,273 billion at end-July 2004" (implying base money coverage of "about 60 percent"). - Ministry of Finance has started bi-weekly treasury bill auctions to roll over bills outstanding with commercial banks; intention to develop a secondary market to facilitate CBI open market operations. - New commercial banking law adopted October 2003; three foreign banks licensed to begin operations; CBI evaluating over 30 license applications; commercial banks required to strengthen capital base. - External sector and debt - Current account deficit estimated at "about US$1.89 billion (18 percent of GDP)" in the first six months of 2004; financed mainly through transfer of government assets held abroad and letters-of-credit under the UN oil-for-food program. - Trade Bank of Iraq established in December 2003 to facilitate international trade. - Iraq secured observer status at the World Trade Organization. - Preliminary external debt estimate at end-2003: "US$125 billion (7 times Iraq’s GDP)" composed of: - "US$42 billion" due to Paris Club sovereign creditors, - "US$67.3 billion" to non-Paris Club sovereign creditors, - "US$0.5 billion" to international financial institutions, - "US$15 billion" to private creditors. - IMF staff Debt Sustainability Analysis (DSA) completed in May indicates Iraq will need "substantial debt reduction (in the neighborhood of 90% to 95%)" to reach external and fiscal viability. - Progress reported in debt reconciliation and data improvement; several major creditors have agreed to make efforts to reach agreement on restructuring Iraq’s debt "by the end of 2004." - Structural reforms and services - New foreign direct investment law enacted allowing ownership in most sectors except natural resources, real estate, and insurance; provides national treatment for foreign firms. - Legal and judicial systems revamped and declared independent from the executive branch. - Re-establishment of essential services: - Electricity generating capacity improved but still short of demand. - Schools reopened despite shortages. - Public food distribution system continued. - Hospitals and health services being refurbished but medicines and supplies fall short. - Significant investment to improve water and sanitation. - Measures to strengthen transparency and public governance: improvements in frequency and amount of economic and financial data reported. - Technical assistance - Comprehensive TA program with the IMF and other donors implemented to strengthen administrative and institutional capacity. - Workshops and seminars held since late 2003 on fiscal and monetary policy and statistics. - Technical advisors financed by USAID and other donors providing continuous support on the ground in Baghdad. ### Government program for 2004 and 2005 — Main challenges - Overarching goals reiterated: improve welfare, enhance political and social stability, and achieve a sustainable external debt position. - Recognized accomplishments: notable economic and structural reforms achieved in a short period under difficult circumstances. - Immediate challenges listed include: - Restoring security. - Preparing the new (constitutional) framework and elections. - Rehabilitating infrastructure and public services. - Addressing reconstruction financing needs and fiscal pressures. - Diversifying revenue base and designing tax regime conducive to growth and revenue generation. - Resolving unsustainable external debt burden through creditor negotiations and large-scale debt reduction as indicated by the DSA. *Source: Memorandum of Economic and Financial Policies for 2004–05 (Iraq), September 24, 2004* ### APPENDIX I ### APPENDIX I ### Principal challenges and reform priorities - Key areas to address: elections, strengthening administrative capacity, broadening the revenue base, stepping up reconstruction, developing an effective social safety net, and promoting the development of the private sector. - Structural reforms required: restructure the public sector; develop a sound banking system; modernize the central bank; establish a market-oriented legal framework conducive to private sector development; strengthen good governance and transparency; increase domestic revenue and strengthen expenditure management. - Success of program closely linked to: (i) return to a more normal and secure environment; and (ii) developments in the international oil market and ability to bring production and exports to full potential. ### Macroeconomic objectives - Real GDP growth targets: - 52 percent in 2004 - 17 percent in 2005 - 10 percent on average over 2006–2009 - Oil production capacity targets: - 2.1 mbpd in 2004 - 2.4 mbpd in 2005 - 3.3 mbpd by 2009 - Inflation forecasts: - 4 to 7 percent per annum in 2004 - about 15 percent in 2005 (reflecting rising activity and demand pressures, stable exchange rate) - caveat: may need revision depending on extent of administered price adjustments in 2005 - Central Bank of Iraq (CBI) net international reserves targets: - at least US$5 billion by end-2004 - US$6 billion by end-2005 ### Macroeconomic policies — principles - Policy principles for 2004–2005: - Fiscal policy constrained by resource envelope based on government revenues and available external resources. - Monetary policy geared toward ensuring price stability while avoiding unwarranted foreign exchange rate fluctuations. ### Fiscal policy — objectives, assumptions, and measures - 2004 fiscal deficit: - Overall government fiscal deficit limited to US$9.0 billion (or 43 percent of GDP) - Fully financed by external financing including: almost US$3.6 billion from letters of credit issued by the UN under the oil-for-food program, and US$5.9 billion in assets accumulated abroad held in the Development Fund for Iraq - Fiscal projections incorporate a moratorium on debt payments to international creditors (Paris Club understandings incorporated) - 2005 fiscal stance: - Overall government deficit limited to US$6.7 billion (or 28 percent of GDP) - Fully financed through external sources, including about US$350 million in new bilateral and multilateral assistance - Budget assumes a moratorium on debt service due to foreign creditors - Oil export price conservatively assumed at around US$26 per barrel for budgetary purposes - A 2005 budget incorporating these parameters to be submitted to the National Assembly by October 10, 2004 - Priority for any additional revenues: capital spending and financing budgets of future years - Revenue and tax measures: - Revenues in 2005 projected to increase by 14 percent compared to 2004, to US$19.5 billion (including oil export revenues of US$17.1 billion) - Planned increase in domestic prices of oil derivative products by end-2004 expected to bring US$1 billion in revenue in 2005 - Plan to bring domestic energy prices to cost recovery levels by end-2009 - Tax and customs administration: strengthen capacity through seminars/courses; with external technical assistance develop by June 2005 a plan to overhaul tax and customs administration - Possible additional tax measures in 2006 may include: - (i) reducing exemptions to the reconstruction levy and turning it into a uniform import duty - (ii) introducing a general sales tax with a single rate of 10 percent to be collected at the border and on manufacturing goods (as a first step toward VAT) - (iii) introducing a uniform excise tax on imported cars - (iv) imposing a tax on cellular phones - (v) introducing a fee on foreign visitors - Expenditure management: - Overall public expenditure in 2005 limited to US$36.7 billion - Off-budget expenditures not allowed; additional spending must be integrated into a revised budget based on availability of additional resources - Wages and pensions: overall wage and pension bill limited to US$ 3.7 billion in 2005–2006, with aim to keep it at about 11 percent of GDP in the medium term (2006–09) - Payroll covering all civil servants and government workers established; automated payroll system to be implemented in 2005 - State-owned enterprises: - Further analysis of nonviable state-owned enterprises to be completed by end-2005, with aim of producing reform/restructuring plans - Until then, operating transfers will be made to help pay wages and finance working capital for enterprises not yet fully operational and profitable - Social safety net reform: - Commitment to move over the medium term from a food ration system to a cash distribution system targeted at the poor and unemployed (monetization of the food basket) - Objectives of monetization: help domestic agriculture, encourage private trade, eliminate price distortions, ensure families in need are compensated - Preconditions: efficient payment system, allow state trade entities to take up commercial business, public information campaign, continued transfers to regions and local governments - Budgetary management and transparency reforms: - Pass regulations related to the financial management law by end-2004 - Introduce a treasury single account by September 2005 - Adjust budget appropriation through mid-year budget reviews - Implement reporting and control modules of a financial management information system (FMIS) nationwide by June 2005 - Implement recommendations of the KPMG audit and of the IAMB, including ensuring oil export sales are in line with international standards and strengthening governance through effective metering of oil production - Publish government’s final consolidated fiscal accounts by June of the following fiscal year, including expenditures financed by donors, starting in June 2005 - Introduce a GFS-compatible budget classification ### Monetary and exchange rate policy - Exchange rate regime: - Broad exchange rate stability to be preserved for the time being - As data and CBI understanding of transmission mechanism improve, regime appropriateness to be reevaluated; exchange rate may be allowed to reflect structural changes and real shocks - Vigilance triggers for greater flexibility include: excessive downward pressure threatening to reduce foreign exchange reserves below a minimum acceptable level of $4 billion, or signs that inflation could exceed forecast - Monetary program and money demand: - Monetary program for 2004 and 2005 formulated; projected growth in currency in circulation consistent with projected net international reserves accumulation and a policy of no lending to the government by the CBI - CBI instruments and operational reforms: - In 2004, CBI relied on foreign exchange auctions as principal instrument to manage liquidity, absorb excess dinars, and provide foreign exchange to private sector activity - Broadening of monetary policy instruments underway: creation of a lender-of-last-resort facility and an overnight standing credit/deposit facility approved by CBI Board - New regulations making reserve requirement regime more flexible - Banking facilities to be in operation by October 1, 2004; reserve requirement regulation to be implemented by no later than December 1, 2004 - Introduction of treasury bills auction to stimulate development of secondary market and enable CBI open market operations; environment to be provided for private banks to increase participation in treasury bills auctions - Transparency and communication: - CBI developing strategy to communicate policies to public; publishes results of daily currency auctions and monthly balance sheet on its website; began issuing policy statements after board meetings - CBI to expand and improve information on its operations - Regularization of government-CBI financial relations: - Ministry of Finance and CBI in process of agreeing to restructure all government obligations held by the CBI; to be implemented in installments to facilitate government payments while minimizing negative impact on CBI capital and taking into account acceptable international accounting standards - CBI intends to return any excess realized profits (after CBI capital reaches required regulatory minimum) to the Ministry of Finance; government to propose an amendment to the CBI law to facilitate transfer of excess earnings - Agreement calls for formal closure of government overdraft facility at the CBI ### External sector policies - Data limitations and balance of payments outlook: - Data and information on the balance of payments are extremely limited; priority to improve data collection - Initial estimates: despite a very large current account deficit (equivalent to 18 percent of GDP), there should be a balance of payments surplus in 2004, largely from large public sector capital inflows - 2005 balance of payments outlook uncertain and depends on level of donor assistance - Projected current account deficit in 2005 equivalent to about 20 percent of GDP; expected to be covered by donor assistance and public capital flows - Trade and exchange commitments: - Government committed to an open trade and exchange system and taking steps to become a full member of the World Trade Organization - Government will avoid imposing restrictions on payments and transfers for international transactions, introducing new or intensifying trade restrictions for balance of payments purposes, or resorting to multiple currency practices - Government will discuss with IMF staff possibility of accepting as early as possible the obligations of Article VIII, Sections 2, 3, and 4 of the IMF’s Articles of Agreement - External debt and debt relief expectations: - IMF staff debt sustainability analysis indicates deep debt reduction ranging from 90% to 95% necessary to restore debt sustainability - Government encouraged by international reaction; many countries have agreed to substantially reduce claims on Iraq - Intention to reach agreement with the Paris Club on substantial reduction in value of Iraq’s debt as soon as possible - Expectation that non-Paris Club creditors will treat their claims comparably to Paris Club treatment; legal advisors developing strategy for dealing with non-Paris Club official bilateral and private sector creditors - Contacts initiated with non-Paris Club official bilateral creditors to begin data reconciliation; several such creditors have indicated willingness to reduce substantially their claims ### Structural reforms - Interim national development strategy: - Interministerial committee established to prepare an interim national development strategy outlining structural reforms for transition to a market economy, oil sector development, diversification, social indicators improvement, and regional development - Draft to be discussed at next donors’ meeting in Tokyo; final draft expected to be discussed by the new national assembly in March 2005 - Financial sector and central bank modernization: - Further steps to modernize central bank and create a sound financial system - Priorities include: reliable and regularly reported data for individual banks; develop institutional capacity for bank resolution and a bank resolution strategy; develop legal and monetary elements of a systemic safety net; strengthen payments infrastructure - Specific actions: - (i) enhance payments system through establishment of an automatic clearing house and pass payments system law to regulate its activities - (ii) make CBI operations more transparent, including regular dissemination of monetary statistics and undergoing an external audit of the 2004 financial statements according to international standards by mid-2005 *Source: APPENDIX I of the provided IMF document.* ### APPENDIX I ### APPENDIX I ### Program scope and timeline - Duration of the program supported by the Emergency Post-Conflict Assistance: from November 1, 2004 through end-December 2005. - Monitoring instruments: quantitative indicative benchmarks and structural indicative benchmarks (see Tables summarized below). - Government commitments: set up an interministerial technical committee; request for IMF resident representative; provide IMF with requested information for monitoring. ### Structural and policy actions (selected) - Strengthen public financial management and budget execution, including: - Establishment of an automatic payroll system for all government employees (deadline: June 2005). - Development of monthly fiscal accounts for the central government and the oil sector (deadline: December 2004). - Adoption of a plan to overhaul the tax and customs administration (deadline: June 2005). - Financial sector reforms: - Issuance of regulations regarding bank licensing and standard prudential ratios (deadline: December 2004). - Enactment of payments systems law (deadline: December 2004). - Enhancing the CBI’s supervisory capacity; plan for restructuring state-owned banks (plan to be adopted by end-June 2005). - Oil sector: - Review fiscal regime for the oil sector and prepare an overall restructuring plan by end-2005. - Take steps to address governance issues in the oil sector along the lines of the recommendations of the IAMB. - Statistics and transparency: - CSO currently publishes a monthly CPI excluding northern Iraq; plans to publish a CPI covering the entire territory and subannual agricultural and industrial production statistics. - CBI will start collecting banking-system information to prepare a monthly monetary survey. - Completion of population census and household expenditure survey field work by end-2004 to support poverty and social indicators. - Ensure greater transparency in production and dissemination of statistics. - Technical assistance priorities for end-2004 and 2005: - (i) banking supervision, monetary operations, and payments system; - (ii) budget execution and public expenditure management, tax policy and administration, fiscal federalism, tax regime for the oil sector, and customs administration; - (iii) compilation and dissemination of economic statistics. ### Quantitative indicators (key numeric targets and definitions) - Quantitative indicators include: - a range on currency in circulation; - a floor on net international reserves (NIR) of the Central Bank of Iraq (CBI); - a ceiling on lending to the government by the CBI; - a ceiling on the primary deficit of the government; - a ceiling on external arrears on new borrowing (continuous ceiling); - a ceiling on contracting and guaranteeing of nonconcessional external debt. - Program exchange rate for monitoring: ID 1,460 per U.S. dollar (U.S. dollar/Iraqi dinar exchange rate on or about August 31, 2004). - Currency issued: defined as currency holdings by the public plus cash in commercial banks. - Stock as of June 30, 2004: ID 7,003 billion. - Net international reserves (NIR): gross usable reserves minus reserve liabilities of the CBI. - As of June 30, 2004, NIR amounted to US$ 3,017 million (ID 4,407 billion). - Lending by the CBI to the central government: CBI holdings of treasury bills plus outstanding balance in the government overdraft account at the CBI (excluding accrued interest not yet due). - As of end-June: treasury bill holdings by the CBI amounted to ID 2,528 billion; balance of the overdraft account at the CBI stood at ID 1,458 billion. - Primary fiscal deficit: primary government expenditure (including oil extraction and oil-related investment activities and donor-financed expenditures) excluding interest payments, minus government revenue valued on a cash basis. - Indicative ceiling measurement: cumulative from January 1, 2004 for end-2004 test; cumulative from January 1, 2005 for 2005 test dates. - Continuous indicative ceiling: non-accumulation of external payments arrears on new external debt contracted or guaranteed by the central government or the CBI (external debt service obligations falling due after September 30, 2004). ### Quantitative timetable and target values (selected figures from Table 1) - Currency issued (range): - Stock 6/30/04: 7,003 - 12/31/04 Ind.: 9,000-11,000 - 3/31/05 Ind.: 9,700-11,800 - 6/30/05 Ind.: 10,400-12,700 - 9/30/05 Ind.: 11,100-13,600 - Net international reserves of the central bank (floor) (in millions of U.S. dollars): - Stock 6/30/04: 3,193 - 12/31/04 Ind.: 4,000 - 3/31/05 Ind.: 4,250 - 6/30/05 Ind.: 4,500 - 9/30/05 Ind.: 4,750 - Lending to the government by the CBI (ceiling) (in billions of Iraqi dinars): - Stock 6/30/04: 3,986 - 12/31/04 Ind.: 3,986 - 3/31/05 Ind.: 3,100 - 6/30/05 Ind.: 3,100 - 9/30/05 Ind.: 3,100 - Government primary fiscal deficit (in millions of US$; ceiling, cumulative flows): - 12/31/04 Ind.: 8,852 - 3/31/05 Ind.: 1,800 - 6/30/05 Ind.: 3,500 - 9/30/05 Ind.: 4,750 - New medium- and long-term nonconcessional external debt contracted or guaranteed by the government (in millions of U.S. dollars; ceiling): - 12/31/04 Ind.: 0 - 3/31/05 Ind.: 0 - 6/30/05 Ind.: 500 - 9/30/05 Ind.: 750 - (later indicated) 1,000 - External arrears on new borrowing (in millions of U.S. dollars; ceiling): continuously monitored and set at 0 for the listed dates. - Note: The government will not contract any loans collateralized by future oil revenues. ### Definitions and debt/concessionality rules (selected) - Reserve conversions: - CBI assets/liabilities in U.S. dollars converted at ID 1,460 per U.S. dollar (August 31, 2004 rate). - SDRs and other currencies converted to U.S. dollars at SDR-exchange rates prevailing as of August 31, 2004. - Reserve assets excluded from gross usable reserves: resources of the Development Fund for Iraq; assets pledged, collateralized, or encumbered; claims on residents; precious metals other than monetary gold; assets in nonconvertible currencies; illiquid assets; claims arising from derivatives. - Reserve liabilities: foreign currency denominated liabilities of the CBI with original maturity of one year or less, and all liabilities to the Fund; include foreign currency reserves of commercial banks held at the CBI and commitments from derivatives; exclude government foreign currency deposits at the CBI. - Debt definition: follows Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85) August 24, 2000); includes loans, suppliers' credits, and leases (present value of lease payments at inception). - Guarantees: any explicit legal obligation of the government or CBI to service a debt in the event of nonpayment by recipient. - Limits on medium- and long-term external debt: apply to contracting or guaranteeing by the government of new, nonconcessional external debt with original maturity of more than one year, excluding IMF obligations; external debt expressed in U.S. dollar terms using market rates as of August 31, 2004. - Concessionality methodology: - Based on OECD CIRRs with currency-specific discount rates. - For loans of original maturity at least 15 years: use average of CIRRs over last 10 years. - For loans with original maturities less than 15 years: use average of CIRRs of the preceding six-month period. - Added margins: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15–19 years; 1.15 percent for 20–30 years; and 1.25 percent for over 29 years. - Loans with grant element equivalent to 50 percent or more are excluded from the debt limits. - Debt limits do not apply to loans contracted for debt rescheduling or refinancing. ### Data provision and reporting requirements (selected frequencies and deadlines) - Inter-agency Technical Committee to coordinate EPCA and provide data to the Fund. - Reporting frequencies and maximum lags: - CBI gross foreign exchange reserves (weekly) and balances on the Development Fund for Iraq: reported no longer than 2 weeks after end of reference week. - Monthly balance sheet of the CBI: with a month lag. - Balance sheets of Rafidain and Rasheed banks: quarterly. - Weekly preliminary monetary and financial aggregates (including exchange rate data daily): data (excluding exchange rates) no longer than three weeks after end of reference period. Items include currency in circulation, demand and savings deposits at commercial banks, balances on government accounts at the CBI, interest rates on savings deposits at commercial banks, holdings of government securities, and credit outstanding to public and private sectors. - Consumer price index (CPI), including indices for main cities (monthly): reported no longer than a month after the end of the relevant month. - Detailed operational budget operations and their financing, including wage and non-wage support for state-owned enterprises, customs revenues collected, amount of treasury securities outstanding, and interest rates on treasury securities: (reporting periodicity implied as part of fiscal reporting; program designed with quarterly quantitative targets and actual outcome should be provided within six weeks following end of quarter). *Source: APPENDIX I; Technical Memorandum of Understanding, September 24, 2004.* ### APPENDIX I ### _cr04325 - APPENDIX I ### Reporting, Data, and Statistical Requirements - Monthly fiscal reporting: - Data to be reported on a monthly basis and reported no more than a month after the end of the reference month. - External assistance and debt: - Detailed data on disbursement of external assistance from the US Supplemental and other donor assistance, including by recipient sector; foreign debt amortization and interest payments made; and total outstanding domestic and external debt. - Quarterly loan reporting: - List of short, medium, and long-term government or government-guaranteed external loans contracted during each quarter, identifying for each loan: the creditor, the borrower, the amount and currency, the maturity and grace period, and interest rate arrangements (quarterly). - Foreign trade and activity indicators: - Foreign trade statistics (imports, exports, re-exports) (quarterly). This should be reported no longer than eight weeks after the end of the reference period. - Indicators of real economic activity (quarterly). These data should be reported no longer than eight weeks after the end of the reference quarter. ### Structural Reforms and Bank Restructuring - Structural reform reporting: - The authorities will prepare and send to the IMF reports, with appropriate documentation, indicating progress achieved, explaining any deviations relative to the initial planning, and specifying expected revised completion dates. - State-owned banks: - The authorities will provide staff with relevant documents and information dealing with the restructuring of the commercial banks. ### Other Government Measures - Other information: - Other details on major economic and social measures taken by the government that are expected to have an impact on program sequencing (such as changes in legislation, regulations, or any other pertinent document) will be sent in a timely manner to IMF staff, for consultation or information. ### Relations with the Fund — Financial and Membership Status (As of September 23, 2004) - Membership: - Joined: December 27, 1945; Article XIV - General Resources Account (SDR / Million / %Quota): - Quota 504.00 100.00 - Fund holdings of currency 504.01 100.00 - Reserve Position 0.00 0.00 - Holdings 0.00 0.00 - SDR Department (SDR Million %Allocation): - Net cumulative allocation 68.46 100.00 - Holdings 0.00 0.00 - Outstanding Purchases and Loans: - None - Latest Financial Arrangements: - None - Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): - Charges/Interest 0.52 1.36 1.36 1.36 1.36 (for years 2004 2005 2006 2007 2008 respectively) - Total 0.52 1.36 1.36 1.36 1.36 - Implementation of HIPC Initiative: - Not Applicable. - Safeguards Assessments: - None. ### Exchange Rate Arrangement - Central Bank operations and policy: - The Central Bank of Iraq has been conducting foreign exchange auction on a daily basis since October 4, 2003. - The central bank has followed a policy of broad exchange rate stability which has translated in a de facto peg of the exchange rate since early 2004. - The existing exchange system may still contain several de jure restrictions on the making of payments and transfers for current international transactions, which the authorities are in process of assessing with a view to removing them in the near term. ### Article IV Consultations and Recent Technical Assistance - Article IV consultations: - A report for the 1983 Article IV consultation was issued to the Executive Board on August 5, 1983; however no Board meeting was convened. - The last Article IV consultation took place in November 1979. - Recent Technical Assistance (Department — Date — Topic): - FAD: - July 15–31, 2003 Public expenditure management - December 2003 Public expenditure management - February 29–March 4, 2004 Fiscal seminar for high level officials - April 4–8, 2004 Training course in budget preparation - May 31–June 8, 2004 Tax Policy and Tax Administration Workshop - June 2004 Expenditure management - LEG: - July–October 2003 Wrote first draft of new Central Bank legislation - July–October 2003 Wrote first draft of new Commercial Banking legislation - MFD: - July 2003 Monetary and financial systems areas - November 2003 Market policy and operations - December 2003 Accounting and financial reporting - January 2004 Central bank reform - June 2004 Banking supervision - June 2004 Market policy and operations - STA: - July 8–14, 2003 Monetary and financial statistics (jointly with MFD) - December 1–11, 2003 Multisector statistics - January 17–22, 2004 National accounts statistics - January 24–29, 2004 Consumer price statistics ### Iraq: Relations with the World Bank Group — Key Points - Historical lending and arrears: - Iraq received six loans from the IBRD between 1950 and 1973. The last loan closed in 1979. - Iraq has been in non-accrual status since 1990. - Indicative Bank lending (Madrid Conference, October 2003): - Possible range of lending of US$3.0-5.0 billion over five fiscal years, including up to $500 million for FY05-06, once “threshold issues” are resolved. - As of the transfer of authority to an Interim Iraqi Government on June 28, 2004, Iraq has a de jure government that can access Bank resources, pending clearance of arrears (about US$100 million, which is included in Iraq’s 2004 budget). - No formal request for accessing IDA/IBRD has been made to date. - World Bank Interim Strategy and ITF resources: - Interim Strategy focuses on: (i) building Iraqi capacity; (ii) emergency operations to generate employment and restore essential infrastructure and services; and (iii) laying the foundation for the medium-term program, through studies and policy advice. - Commitments to the World Bank ITF currently stand at US$413 million, of which US$360 million have been deposited into the ITF account. - One project funded from the ITF (First Capacity Building) is completed and another project (Emergency Textbook Provision) is underway. - Seven additional emergency operations amounting to about US$320 million will be appraised and approved in the next few months, resulting in the commitment of nearly all ITF funds. These seven operations in the pipeline are: - Emergency Community Infrastructure Project (US$20 million) - Emergency School Rehabilitation Project (US$60 million) - Emergency Baghdad Water Supply and Sanitation Project (US$60 million) - Emergency Water Supply and Sanitation and Urban Development Project (US$90 million) - Emergency Health and Rehabilitation Project (US$25 million) - Second Capacity Building Project (US$10 million) - Emergency First Private Sector Development Project (US$55 million) - Bank support for medium-term program and NDS: - Economic and sector work grouped into three clusters: (i) economic reform and transition; (ii) poverty, safety nets, and social development; and (iii) public sector management. - The Bank has encouraged and supported Iraq’s elaboration of a National Development Strategy (NDS). - The Interim Iraqi Government will share the NDS with donors at the Facility Donor Committee Meeting in Tokyo on October 13-14, 2004. - Operational modalities and presence: - The Interim Iraq Office in Amman facilitates meetings and workshops; videoconferencing facilities in Baghdad are in use and will extend to the Ministry of Finance; the Bank has Iraqi staff and consultants in Baghdad. - The World Bank is a member of the International Advisory Monitoring Board (IAMB), which commenced in December 2003. - IFC initiatives: - IFC is implementing the Iraq Small Business Financing Facility and the Private Enterprise Partnership for the Middle East (PEP-ME). - IFC finalized a Financial Sector Review of private Iraqi banks; has worked to upgrade financial statements to international standards; faces delays in investments and technical assistance due to legal issues and security concerns; PEP-ME conducted a three-day training session in Amman. - IFC has appointed a Head of Mission for Iraq, co-located with the World Bank Head of Mission in Amman. ### IMF–World Bank Collaboration: Objectives, Lead Roles, and Shared Responsibilities - Shared core reform agenda (broad agreement between IMF and World Bank staffs): - (i) reinforcing public governance and institutions, including management of oil revenues; - (ii) ensuring coherent and well-sequenced market-focused reforms; - (iii) strengthening social safety nets; - (iv) improving the delivery of essential services, including education and health. - Table of lead institution by area (summary of lead roles): - Market-focused reforms: - Reform of domestic subsidies: World Bank/IMF - Trade reform/WTO accession: World Bank - Monetary and credit policies: IMF - External sector: - Balance of Payments: IMF - Debt sustainability: IMF - Public Sector Governance: - Revenue management, incl. oil: IMF/World Bank - Tax administration: IMF - Public financial management: IMF/World Bank - Intergovernmental finance: IMF/World Bank - Civil service reform and governance: World Bank - Public Service delivery: - Agriculture, water and environment: World Bank - Urban infrastructure: World Bank - Telecommunications: World Bank - Education and health: World Bank - Private sector development: - Investment climate: World Bank - SOE reform: World Bank - Financial sector development, incl. Payment system and bank supervision: IMF/World Bank - Human development: - Pension and labor market reform: World Bank - Social development and poverty analysis: World Bank - Gender issues: World Bank - Other: - Oil and gas sector: World Bank - Statistical capacity building: IMF - Areas led by the World Bank with no direct IMF involvement: - Emergency support to rehabilitate public services (education, health systems, water supply and sanitation, urban infrastructure, telecommunications) via ITF-funded projects. - Poverty analysis, social development report, and gender issues. - Areas where World Bank analysis serves as input into IMF-supported program: - Policy advice and inputs to the Prime Minister’s Supreme Economic Committee in drafting the NDS. - Policy notes on pension and labor market reforms, SOE reform and investment climate, agriculture, and trade reform. - Work with World Food Program on food market issues. - Policy notes on oil and gas sector governance, public finance and civil service reform. - Areas of shared responsibility: - Macroeconomic and fiscal sustainability agendas, including revenue management and reform of domestic subsidies. - Financial sector development (payment system and banking supervision and regulation). - Statistical capacity building. - Coordination on intergovernmental finance and capacity building in macroeconomic management, public sector governance, private sector development, and social safety nets. - Areas where the IMF leads and World Bank inputs feed into Bank programs: - IMF leads on core macroeconomic policies, Debt Sustainability Analysis, monetary policy, and management of aggregate expenditures. - The Bank works with the IMF to ensure consistency of NDS and project work with the macroeconomic and fiscal framework. *Source: _cr04325 - APPENDIX I (excerpts).* ### 15. The IMF leads the dialogue on monetary and credit policies, exchange rate management, tax ### 15. The IMF leads the dialogue on monetary and credit policies, exchange rate management, tax administration, and balance of payments issues. ### Background - Iraq’s macroeconomic statistics, once among the most developed in the region, have suffered from years of repression and neglect; statistics were mostly confidential and had limited use. - Central Statistical Office (CSO) experience: national accounts experience solely with System of National Accounts 1968 (1968 SNA). - Central Bank of Iraq (CBI) statistical capacity: slightly better than CSO but staff need training. - IMF’s Statistics Department (STA) technical assistance (TA) since 2003: - Monetary statistics mission visited Baghdad in July 2003 as part of an MFD-led mission. - December 2003 multisector statistics mission met Iraqi representatives (CBI, CSO, Ministry of Planning) in Amman, Jordan; mission covered money and financial statistics, balance of payments and foreign trade statistics, national accounts, and consumer price statistics. - January 2004: STA hosted two workshops for Iraqi statisticians in Amman (national accounts and consumer price indices). - FY 2005 RAP includes terms for follow-up missions in all statistical areas; STA will deliver missions taking due account of absorptive capacity and other donors’ contributions. ### Shortcomings with the statistical framework — Key findings - National accounts - CSO reports to the Minister of Planning under the existing Statistical Act; Minister must agree on data before release, affecting statistical independence. - Public releases of national accounts are limited: current price estimates published in the Statistical Yearbook with limited circulation and access conditional on Minister of Planning approval; constant price estimates are classified as a State secret. - National accounts follow the 1968 SNA but have gaps and flaws in implementation: - Deficiencies in geographical and industrial scope; accounts do not include the northern region (Kurdistan) since 1991. - Poor coverage of the informal sector; surveys out-of-date. - Significant portion of the building industry missing for political reasons. - Gaps in coverage of business, community, social, and personal services. - Use of out-of-date classifications not following standard international best practice. - Data collection and timeliness: - Current price data collections reasonably comprehensive for formal sector; businesses with more than 10 employees must report calendar year data by the following October; small businesses by the following June. - Penalties for noncompliance produce timely reporting historically, but timeliness expected to worsen with recent changes. - Shortage of quarterly and monthly indicators and lack of timely data for services; extrapolation from out-of-date benchmarks adversely affects quality. - Statistical techniques needing improvement: - Total manufacturing estimates extrapolated with total industrial production index. - Frequent use of overall CPI as a deflator when not appropriate. - Deflation often applies a single deflator to value added, which can be misleading. - Consumer price index (CPI) - Staff numbers inadequate and need training. - Insufficient computer hardware and software. - Adverse economic circumstances reduced data collection quality (e.g., price collectors paying for transport). - 1993 weights are outdated; possibly updatable using the 2002 household budget survey. - CSO needs to document procedures and methods for CPI compilation. - Monetary and financial statistics - CBI staff numbers sufficient but need training on Monetary and Financial Statistics Manual (MFSM) methods. - Computer availability is far from satisfactory. - Monetary survey excludes banking activity data from the northern region (Kurdistan). - Monetary survey presents government claims and liabilities but lacks sufficiently detailed breakdown of financial instruments by resident economic sectors. - Need clarifications for classification of economic units in government sector and public nonfinancial corporations subsector. - CBI valuation and accounting practices: - Monetary gold valued at historic cost or market price, whichever is lower. - Loan values adjusted for expected losses from anticipated defaults; these values exclude accrued interest (accrued interest included in capital account). - End-of-month foreign currency assets and liabilities valued using various exchange rates. - No cross-checking between monetary data and matching balance of payments information. - Balance of payments statistics - Time series available from 1988 to 2002 presented according to BPM4 format, but with deviations in definitions, coverage, classification, valuation, and sectorization. - For 1990 and 2002, BPM5-format presentation available but limited and with same deviations. - Major coverage issue: balance of payments statistics do not include the northern region (Kurdistan). - Residency criteria application by CBI unclear, potentially affecting coverage. - Nonbank sources unreliable due to collection method shortages. - CBI relies on Banking Sector reporting to capture services, income, and Capital and Financial account transactions; Financial Account transactions from nonbank sources are on a cash rather than accrual basis. - Government transactions in Balance of Payments Division are recorded on an accrual basis using administrative records. - Most goods and services components recorded gross; transfers and most Financial Account transactions are net. Financial account recorded on a net basis with no component breakdown. - Data collection not comprehensive; major deficiencies in service transactions, income transactions, transfers, capital, and financial accounts. - No breakdowns available for foreign direct investment, portfolio investment, and other investment (e.g., trade credits). - Almost no services account data except travel, and freight and insurance components of imports. - Balance of Payments Division does not record transactions of NGOs, foreign embassies, and international organizations. - Data compilation procedures error prone: trade and bank reporting data received in hard copy; no procedures manual; large data adjustments and transformations. - Trade statistics adjustments: classification and coverage adjustments to include smuggled, bartered, and free trade; imports converted from c.i.f. to f.o.b. using a constant factor. - No consistency between external trade data from CSO and data compiled by CBI; Balance of Payments Division receives CBI’s and commercial banks’ transactions directly from internal departments. - External trade statistics - Insufficient staff in CSO section compiling external trade data. - Data entry software out-of-date; only one, out-of-date computer available. - Staff main tasks: checking customs declaration forms and keypunching into computer files. - Customs declaration forms outdated, often unreadable and missing important information. - Coverage excludes the northern region (Kurdistan). - Customs Department often classifies items by customs duties, complicating CSO reclassification and increasing margin of error. - Foreign trade data are monthly but timeliness is poor; releases can take up to one year. - No legal requirements on timeliness of source data. - No consistency between CSO external trade data and CBI-compiled data; CBI Balance of Payments Division uses CSO data only to a limited extent. - Government finance - Iraq does not report government finance statistics for publication in the Government Finance Statistics (GFS) Yearbook or International Financial Statistics (IFS). - STA has not been able to properly assess fiscal data quality due to lack of appropriate counterparts. ### IMF Executive Board Press Release — Emergency Post-Conflict Assistance (EPCA) approval (Press Release No. 04/206, September 29, 2004) - Approval: - Executive Board approved SDR 297.1 million (about US$436.3 million) in Emergency Post-Conflict Assistance to Iraq. - Amounts provided under the EPCA to Iraq represent 25 percent of its current quota. - Iraq’s IMF financial status and quota: - Iraq settled overdue financial obligations to the IMF totalling SDR 55.3 million (about US$81 million) on September 22, 2004 and is now current on IMF financial obligations. - Iraq paid its quota increase under the Eleventh General Review of Quotas: current quota SDR 1.19 billion (about US$1.75 billion), up from SDR 504 million (about US$740.1 million). - EPCA objectives and IMF role: - EPCA designed to promote strengthening of administrative and institutional capacity necessary to sustain economic recovery and catalyze additional international support, including debt relief. - IMF providing extensive technical assistance and training in tax policy, budget preparation and execution, central banking, creation of a treasury bill market, and statistics. - IMF statements (Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair): - EPCA intended to help stabilize the economy, lay groundwork for reform program, and begin restoring external debt sustainability. - Program underpinned by prudent fiscal policy limiting spending to available government revenues and external resources, use of exchange rate to anchor inflationary expectations, and implementation of key structural reforms to transform Iraq into a market economy. - Authorities’ achievements noted: degree of macroeconomic stability, commitment to reform, and plans to use windfall oil revenues for reconstruction investment and/or budgetary needs in 2006 and beyond. - Monetary policy: authorities succeeded in managing monetary policy consistent with price stability but should remain vigilant and develop a wider menu of liquidity-managing instruments. - Structural reform priorities: rebuilding administrative capacity, improving program monitoring, tax reform, financial sector reform, restructuring state-owned enterprises, enhancing governance and transparency of the oil sector. - Risks: program implementation risks, external developments such as lower oil prices, hazardous security situation, and unsustainable external debt. - Bilateral creditors’ assurances: bulk of Iraq’s official bilateral creditors reaffirmed recognition of IMF preferred creditor status for EPCA drawings and indicated willingness to make best efforts to provide debt relief to ensure timely repayment to the Fund; confirmed a deferral will be in place for obligations of Iraq falling due to them during the EPCA-supported economic program period. ### Statement by A. Shakour Shaalan, Executive Director for Iraq (September 29, 2004) — Key points - Recent developments and context - Long-term decline in living standards: per-capita income declined from over $3000 in the early 1980s to $500 in 2003. - Since early 2003: oil production resumed, functioning payment system established, new bank notes introduced, trade regime reformed, new tax law introduced, new banking sector legislations approved. - Recovery prospects: increase in oil production likely to lead to a sharp rebound in overall activity in 2004; inflation kept under control; stable exchange rate; increase in base money indicates improving confidence despite security concerns. - Treasury-bill market: first treasury-bill auction completed and held bi-weekly since July 2004. - Security situation: ongoing daily attacks complicate reforms and increased oil production but authorities remain committed. - Emergency Post-Conflict Assistance (EPCA) — authorities’ view - EPCA critical to build on reforms, catalyze additional international support including debt relief, and pave the way for meaningful reconstruction and rehabilitation. - Authorities taking steps to clear arrears with the World Bank and the Arab Monetary Fund. - Authorities intend to adhere to the staff-agreed program to build a track record to move to an upper credit tranche stand-by arrangement in 2005. - Economic program objectives - Maintain stable macroeconomic environment while implementing comprehensive structural reform agenda to transform Iraq into a market-based economy with larger private sector role. - Main macro targets: enhance growth performance, keep inflation under control, maintain sound fiscal policy. - Fiscal policy — targets and measures - Primary fiscal deficit projections: - Projected to decline to around 42 percent of GDP in 2004 and 27 percent in 2005. - Financing sources anticipated: United Nations oil-for-food program resources, assets held in the Development Fund for Iraq, and donors’ project financing. - Commitment not to borrow directly from the central bank in accordance with the new central bank law. - 2005 budget aims: - Reduce recurrent spending from 107 percent of GDP (2004) to 88 percent of GDP (2005). - Achieve by limiting wage and pension increases to 11 percent and decreasing outlays on goods, services, and transfers. - Oil-related spending directed at rehabilitating oil production in line with projections. - Fuel subsidy reform: - Authorities intend to begin reducing price subsidy on domestic consumption of oil derivatives by end 2004 with a view to full elimination by 2009; approach deliberate and gradual given high social sensitivity. - Revenue-side reforms: - Simplified tax regime in place including a 5 percent reconstruction levy. - Revised personal and corporate income tax with a maximum marginal tax rate of 15 percent and higher personal income allowances introducing progressivity. - Plans to broaden tax base starting in 2005. - Reform of tax and customs administration to be undertaken. - General sales tax likely to be introduced in 2006. - Longer-term fiscal sustainability requires curtailing government role: reduce wage and pension bill, reform state-owned enterprises, and replace food ration system with a cash-based distribution system better targeted to the needy. - Monetary and exchange rate policy - Introduction of a new currency and new central bank law endowing CBI with independence and accountability as key to prudent monetary policy aimed at price stability. - Exchange rate system still under consideration; exchange rate used to anchor inflationary expectations and has been effective in maintaining stability. - Central bank reforms underway: - Introduction of lender of last resort and overnight standing credit/deposit facilities to manage liquidity. - Work to implement regulations on loan classification, capital requirements, and risk management. - Need for restructuring state banks to improve efficiency and governance given their dominance. - Structural reforms and capacity building - Plans to improve governance in the oil sector, review financial operation, and prepare a restructuring plan including recommendations of the International Advisory and Monitoring Board regarding monitoring and control systems. - Authorities emphasize importance of continued technical assistance and training from donors and the Fund in statistical, fiscal, monetary, and financial areas. - Need for continuity and follow-up training to ensure initial TA is disseminated and implemented across ministries and departments. - Authorities look forward to continued training and assistance including through the Middle East Technical Assistance Center. *Source: IMF staff report and accompanying Press Release No. 04/206 and statement dated September 29, 2004.* ### Conclusion ### Conclusion ### Overview - In spite of all the progress made over the past year in reforming the economy and the ongoing economic rebound, the authorities are very well aware of the difficult situation Iraq finds itself in and the many obstacles and risks facing them. - They also recognize that in addition to the wide ranging fiscal, monetary, and financial sector reforms planned for the period ahead, placing the economy on the path of sustainable recovery requires the implementation of a far reaching reform agenda to enhance the role of the private sector in Iraq which has been suppressed for many years. ### Reform agenda and priorities - Preparation of a national development strategy is nearing completion; it entails plans to: - rehabilitate the oil sector, - diversify the economy, - improve social conditions, - undertake regional development. - Emphasis on wide ranging fiscal, monetary, and financial sector reforms planned for the period ahead. - Emphasis on a far reaching reform agenda to enhance the role of the private sector. ### Outlook and confidence - The authorities are confident that with the generous support of the international community, their commitment to political, economic, and social reform, and the Iraqi people’s well known resilience, entrepreneurship, and human capital endowment, peace and prosperity will return to Iraq. *Source: _cr04325 - Conclusion* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04325.pdf_