## _cr05294 ## Source details **Canonical URL:** [_cr05294](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05294.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05294.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05294.pdf.json) --- ### Executive summary — context, data, and political environment - First Article IV Consultation with Iraq in 25 years; last Article IV Consultation was in 1979. - EPCA purchase approved on September 29, 2004: SDR 297.1 million (25 percent of quota). - Authorities hope to enter into a stand-by arrangement later in 2005. - Statistical information judged "just adequate for surveillance": - Oil sector comprises three quarters of GDP. - Inflation data incomplete (does not cover the Kurdish region). - Monetary data available only for CBI balance sheet; CBI balance sheet not yet prepared in line with internationally accepted accounting standards or audited in line with International Standards on Auditing (ISA). - Fiscal monitoring suffers from long reporting lags and coverage gaps (DFI, OFFP letters of credit, donor-financed spending, government balances in the banking system). - IAMB established October 21, 2003; membership expanded June 2004; May 2005 IAMB noted major weaknesses in DFI administration and oil operations. - Political timeline and milestones (selected): - TNA elections: January 30, 2005. - TNA elected leadership including Jalal Talabani as President: April 4, 2005. - New government sworn in: May 3, 2005. - Constitution committee expected to finalize by August 15, 2005; referendum by October 15, 2005; elections by December 31, 2005 if ratified. - Security and social environment: - Security costs for reconstruction estimated in the range of 30–50 percent of total costs. - UNDP Human Development Index fell from 50th (1990) to 126th (just over a decade later). - Selected MDG indicators (UNDP Iraq Living Conditions Survey 2004): - About 7 percent of households considered poor (subjective measures). - About 96 percent of households receive monthly food rations. - 23 percent of children aged between six months and five years suffer chronic malnutrition; 12 percent general malnutrition; 8 percent acute malnutrition. - Net primary school enrollment: 79 percent. - Youth (15–24 years) literacy: 74 percent; adult literacy: 65 percent. - Under five years mortality: 115 per 1,000 live births; infant mortality: 102 per 1,000 live births. - Maternal mortality: 193 per 100,000 births. - Reported incidence of tuberculosis: 132 per 100,000 people. - Unemployment estimates (different sources): UNDP (ILO methodology) about 10.5 percent overall; Ministry of Planning 28 percent; CPA 30 percent; Brookings Institution 30–45 percent; Baghdad University 70 percent. - Public services: 98 percent of households connected to electricity grid (three-quarters report supply extremely unreliable); 78 percent have piped water; 37 percent connected to sewage system. ### Macroeconomic developments and program performance - GDP and oil sector: - GDP rebounded by nearly 50 percent in 2004, driven mainly by oil sector recovery. - Oil production expanded by 74 percent from 1.2 mbpd in 2003 to 2.0 mbpd in 2004 (pre-war production level 2.5 mbpd; slightly below EPCA projections). - Non-oil GDP expanded more moderately in 2004. - Inflation and prices: - Consumer price inflation year to December 2004: 31.7 percent (projected 7 percent under EPCA). - Price dynamics: - First half of 2004: prices broadly stable. - August 2004 onward: inflation picked up sharply. - Cumulative increase first five months of 2005: 4.7 percent. - Year-on-year inflation in May 2005: 33.9 percent. - EPCA objective for end-2005: 15 percent. - Fiscal outcomes and oil revenues: - Fiscal deficit for 2004 slightly larger than envisaged under EPCA. - Oil export prices in 2004 averaged $31.6 per barrel (EPCA assumption $30.5). - Oil export volumes in 2004 close to target, yielding an additional ID1 trillion in oil export revenues relative to ID25.3 trillion assumed in the program. - Wage and pension outlays slightly lower than budgeted; spending on goods and services higher than budget. - Investment and reconstruction financing: - Donor contributions to IRFFI: about US$1 billion deposited. - Disbursements in 2004 from IRFFI projects: about $103 million. - U.S. bilateral spending in 2004: reportedly about $2.2 billion (only two-thirds estimated spent in domestic economy; up to one-half on security). - 2005 budget assumptions and oil market performance: - Budget oil price assumption: $26 per barrel. - Oil exports projected to increase from 1.4 mbpd in 2004 to 1.8 mbpd in 2005. - Assumed start of reduction in domestic petroleum subsidy by beginning of 2005. - Oil export performance first five months of 2005: - Volumes average 1.4 mbpd. - Average export prices $36.4 per barrel. - Differential relative to WEO benchmark: increased from $6.4 per barrel average in 2004 to $13.4 per barrel in Q1 2005, then narrowed to $8.6 per barrel in April–May 2005. ### Petroleum subsidies — fiscal impact and valuation (Box 2 summary) - Government imports of petroleum products in 2004: $3.2 billion. - Resulting fiscal loss from subsidized domestic sales: nearly $8 billion (or some 30 percent of 2004 GDP). - Domestic petroleum product sales valued (volumes as of 2004, prices as of June 2005): - Daily production (millions of liters/cylinders): LPG 0.3; Regular gasoline 8.0; Kerosene 5.3; Diesel 9.7. - Daily imports (millions of liters/cylinders): Premium gasoline 11.0; Kerosene 3.1; Diesel 8.2. - Daily consumption (millions of liters/cylinders): LPG 0.3; Regular 8.0; Premium 11.0; Kerosene 8.4; Diesel 17.9. - Official price (ID per liter/cylinder): Regular 250; Premium 20; Kerosene 50; Diesel 5; Total 10. - Official price (US cents per liter/cylinder) 3/: Regular 16.7; Premium 1.3; Kerosene 3.3; Diesel 0.3; Total 0.7. - Price on international markets (US cents per liter/cylinder): LPG 420; Regular 42.7; Premium 48.1; Kerosene 44.3; Diesel 45.7. - Ratio of Iraq price to international price (percent): LPG 4.0; Regular 3.0; Premium 6.9; Kerosene 0.7; Diesel 1.5. - Annual sales at official prices (millions of US$): LPG 20; Regular 39; Premium 134; Kerosene 10; Diesel 44; Total 247. - Annual sales valued at international prices (billions of US$): LPG 0.5; Regular 1.2; Premium 1.9; Kerosene 1.4; Diesel 3.0; Total 8.0. - Difference between total sales valued at official and international prices (billions of US$): LPG 0.5; Regular 1.2; Premium 1.8; Kerosene 1.3; Diesel 2.9; Total 7.8. - Note: 3/ Using an exchange rate of ID1500/dollar. ### Monetary policy, liquidity management, and reserves - Reserve money growth in 2004: 117 percent (in line with EPCA projection). - Currency in circulation growth in 2004: 75 percent (EPCA projection: 118 percent). - CBI instruments and measures: - March 14, 2005: separate dinar and dollar overnight deposit facilities introduced paying 4 percent and 2 percent per annum, respectively. - As of end-May 2005: banks deposited ID1.7 trillion in the dinar facility and $540 million in the dollar facility. - Reserve money growth slowed to 6 percent in Q1 2005. - April 1, 2005: CBI reintroduced coverage of required reserves to include government deposits. - Rate on dollar facility increased to 2.5 percent on June 1, 2005; dinar overnight facility raised to 5 percent on July 3, 2005; new 14 day and 30 day deposit facilities at 6 and 7 percent respectively. - Treasury bill auctions: - Interest rates averaged 4 percent in 2004; rates rose to 7 percent by mid-June 2005; later auction interest rate rose to 9.9 percent (July 4 auction). - Exchange rate and foreign exchange operations: - Dinar de facto pegged to the U.S. dollar since May 2004. - Dollar sales at daily CBI auctions: about $25 million per day during 2004 and early 2005; increased to about $50 million a day from mid-April 2005. - CBI on some occasions rationed supply of dollars at auction. - External reserves: - External reserves held by CBI at end-2004: $7.4 billion (net), above EPCA target of $4 billion. - Reserves increased to $7.7 billion in March 2005 and estimated to have stayed around this level through end-May 2005; supplementary information notes external reserves increased to $8.8 billion in May 2005. ### Fiscal management, fragmentation, and budget execution - Budgetary management in 2004: - Ministry of Finance began receiving reports on budget outturns, reporting lag still more than three months. - Fiscal monitoring suffered from multiplicity of DFI subaccounts, limited donor reporting, and off-budget reallocations toward security in late 2004. - From 2005 authorities committed to approve additional spending only in context of a supplementary budget. - Modern Financial Management Law adopted in 2004; implementing regulations still needed. - Fragmentation of fiscal accounts (components): - Official budget for 18 governorates; Northern governorates allocate spending autonomously. - DFI receives frozen assets, OFFP balances, and 95 percent of oil export sales (5 percent for war reparations to Kuwait). - U.S. responsible for spending from two DFI subaccounts ("vested" and "transaction") and seized cash assets. - OFFP letters of credit fully financed by past oil export proceeds sequestered at BNP. - Donor-financed expenditures often paid abroad or directly to suppliers; donor coordination weak. - Oil-related SOE operations not included in budget. ### Banking sector structure, weaknesses, and reform - Banking system composition: - CBI and 26 chartered banking institutions. - Two state-owned commercial banks (Rafidain and Rasheed) account for over 90 percent of commercial banking assets and 75 percent of branch network; heavily overstaffed, weak skills. - Four specialized state-owned banks for agriculture, industry, real estate, social sectors. - 19 private commercial banks. - Trade bank established after the war to provide U.S. dollar letters of credit. - System size and capitalization: - Aggregate assets around $2 billion (about 7 percent of GDP); undercapitalized. - Most bank assets are treasury bills; loan portfolios very small; staff lack expertise. - Payment system: - Outdated technical infrastructure; cannot process payments electronically; rudimentary check clearing; checks in Baghdad could take up to 10 days to clear, outside Baghdad up to a month. - CBI modernizing payment infrastructure; a detailed plan for RTGS and ACH by early 2006 has been developed. - Supervision and legal framework: - On-site and off-site supervision (security permitting). - Prudential regulations in process of revision. - Modern central bank, commercial bank, and AML laws adopted in 2004; implementing regulations being finalized. - Bank sector reform proposals: - Restructure Trade Bank of Iraq; invite foreign participation in Rafidain and Rasheed; amalgamate four smaller specialized banks into two regional development banks; set up Islamic banks. - Authorities keen on deposit insurance scheme but will proceed cautiously; modalities under discussion. ### External debt, Paris Club agreement, and debt sustainability - Paris Club agreement (November 21, 2004): total 80 percent NPV debt reduction in three stages: - First stage: 30 percent debt reduction and interest deferral; effective upon signing. - Second stage: further 30 percent reduction triggered by approval of an upper credit tranche arrangement (expected by end-2005). - Final stage: additional 20 percent reduction following IMF Executive Board final review of three years of upper credit tranche arrangement(s). - Post-first stage debt stock: estimated about $78 billion (reduced from $114 billion pre-Paris Club), roughly three times GDP. - Without additional stages debt would remain unsustainable; with second and third stages debt would decline significantly (Table figures provided). - Engagement with creditors: - Vast majority of Paris Club claims reconciled. - Proportion of non-Paris Club official debt reconciled still small; negotiations with Gulf creditors separate. - Private creditors: about $10 billion of claims submitted for consideration as of May 4, 2005 Dubai meeting. - Only bilateral agreement signed so far: United States (November 2004) granting 100 percent debt cancellation; further Paris Club members close to signing; progress with some non-Paris Club creditors. ### Medium-term prospects, scenarios, and vulnerabilities - Scenario assumptions: - Oil production expansion proceeds without undue interruption and world oil prices remain favorable. - Reconstruction undertaken relatively smoothly; security progressively restored; political transition goes forward as planned. - Considerable downside risks acknowledged: oil price uncertainty, continuation of insurgency, political transformation. - Growth and production projections: - Overall GDP growth: 17 percent in 2006, declining to 7 percent by 2010. - Oil production projected: 2.4 mbpd in 2006 and 3.5 mbpd by 2010. - Non-oil real GDP growth projected strong, sustained by high (mostly public) investment. - Inflation expected to fall to single digits over medium term. - Fiscal outlook: - Financing gaps for 2005 and 2006; largely disappear thereafter under scenario. - Scenario assumes existing subsidy of domestic petroleum prices is maintained (not a policy recommendation). - EPCA envisaged phased elimination of subsidy over five years ending 2009 — illustrative revenues would have been $1 billion higher in 2005 and $3.5 billion higher in 2006 under that plan. - Oil price treatment in projections: - Iraqi oil prices based on WEO projections, adjusted downward by $7 per barrel on average for transportation and quality, and by additional $4.5 per barrel to account for uncertainty (footnote: $4.5 equals one standard deviation in monthly oil price variation over past 20 years). - Stress-test scenarios: - Production shock: limits oil production to 3.0 mbpd in 2008–10. - Price shock: lowers oil export price by $4.5 per barrel in 2006–10. - Outcomes: liquidity needs increase substantially under shocks; debt stock becomes more unsustainable without further debt relief. ### Staff appraisal — findings and policy recommendations - Commendations and risks: - Staff commends authorities for achieving macroeconomic stability and initiating reforms despite difficult circumstances. - Warns of risks from spending pressures, revenue shortfalls, or adverse monetary developments. - Fiscal policy and public financial management priorities: - Prioritize resources; contain recurrent spending (wages, pensions, transfers, non-essential projects). - Continue "no overdraft" rule; aim at 2005 spending financed within available resources (expected oil revenues, domestic revenues, liquid funds abroad, external grants); avoid accumulation of arrears. - Fully account for operations of the DFI and publish DFI accounts monthly. - Ensure FMIS addresses needs in line with GFSM-compliant chart of accounts; adopt implementing regulations for Financial Management Law; establish roster of government employees and automated payroll. - Strengthen debt management. - Petroleum subsidy reform: - Urged to quickly reduce government subsidies for petroleum products to alleviate market distortions and generate budget resources; critical to help close emerging financing gap. - Monetary and exchange rate policy advice: - Continue to support exchange rate peg to the dollar. - Fully satisfy dollar demand at auction cut-off rate; avoid administrative screening/rationing that could constitute exchange restrictions. - Raise dinar interest rates to bolster defense of the exchange rate; drain liquidity via dinar deposit facility if reluctant to use dollars. - Financial sector and governance: - Push ahead with reform program: restructure state banks and SOEs; prepare oil sector restructuring and fiscal framework review; implement IAMB recommendations (oil metering, strengthen internal controls and audits). - Modernize prudential regulations and supervisory framework; implement CBI audit per ISA. - Debt treatment and creditor engagement: - Urged to secure comparable terms from non-Paris Club and private creditors; act in "good faith" and comply with Fund’s lending into arrears policy if entering a SBA. - Stand-by arrangement objective: - Authorities desire a stand-by arrangement by end-2005; progression to an SBA would underpin macro framework and facilitate sustainable external debt resolution under Paris Club terms. - Technical assistance and capacity building: - Fund staff, with World Bank and bilateral donors, provided advice and TA on fiscal federalism, oil sector tax regimes, budget classification, public expenditure management, banking supervision, payment systems, macro statistics, and macroeconomic policy training. ### Quantitative highlights and selected exact figures (tables and indicators) - GDP and prices: - Nominal GDP (millions of US$): 21,132 25,539 24,295 29,341 39,003 45,203 51,389 55,318 60,306 - Real GDP (percent change): 51.7 46.5 16.7 3.7 16.8 13.6 12.5 7.8 7.2 - Oil production (mbpd): 2.1 2.0 2.4 2.0 2.4 2.8 3.1 3.3 3.5 - Iraq oil export prices (US$/bbl): 30.4 31.6 26.0 36.0 40.5 39.8 38.8 38.5 38.5 - Domestic consumer price inflation (year-on-year): 7.0 32.0 15.0 20.0 12.0 10.0 8.0 7.0 5.0 - Fiscal and oil sector levels (In billions of ID): - Revenues and Grants: 28,730 30,018 35,618 38,585 56,484 65,661 73,491 78,696 86,381 - Crude oil export revenues: 24,300 25,326 25,670 27,614 43,783 55,299 66,306 73,691 80,717 - Expenditures: 42,324 45,244 45,707 50,782 59,220 66,122 74,559 80,459 88,419 - Balance (including grants): -13,595 -15,225 -10,089 -12,197 -2,736 -461 -1,068 -1,763 -2,038 - Monetary and external sector (selected): - Base money (In billions of ID): 5,638 12,228 12,235 12,904 14,064 12,922 12,070 13,765 16,252 - Gross foreign exchange assets (millions of US$): 1,134 7,902 5,691 8,882 9,421 8,239 8,356 9,602 8,353 - Central bank reserves (In US$ million): 5,691 7,902 8,289 9,602 10,995 12,045 13,218 14,445 15,573 - External debt (selected table figures): - Total debt before debt reduction (2004): 113.6 (In billions of US$) - Total debt after debt reduction (2004): 78.2 - Total debt (2005): 82.1; (2006): 86.3; (2007): 90.8; (2008): 95.2; (2009): 99.4; (2010): 102.6 - With second and third stage of debt reduction — Total debt (2005): 51.1; (2006): 53.5; (2007): 56.3; (2010): 34.1 - Quantitative EPCA indicators (selected exact values): - Reserve money growth in 2004: 117 percent (Act 116.9 percent). - Currency issued growth in 2004: 118.4 percent (Act 74.9 percent). - Net international reserves of central bank (floor) targets: 4,000 (12/31/04 Indic.); Actual 7,358 (12/31/04). - Government primary fiscal deficit (ceiling, in millions of US$): 10,175 (12/31/04 Actual). - Lending to government by CBI (ceiling, ID billions): 3,986 (06/30/04 stock). - Selected social indicators (Table 1 excerpt): - Life expectancy at birth (years): 61 69 69 - Infant mortality (per 1,000 live births): 102 37 30 - Literacy (percent of population age +15): 65 35 13 - Gross primary enrollment (percent): 99 95 111 ### Structural benchmarks, TA, and statistical capacity - Structural indicative benchmarks (selected): - Development of a monetary survey. Target: Mar-05. Status: Preparatory work ongoing. - Automatic payroll system for all government employees. Target: Jun-05. Status: Pending. - Monthly fiscal accounts for central government and oil sector. Target: Dec-04. Status: Data being generated with long lags. - Issuance of regulations regarding bank licensing and standard prudential ratios. Target: Dec-04. Status: Pending. - Enactment of payments systems law. Target: Dec-04. Status: Draft law being prepared. - Adoption of a plan to overhaul tax and customs administration. Target: Jun-05. Status: Tax policy unit to be established. - Technical assistance (selected departments and activities; dates provided in source): - FAD, LEG, MFD, STA, INS provided multiple missions and workshops on public expenditure management, tax policy, banking supervision, payments and settlement systems, national accounts, CPI, balance of payments, and GDDS metadata development. - Statistical issues and deficiencies: - National accounts based on 1968 SNA; gaps in coverage (excludes Kurdistan, informal sector), outdated classifications, shortage of quarterly/monthly indicators. - CPI weights outdated (1993); household budget survey planned for 2005/2006. - Monetary statistics exclude northern region; reporting forms provided; preliminary monetary survey work ongoing. - Balance of payments improvements underway (BPM5 adoption for 2002–2004) but data quality issues persist. - Government finance statistics not reported for GFSY or IFS; GFS unit creation recommended. ### Executive Board assessment and concluding priorities - Directors commended authorities for macro stability efforts and reforms amid extreme difficulties. - Emphasized priorities: - Contain recurrent spending; prioritize reconstruction needs; avoid accumulation of arrears. - Rapidly reduce petroleum subsidies where feasible, with careful communication and social impact measures. - Strengthen governance, transparency, and audit (including international audit of CBI and DFI operations). - Improve statistical framework, especially fiscal data, for program monitoring. - Continue EPCA-supported program implementation and prepare for a possible stand-by arrangement by end-2005. - Directors recommended continuation of exchange rate peg as monetary anchor and urged use of market-based monetary instruments (raise dinar interest rates, satisfy dollar demand at auctions, avoid administrative rationing). *Source: _cr05294 — IMF staff report for the 2005 Article IV Consultation and Executive Board assessment.* ### Executive Summary ...................................................................................................... ### EXECUTIVE SUMMARY ### Key context and program engagement - This report is for the first Article IV Consultation with Iraq in 25 years. The last Article IV Consultation was in 1979. The Board last met to discuss Iraq on September 29, 2004 for the approval of Emergency Post Conflict Assistance (EPCA) in support of Iraq’s economic program for 2004 and 2005. - On September 29, 2004, the Executive Board approved a request by the Government of Iraq for a purchase in an amount equivalent to SDR 297.1 million (25 percent of quota) under the Fund’s policy on Emergency Post Conflict Assistance (EPCA). - The authorities hope to enter into a stand-by arrangement later in 2005. ### Data and institutional capacity - The statistical information provided by Iraq is "just adequate for surveillance": - Sufficient data on the oil sector (which comprises three quarters of GDP). - Very little information on non-oil economic activity. - Inflation data is timely, but incomplete in geographical coverage (does not cover the Kurdish region). - Monetary data currently available only for the Central Bank of Iraq (CBI) balance sheet; the CBI balance sheet has not yet been prepared in line with internationally accepted accounting standards or audited in line with International Standards on Auditing (ISA). - Fiscal data availability is subject to significant lags; fiscal monitoring suffers from long reporting lags and coverage gaps (transactions and balances of the Development Fund for Iraq (DFI), expenditure financed by letters of credit under the UN oil-for-food program (OFFP), donor-financed spending, government balances in the banking system). - The International Advisory and Monitoring Board (IAMB) was established on October 21, 2003, membership expanded in June 2004 to include a member designated by the Government of Iraq; in its May 2005 review the IAMB noted evidence of major weaknesses in the administration of DFI resources and oil operations. ### Political, security, and social environment - Political timeline and milestones: - Parliamentary elections for the Transitional National Assembly (TNA) held on January 30, 2005. - TNA elected leadership, including Jalal Talabani as Iraq’s President, on April 4, 2005. - Presidential Council nominated Ibrahim al–Jaafari as Prime Minister on April 7, 2005; subsequently ratified by the TNA. - TNA approved the cabinet submitted by the prime minister on April 28, 2005. - The new government was sworn in on May 3, 2005. - A TNA committee (55 members) is drafting a permanent constitution expected to be finalized and approved by August 15, 2005, submitted to public referendum by October 15, 2005; if approved, elections under the constitution should be held by December 31, 2005. - Persistent violence and insecurity: - Violence continues to hamper economic and social recovery; attacks on Iraqi civilians and security and police forces have escalated. - Security and insurance outlays for reconstruction estimated in the range of 30–50 percent of total costs. - Violence has deterred trade and investment flows (for example, none of the foreign banks granted licenses in 2003 had started operations in Iraq to date). - Human development and public services: - UNDP Human Development Index rank fell from 50th in 1990 to 126th just over a decade later. - Box 1 — Selected Millennium Development Goals indicators (UNDP Iraq Living Conditions Survey 2004 and ministry of planning and development): - Goal 1 (poverty and nutrition): about 7 percent of households are considered poor (subjective measures); about 96 percent of households receive monthly food rations; 23 percent of children aged between six months and five years suffer from chronic malnutrition, 12 percent suffer from general malnutrition, and 8 percent suffer from acute malnutrition. - Goal 2 (education): Net primary school enrollment in Iraq is 79 percent; 22 percent of the adult population have never attended school and 15 percent have not completed primary school; youth (15–24 years) literacy rate is 74 percent; adult literacy rate is 65 percent. - Goal 3 (gender equality): 40 percent of girls in rural areas are not enrolled in primary education compared to 20 percent in urban areas; women aged 25–34 years who have not completed elementary school is 36 percent; ratio of literate females to males is 50 percent. - Goal 4 (child mortality): under five years mortality is estimated at 115; infant mortality is currently estimated at 102 per 1,000 live births. - Goal 5 (maternal health): maternal mortality is 193 per 100,000 births; 58 percent of women not receiving any health checks in the 40 days following delivery. - Goal 6 (diseases): reported incidence of tuberculosis at 132 per 100,000 people. - Goal 7 (environment): major risks include lack of appropriate sanitary landfills, open burning of solid waste, lack of working sewage infrastructure, oil fires, and excessive car emissions. - Unemployment estimates (different sources): - UNDP survey (ILO methodology): about 10.5 percent overall unemployment; estimated 37 percent unemployment among the educated young (including discouraged workers). - Ministry of planning estimate: 28 percent. - Coalition Provisional Authority (CPA): 30 percent. - Brookings Institution: 30–45 percent. - Baghdad University: 70 percent. - Public services coverage and reliability: - 98 percent of households connected to the electricity grid, but three-quarters report electricity supply is extremely unreliable. - 78 percent of homes have access to piped water. - 37 percent of all homes are connected to the sewage system; two-thirds of households report poor reliability in provision of safe water and sewage services. ### Recent macroeconomic developments and program performance - Implementation of the EPCA program has been slow due to the ongoing insurgency and slow reconstruction, but authorities have achieved a degree of macroeconomic stability and initiated reforms. - Exchange rate and reserves: - The exchange rate has been de facto pegged to the US dollar since May 2004. - Reserves ended the year well above the floor specified in the EPCA program. - The exchange rate has come under some pressure in recent months; authorities have on a few occasions rationed the supply of dollars. - Fund staff urged the authorities to satisfy the demand for dollars in full (in view of the comfortable level of reserves) and to raise interest rates as needed; authorities have been advised to avoid the use of restrictions. - Fiscal performance: - The fiscal deficit for 2004 was only slightly higher than projected in the EPCA program. - A large ex ante fiscal financing gap is emerging for 2005 and 2006, reflecting additional spending pressures and the delay in implementing the reduction on domestic oil product price subsidies. - Staff urged the authorities to take action to significantly reduce domestic petroleum subsidies to raise revenue, and to ensure that spending is kept under control to avoid accumulation of payments arrears. ### External debt and creditors - The authorities understand the need to ensure that all of Iraq’s external debt should be resolved in a manner comparable and consistent with the Paris Club agreement of November 2004. - Progress reported: - Authorities have made progress reconciling external claims with Paris Club creditors. - Progress with non-Paris Club creditors has been relatively slow. - Authorities understand the need to engage private creditors in good faith should Iraq enter into a stand-by arrangement in line with the Fund’s lending into arrears policy. ### Policy guidance and technical assistance - Fund staff recommendations and priorities: - Continue following the EPCA program to build on the track record of policy implementation. - Improve flow of timely and reliable data. - Audit the central bank according to International Standards on Auditing (ISA). - Implement a plan to significantly reduce the very substantial domestic petroleum product subsidy. - Make monetary policy more adaptable by widening the menu of instruments for managing liquidity conditions. - Focus structural reform efforts on tax administration, payments and settlements systems, state-owned enterprise restructuring, and governance and transparency of the oil sector. - Technical assistance: Fund staff, in coordination with the World Bank and bilateral donors, has provided advice on fiscal federalism issues, tax regimes for the oil sector, budget classification, public expenditure management, banking supervision, payment systems, macroeconomic statistics, and macroeconomic policy training (see Appendix I). *Source: _cr05294 - Executive Summary* ### 14. Gross domestic product (GDP) is estimated to have rebounded by nearly ### _cr05294 - 14. Gross domestic product (GDP) is estimated to have rebounded by nearly ### Economic activity and GDP - Gross domestic product (GDP) is estimated to have rebounded by nearly 50 percent in 2004, driven mainly by the recovery of the oil sector. - Oil production expanded by 74 percent from 1.2 million barrels per day (mbpd) on average in 2003 to 2.0 mbpd in 2004 (although this is still below the pre-war production level of 2.5 mbpd and slightly below EPCA program projections). - Non-oil GDP is estimated to have expanded more moderately in 2004 due to lack of security, electricity shortages, and poor communications. - Some state-owned enterprises (mainly in construction and petro-chemicals) have reactivated production. ### Inflation and domestic prices - Consumer price inflation in the year to December 2004 reached 31.7 percent, compared with a projected 7 percent under the EPCA program. - Price dynamics in 2004–2005: - First half of 2004: prices broadly stable. - August 2004 onward: inflation picked up sharply and remained high for the remainder of the year. - Cumulative increase for the first five months of 2005: 4.7 percent. - Year-on-year inflation in May 2005: 33.9 percent. - EPCA program objective: 15 percent for end 2005. - Surge in prices primarily related to supply shortages of gasoline and food due to intensification of violence in the run up to the elections in January, 2005. ### Fiscal outcomes and oil revenues - Fiscal deficit for 2004 was slightly larger than envisaged under the EPCA program. - Oil export prices averaged $31.6 per barrel in 2004, compared to $30.5 per barrel assumed under the EPCA program. - Oil export volumes in 2004 were close to target, resulting in an additional ID1 trillion in oil export revenues in 2004 relative to the amount of ID25.3 trillion assumed in the program. - Wage and pension outlays were slightly lower than budgeted for 2004; spending on goods and services was higher than the budget (partly due to contractual commitments by the Coalition Provisional Authority (CPA) prior to its dissolution and not included in the budget). ### Investment and reconstruction financing - Overall investment was in line with the budget, but grant-financed (non-oil) reconstruction expenditure in 2004 fell short. - Donor contributions to IRFFI: about US$1 billion deposited into the facility; most committed to reconstruction projects. - Disbursements in 2004 from IRFFI projects: about $103 million actually disbursed in the launch year. - U.S. bilateral spending in 2004: reportedly about $2.2 billion, with only two-thirds estimated to have been spent in the domestic economy (and up to one-half of this on security). - Investment in the oil industry (mainly financed out of Iraq’s own resources) was slightly higher than programmed. ### 2005 budget assumptions and oil market performance - 2005 budget assumptions: - Oil price assumed: $26 per barrel. - Oil exports projected to increase from 1.4 mbpd in 2004 to 1.8 mbpd. - Assumed start of reduction in domestic petroleum subsidy by beginning of the year. - Spending plans constrained to ensure full financing from revenues and available balances abroad (in the DFI and from the winding up of the OFFP). - Oil export performance in first five months of 2005: - Oil export volumes: average 1.4 mbpd (same as average outturn in 2004, below program target). - Average oil export prices: $36.4 per barrel. - Price differentials: differential relative to the WEO benchmark oil price increased from $6.4 per barrel on average in 2004, to $13.4 per barrel in the first quarter of 2005, before narrowing to $8.6 per barrel in April–May 2005. - Authorities explained part but not all movements in the differential. ### Petroleum subsidies (Box 2 summary) - Government imports of petroleum products in 2004: $3.2 billion. - Resulting fiscal loss from subsidized domestic sales: nearly $8 billion (or some 30 percent of 2004 GDP). - Iraq: Domestic Petroleum Product Sales Valued at Domestic and International Prices (volumes as of 2004, prices as of June 2005): - Daily production (in millions of liters/cylinders): LPG 0.3; Regular gasoline 8.0; Kerosene 5.3; Diesel 9.7. - Daily imports (in millions of liters/cylinders): Premium gasoline 11.0; Kerosene 3.1; Diesel 8.2. - Daily consumption (in millions of liters/cylinders): LPG 0.3; Regular 8.0; Premium 11.0; Kerosene 8.4; Diesel 17.9. - Official price (in ID per liter/cylinder): Regular 250; Premium 20; Kerosene 50; Diesel 5; Total 10. - Official price (in US cents per liter/cylinder) 3/: Regular 16.7; Premium 1.3; Kerosene 3.3; Diesel 0.3; Total 0.7. - Price on international markets (in US cents per liter/cylinder): LPG 420; Regular 42.7; Premium 48.1; Kerosene 44.3; Diesel 45.7. - Ratio of Iraq price to international price (in percent): LPG 4.0; Regular 3.0; Premium 6.9; Kerosene 0.7; Diesel 1.5. - Annual sales at official prices (in millions of US dollars): LPG 20; Regular 39; Premium 134; Kerosene 10; Diesel 44; Total 247. - Annual sales valued at international prices (in billions of US dollars): LPG 0.5; Regular 1.2; Premium 1.9; Kerosene 1.4; Diesel 3.0; Total 8.0. - Difference between total sales valued at official and international prices (in billions of US dollars): LPG 0.5; Regular 1.2; Premium 1.8; Kerosene 1.3; Diesel 2.9; Total 7.8. - Notes: - 1/ Based on 2004 figures. - 2/ As of June 2005. - 3/ Using an exchange rate of ID1500/dollar. ### Monetary policy, interest rates, and reserves - Reserve money growth in 2004: 117 percent, exactly in line with the EPCA projection. - Currency in circulation growth in 2004: 75 percent (EPCA projection: 118 percent). - Growth difference led to a large build up in banks’ free reserves with the CBI. - CBI monetary instruments and measures: - On March 14, 2005, CBI activated separate dinar and dollar overnight deposit facilities paying interest at 4 percent and 2 percent per annum, respectively. - As of end-May 2005: banks deposited ID1.7 trillion in the dinar facility and $540 million in the dollar facility. - By end-March 2005: reserve money growth slowed to 6 percent in the first quarter of 2005. - On April 1, 2005, the CBI reintroduced coverage of required reserves to include government deposits. - Rate of interest on the dollar facility was increased to 2.5 percent on June 1, 2005; the rate on the dinar overnight facility was raised to 5 percent on July 3, 2005, and new 14 day and 30 day deposit facilities were introduced at 6 and 7 percent respectively. - Treasury bill auctions: - Interest rates averaged 4 percent in 2004. - Rates began to rise in May 2005, reaching 7 percent by mid-June. - Exchange rate and foreign exchange operations: - Dinar de facto pegged to the U.S. dollar since May 2004. - Dollar sales at daily CBI auctions: about $25 million per day during 2004 and early 2005; increased to about $50 million a day from mid-April 2005. - CBI on some occasions rationed the supply of dollars at auction. ### External reserves and balance of payments - External reserves held by the CBI at end-2004: $7.4 billion (net), above the EPCA target of $4 billion. - Reserves increased in January and February 2005, fell back in March to $7.7 billion, and are estimated to have stayed around this level through end-May 2005. - Balance of payments dominated by oil exports. - Large current account deficits in 2004 and 2005 reflecting high levels of imports for reconstruction and recovery; deficits financed chiefly from assets held abroad, including in the DFI. ### External debt management - Paris Club agreement (November 21, 2004): debt reduction terms equivalent to 80 percent in net present value terms (NPV), in three stages: - First stage: 30 percent debt reduction and interest deferral on the outstanding balance; went into effect upon signing. - Second stage: further 30 percent debt reduction; to go into effect upon approval of an upper credit tranche arrangement (expected by end-2005). - Final stage: additional 20 percent debt reduction; to follow completion of the IMF’s Executive Board’s final review of three years of one (or more) upper credit tranche arrangement(s). - Post-first stage debt stock: estimated to be some $78 billion (reduced from $114 billion pre-Paris Club), or the equivalent of three times GDP. - Without additional stages of Paris Club reduction, Iraq’s debt will remain unsustainable. - Engagement with creditors: - Vast majority of Paris Club claims reconciled. - Proportion of non-Paris Club official debt reconciled so far is still small. - Negotiations with Gulf country creditors handled separately. - Private creditors: about $10 billion of claims submitted for consideration as of May 4, 2005 meeting in Dubai. - Only bilateral agreement signed so far is with the United States (in November 2004), which granted Iraq 100 percent debt cancellation; a further five Paris Club members very close to signing; agreement in principle with four of the 48 non-Paris Club creditors; notable progress with another nine. ### Trade, exchange regime, and structural reform - Trade and investment regime: - Iraq applies a 5 percent custom duty (“reconstruction levy”) on imports, with many exemptions. - According to the 2003 law on foreign direct investment, all sectors are open for foreign investment except direct and indirect ownership of natural resources involving primary extraction and initial processing. - Iraq permits 100 percent foreign ownership and equal treatment for domestic and foreign investors. - Iraq’s exports to the United States receive preferential treatment under the Generalized System of Preference (GSP). - Iraq applied for WTO membership in 2004. - Foreign exchange arrangements (Box 4 summary of practice): - Currency: Iraqi dinar, exchange rate determined in the foreign exchange market with daily auctions. - Payments and receipts: settlement in any convertible currency; no control on use of dinar or foreign currency for transactions in Iraq; no bilateral and regional payment arrangements; payments to and receipts from Israel prohibited. - Controls on trade in banknotes: Iraqi citizens may take out up to 100,000 dinars and up to $10,000 in foreign currency; foreigners may take out foreign currency up to declared amount; both may bring in foreign currency notes in unlimited amounts with declaration; amounts not intended to be taken out are exempt from declaration. - Resident and nonresident accounts: residents and non-residents allowed to open foreign currency accounts at commercial banks and use balances without restriction; non-residents allowed to open domestic currency accounts. - Payments for current and capital transactions: no restriction as long as underlying transactions supported by valid documentation. - Some regulations and laws may exist which, although not enforced, comprise restrictions. - Structural reform implementation: - Benchmarks in the EPCA program delayed relative to schedule. - Reforms related to a functioning payments system, full implementation of a financial management information system (FMIS), and establishment of an automated payroll system likely to take considerably longer than expected due to lack of security, communications problems, and need to tailor systems. - Progress made with Fund staff assistance on developing a monetary survey, drafting new payments system legislation, and improving the banking regulatory framework. *Source: _cr05294 (IMF staff report)* ### 34. Budgetary management remained weak in 2004, although some improvements ### 34. Budgetary management remained weak in 2004, although some improvements ### Budgetary management and fiscal execution - In 2004 the ministry of finance began to receive reports on budget outturns from line ministries and treasury branches in governorates, although the reporting lag is still more than three months. - Fiscal monitoring and execution in 2004 suffered from: - the multiplicity of DFI subaccounts; - limited reporting by donors on their spending; - budget reallocations toward security spending made outside the budgetary process in the last quarter of 2004. - From 2005 onwards the authorities are committed to approve additional spending only in the context of a supplementary budget. - A modern financial management law was adopted in 2004, but implementing regulations still need to be introduced. - Some limited allowances for hazard duty were approved outside of the budget in early 2005. ### Box 5 — The Fragmentation of Iraq’s Fiscal Accounts - Components of Iraq fiscal operations: - The government’s official budget: covers recurrent and capital spending in Iraq’s 18 governorates; Northern governorates allocate spending autonomously and send only limited reports on budget outturns to the central government. The budget is financed by tax and non tax revenues and by Iraqi 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 (the other 5 percent are used for the payment of war reparations to Kuwait). - Spending made by the United States Government out of the DFI: in the second half of 2004 and 2005 the U.S. continued to be responsible for (mostly capital) spending financed from two DFI subaccounts, the “vested” account and the “transaction” account created on June 28, 2004, (pursuant to United Nations Security Council Resolution 1546) and replenished by funds transferred from the main DFI account. The U.S. is also in charge of spending financed by cash assets “seized” from the Saddam Hussein regime in April 2003. - Letters of credit (LCs) issued under the oil-for-food program managed by the UN: fully financed by proceeds of past oil exports sequestered in a bank account at the Banque National de Paris; if LCs expire before they are executed, funds are to be transferred to the UN treasury account in New York, and from that account to the DFI. - Expenditures financed by donors: include bilateral and multilateral grants to Iraq, in particular: (a) U.S. assistance disbursed abroad in U.S. dollars or paid directly in U.S. dollar bank notes in the country to finance investment projects as well as wages, goods, and services; and (b) other donor assistance paid directly to suppliers abroad, or to correspondent banks of Iraqi banks, with sums then transferred directly to individual ministries’ accounts. The Iraqi Strategic Review Board, chaired by the ministry of planning, has been assigned responsibility for coordinating these programs with the Iraqi budget, but has received limited reports from donors. The Transitional Government is reassessing its donor coordination strategy. - Operations of oil-related state-owned enterprises not included in the budget: mainly domestic oil sales which finance oil-sector operating expenditures. ### H. Banking Sector Issues — structure and weaknesses - Iraq’s banking system comprises the CBI and 26 chartered banking institutions: - Two state-owned commercial banks (Rafidain and Rasheed) account for over 90 percent of commercial banking assets and 75 percent of the branch bank network; these banks are heavily overstaffed, and staff skills are weak. - Four specialized, state-owned banks serving the agriculture, industry, real estate, and social sectors, respectively. - 19 private commercial banks. - A trade bank established after the war to provide U.S. dollar letters of credit for imports. - The banking system reportedly has the equivalent of only around $2 billion in aggregate assets (about 7 percent of GDP), and is undercapitalized. - Most banks’ assets are in the form of treasury bills; the banks’ loan portfolio is very small and bank staff lack expertise to offer appropriate credit facilities or assess risks. - The payment system is outdated and lacks an appropriate technical infrastructure: the banking sector is unable to process payments electronically and has a rudimentary check clearing system. Anecdotal evidence suggests checks in Baghdad could take up to 10 days to be cleared, those outside Baghdad could take as much as a month. - The CBI is in the process of trying to modernize the payment infrastructure. - Banks are subject to both on-site (security permitting) and off-site supervision. The CBI has been receiving technical assistance from the IMF and the World Bank and other governments, focusing on introducing best supervisory practices and moving from a rule-based to a prudential-based system. Prudential regulations are in the process of being revised. - Iraq adopted modern central bank, commercial bank, and anti-money laundering (AML) laws in 2004. Related implementing regulations are in the process of being finalized. ### III. Report on the discussions — key issues and outcomes - Data constraints: some continuing problems with data provision due to long lags, but sufficient data were received for staff assessment. - Two dominant issues in discussions: - (i) the possibility of (unfunded) spending increases in the 2005 budget; - (ii) recent pressure on the exchange rate. - Delays in raising domestic petroleum prices (originally slated for end-2004 in the EPCA program) have contributed to an incipient financing gap for the 2005 budget. - Exchange rate pressures since late April: CBI sales of dollars at the daily auction have increased; CBI intensified screening of bids prior to auction and occasionally rationed supply of dollars offered at the auction cut-off price. ### A. Macroeconomic framework for 2005 — projections and risks - Real GDP growth in 2005 revised down to 4 percent (from 17 percent in the program), reflecting downward revisions to oil production. - Oil production now expected to reach only 2.0 mbpd in 2005 (compared with an original program goal of 2.4 mbpd); sabotage and halting of oil exports from the north amounting to 0.3 mbpd. - Inflation projection for end-2005 revised up to 20 percent (compared with a goal of 15 percent under the EPCA program). Some easing in inflationary pressures in the first half of 2005, but supply shortages could resume in the second half; reconstruction may put upward pressure on (mainly nontraded) goods prices. Authorities noted possible upward price effects from adjustments to domestic petroleum prices. - Authorities agreed that a large fiscal financing gap could emerge in the second half of 2005. - Oil export volumes for 2005 as a whole revised down to 1.4 mbpd on average (from 1.8 mbpd under the program). - Shortfall in exports expected to be offset by higher than programmed oil export prices—oil prices are projected to be $36 per barrel (close to the average observed in the first five months of 2005). - Delay in raising official domestic prices of petroleum products was supposed to have raised the equivalent of $1.0 billion in the EPCA program, and $1.5 billion in the approved Iraqi budget. - If oil export prices turn out higher than programmed (for example if the Iraqi oil price differential returns to a more normal level), the gap could possibly be closed without additional measures. - Authorities contemplating a possible supplementary budget for 2005; minister of finance considering including significant upward adjustments to prices of oil products to raise revenue. The staff pressed for raising domestic oil product prices to remove distortion and restore fiscal viability; authorities noted political difficulty and need for a public education campaign. - Budget risks: additional spending commitments in a supplementary budget could offset or exceed revenue measures; authorities may have to reallocate spending within existing allocations. Authorities agreed additional spending commitments should be fully funded by government revenues or from liquidation of government assets held abroad (including seized or frozen assets). The minister of finance affirmed intention to respect the “no-overdraft” rule and avoid recourse to financing from the CBI. - Reserve and exchange rate notes: - Monetary projection for 2005 suggests reserves might increase by an additional $1.7 billion in 2005, but the increase in the five months through end-May is only about $0.5 billion. - Full year projections might be hard to achieve if daily sales of dollars at auction stay as high as $50 million (compared to the more usual $25 million recorded during 2004 and early 2005). - The government is expected to sell (from its oil revenues) an average of around $35 million per day to the CBI to finance its domestic spending in 2005. - CBI actions and staff advice: - CBI has reduced dollar sales by screening out bids on grounds of origination from crime or money laundering and has occasionally rationed supply at the cut-off price. - Staff cautioned that rationing could undermine market confidence and constitute an exchange restriction, and warned against misusing screening as an exchange control device. - Staff urged satisfying dollar demand in full since reserves were at comfortable levels; authorities agreed defense of the exchange rate could be bolstered by raising dinar interest rates in addition to selling dollars. - Dollarization: - Authorities queried whether increased demand for dollars might reflect increasing dollarization in certain regions. Dollarization is believed to be extensive in Iraq and exacerbated by donors (the United States) paying local contractors and employees in U.S. dollars rather than Iraqi dinars. Efforts are underway to reorient the denomination of donor spending toward the Iraq dinar. - Exchange rate regime considerations: - CBI has considered moving to a more flexible exchange rate system; staff cautioned against premature abandonment of the peg and noted requirements for a flexible regime: (i) an appropriate intervention and reserve management policy, (ii) development of a true foreign exchange market, and (iii) strengthened capacity of commercial banks and companies to manage exchange risk. ### B. Structural reforms — PFM, governance, and financial sector modernization - Public financial management: - Authorities intend to prepare consolidated government accounts (including donors’ operations) to improve understanding of fiscal impact. - Staff advised setting budget appropriations close to expected outcomes to limit the need for supplementary budgets and to cast the budget in a medium-term framework. - Governance and anti-corruption: - Authorities intend to make substantial savings by scrutinizing procurement processes and to operate oil-related state-owned enterprises on a commercial basis. - Staff underscored need for transparency in accounting for oil revenues by continuing to have an international accounting firm audit proceeds of oil export sales and DFI operations. - Authorities noted Iraqi inspectors routinely check quantities of oil loaded at each of the seven export points and attributed leakages mostly to saboteurs; they agreed oil metering would aid oil accounting but installation efforts are hampered by security conditions. - Public financial management systems: - Staff encouraged adoption of a chart of accounts compliant with international (GFSM) standards for preparation and execution of the 2007 budget, and introduction of a new FMIS and automated payroll system in due course. - Authorities shared concerns about “ghost workers” and the need for a payroll survey (World Bank offered technical assistance). - Financial system improvements and bank sector reform: - A detailed plan to implement a real time gross settlement (RTGS) system and an automated clearing house (ACH) by early 2006 has been developed. CBI intends to implement a check-clearing system and is drafting rules and regulations for a modern regulatory framework. - Progress made in compiling monetary data for the depository corporations according to the 2001 Monetary and Financial Statistics Manual (MFSM). CBI intends to implement a revised reporting form for commercial banks with sectorization and classification consistent with the MFSM and to compile a preliminary depository corporations survey by September 2005. - Proposals under consideration for banking sector development include restructuring the Trade Bank of Iraq to undertake commercial and possibly investment banking functions; inviting foreign participation in Rafidain and Rasheed; amalgamating the four smaller specialized banks into two regional development banks; and setting up Islamic banks. - Authorities keen to implement a deposit insurance scheme to foster financial stability, but agreed with staff to proceed cautiously: improve regulation and supervision and improve condition of state-owned banks prior to restructuring or privatization. Modalities for funding, membership, and level of coverage are being discussed. *IMF staff report excerpt.* ### 56. Over the medium term, the authorities intend to implement international ### Over the medium term, the authorities intend to implement international ### Implementation of international accounting, auditing, and AML/CFT measures - Authorities intend to implement international accounting and auditing standards, and improve disclosure requirements. - Authorities expressed interest in completing the AML/CFT questionnaire, but noted this may wait until the operational instructions of the AML law are finalized. - The CBI has requested tenders from international auditors to audit its accounts in line with International Standards on Auditing. - Deadline for tenders (originally end-June) extended to end-July; the audit could be underway shortly thereafter. - Completion of this audit should contribute toward the IMF safeguards assessment process. - Authorities are providing other materials requested by staff for the safeguards assessment and have appointed one deputy governor as liaison officer. - Progress in this area would be a key consideration for Iraq’s possible use of Fund resources under a future stand-by arrangement. ### External debt reconciliation and creditor negotiations - Authorities making progress in reconciling external debt claims and reaching tentative bilateral agreements in line with the Paris Club agreement. - Staff assessment: - Progress with Paris Club creditors generally good. - Urged authorities to press ahead in reconciling non-Paris Club claims, especially with Gulf countries, as these were much larger in total than Paris Club claims. - Suggested approaching these creditors directly and via legal and financial advisers. - Authorities’ actions with private creditors: - Advisers followed up on the Dubai meeting with private creditors with further meetings. - Considering offering a menu of options to private creditors to provide flexibility while adhering to comparability of treatment with the Paris Club. - Recognized importance of complying with the Fund’s policy on lending into arrears if entering a stand-by arrangement. - Understood importance of acting in “good faith” though resolution may take time. ### Medium-term prospects, scenario assumptions, and vulnerabilities - Scenario assumptions and conditions: - Satisfactory medium-term outlook provided oil production expansion proceeds without undue interruption and world oil prices remain at favorable levels. - Assumes reconstruction undertaken relatively smoothly, security progressively restored, and political transition goes forward as planned. - Authorities acknowledged considerable downside risks: oil price uncertainty, potential continuation of the insurgency, ongoing political transformation. - Growth and production projections: - Overall GDP growth expected to reach 17 percent in 2006 and then decline slowly to 7 percent by 2010. - Oil production projected to resume expansion to 2.4 mbpd in 2006 and to 3.5 mbpd by 2010. - Non-oil real GDP growth projected to remain strong throughout, sustained by high levels of (mostly public) investment. - Inflation expected to fall to single digits over the medium term. - Fiscal outlook and sensitivities: - Fiscal position sustainable provided authorities contain growth of recurrent expenditures and revenues do not fall. - Financing gaps exist for 2005 and 2006; thereafter they largely disappear. - Scenario reveals little room for maneuver and no space for slippages in fiscal discipline or a deterioration in oil prices. - Oil price treatment in projections: - Iraqi oil prices based on WEO oil price projections, adjusted downward by $7 per barrel on average to reflect transportation costs and quality factors specific to Iraqi oil, and by an additional discount of $4.5 per barrel to account for the uncertainty related to the WEO projections. - Footnoted: The adjustment factor of $4.5 dollars per barrel is equivalent to one standard deviation in the variation of monthly oil prices over the past 20 years. - Petroleum subsidy and revenue implications: - Scenario assumes existing subsidy of domestic petroleum prices is maintained (not a policy recommendation). - EPCA program envisaged a phased elimination of the subsidy over a five year period ending in 2009. - By way of illustration under this plan, revenues would have been $1 billion higher in 2005 and $3.5 billion higher in 2006. - These additional revenues would have covered a large part of the 2005 financing gap and more than covered it for 2006 (not accounting for potential supplemental spending). - Other fiscal measures under consideration: - Authorities considering converting the temporary 5 percent reconstruction levy on imports into a permanent import duty of 10 percent, and strengthening customs collection by creating bonded zones with neighboring countries. - Other new taxes and duties could be introduced starting in 2006. - Specific potentials considered by the minister of finance include: a surcharge on trucks entering Iraq, a 10 percent additional tax on profits of cell phone companies, license fees for cars and weapons, charges for work permits for foreign workers, and special visas for visitors of shrines. - Public spending composition and containment targets: - Scenario assumes efforts to contain recurrent spending while allowing room for investment and reconstruction. - Staff stressed the need to keep the wage and pension bill at around 12 percent of GDP from 2006 and to reduce the share of transfers over the medium term. - Authorities considering reducing the number of non-essential commodities in the commodity distribution system as an expenditure saving measure. - Authorities stressed need to develop an adequate safety net system over the medium term, preferably cash-based; staff cautioned the safety net should be targeted. - Authorities noted potential pressures to increase transfers to regions and provinces if spending responsibilities are devolved in the forthcoming constitution. - Authorities plan to restructure and privatize some state-owned enterprises over the medium term; this might require additional financial support in the next couple of years. - If oil revenues prove stronger than projected, staff encourage prioritizing additional resources for reconstruction investment and/or to meet future budgetary needs per EPCA commitments. - Balance of payments and debt relief effects: - Balance of payments projected to improve as oil exports grow and reconstruction-related imports stabilize. - Balance of trade, in substantial deficit in 2005, expected to move into comfortable surplus by 2007. - Current account projection presumes only the first stage of debt relief (per the Paris Club agreement), so accrued interest remains large and keeps the current account in deficit. - If the second and third stages of debt relief go forward as scheduled, the current account would improve significantly and be approximately balanced by 2010. - Scenario assumes treatment for all creditors (including private) comparable to the Paris Club. ### Staff appraisal: findings and policy recommendations - Macroeconomic assessment and reform urgency: - Staff commends authorities for achieving and maintaining a degree of macroeconomic stability and initiating some structural reforms despite extremely difficult circumstances. - Notes much remains to be done and scope for the economy to derail before recovery and transformation into a market-based economy. - Authorities must remain vigilant against macroeconomic imbalances from spending pressures, revenue shortfalls, or monetary developments, and should accelerate reform momentum and ensure policy continuity where possible. - Fiscal discipline and budget execution: - Iraq faces enormous reconstruction challenges; social indicators have deteriorated and rebuilding will demand significant resources. - Authorities need to prioritize resources and keep recurrent spending (wages, pensions, transfers, non-essential projects) under control. - Staff concerned pressures are mounting for additional mainly recurrent spending without sufficient identified funding. - Urged to pursue a cautious fiscal stance: continue the no overdraft rule; aim at a spending level in 2005 that can be financed within the available resource envelope (expected oil revenues, domestic revenues, (liquid) funds held abroad, and external grant resources); avoid accumulation of arrears. - Any central government–governorate agreements on revenue sharing and spending responsibilities should safeguard macroeconomic stability and establish comprehensive fiscal reporting for adequate monitoring. - Staff encourages bolstering budget execution and financial management efforts: - Fully account for operations of the Development Fund for Iraq (DFI) and publish the DFI accounts on a monthly basis. - Ensure the Financial Management Information System (FMIS) addresses financial management needs in line with the GFSM compliant chart of accounts. - Adopt implementing regulations for the financial management law in budget preparation. - Establish a roster of government employees and eventually develop an automated government payroll and human resource management system. - Strengthen debt management and other key public financial management areas. - Petroleum subsidy reform: - Staff urges authorities to quickly reduce government subsidies for petroleum products to alleviate market distortions and generate budget resources. - A substantial reduction is critical to help close the emerging financing gap and help finance additional spending in any supplementary budget. - Monetary and exchange rate policy: - Reliance on exchange rate stability as monetary framework has served well; real exchange rate appreciation occurred due to relatively high inflation, some of which may unwind. - Recent significant increase in dollars demanded at CBI’s daily auction over the past two months—CBI has not always satisfied demand in full—may signal weakening demand for the dinar; too early to say if sustained. - Staff recommends authorities continue to support the exchange rate peg to the dollar. - Staff urges the CBI to fully satisfy dollar demand at the auction cut-off rate and avoid administrative measures to limit dollar sales. - CBI’s external reserves are more than adequate at present levels and well above the net international reserves objective in the EPCA program; reserves can be deployed in defense of the exchange rate, which will tighten the dinar money supply. - Screening and rationing would likely create a parallel, more depreciated exchange rate and compound dollar demand. - Staff seeking additional information on foreign exchange auctions to determine if they give rise to exchange restrictions or multiple currency practices subject to Fund jurisdiction. - Staff recommends the CBI raise dinar interest rates to bolster defense of the exchange rate. - If reluctant to use dollars to reduce dinar money supply, must drain liquidity using the dinar deposit facility (only domestic monetary instrument presently available). - Treasury bill auction guidance: interest rates rose to 9.9 percent, compared to a dinar deposit rate of 5 percent (increased from 4 percent on July 3, 2005). - Financial sector and oil sector governance: - Urges authorities to push ahead with reform program delayed partly because of security problems. - Reform agenda should focus on: - Developing a strategy for restructuring state banks and other state–owned enterprises (including oil sector). - Preparing an overall restructuring plan for the oil sector, including reviewing the fiscal framework governing the sector. - Formulating strategy for reform and monetization of the in-kind social safety net (public distribution system (PDS)) in parallel with payments system reform. - Modernizing prudential banking regulations and supervisory framework. - Staff underscores need to implement IAMB recommendations without delay, particularly metering of oil production and strengthening internal controls and audit in ministries. - Trade and exchange regime and Article considerations: - Staff welcomes intention to establish a liberal foreign trade and exchange regime. - At present it is not possible to determine whether restrictions exist that might fall under Fund jurisdiction; Iraq continues to avail itself of transitional arrangements under Article XIV, Section 2. - Authorities should review and overhaul legislation and regulations to remove any such restrictions; once confident restrictions removed, they can move toward acceptance of Article VIII, Sections 2, 3, and 4. - Safeguards and audit for CBI: - Staff welcomes CBI’s steps to seek appointment of an international auditor to audit operations; audit will facilitate IMF safeguards assessment, necessary for a stand-by arrangement, and be useful for assessing CBI balance sheet and restructuring CBI claims on government. - Debt rescheduling and creditor engagement: - Staff underscores need to agree debt rescheduling terms for non–Paris Club and private creditors comparable to Paris Club terms to reach bilateral agreements as soon as possible. - Welcomes authorities’ intentions to proceed in good faith toward resolution of external debt arrears, to enter constructive dialogue with all creditors, and to consult the Paris Club on comparability of treatment. - Stand-by arrangement objective and priorities: - Staff notes authorities’ desire for a stand-by arrangement by end of 2005. - Progression to a stand-by arrangement would underpin a sound macroeconomic framework for reconstruction and recovery and pave way for a sustainable external debt situation under Paris Club terms. - Staff urges authorities to build on policy implementation record by continuing the EPCA-supported program with urgent focus on: - Improving flow of timely and reliable data (especially fiscal accounts). - Auditing the CBI according to International Standards on Auditing. - Implementing a plan to significantly increase domestic petroleum prices. *IMF staff report content unit as provided.* ### 81. The staff recommends the next consultation to be held on the standard 12 month ### _cr05294 - 81. The staff recommends the next consultation to be held on the standard 12 month cycle. ### Social indicators (Table 1) - Life expectancy at birth (years): 61 69 69 - Infant mortality (per 1,000 live births): 102 37 30 - Child malnutrition (in percent of children under 5): 12...11 - Access to an improved water source (in percent of population): 81 88 81 - Literacy (in percent of population age +15): 65 35 13 - Gross primary enrollment (in percent of school-age population): 99 95 111 - Male gross primary enrollment: 109 98 111 - Female gross primary enrollment: 89 90 110 - Population, mid-year (in millions): 27.1 30 62,411 - Urban population (in percent of total population): 67 58 49 - Population (average annual growth in percent, (1998–2004)): 2.8 1.9 1.0 - Labor force (average annual growth in percent, 1998–2004): 2.4 2.9 1.2 - Sources: UNDP and World Bank estimates. ### Economic growth, prices, and energy sector (Table 2 highlights) - Nominal GDP (In millions of US$): 21,132 25,539 24,295 29,341 39,003 45,203 51,389 55,318 60,306 - Nominal GDP per capita (In US$): 780 942 870 1,051 1,357 1,528 1,690 1,771 1,882 - Real GDP (percentage change): 51.7 46.5 16.7 3.7 16.8 13.6 12.5 7.8 7.2 - Oil production (In mbpd): 2.1 2.0 2.4 2.0 2.4 2.8 3.1 3.3 3.5 - Iraq oil export prices (US$/bbl): 30.4 31.6 26.0 36.0 40.5 39.8 38.8 38.5 38.5 - Differential between Iraq export prices and WEO prices (US$/bbl): 6.8 6.1 11.3 12.7 8.0 7.5 7.0 6.5 6.0 - Domestic consumer price inflation (year-on-year): 7.0 32.0 15.0 20.0 12.0 10.0 8.0 7.0 5.0 - GDP deflator: 15.0 3.2 -1.5 13.8 24.8 9.9 6.9 4.7 4.6 - Libor (In percent): 1.6 1.6 4.3 4.3 5.5 5.5 5.5 5.5 5.5 - Exchange rate (ID/US$): 1,500 1,460 1,500 .................. - Population growth: 3.0 3.0 3.0 3.0 3.0 2.9 2.8 2.7 2.6 ### National accounts and savings (selected) - Gross domestic investment (percent of GDP): 34.9 26.6 44.8 37.1 30.8 30.7 30.5 31.1 29.1 - Of which: public: 26.4 22.3 37.4 31.8 26.0 25.8 24.5 24.2 22.1 - Gross domestic consumption (percent of GDP): 91.2 97.0 90.7 99.6 85.5 75.9 72.3 68.3 69.6 - Of which: public: 50.5 56.8 45.2 61.5 49.2 41.1 37.6 33.8 33.0 - Gross national savings (percent of GDP): 17.0 -10.4 26.6 6.9 18.6 21.9 21.5 22.1 21.8 - Of which: public: -16.4 -42.2 9.7 -0.7 1.6 4.7 2.9 2.1 0.4 - Residual or Financing gap [+]/surplus[-]: 0.0 0.7 0.0 4.7 3.9 0.0 0.1 0.2 0.3 ### Public finance (Table 3 and Table 4 excerpts) - Government revenue and grants (percent of GDP): 90.6 80.5 97.8 87.7 88.0 81.9 76.3 72.4 70.9 - Government oil revenue (percent of GDP): 79.5 70.0 78.0 65.0 70.3 71.4 71.1 70.1 68.6 - Government non-oil revenue (percent of GDP): 1.4 1.3 2.1 2.5 2.0 2.0 2.1 2.2 2.3 - Grants (percent of GDP): 9.7 9.2 17.5 20.1 15.7 8.5 3.1 0.1 0.0 - Expenditure (percent of GDP): 133.5 121.3 125.4 115.4 92.3 82.5 77.4 74.0 72.5 - Recurrent expenditure: 107.1 99.0 88.0 83.6 66.3 56.7 52.9 49.8 50.5 - Capital expenditure: 26.4 22.3 37.4 31.8 26.0 25.8 24.5 24.2 22.1 - Overall fiscal balance (including grants, percent of GDP): -42.9 -40.8 -27.7 -27.7 -4.3 -0.6 -1.1 -1.6 -1.7 - Primary fiscal balance (percent of GDP): -41.9 -39.8 -27.3 -27.4 -3.8 -0.2 0.1 1.1 3.0 - Non-oil primary fiscal balance (percent of GDP): -96.7 -89.0 -74.2 -69.5 -60.4 -61.2 -60.8 -57.5 -54.1 - Tax revenue/non-oil GDP (percent): 3.0 1.3 3.7 1.9 2.0 2.6 2.8 3.1 3.4 ### Fiscal and oil sector accounts (selected levels, Table 3 detailed figures) - Revenues and Grants (In billions of ID): 28,730 30,018 35,618 38,585 56,484 65,661 73,491 78,696 86,381 - Revenues (In billions of ID): 25,668 26,595 29,238 29,719 46,401 58,818 70,473 78,627 86,321 - Crude oil export revenues (In billions of ID): 24,300 25,326 25,670 27,614 43,783 55,299 66,306 73,691 80,717 - Grants (In billions of ID): 3,062 3,424 6,380 8,865 10,083 6,843 3,019 696 1 - Expenditures (In billions of ID): 42,324 45,244 45,707 50,782 59,220 66,122 74,559 80,459 88,419 - Investment expenditures (In billions of ID): 8,378 8,323 13,631 13,999 16,700 20,680 23,620 26,268 26,930 - Non-oil investment expenditures: 6,488 6,135 9,131 8,509 12,200 14,261 16,034 16,305 15,897 - Oil investment expenditures (including on refineries): 1,890 2,188 4,500 5,490 4,500 6,419 7,586 9,963 11,033 - Balance (including grants, In billions of ID): -13,595 -15,225 -10,089 -12,197 -2,736 -461 -1,068 -1,763 -2,038 - External financing (In billions of ID): 13,598 15,498 10,089 10,114 226 443 1,001 1,564 1,653 - Residual or Financing gap[+]/surplus [-] (In billions of ID): 0 26 0 2,082 2,509 186 719 938 4 ### Monetary indicators and central bank survey (Table 5 highlights) - Net foreign exchange assets (In billions of ID): 1,600 10,743 7,532 12,176 12,966 11,247 11,428 13,558 11,419 - Foreign exchange assets (In billions of ID): 1,916 11,538 8,309 12,967 13,765 12,045 12,225 14,356 12,196 - Net domestic assets (In billions of ID): 4,038 1,296 4,703 729 1,098 1,675 644 207 4,833 - Base money (In billions of ID): 5,638 12,228 12,235 12,904 14,064 12,922 12,070 13,765 16,252 - Currency issued and currency outside banks series shown with levels (currency issued examples): 4,586 8,021 10,014 8,361 9,122 9,463 9,392 10,481 13,301 - Exchange rate (end-of-period): 1,690 1,460 1,460 1,460 1,461 1,462 1,463 1,500 1,460 - Inflation (12-month): 36.3 32.0 7.0 20.0 12.0 10.0 8.0 20.0 15.0 - Non-oil real GDP growth (in percent): -3.4 14.9 5.0 12.0 12.0 12.0 12.0 12.0 10.0 - Gross foreign exchange assets (millions of U.S. dollars): 1,134 7,902 5,691 8,882 9,421 8,239 8,356 9,602 8,353 ### Balance of payments and external sector (Table 6 highlights) - Current account (In millions of US$): -9,985 -9,447 -10,645 -8,847 -4,729 -3,972 -4,602 -4,975 -4,412 - Current account (In percent of GDP): -47.3 -37.0 -43.8 -30.2 -12.1 -8.8 -9.0 -9.0 -7.3 - Trade balance (In millions of US$): -5,137 -1,788 -7,878 -5,127 -817 1,743 2,860 4,087 4,751 - Trade balance (In percent of GDP): -24.3 -7.0 -32.4 -17.5 -2.1 3.9 5.6 7.4 7.9 - Exports of goods (In millions of US$): 16,543 17,782 17,597 19,016 27,273 31,892 36,094 38,125 40,600 - Crude oil exports: 16,200 17,329 17,113 18,410 26,609 31,194 35,359 37,498 39,939 - Imports of goods (In millions of US$): -21,680 -19,569 -25,475 -24,143 -28,090 -30,149 -33,234 -34,038 -35,849 - Financial account (In millions of US$): 8,973 10,842 7,026 9,158 4,597 5,012 5,740 6,101 5,350 - Direct investment (In millions of US$): 200 200 300 300 400 500 1,062 1,768 2,128 - Overall external balance (In millions of US$): -1,013 1,573 -3,619 1,700 1,393 1,050 1,174 1,226 1,128 - Central bank reserves (In US$ million): 5,691 7,902 8,289 9,602 10,995 12,045 13,218 14,445 15,573 - In months of goods and services: 2.6 3.2 3.7 3.4 3.8 3.9 4.2 4.4 4.2 - Debt Stock (In US$ billion): 124.3 78.2 131.5 82.1 86.3 90.8 95.2 99.4 102.6 - Debt service in percent of exports: 0.0 0.0 0.1 0.1 0.1 0.1 2.0 4.2 6.7 - Memorandum: GDP (In millions of US$): 21,132 25,539 24,295 29,341 39,003 45,203 51,389 55,318 60,306 - Memorandum: Non-oil GDP (In millions of US$): 4,173 8,297 5,661 10,854 12,411 14,193 16,230 18,228 20,285 ### Quantitative indicators under Emergency Post-Conflict Assistance (Table 7) - Currency issued (range) (ID billions): 7,003 (06/30/04 stock) 8,021 (12/31/04 Actual) 9,000–11,000 (12/31/04 Indic.) 9,700–11,800 (03/31/05 Indic.; Act 9,463) 10,400–12,700 (06/30/05 Indic.) 11,100–13,600 (09/30/05 Indic.) - Net international reserves of the central bank (floor) (in millions of US$): 3,193 (06/30/04) 7,358 (12/31/04 Actual) 4,000 (12/31/04 Indic.) 4,250 (03/31/05 Indic.; Act 7,692) 4,500 (06/30/05 Indic.) 4,750 (09/30/05 Indic.) - Lending to the government by the CBI (ceiling) (ID billions): 3,986 (06/30/04 stock) 4,165 (12/31/04 Actual) 3,986 (12/31/04 Indic.) 3,100 (03/31/05 Indic.; Act 4,349) 3,100 (06/30/05 Indic.) 3,100 (09/30/05 Indic.) - Government primary fiscal deficit (in millions of US$; ceiling): 10,175 (12/31/04 Actual) 8,850 (12/31/04 Indic.) 1,800 (03/31/05 Indic.) 3,500 (06/30/05 Indic.) 4,750 (09/30/05 Indic.) - New medium- and long-term nonconcessional external debt contracted or guaranteed by the government (in millions of US$; ceiling): 0 0 0 500 750 1,000 - External arrears on new borrowing (in millions of US$; ceiling): 0 0 0 0 0 0 ### Structural benchmarks and key policy measures (Table 8) - Structural Indicative Benchmarks: - Development of a monetary survey. Target: Mar-05. Status: Preparatory work ongoing. - Establishment of an automatic payroll system for all government employees. Target: Jun-05. Status: Pending; government to establish a census of all employees and take measures to control changes in position. - Development of monthly fiscal accounts for the central government and the oil sector. Target: Dec-04. Status: Data is being generated with a long lag and the ministry of finance is establishing committees to accelerate the process and gather missing information. - Issuance of regulations regarding bank licensing and standard prudential ratios. Target: Dec-04. Status: Pending, but authorities believe that the existing regulations are adequate. - Enactment of payments systems law. Target: Dec-04. Status: Draft law is being prepared with the help of MFD. - Adoption of a plan to overhaul the tax and customs administration. Target: Jun-05. Status: Tax policy unit in charge of preparing the plan to be established. - Key Policy Measures: - Increase of domestic prices of oil refined products. Target: Dec-04. Status: Pending; political decision has been postponed. - External audit of Central Bank of Iraq (CBI). Target: Jun-05. Status: Iraqi Supreme Board of Audit conducted audit of end–2003 balance. Request for tender from international audit firms issued. - Adopting implementing regulations for the Financial Management Law. Target: Dec-04. Status: Pending. ### Relations with the Fund; membership and balances (Appendix I) - Membership: Joined December 27, 1945; Article XIV. - Quota (SDR Million; %Quota): Quota 1,188.40 100.00 - Fund holdings of currency: 1,314.41 110.60 - Reserve Position: 171.10 14.40 - Holdings: 0.00 0.00 - SDR Department (SDR Million; %Allocation): Net cumulative allocation 68.46 100.00; Holdings 295.49 431.59 - Outstanding Purchases and Loans: Post-Conflict Emergency Assistance 297.10 25.00 (SDR Million; %Quota) - Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): - Principal forthcoming 2005 2006 2007 2008 2009: Principal 148.55 148.55 - Charges/Interest: 5.52 10.97 10.97 8.48 2.97 - Total: 5.52 10.97 10.97 157.03 151.52 - Safeguards: Iraq is considering an IMF financial arrangement; the Central Bank of Iraq (CBI) would be subject to a safeguards assessment. Documentation has been requested from the CBI. - Exchange rate arrangement: Central Bank of Iraq has been conducting foreign exchange auction on a daily basis since October 4, 2003; de facto peg of the exchange rate since early 2004. ### Article IV consultations, recent technical assistance, and operational notes - Article IV: Last Article IV consultation took place in November 1979; a report for the 1983 Article IV consultation was issued to the Executive Board on August 5, 1983, but no Board meeting convened. - Technical assistance (selected departments and dates/topics): - FAD: July 15–31, 2003 Public expenditure management; December 2003 Public expenditure management; February–March 2004 Fiscal seminar for high level officials; April 2004 Training course in budget preparation; May–June 2004 Tax Policy and Tax Administration Workshop; June 2004 Expenditure management; July 2004 Customs Administration Workshop; December 2004 Fiscal decentralization; January 2005 Petroleum Sector Policies; February 2005 Public financial management; April 2005 Budget classification reform. - LEG: Wrote first draft of new Central Bank legislation; 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; June 2004 Payment and settlement systems; March 2005 Payment and settlement systems. - STA: July 2003 Monetary and financial statistics (jointly with MFD); December 2003 Multisector statistics; January 2004 National accounts statistics; January 2004 Consumer price statistics; October 2004 Price statistics; November 2004 National accounts; April 2005 Balance of Payment Statistics; April 2005 National Accounts; April 2005 Consumer Price statistics; May 2005 General Data Dissemination Standard. - INS: April 2005 External sector policies. *Source: Iraqi authorities and IMF staff estimates, projections, and appended tables as provided in the document._cr05294 - 81.* ### 1. Iraq, a founding member of the International Bank for Reconstruction and ### Iraq, a founding member of the International Bank for Reconstruction and Development (IBRD) ### A. The Bank Group Strategy and Operations - Historical bank relationship and arrears: - Iraq received six loans from the IBRD between 1950 and 1973 for agriculture, education, flood control, telecommunications, and transport. - The last loan closed in 1979. - Iraq was in non-accrual status from 1990 to December 2004, when it paid its arrears to IBRD (about US$108 million). - World Bank interim strategy and operational tracks: - First Interim Strategy Note (ISN) discussed January 29, 2004; Bank authorized to act as Administrator of the World Bank Iraq Trust Fund (ITF). - ISN relied on ITF for emergency operations and Bank budget for analytical and advisory services. - Three activity tracks: - (i) build Iraqi institutional capacity, especially transparency and accountability mechanisms for external funding; - (ii) prepare and start implementing emergency operations to generate employment, kick-start economic activity, and restore essential infrastructure and services; - (iii) lay groundwork for medium-term reconstruction and assist transition to market-driven economy through policy advice and analytical work. - Emergency projects launched March–December 2004 (total value about US$366 million; committed nearly all donor deposits in the ITF): - First Capacity Building Project (US$3.6 million) - Second Capacity Building Project (US$7 million) - Emergency Textbook Project (US$40 million) - Emergency School Rehabilitation and Construction Project (US$60 million) - Emergency Private Sector Development Project (US$55 million) - Emergency Baghdad Water Supply and Sanitation Project (US$65 million) - Emergency Urban Water and Sanitation and Urban Reconstruction Project (US$90 million) - Emergency Community Infrastructure Project (US$25 million) - Emergency Health Rehabilitation Project (US$20 million) - Analytical and advisory work: - Economic and sector work grouped into three clusters: (i) economic reform and transition; (ii) poverty, safety nets, and social development; and (iii) public sector reform and governance. - Support for National Development Strategy (NDS) presented to donors in October 2004. - Country Economic Memorandum (CEM) in process drawing on sectoral studies and 2003–05 policy discussions. - World Bank coordination and other institutions: - World Bank member of the International Advisory Monitoring Board (IAMB) which commenced in December 2003. - International Finance Corporation (IFC) activities: - March 2005 agreement to acquire minority stake in the Credit Bank of Iraq, in partnership with National Bank of Kuwait (NBK). - Iraq Small Business Financing Facility (SBFF) combines investment and technical assistance; first participating bank identified; joint venture partner invested to increase bank capital; agreement with technical assistance provider about to be signed; first commitment expected this fiscal year. - PEP-MENA bank training program for Iraq from September 2004 to February 2005. - IDA and future financing: - Government of Iraq requested resources from IDA in December 2004; met in February 2005 to discuss possible lending program and inputs into a Second Interim Strategy Note expected to provide framework for up to US$500 million of IDA lending as well as additional ITF resources. ### B. IMF-World Bank Collaboration in Specific Areas - Joint activities and policy alignment: - Joint missions, policy workshops, and training courses covering public financial management, oil revenue management, intergovernmental finance, investment climate, payment system, banking supervision, social safety nets, and related topics. - No major differences of views between the two institutions on policy issues. - Broad agreement on core reform program: (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; and (iv) improving delivery of essential services, including education and health. ### C. Areas in Which the World Bank Leads and There is No Direct IMF Involvement - Bank-led emergency support and capacity-building: - Emergency rehabilitation of education, health, water supply and sanitation, urban infrastructure, and telecommunications (all under implementation). - Bank anchors project work in sector analysis and supports Iraqi capacity-building via policy workshops and training courses. - Bank leads on gender issues. - Planned support for a Household Socio-Economic Survey and a Poverty Assessment. ### D. Areas in Which the World Bank Leads and Its Analysis Serves as Input Into the IMF-Supported Program - Bank policy advice and just-in-time inputs: - Inputs to the Prime Minister’s Supreme Economic Committee and key ministries. - Policy notes and sector work on subsidy reforms, pension system, SOE restructuring and investment climate, trade policy and trade facilitation, and telecommunications. - Collaboration with World Food Program on food market issues. - Ongoing work on social safety nets, state bank restructuring, agriculture reform, intergovernmental finance, and civil service reform. - Fund interest and macro perspective: - Fund has strong macroeconomic interest in areas above: economic growth and fiscal sustainability, phasing out nontransparent quasi-fiscal operations. - Fund has strong interest in governance issues, especially oil revenue management. ### E. Areas of Shared Responsibility - Joint Bank–Fund collaboration areas: - Macroeconomic and fiscal sustainability, revenue management, reform of domestic subsidies. - Financial sector reform including state bank restructuring, system and banking supervision and regulation. - Public finance, public debt management, and statistical capacity building. - Close coordination in capacity building: macroeconomic management, public sector governance, private sector development, and social safety nets. - Coordination on macro-modeling work including formulation of an aggregate CGE model to evaluate major reforms. - Bank’s Household Socio-Economic Survey design benefited from Fund comments. ### F. Areas in Which the Fund Leads and Its Analysis Serves as Input Into the World Bank–Supported Programs - Fund leadership and analytical roles: - Leads dialogue on core macroeconomic policies. - Lead on debt sustainability analysis, monetary policy, management of aggregate expenditures, and public expenditure management. - Bank works with Fund to ensure consistency of macroeconomic and fiscal framework. ### G. Areas in Which the IMF Leads and There is No Direct World Bank Involvement - Fund-led topics: - Monetary and credit policies, exchange rate management, tax administration, and balance of payments issues. - Contact: - Iraq Country Director: Mr. Joseph P. Saba, contact number (202) 473-2992. ### Table: Iraq — Bank-Fund Collaboration (area leads, as listed) - 1. Market-focused reforms - Reform of domestic subsidies: World Bank/IMF - Trade policy and facilitation/WTO accession: World Bank - 2. Monetary and credit policies - Lead: IMF - 3. External sector - Balance of Payments: IMF - Debt sustainability: IMF - 4. Public sector governance - Public financial management: IMF/World Bank - Oil revenue management: IMF/World Bank - Civil service reform: World Bank - Tax administration: IMF - Public debt management: World Bank/IMF - Intergovernmental finance: IMF/World Bank - Governance and anticorruption: World Bank - 5. Public service delivery - Education and health: World Bank - Power, water and infrastructure: World Bank - Agriculture, and environment: World Bank - Telecommunications: World Bank - 6. Private sector development - Investment climate: World Bank - SOE reform: World Bank - Financial sector development, incl. payment system and bank supervision: IMF/World Bank - Bank restructuring: World Bank - Housing Finance: World Bank - 7. Human development - Pension reform: World Bank - Social safety nets and poverty analysis: World Bank - Labor market issues: World Bank - Gender issues: World Bank - 8. Other - Oil and gas sector: World Bank/IMF - Statistical capacity building: IMF ### Appendix III — Iraq: Statistical Issues A. Background - Prewar statistical capacity and recent deterioration: - Iraq’s macroeconomic statistics were once among the most developed in the region but suffered from years of neglect; statistics were mostly confidential with limited use. - Central Organization for Statistics and Information Technology (COSIT) remained in place but technical expertise was at best obsolete (national accounts experience solely with System of National Accounts, 1968 (1968 SNA)). - Central Bank of Iraq (CBI) statistical capacity slightly better but staff need training. - STA technical assistance since 2003: - Monetary statistics mission to Baghdad July 2003 as part of MFD-led mission. - December 2003 multisector statistics mission met CBI, COSIT, and ministry of planning (MoP) in Amman covering money and financial statistics, balance of payments and foreign trade statistics, national accounts, and consumer price statistics. - January 2004 STA-hosted workshops in Amman on national accounts and consumer price indices. - FY 2005 follow-up missions in Amman on national accounts, price statistics, and balance of payments statistics. - May 2005 workshop (STA, IMF’s Middle East Technical Assistance Center, World Bank) on General Data Dissemination System (GDDS) metadata development for Iraq and West Bank and Gaza. - STA continues TA program mindful of absorptive capacity and other donors’ contributions. B. Shortcomings with Statistical Framework - National accounts - COSIT compiles national accounts mainly for government use; existing Statistical Act requires COSIT to report to minister of planning who must agree before release, affecting COSIT’s statistical independence. - COSIT releases national accounts statistics to the public only in limited form (current price estimates in the Statistical Yearbook available after application and minister of planning approval). - National accounts follow 1968 SNA, with gaps and flaws in implementation: - Deficiencies in scope: geographical and industrial coverage. - Accounts do not include the northern region (Kurdistan) since 1991. - National accounts do not cover the informal sector; surveys used are out of date. - Missing significant portion of building industry; gaps in business, community, social, and personal services coverage. - COSIT uses out-of-date classifications not following standard international best practice. - Data collection and timeliness: - Current price data in formal sector reasonably comprehensive; businesses employing more than 10 people should report calendar year data by the following October; small businesses report by the following June. - Sizable penalties for noncompliance support meeting deadlines, but recent changes may worsen timeliness. - Shortage of quarterly and monthly indicators and lack of timely data for services; extrapolation from out-of-date benchmarks adversely affects data quality. - STA technical assistance areas for improvement: - Implementation of 1993 SNA. - Improvement of data on external trade and capital formation. - Compilation of accounts by institutional sectors. - Updating of surveys. - Consumer price index (CPI) - Staff inadequate in number and recently received STA training. - Insufficient computer hardware and software to process CPI efficiently. - Recent TA focused on CPI methodologies, quality adjustments, and seasonality adjustments. - CPI improvements limited by outdated weights dating to 1993; weights cannot be updated until household budget survey in 2005/2006. - Limited training on producer price index (PPI) and wholesale price index (WPI) construction and on documentation (metadata); work continuing. - Monetary and financial statistics - CBI staff compiling monetary statistics sufficient in number but require training on Monetary and Financial Statistics Manual (MFSM) methods. - Computer availability far from satisfactory. - Monetary data exclude banking activity from the northern region (Kurdistan). - Standardized reporting forms for Central Bank Survey (CBS), Other Depository Corporations Survey (ODCS), and Depository Corporations Survey (DCS) provided to CBI; CBI staff began compiling CBS in parallel with current reporting format. - Issues under review: classification, inadequate sectorization, and valuation. - Commercial bank balance sheet data are patchy due to inadequate branch reporting; classification and valuation problems exist. - Bearing Point/USAID consultants providing technical assistance in Baghdad. - Monetary and financial statistics mission scheduled July 23–28, 2005. - Balance of payments statistics - Time series available from 1988 to 2002 presented in BPM4 format, but with deviations in definitions, coverage, classification, valuation, and sectorization. - For 2002 to 2004, balance of payments statistics in BPM5 format; quality improved but presentation still limited with deviations from internationally acceptable methodologies. - Balance of payments technical assistance mission met with CBI BOPSD counterparts in Jordan April 9-21, 2005 to improve collection and compilation methods, provide hands-on training, and guide preparation of a methodological note. - Mission progress findings since December 2003 multisector mission: - (a) new CBI Law and Banking Law reference compulsory reporting for publication, among others, of balance of payments statistics; - (b) exchange rate problems largely eliminated as most transactions currently reported and compiled in U.S. dollars; - (c) stock data removed from historical transactions series; - (d) new reporting forms for commercial banks designed. *Source: IMF staff report text (Iraq — Bank–Fund collaboration and statistical issues).* ### 31. The mission noted that the quality of information has been seriously hampered ### _cr05294 - 31. The mission noted that the quality of information has been seriously hampered ### Balance of payments: data quality and impacts - Identified causes of poor data quality: - incorrect interpretation of key balance of payments concepts; - lack of human and technological resources; - lack of internal cooperation within the CBI; - nonresponse to surveys and reporting forms by external sources; - difficulties in collecting information due to the current security situation; - exclusion of the Kurdish areas in most of the balance of payments statistics components. - Consequences: - balance of payments largely dependent on the BOPSD’s ad-hoc observations and estimates; - lack of information affects quality in services, income, and transfers in the current account; - all components in the capital and financial account are affected. ### Balance of payments: mission recommendations - improve human and technological resources for the BOPSD; - improve the legal framework for collecting and compiling balance of payments statistics; - align the concept of residence with the fifth edition of the Balance of Payments Manual (BPM5); - present the balance of payments with the required BPM5 components and breakdown by sector; - reintroduce customs forms for compiling goods data; - improve coverage of services, income and current transfers account by introducing the new surveys developed by the mission; - use the results of the exploratory survey by the ministry of planning conducted in 2003 to create a business directory register and participate in the review of the forthcoming FDI survey to be implemented by the ministry of planning in 2005; - compile financial account data, within the current limitations of the compilers, with more reliable data sources; - compile and disseminate data on external debt consistent with the international guidelines. ### External trade statistics: capacity and coverage issues - COSIT staff and systems: - COSIT lacks enough staff in the section responsible for compiling external trade data; - software for data entry is out of date; - there is only one computer available, which is also out of date. - Operational practices and data gaps: - staff main responsibility is checking customs declaration forms for consistency and keypunching relevant data into computer files; - gaps in customs data occur in 2003 and 2004 because there were no customs inspections at the borders; - customs declaration forms reflect an outdated declaration method; forms are old, often unreadable, and miss important information; - a customs form for exports exists but is not used by the CBI as the primary source for compiling trade data; - customs forms for imports ceased to be used from 2003. - Coverage and classification problems: - external trade statistics do not include the northern region of the country (Kurdistan); - Customs Department classifies items often by customs duties, complicating COSIT reclassification and producing a large margin of error in the final product. - Timeliness and consistency: - foreign trade data are monthly but there are serious problems of timeliness; sometimes release of the data may take up to one year; - there are no legal requirements on the timeliness of source data; - external trade data from COSIT and data compiled by the CBI are not consistent; the Balance of Payments Division of the CBI does not use external trade data from the COSIT. ### Government finance statistics: reporting and development plan - Current reporting status: - Iraq does not report government finance statistics for publication in the Government Finance Statistics Yearbook (GFSY) or International Financial Statistics (IFS); - no fiscal statistics published by the government beyond the summary central government budgetary estimates and outturn. - February 2005 GFS mission (joint with FAD and World Bank) outcomes: - discussed a work plan to build GFS reporting as part of major rehabilitation of budgetary, accounting, and fiscal management information system; - identified institutional, technical, resource, and coordination issues needing resolution prior to developing GFS for Iraq; - recommended the creation of a GFS unit. - Key first steps for the GFS unit: - implement the GFS classification for mapping the chart of accounts and budget classification onto the format of the Government Finance Statistics Manual (GFSM) 2001; - initiate a General Data Dissemination System (GDDS) project to draw up plans for GFS development and dissemination; - create preliminary estimates of GFS-compliant data for general government on a best effort basis. ### External Debt Outlook: Paris Club agreement and implications - Paris Club agreement (November 21, 2004) stages: - 30 percent debt reduction upon signing the agreement, combined with interest deferral on the outstanding balance; - 30 percent additional debt reduction upon approval of an upper credit tranche arrangement with the IMF (expected by end-2005); - a further 20 percent debt reduction following completion of the IMF’s Executive Board’s final review of three years of one (or more) upper credit tranche arrangement(s). - Rescheduling and capitalization: - rescheduling of remaining debt stock with repayments starting in July 2011 and ending in January 2038; - interest payments accrued during 2005–07 are fully capitalized; - interest payments accrued during 2008–10 are partially capitalized. - Immediate impact of first-stage debt reduction: - if all creditors provide reductions comparable to Paris Club, debt forgiveness in 2004 would amount to some $36 billion; - the United States granted 100 percent debt cancellation; other countries assumed to provide 30 percent; - Japan and Russia indicated opting for debt service reduction comparable in net present value terms; - first stage reduces debt service over the medium term by deferring principal and most interest until 2011. - Debt stock projections and sustainability: - with first-stage debt reduction, stock of external debt outstanding at end 2004 estimated to be about $78 billion, or about three times Iraq’s GDP; - without additional debt reduction, external debt stock would increase to about $103 billion by 2010 (about 170 percent of GDP), partly because of capitalization of interest payments during 2005–10; - with second and third stages of debt reduction, external debt stock would decline to about $34 billion (57 percent of GDP) by 2010. ### External debt simulations and vulnerabilities - Liquidity and shock vulnerability: - because most interest payments are deferred until 2010, Iraq would have limited liquidity needs after first-stage debt reduction despite high debt stock; - Iraq would be very vulnerable to a negative oil shock. - Stress-test scenarios (described in text): - production shock: limits oil production to 3.0 mbpd in 2008–10; - price shock: lowers oil export price by $4.5 per barrel (equivalent to one standard-deviation) in 2006–10. - Outcomes of shock simulations: - liquidity needs would increase substantially under the two oil shocks, requiring significant borrowing on international markets to close ex ante financing gaps; - Iraq’s already unsustainable debt stock would increase under these scenarios. ### Key tabled debt and macroeconomic figures (selected exact values from tables) - Table 1: Iraq: Estimated External Debt Stock, 2004–10 (In billions of US$ unless otherwise indicated) - Total debt before debt reduction (2004): 113.6 - Total debt after debt reduction (2004): 78.2 - Total debt (2005): 82.1 - Total debt (2006): 86.3 - Total debt (2007): 90.8 - Total debt (2008): 95.2 - Total debt (2009): 99.4 - Total debt (2010): 102.6 - Total debt (in percent of GDP) row: 444.9, 306.2, 279.8, 221.2, 200.9, 185.3, 179.6, 170.1 - Total debt service (row, without second/third stage): …, 0.0, 0.0, 0.0, 0.0, 0.7, 1.6, 2.7 - With second and third stage of debt reduction — Total debt (2005): 51.1; (2006): 53.5; (2007): 56.3; (2008): 31.0; (2009): 32.9; (2010): 34.1 - With second and third stage — Total debt (in percent of GDP) row: 444.9, 306.2, 174.3, 137.2, 124.6, 60.3, 59.4, 56.6 - Extracts from External Debt Sustainability Framework (2004–10) projections and indicators (exact figures preserved): - External debt (percent of GDP): 306.2, 279.8, 221.2, 200.9, 185.3, 179.6, 170.1 - Change in external debt (1): -528.1, -26.4, -58.5, -20.4, -15.5, -5.7, -9.5 - Identified external debt-creating flows (2): -395.6, -32.3, -62.1, -22.7, -17.4, -7.5, -11.4 - Current account deficit, excluding interest payments: 14.7, 16.9, 1.7, -0.7, 0.1, 0.4, -1.0 - Deficit in balance of goods and services: 22.5, 36.7, 16.3, 6.6, 2.7, -0.6, -1.3 - Exports: 69.6, 64.8, 69.9, 70.6, 70.2, 68.9, 67.3 - Imports: 92.1, 101.5, 86.2, 77.1, 73.0, 68.4, 66.1 - Net non-debt creating capital inflows (negative) 1/: -41.9, -22.8, -4.9, -1.1, -2.1, -3.4, -3.8 - Automatic debt dynamics 2/: -368.4, -26.5, -58.8, -20.8, -15.4, -4.5, -6.6 - Contribution from nominal interest rate: 21.1, 13.2, 10.5, 9.5, 8.8, 8.6, 8.3 - Contribution from real GDP growth: -207.0, -9.9, -35.4, -26.0, -22.0, -13.4, -11.8 - Contribution from price and exchange rate changes 3/: -182.4, -29.8, -33.9, -4.4, -2.2, 0.2, -3.0 - Residual, incl. change in gross foreign assets (1-2): -132.5, 5.8, 3.6, 2.3, 1.8, 1.8, 1.9 - Change in official reserves (increase = positive): 26.5, 5.8, 3.6, 2.3, 2.3, 2.2, 1.9 - External debt-to-exports ratio (in percent): 439.8, 431.7, 316.4, 284.7, 263.9, 260.6, 252.6 - Gross external financing need (in billions of US dollars) 4/: 8.7, 7.5, 3.2, 4.0, 4.6, 4.9, 4.2 - Gross external financing need (in percent of GDP): 34.1, 25.4, 8.2, 8.8, 8.9, 8.8, 7.0 - External debt service in percent of exports 5/: 30.3, 20.4, 15.0, 13.5, 12.6, 12.5, 12.3 - Debt-stabilizing non-interest current account (positive = surplus) 6/: -542.8, -43.4, -60.2, -19.7, -15.6, -6.1, -8.6 - Key macroeconomic assumptions (exact series): - Real GDP growth (in percent): 46.5, 3.7, 16.8, 13.6, 12.5, 7.8, 7.2 - GDP deflator in US dollars (change in percent): 28.0, 10.8, 13.8, 2.0, 1.1, -0.1, 1.7 - Nominal external interest rate (in percent): 4.7, 5.0, 5.0, 5.0, 5.0, 5.0, 5.0 - Growth of exports (US dollar terms, in percent): 91.7, 6.9, 43.4, 16.9, 13.2, 5.6, 6.5 - Growth of imports (US dollar terms, in percent): 194.1, 26.6, 12.9, 3.7, 7.6, 0.8, 5.3 - Limited oil production 7/ (levels): 279.8, 221.2, 200.9, 192.8, 200.7, 203.2 - Lower oil price in 2005–06 8/ (levels): 279.8, 243.9, 227.8, 213.2, 206.8, 194.4 - Limited oil production 7/ (percent): 20.4, 15.0, 13.5, 13.1, 14.3, 15.6 - Lower oil price in 2005–06 8/ (percent): 20.4, 16.8, 15.6, 15.2, 15.4, 15.1 - Memorandum items: - Real GDP growth under stress scenarios (in percent): - Limited oil production 7/: 3.7, 16.8, 13.6, 10.2, 3.8, 3.6 - Lower oil price in 2005–06 8/: 3.7, 16.8, 13.6, 12.5, 7.8, 7.2 - Non-interest current account deficit under stress scenarios (in percent of GDP): - Limited oil production 7/: 16.9, 1.7, -0.7, 2.4, 5.6, 6.9 - Lower oil price in 2005–06 8/: 16.9, 5.6, 4.0, 5.0, 5.4, 3.8 ### Supplementary information (developments since staff report) - Donors' conference (Jordan, Dead Sea, July 18–19): - Donors reiterated support for government reconstruction program and welcomed Iraqi led donor coordination mechanism; - Japan outlined an agreement to provide $3.5 billion in low-interest loans for infrastructure projects; - World Bank announced a lending program of $500 million over the next two years; - Iran announced it would grant Iraq a $1 billion credit line (announced outside donors’ conference). - Consumer Price Index and fuel prices: - overall CPI index increased by 1.0 percent in June; - CPI increased by a cumulative 5.7 percent in the first six months of 2005, or by 37.2 percent in the year to June 2005; - fuel prices rose by 237 percent during July through December 2004, and fell by 48 percent during January through June 2005. - Monetary and reserve developments: - cumulative increase in reserve money in the five months to May 2005 was 1.2 percent; - increase in currency in circulation for the same period was 18.8 percent; - overnight deposit facility attracted about ID 1,753 billion (the equivalent of 14.2 percent of reserve money) by end-May; - external reserves of the CBI increased to $8.8 billion in May, compared with $7.7 billion in March, and $7.4 billion in December, 2004. - CBI measures adopted effective July 3, 2005: - increase in the interest rate on the overnight dinar deposit facility from 4 to 5 percent per annum; - introduction of a 14-day deposit facility yielding 6 percent and a 30-day deposit facility yielding 7 percent; - interest rate rose to 9.9 percent in the July 4 treasury bill auction. *International Monetary Fund — Staff Report for the 2005 Article IV Consultation (supplementary information), Prepared by the Middle East and Central Asia Department; Approved July 25, 2005.* ### 7. The exchange rate has continued to be under some pressure. The exchange rate in the ### _cr05294 - 7. The exchange rate has continued to be under some pressure. The exchange rate in the ### Exchange rate and oil export developments - Exchange rate (first three weeks of July): ranged between ID1,476 to ID1,470 per dollar, from an average of ID1,460 in June. - Oil export volume: - June: 1.5 million barrels per day (mbpd). - Average first five months of 2005: 1.4 mbpd. - Average oil export prices: - June: $39 per barrel. - Average first five months of 2005: $36.4 per barrel. - Northern Oil pipeline: resumed operation in mid-July, allowing the shipment of about 250,000 barrels per day. ### Statement by A. Shakour Shaalan, Executive Director for Iraq (August 1, 2005) — Background and context - Resumption of the Board’s review of an Article IV consultation for Iraq after a quarter century interruption. - Authorities express commitment to sound policies, structural reforms, and rebuilding institutions. - Social and political context: - Unemployment rate estimated by the Ministry of Planning to be around 28 percent (probably an underestimate). - UNDP survey findings: widespread chronic children malnutrition and endemic diseases; poor provision of water, sewage services and electricity. - Timing of reforms (e.g., petroleum subsidy reduction) is politically sensitive; compensatory measures and donor disbursements are critical. ### Recent developments and growth outlook - Political milestones: January 2005 parliamentary elections; election of the president; new cabinet in April; committee drafting a new constitution; forthcoming public referendum. - GDP and oil sector: - GDP growth in 2004: close to 50 percent (albeit from a low level), reflecting increases in oil production to about 2 mbpd and sustained non-oil growth. - Violence and insecurity have limited oil expansion in 2005; expected rebound in 2006 with a prospect for real GDP growth to be in the double digits again. - Proven oil reserves: estimated at around 115 billion barrels (world’s third largest). - Potential oil production expansion: to 2.4 mbpd in 2006 and to a further 3.5 mbpd by 2010, contingent on improved security and reduced sabotage to northern pipelines. ### Monetary policy stance and instruments - Inflation and EPCA target: - High inflation in 2004 linked to violence-related shortages. - Prices stabilized relatively in 2005; EPCA target adjusted to 20 percent for end-2005. - Central Bank of Iraq (CBI) measures: - Introduced separate dinar and dollar deposit facilities to reduce liquidity and stem price pressures. - Early July: increased dinar overnight remuneration from 4 to 5 percent annually. - Introduced 14 and 30-day deposit facilities with 6 and 7 percent interest rates respectively. - Treasury bills’ rates: increased from 4 percent in 2004 to 7 percent in June 2005. - Exchange regime and reserves: - Authorities considered a flexible exchange regime but maintained the peg to the dollar as a nominal anchor. - International reserves at the CBI almost reaching US$9 billion in May, providing a safety cushion for the peg. - Authorities stress need for prudent monetary and fiscal policies to support the peg. ### Fiscal sector developments and risks - 2004 fiscal outcome: fiscal deficit slightly higher than the EPCA’s target; higher oil revenues and lower-than-expected wage and pension outlays mitigated increased spending in goods and services. - Investment spending: lower overall due to weak disbursement in donor-financed non-oil reconstruction; Iraqi investment in the oil sector was close to target. - Revenue and price volatility: - Further oil price increases in 2005 keeping oil revenue targets in line despite lower export volumes. - Doubling of the differential between the price of Iraqi oil exports and world prices in 2005 means Iraq is not reaping full benefits of stronger prices; authorities are investigating causes to narrow the differential. - Petroleum product subsidy: - Foregone revenues from the subsidy are the major fiscal issue for medium- to long-term sustainability. - Authorities committed to start significantly reducing the subsidy when feasible, emphasizing the need for communication and education strategies. - Financing gap risks: - Delay in subsidy reduction and pressures to increase spending (including security) could create a financing gap for 2005 and 2006. - If higher oil revenues do not close the gap, additional measures (supplementary budget) may be needed; any additional spending commitment to be funded from government revenues and sale of assets held abroad. - Accumulation of arrears will continue to be avoided. ### Structural reforms and institutional strengthening - Budgetary management: - Improved reporting on budget outturns in line ministries, though with significant delay. - MOF committed to approve additional spending only through a supplementary budget to address fiscal fragmentation and off-budget operations. - Plans to prepare consolidated government accounts and follow International Advisory and Monitoring Board recommendations regarding the Development Fund for Iraq and audit of the oil sector. - Inspections and verification of oil exports are already taking place. - Revenue enhancement measures under consideration: - Scrutinizing procurement practices; diversifying and increasing revenue sources. - Conversion of the levy on imports into a permanent import duty; strengthening customs collection and administration. - Contemplated taxes/surcharges, including on profits in the cell phone sector. - Financial sector modernization: - Adoption of modern central bank, commercial bank, and AML laws. - Development of a modern payment system including a real time gross settlement system and an automated check-clearing system and accompanying regulation. - Restructuring existing banks and inviting foreign participation in commercial banks planned; security situation has slowed international bank entry. - Consideration of a deposit insurance scheme after supervisory framework establishment; application of international auditing and accounting standards. - CBI has requested tenders for an international auditor to audit its operations according to the International Standards on Auditing (relevant for safeguard assessment and a pre-condition for an SBA with the Fund); audit could take place shortly after the end-July tender deadline. ### Debt restructuring and external engagement - Paris Club agreement (November 2004) enabled major restructuring toward sustainability. - Progress: - Good progress with Paris Club creditors in reconciling debt claims. - Engagement with non-Paris Club creditors, including Gulf countries, to secure similar restructuring terms. - Engagement in good faith with commercial creditors; met with private creditors in Dubai in May 2005 and issued an offer to settle such claims in a press release on July 26 (further details to be communicated to the Board). - Authorities are seeking to enter into a stand-by arrangement with the Fund towards the end of the year, given the Paris Club structure and conditioning of further debt relief on an arrangement with the Fund. _Statement by A. Shakour Shaalan, Executive Director for Iraq; August 1, 2005 — extracted from the source content provided._ ### 14. The authorities are very well aware of the daunting challenges facing Iraq and of the ### 14. The authorities are very well aware of the daunting challenges facing Iraq and of the ### Background and program context - The last Article IV consultation with Iraq was concluded by the Executive Board on February 29, 1980; the Executive Board concluded the Article IV consultation with Iraq on August 1, 2005. - The government of Iraq requested and received a purchase equivalent to SDR 297.1 million (about US$436.3 million; 25 percent of quota) under the Fund’s policy on Emergency Post Conflict Assistance (EPCA). The EPCA-supported program runs through the end of 2005. - Implementation of the EPCA program has been hampered by the difficult security situation, a slow-moving reconstruction process, the protracted electoral process, and slower-than-expected progress in strengthening administrative and institutional capacity; performance under the EPCA program has been mixed. ### Economic activity and inflation - Real GDP: estimated increase in 2004 of nearly 50 percent, mainly reflecting recovery of the oil sector. - Consumer price developments: - Upsurge in consumer prices in late 2004 and January 2005 mostly due to supply shocks. - 12-month inflation rate through June was 37 percent, exceeding the EPCA-supported program projection for end-2005 of 15 percent. ### External reserves and exchange rate - The Central Bank of Iraq (CBI) reports net international reserves of US$7.4 billion at end-December 2004, above the program floor of US$4 billion. - Exchange rate developments: - After appreciating in early 2004 following introduction of the new currency, the dinar has remained broadly stable since May 2004. - More recently exchange rate has been under pressure, with dollar sales volumes at the daily CBI foreign exchange auctions having almost doubled. - Monetary operations: - CBI activated separate dinar and dollar overnight deposit facilities to better manage overall liquidity in the banking system. ### Fiscal performance and reconstruction financing - Fiscal outturns: - The fiscal deficit for 2004 was somewhat larger than targeted under the EPCA program. - Spending on goods and services higher than budget, with larger outlays for defense and security. - Grant-financed reconstruction: - Donors to the International Reconstruction Fund Facility for Iraq deposited about US$1 billion into the facility. - Only about US$103 million were disbursed to finance projects in 2004. ### Structural benchmarks, reforms, and capacity - Delays in implementation of all structural benchmarks under the EPCA program, including: - Commitment to increase domestic prices of refined oil products. - Development of payment systems. - Full implementation of a financial management information system. - Establishment of an automated payroll system. - Causes of delays: continuing lack of security, communications problems, need to tailor systems to Iraq’s circumstances. - Progress made: - Development of a monetary survey. - Drafting a new payments system legislation. - Improving the banking regulatory framework. ### Debt treatment and creditor engagement - Paris Club: On November 21, 2004, Paris Club creditors agreed to debt reduction terms for Iraq to be implemented in three stages amounting to a total of 80 percent debt reduction. - Iraqi government actions: began reconciling external claims and moving toward concluding bilateral agreements with Paris Club and most non-Paris Club official creditors; held a meeting for private creditors in Dubai on May 4. - Directors urged acceleration of debt reconciliation with official creditors and reaching comparable terms with non–Paris Club and private creditors. ### Executive Board assessment: macroeconomic stability and risks - Directors commended authorities for establishing and maintaining a degree of macroeconomic stability and for initiating structural reforms under extremely difficult circumstances. - Key risks and vulnerabilities identified: - Potential macroeconomic imbalances from spending pressures, fluctuations in oil revenue, or adverse monetary developments. - Fragile economy needing transformation to a market economy and sustained growth. - Policy imperatives emphasized: - Readiness to act resolutely to contain macroeconomic imbalances. - Proceed with urgent structural reforms and maintain overall policy momentum. - Timely disbursement of aid commitments to speed investment in infrastructure, social services, and poverty reduction. ### Fiscal strategy and subsidies - Directors stressed critical importance of a coherent fiscal strategy to: - Prioritize use of available resources. - Contain recurrent expenditures, particularly on wages, pensions, transfers, and non-essential projects. - Strengthen public expenditure management, continue adherence to the “no overdraft” rule, and avoid accumulation of arrears. - Price distortions and subsidies: - Key challenge: elimination of existing price distortions to alleviate market distortions and corruption and generate additional budget resources for priority sectors (education, health, security). - Directors urged authorities to start phasing out significant government subsidies on petroleum products as quickly as feasible, while noting political and social difficulties. - Successful implementation of subsidy reform requires careful preparation and supportive policies: effective communication and public education, consideration of a pre-announced schedule, and careful social impact assessment. - Role of technical assistance from the Fund and World Bank emphasized. ### Transparency, governance, and oil sector management - Positive steps welcomed: - Intention to appoint an international auditor to conduct an audit of central bank operations. - Steps to modernize the payments system and tackle corruption. - Further measures encouraged: - Broaden efforts to support budget execution and financial management. - Strengthen governance and management of oil sector operations. - Implement Financial Management Law without delay. - Implement recommendations of the International Advisory and Monitoring Board, including metering of oil production and exports and strengthening internal controls and audit in ministries. - Authorities encouraged to subscribe to the Extractive Industries Transparency Initiative (EITI). ### Monetary framework and policy advice - Directors agreed exchange rate stability has served as the pillar of monetary policy and advised continuation of the exchange rate peg to the dollar given relative stability and absence of suitable alternative anchor. - Credibility conditions and responses to pressures: - Central bank should refrain from administrative limits on dollars sold in foreign exchange auctions and should satisfy total amount demanded at the cutoff rate. - Persistent pressures on the exchange rate should be met with tightening of monetary policy, including raising interest rates on the central bank’s overnight deposit facility; Directors welcomed recent moves in this direction. - Authorities encouraged to use monetary policy instruments to adjust liquidity conditions as needed and to develop additional monetary instruments to facilitate policy implementation. ### Structural reform priorities (recommended) - Develop a strategy for restructuring state banks and other state-owned enterprises as part of reducing the role of the state over the medium term. - Prepare an overall restructuring plan for the oil sector, including review of the fiscal framework governing the sector. - Formulate a strategy for reform and monetization of the in-kind social safety net in parallel with payments system reform. - Phase out price distortions. - Modernize prudential banking regulations and the supervisory framework. - Strengthen financial management in the public sector, diversify revenues and the economy, and enhance governance. - International community to continue supporting reform and institution-building efforts. ### Trade, exchange regime, and AML/CFT - Directors welcomed authorities’ intention to establish a liberal foreign trade and exchange regime and looked forward to Iraq’s acceptance of relevant Article VIII obligations. - Authorities should move expeditiously to review and overhaul legislation and regulations to remove possible exchange restrictions under Fund jurisdiction. - Progress noted on legal framework for Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) and Directors looked forward to its implementation. ### Statistics and program monitoring - Statistical provision: improvements noted but statistical information provided by Iraqi authorities is just adequate for surveillance purposes. - Directors urged further efforts to strengthen statistical framework, particularly in the fiscal area. - Directors took note of authorities’ desire to enter into a Stand-By Arrangement by the end of 2005; progression to a Stand-By Arrangement would help underpin a sound macroeconomic framework for reconstruction and recovery and pave the way toward a sustainable external debt situation under Paris Club terms. - Authorities urged to continue implementing EPCA-supported program, reinvigorate structural reforms, improve governance and institutional capacity, and strengthen quality and timeliness of basic economic data essential for program monitoring. ### Key statistics (2004: EPCA Projections vs. Estimated Outturn) - Real GDP: 51.7 (EPCA Projections) ; 46.5 (Estimated Outturn) - Consumer price inflation (year to December): 7.0 (EPCA Projections) ; 32.0 (Estimated Outturn) - Government revenue and grants (In percent of GDP): 90.6 (EPCA Projections) ; 80.5 (Estimated Outturn) - Expenditure (In percent of GDP): 133.5 (EPCA Projections) ; 121.4 (Estimated Outturn) - Overall fiscal balance (including grants): -42.9 (EPCA Projections) ; -40.9 (Estimated Outturn) - Reserve money (year to December, Percent change): 117.0 (EPCA Projections) ; 116.9 (Estimated Outturn) - Currency issued (year to December, Percent change): 118.4 (EPCA Projections) ; 74.9 (Estimated Outturn) - Exports of goods (In US$ billion): 16.5 (EPCA Projections) ; 17.8 (Estimated Outturn) - Imports of goods (In US$ billion): -21.7 (EPCA Projections) ; -19.3 (Estimated Outturn) - Trade balance (In US$ billion): -5.1 (EPCA Projections) ; -1.5 (Estimated Outturn) - International reserves (stock at end-December, In US$ billion): 5.7 (EPCA Projections) ; 7.9 (Estimated Outturn) *Iraq: Selected Economic and Financial Indicators and Executive Board assessment as presented in Public Information Notice (PIN) No. 05/117, August 16, 2005.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05294.pdf_