## _cr07301 ## Source details **Canonical URL:** [_cr07301](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07301.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07301.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07301.pdf.json) --- ### Executive summary — key findings and priorities - Security deterioration has hampered investment, kept oil production and economic growth low, and contributed to shortages that pushed inflation sharply higher in 2006. - Policy response and outcomes: - Exchange rate appreciation and policy tightening reduced inflation markedly during the first part of 2007. - Official fuel prices were increased to regional levels. - Progress on modernizing public financial management, strengthening central bank safeguards, and banking sector reform. - Iraq continues to make progress in resolving debt to official and private creditors. - Program status: - Completion of the fifth review under the Stand-By Arrangement (SBA); authorities requested a three-month extension to keep a policy framework in place during discussions for an envisaged successor arrangement. - Key policy priorities: - Increase investment, especially in the oil sector; continue macroeconomic policies to bring inflation down; press ahead with priority structural reforms. - Contain current spending (wages and pensions); enact pension law amendments soon. - Allow the dinar to appreciate gradually; tighten monetary policy if inflation remains high. - Actively support private fuel imports to reduce shortages. - Structural priorities: broaden FMIS coverage; develop medium-term tax modernization strategy; improve CBI internal controls and accounting; advance banking sector reform; establish new legislative framework for the oil sector. ### Inflation, monetary policy, and exchange rate - Inflation developments: - Annual consumer price inflation: 31½ percent at end-2005; increased to 66½ percent in January 2007; declined to 38 percent in May 2007; rose to 46 percent in June 2007. - Core inflation (excluding fuel and transportation): about 32 percent in 2006; 21 percent in May 2007; 19 percent in June 2007. - Shortages of fuel affected headline vs. core inflation dynamics. - Monetary and exchange rate actions: - CBI policy interest rate raised in two steps to 20 percent between mid-November 2006 and end-January 2007. - Exchange rate appreciated by 12½ percent during that period and by a further 2½ percent through end-June 2007 (total 15 percent appreciation since mid-November 2006 in some references). - Dinar currency in circulation expanded by 20½ percent between November 2006 and April 2007 while the CPI increased by 13 percent over the same period. - Staff supports allowing the dinar to appreciate gradually through end-2007 and stands ready to tighten monetary conditions if inflation deviates upward or dollarization is not reduced. - Monetary indicators (selected): - CBI gross international reserves: $18.7 billion at end-2006; $21,313 million projected for 2007 in some tables. - CBI net international reserves cumulative change targets/floors referenced (e.g., floor: 8,500 in the addendum). ### Fiscal outcomes, oil sector, and public finances - Fiscal outturns: - Fiscal surplus of 11 percent of GDP in 2005; surplus of almost 12 percent of GDP in 2006 due largely to underspending. - Balance in the Development Fund for Iraq (DFI): $8.6 billion at end-2006. - CBI gross international reserves increased to $18.7 billion at end-2006 (almost 6 months of import cover). - 2007 budget and implementation: - 2007 budget supports an ambitious investment program; need to increase project implementation rate; strict containment of current spending required. - Officials aim to keep the overall fiscal deficit below 10 percent of GDP in 2007. - DFI projected balances (selected, US$ million): 2007: 4,808; 2008: 1,736; 2009: 425; 2010: 332; 2011: 285; 2012: 4,077. - Oil production and revenues: - Oil production: outcome 2006: 2.0 mbpd (target 2.3 mbpd); crude oil production recovered to 2.1 mbpd in March/April 2007 but averaged 1.9 mbpd during first four months of 2007. - Example projection: oil production could reach close to 2.1 mbpd in 2007. - Crude oil export prices (selected): 2006: $55.7 per barrel; 2007 proj.: $50.6 per barrel. - Fuel pricing and private imports: - Domestic fuel prices raised in March and June 2007; regular gasoline now 32 U.S. dollar cents per liter. - In the 2007 budget explicit subsidies for fuel imports eliminated except for a small kerosene subsidy. - About 20 licenses issued to private importers; government to provide SOMO a revolving credit ceiling of ID 400 billion to finance imports of fuel products. ### Medium-term outlook and scenarios - Baseline assumptions and projections: - Real GDP growth: 2007: 6.3 percent; 2008: 5.3 percent; 2009: 8.2 percent; 2010: 10.2 percent; 2011: 11.7 percent; 2012: 10.6 percent. - Oil production (mbpd): 2007: 2.1; 2008: 2.2; 2009: 2.4; 2010: 2.7; 2011: 3.1; 2012: 3.5. - Consumer price inflation (end of period): 2007: 30.0 percent; 2008: 12.0 percent; 2009: 7.0 percent; 2010–2012: 5.0 percent each year. - Current account balance (percent of GDP): 2007: -5.3; 2008: -2.8; 2009: -2.2; 2010: -0.2; 2011: 3.0; 2012: 6.6. - Overall fiscal balance (percent of GDP): 2007: -9.7; 2008: -6.6; 2009: -4.5; 2010: -1.9; 2011: 1.5; 2012: 5.1. - Scenarios and risks: - If envisaged oil-sector investments are realized, gradual expansion of oil production is achievable; if security improves, growth could increase to about 10 percent thereafter. - Downside risks: unsettled security situation; volatile oil prices; lower-than-projected oil production. - Stress scenarios modeled: - Limited oil production: production constant at 2.0 mbpd in 2007–08 then +0.2 mbpd per year. - Lower oil price: oil export price lower by $4.5 per barrel during 2008–12. - Debt sustainability: without third stage Paris Club reduction, external debt would be about $62 billion (about 55 percent of GDP) by 2012; with third stage (expected 2008) external debt could be about $36 billion (32 percent of GDP) by 2012. ### External sector and debt resolution - Current account and reserves: - Current account expected to deteriorate in 2007 and remain in sizable deficit through 2009; gross international reserves expected to gradually increase to about eight months of import cover. - Debt reduction and restructuring: - Paris Club agreement (November 21, 2004): 80 percent NPV reduction in three stages; final 20 percent contingent on completion by end-December 2008 of the final review of the third year of upper credit tranche arrangements with the Fund. - Iraq signed bilateral agreements with all Paris Club creditors except Russia, and with nine non-Paris Club creditors. - Total debt to non-Paris Club official creditors estimated at $67.7 billion; bilateral agreements signed for $3.4 billion of that total; bulk of unresolved debt (>80 percent) to Gulf countries and China. - SPV established March 2007 to securitize restructured debt; by mid-2007 Iraq had settled more than $19.7 billion claims submitted by private creditors. - External debt indicators (selected): - External debt estimates: end-2005: $69 billion (220 percent of GDP); end-2006: $55 billion (111 percent of GDP). - External debt-to-exports ratio (percent): 2004: 549.0; 2005: 345.8; 2006: 191.7; 2007: 190.2; 2012 (baseline): 106.3. - External debt (percent of GDP): 2005: 378.9; 2006: 219.5; 2007: 110.5; 2012: 63.6 (without third stage) / 36.6 (with third stage as presented). - Gross external financing need (US$ billions): 2007: 3.4; 2008: 2.0; 2009: 1.8; 2010: 0.2; 2011: 0.1; 2012: -4.3. ### Public financial management, payroll, and social safety net - Public financial management reforms: - MoF adopting chart of accounts and budget classification in line with GFSM 2001 within a cash accounting framework; FMIS trial use since January 2007 with legacy systems in parallel. - Broaden FMIS coverage and finalize adoption of budget classification as priorities. - Payroll and census: - Census of public service employees started; data collection phase expected to be completed by end-November 2007 (census not completed by end-June 2007 due mainly to security constraints). - Pensions and social safety net: - New pension law (November 2005) is fiscally unsustainable; authorities seeking amendments to provide gradual reduction of replacement rates and zero indexation in 2007. - Progress in social safety net: more than 1 million families identified and received cash payments up to $80 per month; coverage target for 2007: 1.5 million families. - Rationalization of the Public Distribution System underway. ### Banking sector reform and financial sector issues - Banking sector structure (end-2006): - Seven state-owned banks and 22 private banks. - Consolidated banking sector assets about $26 billion (51 percent of GDP). - SOBs account for 90 percent of sector assets (Rafidain and Rasheed account for 70 percent of assets). - Total loans portfolio $2.2 billion (4 percent of GDP) at end-2006; deposits $12.9 billion (26 percent of GDP). - Reform steps underway: - MoUs for restructuring Rafidain and Rasheed banks implemented; international auditor selected for operational and financial audits to be completed by early 2008. - Real time gross settlement (RTGS) and automated clearing house (ACH) implemented; CBI expanding payment system coverage to most banks by end-2007. - CBI issued AML implementing regulations and set up new AML office. ### Program monitoring, SBA status, and staff recommendations - SBA and reviews: - SBA approved December 23, 2005 (SDR 475.4 million; 40 percent of quota); arrangement extended to September 28, 2007; authorities requested extension to December 28, 2007 and rephasing of purchases. - All quantitative performance criteria set for end-March 2007 were met; structural conditionality experienced slippages. - Waivers sought for nonobservance of the end-May and end-June structural performance criteria and waiver of applicability of end-June quantitative performance criteria. - Proposed establishment of quantitative performance criteria for end-September 2007 and rescheduling/redefinition of the census completion PC to completion of data collection by end-November 2007. - Staff appraisal and recommendations (selected): - Main actions needed to raise growth and reduce inflation: - Speed up reconstruction and increase investment, especially in the oil sector. - Continue macroeconomic policies to bring inflation further down (exchange rate appreciation and monetary tightening as needed). - Implement priority structural reforms: modernize chart of accounts and broaden FMIS coverage; modernize and streamline tax system; press ahead with banking sector restructuring; ensure efficient government support to public enterprises and reflect it in the budget; put in place new hydrocarbon legislative framework. - Fiscal prudence emphasized given limited available resources in the near term (expected oil revenues, domestic revenues, DFI assets, and remaining external grants). - Staff supports CBI’s gradual appreciation of the dinar and urges readiness to increase pace and tighten policy if inflation or dollarization persist. - It remains crucial that pension law amendments be enacted soon to ensure long-run fiscal sustainability. *Source: IMF staff report — Executive Summary and selected sections (content unit _cr07301).* ### Executive Summary ...................................................................................................... ### _cr07301 - Executive Summary ### Executive summary — key findings and priorities - Recent years: very difficult economic situation mainly due to deterioration in security; progress made in strengthening macroeconomic management and continuing structural reforms. - Security effects: - Hampered investment and kept oil production and economic growth low. - Shortages of key commodities contributed to sharply rising inflation in 2006. - Policy response and outcomes: - Intensified policy effort, including appreciating the exchange rate, reduced inflation markedly during the first part of 2007. - Official fuel prices were increased to regional levels. - Progress on modernizing public financial management, strengthening central bank safeguards, and banking sector reform. - Iraq continues to make progress in resolving debt to official and private creditors. - Program status: - Completion of the fifth review under the Stand-By Arrangement; authorities requested a three-month extension to keep a policy framework in place during discussions for an envisaged successor arrangement. - Outlook and risks: - Prospects for 2007 and beyond depend critically on the security situation. - If envisaged investments in the oil sector are realized, a gradual expansion of oil production is achievable. - Medium-term outlook is promising given current favorable world oil price projections. - Significant downside risks include volatile oil prices and the political and security situation. - Key challenges and required actions: - Increase economic growth and further reduce inflation by: - (i) increasing investment, especially in the oil sector; - (ii) continuing macroeconomic policies to bring inflation down; - (iii) moving ahead with priority structural reforms. - Specific policy points highlighted: - The 2007 budget allows for an ambitious investment program but sustained efforts are needed to increase the project implementation rate; current spending, including on wages and pensions, needs strict containment to maintain fiscal sustainability; crucial that pension law amendments be enacted soon. - Authorities intend to allow the dinar to gradually appreciate in the coming months; pace of appreciation will be adjusted and monetary policy tightened if inflation remains high; government should actively support private fuel imports to reduce shortages. - Structural reform priorities: (i) broaden coverage of the Financial Management Information System (FMIS); (ii) develop a medium-term strategy to modernize the tax system and strengthen tax administration; (iii) further improve CBI internal controls and accounting; (iv) move ahead with banking sector reform; (v) establish a new legislative framework for the oil sector. ### Introduction — program and international frameworks - Article IV consultations: - Last Article IV consultation concluded on August 1, 2005 (first Article IV consultation in 25 years). - Stand-By Arrangement (SBA): - Approved on December 23, 2005 in an amount equivalent to 40 percent of quota (SDR 475.4 million). - Arrangement originally ran through March 22, 2007, extended on March 12, 2007 to September 28, 2007. - First and second reviews completed on August 2, 2006; third and fourth reviews concluded on March 12, 2007. - SBA treated by Iraq as precautionary. - Paris Club debt reduction: - Agreement on November 21, 2004 to a debt reduction equivalent to 80 percent in net present value (NPV) terms, to be achieved in three stages. - First and second stages: each 30 percent debt reduction in NPV terms (went into effect in November 2004 and in December 2005). - Final stage: additional 20 percent debt reduction dependent on completion by end-December 2008 of the final review of the third year of one or more upper credit tranche arrangements with the Fund. - International Compact with Iraq (ICI): - Formally endorsed May 3, 2007 in Sharm el-Sheikh, Egypt. - ICI aims to put in place a medium-term framework for political, security and economic reforms; Fund contributes preparation of medium-term macroeconomic framework of the SBA-supported program. ### Background — political and security environment - Political developments: - Iraq’s first constitutional government since the fall of the Saddam Hussein regime was approved by the Council of Representatives on May 20, 2006, following elections on December 15, 2005. - Political tensions within the coalition government; prime minister and key ministers have kept their positions. - Resignation of six ministers from the Al-Sadr movement in April 2007 undermined political consensus. - Security situation: - Security deteriorated in 2006 and, despite a new security plan in 2007, Iraq continues to suffer serious security problems. - Worsened living conditions, adversely affected economic activity, and induced emigration of professionals and skilled labor. - Violence indicators charted (casualties and oil sector attacks per month) cover June 2003–May 2007. ### Background — social and human development - Living conditions: - 2004 UNDP survey showed poor scores on the Millennium Development Goals: widespread malnutrition, low primary school enrollment, high child mortality. - 2007 Iraq Poll indicates further deterioration in living conditions (Box 1). - Displacement and refugees: - Over 4 million Iraqis displaced, including some 1.9 million inside Iraq and over 2 million in neighboring countries. - Neighboring country burdens: Syria has 1.2 million refugees; Jordan about 750,000 refugees. - Large numbers of refugees causing supply bottlenecks and rising real estate prices in neighboring countries. - Quality of life poll highlights: - When asked “how things are going in their lives these days?” 60 percent of respondents in the 2007 Iraq Poll answered “very bad” or “quite bad”, compared to 29 percent in 2004 and 2005. - More than three quarters of Iraqis say jobs are hard to find; official under-employment estimates range from 30 to 50 percent. - Availability of clean water, medical care, and basic goods and services deteriorated after some improvement in 2005. - Three out of five Iraqis consider conditions of local schools to be bad, more than twice as many as in 2004. - When asked about the “biggest single problem facing Iraq” more than half mentioned security; followed by political and military issues (26 percent), social issues (12 percent), and economic issues (9 percent). ### Background — institutional and administrative capacity - Data and statistics: - Progress in data provision, but weaknesses remain. - Oil sector data generally adequate and timely; little information on non-oil economic activity and on the balance of payments. - CBI balance sheet and consumer price data available with relatively short lags but do not cover the Kurdish region. - CBI started producing a monetary survey, which also excludes the Kurdish region. - Incomplete data on letters of credit issued by the Trade Bank of Iraq hampers assessment of the fiscal stance. - Oversight and institutional transition: - IAMB mandate to audit and oversee the Development Fund for Iraq (DFI) extended through December 2007 (UN Security Council Resolution 1723, November 28, 2006). - Council of Ministers approved establishment of the Committee of Financial Experts (COFE) in October 2006, to be chaired by the president of the Board of Supreme Audit; COFE working in parallel with IAMB to smooth transition once IAMB’s mandate expires. - Development Fund for Iraq (DFI) role: - DFI established May 2003 pursuant to UN Security Council Resolution 1483 to hold proceeds of Iraq’s oil exports, remaining balances from UN Oil-for-Food Program and other frozen Iraqi funds; disbursements must be used for the benefit of the Iraqi people. - DFI consists of bank accounts at the Federal Reserve Bank of New York and the CBI. - Oil export receipts are the main inflow (over 95 percent of total); other inflows include returned Letters of Credit, interest on overnight deposits and U.S. T-Bill holdings, surplus UN Oil for Food funds, and transfers of previously frozen funds. - DFI is main source for budgetary financing: import financing channeled through Trade Bank of Iraq; Ministry of Finance credits CBI’s dollar account from the DFI (increasing CBI gross reserves) while receiving dinars in its CBI account in Baghdad. - Technical assistance outcomes: - Despite adverse security, progress in TA delivery. - Monetary and banking TA: (i) production of a monetary survey; (ii) replacement of obsolete paper-based system with modern electronic payment systems; (iii) improved banking supervision; (iv) initiation of restructuring of two largest state-owned banks. - Fiscal TA: design of a Chart of Accounts and implementation of FMIS. - Statistics TA: training that significantly improved quality and coverage of fiscal, monetary and balance of payments data. ### Recent economic developments — activity, oil, inflation, and fiscal/external positions - Growth and oil production: - Economy did not grow as fast as expected at time of last Article IV consultation due to insecurity hampering reconstruction and investment, resulting in lower-than-foreseen oil production and slower economic growth. - Example: 2005 Article IV projected oil production at 2.4 million barrels per day (mbpd) in 2006 whereas the outcome was 2.0 mbpd. - Following a decline in oil production and real GDP in 2005, economic growth is estimated at 6¼ percent in 2006. - Oil production increased slightly to 2 million barrels per day (mbpd) in 2006 but remained well below the 2.3 mbpd target for the year. - Crude oil production recovered to 2.1 mbpd in March/April 2007 but averaged only 1.9 mbpd during the first four months of 2007. - Based on cement, fertilizers, and electricity production indicators, real non-oil GDP is estimated to have increased by 7½ percent in 2006. - Non-oil investment is being adversely affected by the prevailing security situation. - Inflation and commodity shortages: - Shortages of key commodities contributed to rising inflation in 2006. - After policy measures including exchange rate appreciation, inflation came down markedly during the first part of 2007. - Fiscal and reserve positions: - Low implementation rate of government investment program resulted in large fiscal and external surpluses. - Balance in the DFI stood at $8.6 billion at end-2006. - CBI gross international reserves increased to $18.7 billion at end-2006 (almost 6 months of import cover). ### Policy directions and structural priorities (summary) - Fiscal policy: - 2007 budget supports ambitious investment program; need to increase project implementation rate. - Strict containment of current spending, including wages and pensions, required to maintain fiscal sustainability. - Enactment of pension law amendments is crucial and time-sensitive. - Monetary and exchange rate policy: - Authorities intend to allow the dinar to gradually appreciate in the coming months. - Pace of appreciation and monetary tightening will be adjusted if inflation remains high. - Government should actively support private fuel imports to reduce shortages. - Structural reforms (authorities’ priorities): - Broaden coverage of the Financial Management Information System (FMIS). - Develop a medium-term strategy to modernize the tax system and strengthen tax administration. - Further improve CBI internal controls and accounting. - Move ahead with banking sector reform. - Establish a new legislative framework for the oil sector. *Source: IMF staff report — Executive Summary (content unit _cr07301).* ### 14. Inflation reached worrisome levels in 2006, but came down markedly during ### _cr07301 - 14. Inflation reached worrisome levels in 2006, but came down markedly during ### Inflation developments - Annual consumer price inflation increased to 66½ percent in January 2007 from 31½ percent at end-2005. - Core inflation (excluding fuel and transportation) remained high at about 32 percent in 2006. - Annual inflation declined to 38 percent in May 2007; core inflation decreased to 21 percent in May 2007. - In June 2007, headline inflation increased to 46 percent; core inflation continued to decline to 19 percent. - Fuel shortages influenced the gap between headline and core inflation: shortages eased in early 2007 but worsened again in June 2007. ### Monetary policy, exchange rate, and dollarization - Between mid-November 2006 and end-January 2007, the CBI raised its policy interest rate in two steps to 20 percent. - The exchange rate appreciated by 12½ percent during that period and by a further 2½ percent through end-June 2007. - Dinar currency in circulation expanded by 20½ percent between November 2006 and April 2007, while the CPI increased by only 13 percent over the same period. - Cash sales of dollars at the foreign exchange auction dropped considerably in December 2006 and remained well below 2006 levels thereafter. - The increase in inflation in 2006 appears to have been accommodated by pervasive cash dollarization rather than by dinar money supply growth (currency in circulation growth was well below the rate of inflation in 2006). ### Fiscal developments and balances - Following a fiscal surplus of 11 percent of GDP in 2005, the fiscal outturn for 2006 showed a surplus of almost 12 percent of GDP, largely due to underspending. - The surplus resulted in accumulation of balances in the DFI of $2.4 billion and of government deposits at the CBI of ID 755 billion, while almost ID 950 billion of outstanding Treasury bills were redeemed. - Preliminary information for Q1 2007 indicates continued underspending resulting in a fiscal surplus; budget execution accelerated in April/May 2007. - The balance of the DFI is projected (medium term outlook table) as: - 2007: 4,808 (in US$ million) - 2008: 1,736 - 2009: 425 - 2010: 332 - 2011: 285 - 2012: 4,077 ### Medium-term macroeconomic outlook and scenarios - Assumptions and targets: - Oil production could reach close to 2.1 mbpd in 2007. - Real GDP growth projected at about 6 percent in 2007. - Medium-term output growth projected to average some 6¾ percent in 2008–09. - If security improves, economic growth could increase to about 10 percent thereafter. - Inflation targeted to come down to about 30 percent by end-2007. - From 2009 on, inflation is expected to gradually fall to single digit levels. - Iraq: Medium Term Outlook (selected series) - Real GDP (percent change): 2007: 6.3; 2008: 5.3; 2009: 8.2; 2010: 10.2; 2011: 11.7; 2012: 10.6. - Oil production (In mbpd): 2007: 2.1; 2008: 2.2; 2009: 2.4; 2010: 2.7; 2011: 3.1; 2012: 3.5. - Consumer price inflation (percentage change): 2007: 30.0; 2008: 12.0; 2009: 7.0; 2010: 5.0; 2011: 5.0; 2012: 5.0. - Current account balance (percent of GDP): 2007: -5.3; 2008: -2.8; 2009: -2.2; 2010: -0.2; 2011: 3.0; 2012: 6.6. - Overall fiscal balance (percent of GDP): 2007: -9.7; 2008: -6.6; 2009: -4.5; 2010: -1.9; 2011: 1.5; 2012: 5.1. ### External sector and risks - Current account balance expected to deteriorate in 2007 and remain in sizable deficit through 2009 due to only slight increases in oil exports, higher investment-related imports, and lower inflows of foreign grants. - With more rapidly increasing oil exports from 2010, the external current account balance would improve over the medium term. - Gross international reserves expected to gradually increase to a level equivalent to eight months of import cover. - Key risks: - Unsettled security situation impedes investment and private activity. - Possible terms of trade shocks and lower-than-projected oil production would raise fiscal deficits and financing gaps from 2008. - Debt sustainability analysis indicates vulnerability to negative oil price and production shocks. ### Debt resolution and restructuring - Iraq has signed bilateral agreements with all Paris Club creditors except Russia, and with nine non-Paris Club creditors. - Of the nine non-Paris Club creditors with agreements, six (Czech Republic, Hungary, Indonesia, Malaysia, Romania, and South Africa) provided debt reduction comparable to Paris Club terms; three (Cyprus, Malta, and Slovak Republic) provided 100 percent reduction. - The total debt to non-Paris Club official creditors is estimated at $67.7 billion, of which bilateral agreements have been signed for an amount of $3.4 billion. The bulk of unresolved debt (more than 80 percent) is to the Gulf countries and China. - A Special Purpose Vehicle (SPV) was established in March 2007 to provide single securitization of restructured debt to official creditors; the SPV would issue U.S. dollar-denominated notes secured by rights under bilateral agreements. - By mid-2007, Iraq had settled more than $19.7 billion claims submitted by private creditors; most unresolved claims (about 4 percent of total claims) are being reconciled related to the liquidation of the London branch of Rafidain Bank. ### Fiscal policy and structural reform measures - Authorities’ priority actions agreed with Fund staff: (i) increase investment, especially in the oil sector; (ii) bring inflation down further; and (iii) move ahead with priority structural reforms. - The 2007 budget allows for an ambitious investment program while maintaining overall fiscal sustainability; overall fiscal deficit expected to be kept below 10 percent of GDP in 2007, taking into account exchange rate appreciation effects on oil revenues. - Administrative measures to increase execution of investment projects include accelerating cabinet approval of large projects and shortening procurement periods, but short-term impact limited by security and project gestation. - Fuel policy: - Domestic fuel prices raised on July 1 (broadly in line with the program); aim to avoid emergence of explicit budgetary subsidies except a small kerosene subsidy. - About 20 licenses issued to private importers to reduce fuel shortages; private imports in the Kurdish region have begun. - Government to make storage facilities and pump stations available to private operators and to provide SOMO a revolving credit with a ceiling of ID 400 billion to finance imports of fuel products. - Tax reform: - Authorities developing a medium-term tax reform strategy with technical assistance; considering introduction of a sales-tax as precursor to a value-added tax; aim to strengthen tax and customs administration. ### Box 3 — Official fuel price adjustments (summary of findings) - Prior to December 2005 adjustments, regular gasoline sold in Baghdad for about 3 U.S. dollar cents per liter, and less than half of that outside the capital. - In March and June 2007, prices of regular and premium gasoline and diesel were increased to a level exceeding the regional average. - Prices for regular gasoline are now 32 U.S. dollar cents per liter; prices for premium gasoline largely reflect actual import cost. - Price differentials of premium gasoline between Iraq and Iran and Kuwait were eliminated; differentials with Syria and Jordan were reduced from more than ninety to less than fifty percent. - Fiscal impact: - In 2004, net budget subsidy for fuel imports was ID 4.8 billion (12¾ percent of GDP). - By 2006, the price adjustments reduced this subsidy to ID 3.2 billion (4½ percent of GDP). - In the 2007 budget, explicit subsidies for fuel imports eliminated except for a small kerosene subsidy. ### Public financial management and payroll/census - Authorities working to modernize public financial management: chart of accounts and budget classification being brought in line with GFSM 2001 within a cash accounting framework. - Financial Management Information System (FMIS) has been used on a trial basis since January 2007; legacy systems to continue in parallel until FMIS fully operational. - Census of public service employees has started; preparations completed and questionnaires sent to most relevant agencies. Data collection phase expected to be completed by end-November (2007). The census is linked to preparations for a computerized payroll and has faced delays due to the security situation. *Source: IMF staff report (text from content unit)._ ### 33. The authorities indicated that they are actively seeking to have the amendments ### _cr07301 - 33. The authorities indicated that they are actively seeking to have the amendments ### Pension Law Amendments and Social Safety Net - The new pension law passed in November 2005 is described as fiscally unsustainable over the medium term. - Authorities are actively seeking to have amendments to the new pension law enacted by the CoR as soon as possible (SMEFP-3,¶15). - Amendments, once enacted, will: - provide for a gradual reduction of replacement rates to sustainable levels; - provide for zero indexation in 2007, in line with earlier understandings with Fund staff. - Progress is being made in streamlining the social safety net (SMEFP-3,¶17). ### Monetary and Exchange Rate Policy - The CBI will continue to manage the exchange rate to reduce inflation and reverse dollarization; monetary policy will be further tightened if the inflation situation required this (SMEFP-3,¶11). - Authorities committed to allow the exchange rate to appreciate gradually in the coming months, while closely monitoring effects and adjusting pace as needed. - The authorities intend to maintain the link of the dinar to the dollar; absent an effective monetary transmission mechanism and indirect monetary policy instruments, the CBI will continue relying on the exchange rate as the principal nominal anchor. - The exchange rate will remain the main policy instrument, backed up as needed by adjustments in the policy interest rate. - Due to data limitations and structural changes, it is not possible to estimate the equilibrium real exchange rate. - Improvements in terms of trade over the past three years and higher current government spending in 2006 have most likely resulted in an appreciation of the equilibrium real exchange rate. - With a nominal exchange rate fixed to the dollar for most of the past two years, the adjustment of the real exchange rate to its new equilibrium was reflected in persistent high core inflation. - Allowing the exchange rate to appreciate and the subsequent drop in inflation have significantly reduced the undervaluation of the exchange rate, though the real exchange rate likely remains somewhat undervalued as core inflation is still high. - Authorities agreed that the nominal exchange rate should appreciate further to help contain inflationary expectations; gradual appreciation is believed to have minimal impact on competitiveness given Iraq’s main export commodity is oil and the need for security and productivity-enhancing structural reforms to achieve lasting competitiveness gains. - Iraq continues to maintain a liberal exchange regime; in practice there are no restrictions on current and capital transactions as long as underlying transactions are supported by valid documentation. - It remains unclear whether Iraq maintains exchange restrictions subject to Fund jurisdiction as staff review of exchange regulations is ongoing; authorities have submitted exchange regulations and recently provided requested clarifications. ### CBI Governance, Audits, and Safeguards - The CBI’s external audit firm, Ernst and Young (E&Y), issued in July an interim audit report of the CBI 2006 financial statements summarizing control weaknesses and recommending remedial measures (SMEFP-3,¶19). - The CBI indicated commitment to addressing all of E&Y’s audit observations during the course of this year, so improvements would be reflected in the 2007 financial accounts as far as possible. - The CBI has made some progress in addressing concerns raised by staff and E&Y in the interim safeguards assessment report (ISAR) and the audit of 2005 CBI financial accounts (SMEFP-3,¶20). - The CBI Board adopted a timetable envisaging full implementation of International Financial Reporting System (IFRS) as the CBI’s financial reporting framework by end-2009. - The capital of the CBI was increased to the statutory level of ID 100 billion in February 2007. - Work is underway to address the lack of proper accounting records and to establish adequate control procedures for reserves management. ### Financial Sector Reform - Authorities continue to expand coverage of the new payment system (SMEFP-3,¶21); the CBI will continue to encourage banks to connect to the real time gross settlement payment system and the automated clearing house, and expected to cover most banks by end-2007. - Memoranda of Understanding (MoUs) signed in December 2006 between the CBI and the ministry of finance for restructuring the two largest state-owned banks are being implemented (SMEFP-3,¶22). - An international auditor has been selected to conduct operational and financial audits of both banks; audits are expected to be completed by early 2008. - Restructuring of the remaining state-owned banks will be initiated later this year, in line with the approach adopted with Rasheed and Rafidain banks. - The CBI issued implementing regulations for the 2004 Anti-Money Laundering (AML) law in September 2006; a new AML office was set up within the CBI to implement these regulations. ### Banking Sector Structure and Intermediation (Box 4) - As of end-2006, Iraq’s banking sector comprised seven state-owned banks (SOBs) and 22 private banks. - Consolidated assets totaled about $26 billion (or 51 percent of GDP). - SOBs account for 90 percent of the banking sector total assets (70 percent for Rafidain and Rasheed banks alone). - Total loans portfolio of the banks was $2.2 billion (4 percent of GDP) at end-2006, mostly in the form of overdrafts, despite credit to the private sector more than doubling in 2006. - Total deposits in the banking sector were $12.9 billion (26 percent of GDP). - Financial intermediation is weak; banks’ asset composition is heavily tilted toward government securities and few banks offer loans with more than one year maturity. - Banking supervision has improved over the past two years, moving from a rule-based to a risk-based system, aided by Fund technical assistance. ### Other Structural Issues - Negotiations on a new legal framework for the oil sector are ongoing (SMEFP-3,¶23); the envisaged legal framework is provided by four draft laws: the draft hydrocarbon law and three accompanying draft laws reestablishing the Iraq National Oil Company, reorganizing the ministry of oil, and setting parameters for revenue distribution and intragovernmental fiscal relations. - Authorities attach great importance to enhancing transparency and fighting corruption in the oil sector (SMEFP-3,¶24). - Oil meters at the Basra export terminal have become operational for the most part; implementation of a comprehensive country-wide metering system is still underway. - Authorities intend to join the Extractive Industries Transparency Initiative; as a first step, the ministry of oil will start, during the second half of the year, to publish oil-related data on its website. - Authorities are rehabilitating commercially viable state-owned enterprises (SMEFP-3,¶25); about 21 public enterprises have been selected in cement, textile, pharmaceutical, and petrochemical sectors and have submitted business plans to Rasheed and Rafidain banks to obtain financing. - The new investment law (Presidential Council, November 2006) covers all areas of investment except banking, insurance, and oil and gas extraction/production, promotes equal treatment for investors, establishes national and regional investment commissions and one-stop agencies, specifies rights (e.g., leasing land up to 50 years renewable), benefits, and obligations, and provides various tax holidays (Box 5). - An investment project may be exempted from taxes for a period of 10 years after commercial operation starts. - Imported assets for the project would be exempted from customs duties, provided they are brought into Iraq within three years from the date of granting the investment license. - Iraq maintains an open trade regime and has made significant progress in WTO accession. - Authorities intended to maintain the 5 percent custom duty (reconstruction levy) on imports while reducing numerous exemptions. - Working Party on Iraq’s WTO accession met for the first time in Geneva in May 2007; Iraqi delegation met bilaterally with representatives of more than ten WTO members and was invited to submit initial offers to advance market access negotiations on goods and services. - Authorities reiterated commitment to resolving remaining external claims (SMEFP-3,¶28); official contacts established with key creditor countries in the Gulf region and China, debt negotiation and reconciliation ongoing. - Authorities hoped the SPV for debt securitization would facilitate negotiations with other official creditors. - Expected that liquidation of the London branch of Rafidain Bank could be completed by end-2007, enabling completion of resolution of all private claims. ### Program Monitoring and Financing Assurances - All quantitative performance criteria set for end-March 2007 were met; there have been slippages in structural conditionality (Tables 7 and 8). - Measures set as structural performance criteria for end-May and end-June are expected to be implemented partially or with delay; waivers are sought for the following performance criteria (LOI, ¶4): - The audit of CBI net international reserves data was completed on time but the interim audit report of the CBI 2006 financial accounts was delayed and was completed on July 15. - Adoption of a fully detailed budget classification and chart of accounts in line with the IMF’s GFSM 2001 within a cash accounting framework is expected shortly. Progress was hampered by the kidnapping of an external consultant in May. - The census of public service employees, while in progress, was not completed by end-June as planned due mainly to the prevailing security situation and linkage to preparation for a computerized payroll. - Authorities requested an extension of the SBA until December 28, 2007 to keep a policy framework in place during discussions for a successor arrangement they intend to seek (LOI, ¶3). - Authorities requested a waiver of applicability for all the end-June quantitative performance criteria; data to verify performance against these targets will not be available by the time of the Board discussion scheduled for August 1. - For an SBA extension of three months to December 2007, authorities requested establishment of the quantitative performance criteria proposed in the SMEFP-3 for end-September and redefinition/rescheduling of the structural performance criterion on completion of the census to completion of data collection for the census of all public service employees by end-November 2007. - Authorities requested that the penultimate purchase linked to the fifth review and the last purchase available upon observance of the end-June 2007 performance criteria be rephased, while leaving total access under the arrangement unchanged (Table 10). - If arrears to private creditors remain by end of the program period, a financing assurances review will be undertaken. ### Staff Appraisal: Findings, Risks, and Policy Recommendations - Recent economic difficulties stem from unsettled political situation and deterioration in security in 2006; reconstruction and investment have proceeded slowly, keeping oil production low and hampering growth; shortages contributed to sharply rising inflation in 2006. - Staff commends authorities for strengthening economic policies and progress in structural reforms, including intensifying policy response to reduce inflation and increasing fuel prices to regional levels. - Main economic challenges and required actions: - Increase economic growth and further reduce inflation by: - speeding up reconstruction and increasing investment, especially in the oil sector; - continuing macroeconomic policies to bring inflation further down; - pressing ahead with priority structural reforms. - Medium-term outlook is promising given current favorable world oil price projections, but available resources will be limited in the next few years (expected oil revenues, domestic revenues, assets held in the Development Fund for Iraq, and some remaining external grants), so fiscal prudence is of utmost importance. - Significant downside risks include volatile world oil prices and the political and security situation. - Staff welcomes government commitment to keep current spending in 2007 within budget limits and to maintain fiscal sustainability over the medium term; this requires resisting undue spending pressures and strictly containing the wage bill, pensions, and transfers. - It remains crucial that pension law amendments be enacted soon to ensure long-run fiscal sustainability of the pension system. - Staff welcomes recent increase in official fuel prices, enabling government to avoid direct subsidies on fuel products except for kerosene. - Expansion of the new social safety net and rationalization of the Public Distribution System are encouraging. - Staff supports CBI decision to allow gradual appreciation of the dinar through end-2007 to reduce inflation and dollarization and help correct modest undervaluation of the exchange rate in light of favorable terms of trade. - CBI should monitor inflation closely and be ready to increase the pace of appreciation and tighten monetary conditions if inflation deviates upward or dollarization is not reduced. - Government can assist by restraining public spending pressures on the small non-oil economy and supporting private sector fuel imports to reduce shortages. - Priority structural reforms to be implemented expeditiously as circumstances permit: - Modernize chart of accounts and budget classification and broaden coverage of the FMIS. - Modernize and streamline the tax system to expand the tax base and improve incentives for economic activity. - Press ahead with restructuring of the banking system to enhance banks’ role in financing new investments. - Ensure any government financial support to rehabilitated public enterprises is efficient and fully reflected in the budget. - Put in place a new legislative framework for the hydrocarbon sector as soon as possible to support large investment needs to increase oil production. *Source: _cr07301 - 33. The authorities indicated that they are actively seeking to have the amendments* ### 61. Staff welcomes the authorities’ intention to maintain open trade and investment ### 61. Staff welcomes the authorities’ intention to maintain open trade and investment ### Trade and investment regime - Staff welcomes the authorities’ intention to maintain open trade and investment regimes, and supports their efforts to secure WTO accession. - While keeping the present low import tariff (reconstruction levy), it is important to increase revenues by scaling down exemptions and strengthening the customs administration. - The new investment law provides an important framework to attract much-needed foreign investment, although the numerous tax holidays seem excessive. - Staff encourages the authorities to establish the National Investment Commission as soon as possible. ### Exchange regime and Article VIII - Staff welcomes the authorities’ intention to establish a liberal exchange regime and is in the process of examining additional information provided by the authorities to determine whether or not any exchange restrictions exist that might fall under Fund jurisdiction. - Staff urges the authorities to remove any such restrictions, and encourages them to subsequently accept the obligations under Article VIII, Sections 2(a), 3, and 4. ### Public financial management and governance - Staff urges the authorities to improve the transparency and accountability of public financial management and step up their fight against corruption, which hurts the economy and undermines the credibility of their reform program. - Staff underscores the need to put in place a comprehensive oil metering system and encourages the authorities to follow up on their intention to join the EITI. ### Central Bank safeguards - Staff welcomes the steps taken in the central bank safeguards area and urges the CBI to address all recommendations of the ISAR and the interim audit report on its 2006 financial statements. - Satisfactory progress in this area will be important in securing a successor arrangement. ### Debt resolution - Staff urges the authorities to continue their efforts to conclude debt agreements with the remaining official and private creditors. - However, despite good faith efforts by the authorities, the process of resolving Iraq’s debt to non-Paris Club official creditors remains slow. ### Statistics - Staff underscores the importance of further improving the statistical database, notably as regards real sector data, the balance of payments, and public finances. ### SBA review and IMF requests - Staff recommends that the fifth review under the SBA be completed. - In view of the authorities’ commitment to the program, and the policies and measures described in the third SMEFP, staff supports the authorities’ request for: - (i) a waiver of applicability of end-June quantitative performance criteria; - (ii) waivers for the nonobservance of the end-May and end-June structural performance criteria; - (iii) an extension of the SBA through December 28, 2007, and the rephasing of purchases under the SBA; - (iv) the establishment of quantitative performance criteria for end-September 2007; and - (v) the setting of a new structural performance criterion (relating to the census of public sector employees) for end-November 2007. ### Financing assurances review - Staff supports the completion of the financing assurances review. - Staff believes that Iraq is making best efforts to reach bilateral agreements on its arrears to official non-Paris Club creditors and that the authorities have been negotiating in good faith to resolve the remaining arrears to private creditors, consistent with the Fund’s policy on lending into arrears. * _cr07301 - 61. Staff welcomes the authorities’ intention to maintain open trade and investment_* ### 69. It is proposed that the next Article IV consultation be held according to the provisions ### _cr07301 - 69. It is proposed that the next Article IV consultation be held according to the provisions ### Overview - It is proposed that the next Article IV consultation be held according to the provisions applying to countries with Fund arrangements. - Sources: Iraqi authorities and Fund staff estimates and projections. ### Macroeconomic projections and key real sector indicators (selected items, 2004–12) - Real GDP (percentage change): 46.5 2.6 -0.7 10.4 6.2 6.3 5.3 8.2 10.2 11.7 10.6 - Non-oil real GDP (percentage change): 14.9 8.0 12.0 8.0 7.5 5.0 6.0 7.0 7.0 7.0 7.0 - GDP per capita (US$): 951 1,189 1,124 1,452 1,722 2,109 2,321 2,510 2,730 3,049 3,369 - GDP (US$ million): 25,763 33,182 31,375 41,741 49,516 62,384 70,578 78,391 87,489 100,136 113,330 - Oil production (In mbpd): 2.0 2.0 1.9 2.3 2.0 2.1 2.2 2.4 2.7 3.1 3.5 - Oil exports (In mbpd): 1.4 1.4 1.4 1.6 1.5 1.6 1.6 1.8 2.0 2.5 2.9 - Iraq oil export prices (US$ pb): 31.6 43.0 43.9 46.6 55.7 50.6 55.8 56.0 54.8 54.5 54.5 - Population growth (in percent): 3.0 3.0 3.0 3.0 3.0 2.9 2.8 2.7 2.6 2.5 2.4 - Consumer price inflation (percentage change; end of period): 31.7 20.0 31.6 15.0 64.8 30.0 12.0 7.0 5.0 5.0 5.0 - Exchange rate (dinar per US$; period average) 1/ for 2007 average is for January–June: 1,453 1,500 1,469 1,500 1,467 1,275 ............... ### Public finance and fiscal balances (selected indicators, in percent of GDP unless otherwise indicated) - Total government debt (in billions of US$): 97.6 51.2 68.9 52.2 54.7 56.4 59.4 62.5 65.2 63.7 61.7 - Government revenue and grants: 79.6 93.6 107.4 96.3 80.5 62.3 59.0 55.6 56.4 58.4 59.8 - Government oil revenue: 69.2 67.8 76.6 72.9 65.2 51.1 51.3 52.1 53.1 55.3 56.8 - Government non oil revenue: 1.3 2.6 2.8 3.0 2.9 2.9 3.2 3.3 3.2 3.1 3.0 - Grants: 9.1 23.2 27.9 20.4 12.5 8.3 4.5 0.2 0.0 0.0 0.0 - Expenditure: 120.8 104.5 96.6 105.3 68.5 72.0 65.7 60.1 58.3 56.9 54.7 - Current expenditure: 98.6 78.9 77.2 80.0 55.5 56.1 49.7 44.8 43.5 42.6 40.5 - Capital expenditure: 22.2 25.6 19.4 25.3 13.0 15.8 15.9 15.3 14.8 14.3 14.1 - Overall fiscal balance (including grants): -41.2 -10.9 10.9 -9.0 12.0 -9.7 -6.6 -4.5 -1.9 1.5 5.1 - Primary fiscal balance: -40.2 -10.8 11.1 -8.2 12.5 -9.0 -5.7 -3.1 0.2 4.6 7.7 - Gross borrowing/use of external assets: 43.0 11.9 6.4 9.3 -2.3 8.4 5.4 3.4 1.9 1.6 -2.4 - Amortization: 1.8 0.6 0.5 0.3 2.5 0.3 0.0 0.0 0.0 3.1 2.8 ### Fiscal and oil sector accounts (in billions of ID; Table highlights, 2008–12 projections) - Revenues and Grants (2008–12): 29,784 45,490 49,505 60,316 58,497 48,453 56,997 62,528 72,734 88,628 105,641 - Revenues (2008–12): 26,376 34,211 36,655 47,529 49,430 41,987 52,645 62,298 72,671 88,596 105,625 - Crude oil export revenues (2008–12): 25,108 31,919 33,896 42,109 43,736 35,666 44,537 51,818 60,164 73,924 88,472 - Grants (2008–12): 3,408 11,279 12,850 12,787 9,067 6,466 4,352 230 633 216 0 - Expenditures (2008–12): 45,202 50,797 44,497 65,935 49,756 55,983 63,399 67,565 75,185 86,369 96,590 - Current expenditures (2008–12): 36,887 38,368 35,560 47,698 40,188 42,531 46,692 48,827 54,369 62,756 69,467 - Salary and pension (2008–12): 4,532 8,591 9,282 12,899 10,959 15,244 17,323 18,636 19,836 21,836 23,804 - Investment expenditures (2008–12): 8,314 12,430 8,936 15,862 9,464 12,315 15,370 17,201 19,079 21,676 24,985 - Balance (including grants, 2008–12): -15,417 -5,308 5,008 -5,619 8,741 -7,530 -6,402 -5,037 -2,451 2,259 9,051 - Balance (excluding grants, 2008–12): -18,826 -16,587 -7,842 -18,404 -326 -13,996 -10,754 -5,267 -2,514 2,227 9,035 - Financing (of which external financing, 2008–12): 14,893 5,308 -2,095 5,619 -6,354 7,530 6,402 5,037 2,451 -2,259 -9,051 - External financing (2008–12): 15,426 5,484 2,721 5,619 -3,522 6,330 5,202 3,837 2,451 -2,259 -9,051 - Assets held abroad (2008–12): 10,127 2,528 1,462 5,411 -2,147 6,001 3,621 1,765 121 58 -5,925 - Amortization (2008–12): 670 293 227 205 1,833 209 0 0 4,692 4,860 0 - Primary fiscal balance (memorandum): -15,048 -5,239 5,094 -5,136 9,054 -6,981 -5,494 -3,469 210 6,954 13,650 - Non-oil primary fiscal balance (memorandum): -33,159 -27,759 -22,696 -39,338 -29,973 -40,817 -48,124 -53,261 -58,338 -65,201 -73,333 - External assets held abroad (memorandum): 6,650 5,988 9,111 428 11,996 5,995 2,375 610 489 431 6,357 ### Monetary indicators and central bank (selected items) - Growth in reserve money (annual growth, percent): 116.9 12.9 12.0 20.6 29.0 38.9 20.3 ............ - Gross reserves (In US$ million): 7,902 9,311 12,024 11,013 18,723 21,313 24,279 26,391 29,149 31,150 33,306 - Gross CBI foreign exchange assets/Reserve money (percent): 94.4 98.8 129.4 99.2 147.4 109.5 113.7 ............ - In months of imports of goods and services (gross reserves): 3.2 3.1 5.4 3.6 6.2 6.9 7.8 8.0 8.0 7.9 7.9 - Policy interest rate (end of period) 2/ (for 2007, as of January 7): 6.0 7.0 7.0 7.0 16.0 20.0 ............... - Central bank reserves (increase -): -26.3 -4.2 -13.1 -4.0 -13.5 -4.2 -4.2 -2.7 -3.2 -2.0 -1.9 Central Bank Survey (selected balance sheet items, in billions of ID) - Net foreign exchange assets: 10,743 17,078 12,993 25,413 15,869 21,713 25,073 31,352 36,042 - Foreign exchange assets: 11,538 17,724 13,639 26,043 16,515 22,308 25,668 31,981 36,333 - Reserve money (levels): 12,228 13,698 13,804 17,664 16,646 19,066 18,807 24,531 29,508 - Currency outside banks (levels): 7,163 9,110 8,815 10,789 10,949 11,560 11,600 15,289 18,695 - Currency issued (levels): 8,021 10,257 9,679 11,917 12,022 12,924 12,963 16,886 20,499 - Gross foreign exchange assets (in millions of U.S. dollars; memorandum): 7,941 12,067 9,346 17,749 11,012 17,469 20,195 21,313 24,279 ### Balance of payments and external sector (selected items, 2004–12) - Trade balance (US$ millions): -2,173 -1,636 1,024 476 6,932 -1,410 1,283 3,701 6,111 10,257 15,314 - Exports (US$ millions): 17,782 22,781 19,772 28,745 28,412 29,488 33,518 37,195 41,814 49,826 57,879 - Crude oil exports: 17,329 22,176 19,184 28,073 27,692 28,601 32,558 36,147 40,809 48,758 56,741 - Imports (US$ millions): -19,955 -24,416 -18,748 -28,269 -21,480 -30,898 -32,235 -33,494 -35,702 -39,569 -42,565 - Income, net: -5,159 -3,741 -3,349 -2,237 -1,344 -1,202 -1,448 -1,529 -1,988 -2,154 -2,113 - Services, net: -4,325 -6,477 -6,119 -7,093 -5,317 -5,224 -4,520 -3,551 -3,788 -4,209 -4,532 - Transfers, net: 1,980 7,090 8,290 7,721 5,394 4,545 2,676 -345 -500 -859 -1,213 - Private transfers (incl. NGOs): 500 500 500 600 600 790 1,123 1,302 1,498 1,558 1,603 - Official transfers: 1,480 6,590 7,790 7,121 4,794 3,755 1,553 -1,647 -1,998 -2,417 -2,816 - Current account (US$ millions): -9,678 -4,763 -154 -1,133 5,666 -3,291 -2,009 -1,725 -165 3,036 7,457 - Current account (percent of GDP): -37.6 -14.4 -0.5 -2.7 11.4 -5.3 -2.8 -2.2 -0.2 3.0 6.6 - Financial account (US$ millions): 11,018 6,172 3,639 2,821 1,932 5,945 4,975 3,837 2,922 -1,034 -5,301 - Direct investment (US$ millions): 200 300 400 300 300 400 600 750 1,311 1,588 1,973 - Overall balance (US$ millions): 1,701 1,409 3,508 1,688 7,488 2,655 2,966 2,112 2,757 2,002 2,156 - Overall balance (percent of GDP): 6.6 4.2 11.2 4.0 15.1 4.3 4.2 2.7 3.2 2.0 1.9 - Central bank reserves (levels): 7,902 9,311 12,024 11,013 18,723 21,313 24,279 26,391 29,149 31,150 33,306 - Central bank reserves (in months of imports of goods): 3.2 3.1 5.4 3.6 6.2 6.9 7.8 8.0 8.0 7.9 7.9 ### Debt, arrears, and financing (selected items) - Change in arrears (net, decrease -): -34,723 -27,987 -32,448 -1,195 -16,005 -962 0 0 0 0 0 - Debt forgiveness (notional): 34,538 27,987 33,062 1,195 15,215 898 0 0 0 0 0 - Amortization (Table 6 memorandum): 0 -200 -115 -136 -281 -103 0 0 -3,095 -3,117 ### Quantitative performance criteria, indicative targets, and structural benchmarks (SBA 2005–07) - Performance criteria and indicative targets (selected): - Net international reserves of the CBI (floor; in millions of U.S. dollars): target examples include 8,500 and -1,000 (estimated), with actual cumulative changes from September 2005 shown as +3,041, +3,635, +3,554, +5,252, +9,770, +8,503. - Government primary fiscal deficit (ceiling; deficit [+]/surplus[-]): illustrative cumulative flows include 5,400 1,950 3,600 4,850 5,300. - Government wage and pension bill (ceiling; cumulative flows shown): 6,650 2,400 4,750 7,100 9,500 2,525 5,050 7,575 (Actual values shown: 7,069 2,051 3,898 5,875 7,792 1,644). - Revenue of oil related enterprises remitted to budget (floor): program flows include ... 900 700 1,500 2,100 2,800; actuals: 1,456 509 1,454 2,651 3,611 1,135. - Government imports of petroleum products (ceiling): program flow examples: ... 6,000 1,700 3,400 4,000 4,200 100 200 300; actuals: 4,128 1,045 1,884 3,120 4,082 104. - Structural performance criteria and benchmarks (status highlights): - Avoid administrative measures limiting participation or bids in the CBI's regular auction of foreign exchange other than screening related to anti-money laundering or counter-terrorism: Continuous — Met. - Final audit of CBI 2005 financial operations and statements (May 15, 2006): Waived; Completed on October 1, 2006. - Adoption of fully detailed budget classification and chart of accounts (June 30, 2007): Not met. Expected soon. - Completion by Ernst & Young of NIR audit and interim audit report (May 31, 2007): NIR audit completed on time; interim audit report completed on July 15. - Completion of census of all public service employees (central government and military) (June 30, 2007): Not met; replaced with a new PC. New deadline: Completion of the data collection for the census by November 30, 2007. - Implementation of payment system regulations (June 30, 2006): Met. - Establishment of an audit oversight committee effective by December 31, 2006: Met in November 2006; IAMB mandate extended to December 31, 2007. - Reform of pension law in line with sustainable pension system (September 30, 2006): Underway. - Approval by Council of Representatives of law liberalizing private gasoline imports (September 30, 2006): Met. - Commencement of operation of RTGS linking banks to CBI (August 31, 2006): Met. - Commencement of ACH payments clearing (November 30, 2006): Met. - Full capitalization of CBI to ID 100 billion (by December 31, 2006): Met in February 2007. - Adopt a CBI Board-approved timetable for full implementation of IFRS as the bank’s financial reporting framework (March 31, 2007): Met on April 1, 2007. - Appoint internationally reputable audit firm to audit Rasheed and Rafidain banks based on 2006 accounts (April 30, 2007): Underway; auditor selected and appointment process ongoing. - Address lack of proper accounting records at the CBI (June 30, 2007): Underway. - Establish adequate control procedures for reserves management, including developing reserves management policy and investment guidelines (June 30, 2007): Underway. ### Indicative quantitative benchmarks (fuel prices and related items) - Official domestic prices of petroleum products (Iraqi dinars per unit; selected program/actual prices by dates): - LPG (per 12 kg cylinder): program/actual paths include values such as 250 600 700 600 800 1,000 900 1,000 1,000 1,000 3,000 3,000 3,000. - Regular gasoline: sample values across reviews include 20 100 130 100 155 175 175 175 200 250 300 350 400. - Premium gasoline 1/: 50 250 300 250 350 350 400 350 450 350 ... (note: Starting 2007, premium gasoline is to be sold only by the private sector at unregulated prices.) - Kerosene: 5 25 50 25 75 75 90 75 115 75 150 200 150. - Diesel: 10 90 110 90 125 125 155 150 175 150 350 350 400. - Table dates include program checkpoints such as 03/31/06, 06/30/06, 09/30/06, 12/31/06, 03/05/07, 06/30/07. ### Fund access and availability under the Stand-By Arrangement (2007 schedule) - Current schedule availability amounts and dates (SDR; percent of quota): - March 12, 2007: SDR 316,906,668 (26.67 percent) — Completion of third and fourth reviews and observance of end-December 2006 performance criteria. - May 15, 2007: SDR 79,226,667 (6.67 percent) — Completion of fifth review and observance of end-March 2007 performance criteria. - August 15, 2007: SDR 79,226,665 (6.67 percent) — Observance of end-June 2007 performance criteria. - Total access: SDR 475,360,000 (40.00 percent). - Proposed new schedule (2007): - August 1, 2007: SDR 369,724,447 (31.11 percent) — Completion of fifth review and observance of end-March 2007 performance criteria. - September 15, 2007: SDR 52,817,777 (4.44 percent) — Observance of end-June 2007 performance criteria. - December 15, 2007: SDR 52,817,776 (4.44 percent) — Observance of end-September 2007 performance criteria. - Total access (proposed new schedule): SDR 475,360,000 (40.00 percent). ### Indicators of Fund credit and obligations (2004–11, selected) - Disbursements of Fund credit: - EPCA: 297.1 (2004 level) then 0.0 thereafter in table. - SBA disbursements indicated as 0.0 0.0 0.0 475.4 0.0 0.0 0.0 0.0. - Outstanding Fund credit (SDRs, selected years): EPCA 297.1 (persisting until 2007 then 148.6 0.0 0.0); SBA outstanding reaching 475.4 then 475.4 422.5 184.9 0.0. - Total obligations (selected items, in SDRs): Clearance of arrears: 55.3; Total obligations across years: 56.0 10.5 14.4 15.4 187.1 232.0 256.7 190.9. - Total outstanding Fund credit as percent of IMF Quota: 25.0 25.0 25.0 65.0 52.5 35.6 15.6 0.0. *Sources: Iraqi authorities and Fund staff estimates and projections.* ### 1. Iraq has received substantial debt reduction from official and private creditors, but the ### 1. Iraq has received substantial debt reduction from official and private creditors, but the ### External debt stock and impact of debt reduction - Latest estimates of external debt: - $69 billion (220 percent of GDP) at end-2005. - $55 billion (111 percent of GDP) at end-2006. - Assumption: debt reduction comparable to the Paris Club agreement is applied to non-Paris Club creditors’ claims. - Without the third stage of debt reduction, external debt would increase to about $62 billion (about 55 percent of GDP) by 2012. - The third stage reduction (expected in 2008) would reduce Iraq’s external debt to about $36 billion (32 percent of GDP) by 2012. - Medium-term projections assume that new debt disbursement is mostly from multilateral creditors and Japan. - Notes: - The third stage of debt reduction would be contingent on Iraq completing the final review of the third year of upper credit tranche arrangements with the Fund. - The assumptions made in the debt stock table are for purposes of illustration and discussion only; debt reconciliation is ongoing and IMF use of unreconciled data does not amount to recognition or denial of particular claims. ### Debt service and timing of repayments - Based on the Paris Club agreement in 2004: - Repayment of the remaining debt stock would start in 2011. - Interest payments accrued during 2005–10 are mostly capitalized. - Debt service dynamics: - Debt service would be relatively small until 2010 before it increases to about 10 percent of exports in 2011. - Table entries (selected): - Total debt service (with third stage in 2008): ...0.20.21.20.40.70.81.03.23.2 (annual series shown in source table). - Total debt service (without third stage): ...0.20.21.20.40.71.11.76.16.0 (annual series shown in source table). - Simulations for two oil shocks indicate significant borrowing needs: - Production shock: oil production constant at 2.0 mbpd in 2007–08 followed by a gradual production increase of 0.2 mbpd per year. - Price shock: oil export price lower by $4.5 per barrel during 2008–12 (equivalent to one standard deviation). - These simulations show Iraq would require significant borrowing from international markets to close financing gaps (Appendix, Table 2). ### External Debt Sustainability Framework (selected indicators and projections) - External debt (percent of GDP) series (estimates/projections from source table): - 2004: 512.0 percent of GDP (table shows "In percent of GDP 512.0" corresponding to 2004 row). - 2005: 378.9 - 2006: 219.5 - 2007: 110.5 - 2008: 90.4 - 2009: 84.2 - 2010: 79.7 - 2011: 74.6 - 2012: 63.6 (without third stage) and 36.6 (with third stage according to other rows) - Change in external debt (selected annual values from source table): - 2005: -159.5 - 2006: -108.9 - 2007: -20.2 - 2008: -6.2 - 2009: -4.5 - 2010: -5.1 - 2011: -10.9 - 2012: -9.2 - Identified external debt-creating flows (selected): - Current account deficit, excluding interest payments series: 17.2 (2005), -11.6 (2006), -16.0 (2007), 1.4 (2008), -0.8 (2009), -1.2 (2010), -3.0 (2011), -5.9 (2012), -9.1 (2013) — (table format preserved from source). - Exports (U.S. dollar terms): 69.0 (2004), 63.5 (2005), 57.7 (2006), 47.5 (2007), 47.7 (2008), 47.7 (2009), 48.0 (2010), 49.9 (2011), 51.2 (2012) — (series shown in source table). - Imports (U.S. dollar terms): 94.2 (2004), 79.7 (2005), 54.4 (2006), 58.2 (2007), 52.3 (2008), 47.5 (2009), 45.3 (2010), 43.9 (2011), 41.7 (2012) — (series shown in source table). - External debt-to-exports ratio (in percent) series: - 2004: 549.0 - 2005: 345.8 - 2006: 191.7 - 2007: 190.2 - 2008: 176.5 - 2009: 167.2 - 2010: 155.4 - 2011: 127.4 - 2012: 106.3 - Gross external financing need (in billions of US dollars) series: - 2004: 10.0 - 2005: 0.3 - 2006: -5.5 - 2007: 3.4 - 2008: 2.0 - 2009: 1.8 - 2010: 0.2 - 2011: 0.1 - 2012: -4.3 - External debt service in percent of exports series: - 2004: 29.5 - 2005: 19.7 - 2006: 8.9 - 2007: 8.6 - 2008: 7.7 - 2009: 7.3 - 2010: 6.8 - 2011: 12.1 - 2012: 10.3 - Debt-stabilizing non-interest current account (positive = surplus) series: - 2004: -673.7 - 2005: -147.9 - 2006: -92.9 - 2007: -21.6 - 2008: -5.4 - 2009: -3.3 - 2010: -2.1 - 2011: -5.0 - 2012: -0.1 ### Key macroeconomic assumptions and stress scenarios (selected) - Real GDP growth (in percent) series: - 2004: 46.5 - 2005: -0.7 - 2006: 6.2 - 2007: 6.3 - 2008: 5.3 - 2009: 8.2 - 2010: 10.2 - 2011: 11.7 - 2012: 10.6 - GDP deflator in U.S. dollars (change in percent) series: - 2004: 38.0 - 2005: 22.7 - 2006: 48.6 - 2007: 18.5 - 2008: 7.5 - 2009: 2.6 - 2010: 1.2 - 2011: 2.5 - 2012: 2.3 - Nominal external interest rate (in percent) series: - 2004: 4.0 - 2005: 3.9 - 2006: 3.3 - 2007: 4.5 - 2008: 4.6 - 2009: 4.6 - 2010: 4.6 - 2011: 4.6 - 2012: 4.5 - Growth of exports (U.S. dollar terms, in percent) series: - 2004: 91.7 - 2005: 12.0 - 2006: 43.4 - 2007: 3.8 - 2008: 13.6 - 2009: 10.9 - 2010: 12.4 - 2011: 19.1 - 2012: 16.1 - Growth of imports (U.S. dollar terms, in percent) series: - 2004: 203.7 - 2005: 3.0 - 2006: 7.7 - 2007: 34.6 - 2008: 1.7 - 2009: 0.8 - 2010: 6.6 - 2011: 10.9 - 2012: 7.6 - Limited oil production scenario assumptions: - Assumes oil production is constant at 2.0 mbpd in 2007-08, followed by a gradual production increase of 0.2 mbpd per year. - Lower oil price scenario assumptions: - Assumes that oil price in 2008–12 is US$4.5 lower than in the baseline, equivalent to one standard-deviation shock. - Memorandum items — real GDP growth under stress scenarios (in percent): - Limited oil production: -0.7 (2005), 6.2 (2006), 3.4 (2007), 2.5 (2008), 8.7 (2009), 8.2 (2010), 7.8 (2011), 7.4 (2012). - Lower oil price in 2007–11: -0.7 (2005), 6.2 (2006), 6.3 (2007), 5.3 (2008), 8.2 (2009), 10.2 (2010), 11.7 (2011), 10.6 (2012). - Memorandum items — non-interest current account deficit under stress scenarios (in percent of GDP): - Limited oil production: -11.6 (2005), -16.0 (2006), 3.7 (2007), 3.5 (2008), 2.7 (2009), 2.6 (2010), 1.7 (2011), 0.1 (2012). - Lower oil price in 2007–11: -11.6 (2005), -16.0 (2006), 1.4 (2007), 1.8 (2008), 1.4 (2009), -0.4 (2010), -3.4 (2011), -6.5 (2012). ### Stand-By Arrangement (SBA), program implementation, and policy priorities - Timeline and reviews: - SBA approved December 23, 2005. - First and second reviews completed August 2, 2006. - Third and fourth reviews completed March 12, 2007. - Arrangement extended to September 28, 2007 to allow more time to reach objectives and complete reforms. - Request to extend current SBA by three months to December 28, 2007 to keep policy framework in place during discussions for an envisaged successor arrangement. - Intention: completion of the final review of three years of implementation of upper credit tranche Fund arrangements by end-December 2008 to benefit from last stage of the 2004 Paris Club debt reduction agreement. - Iraq intends to continue to treat the SBA as precautionary (i.e., not intending to make purchases under the SBA that will become available after observance of performance criteria and completion of the fifth review). - Program performance and missed criteria: - Iraq met all quantitative performance criteria set for end-March 2007. - Structural performance criterion on completion by May 31, 2007 of an audit of the net international reserves of the Central Bank of Iraq (CBI) was met; interim audit report of the CBI 2006 financial accounts completed on July 15. - Structural performance criteria missed for end-June 2007: - Adoption of a chart of accounts and budget classification in line with the IMF’s Government Finance Statistics Manuel 2001. - Completion of a census of all public service employees by end-June 2007. - Requests: - Waivers for nonobservance of missed performance criteria and completion of the fifth review under the SBA. - Waiver of applicability of end-June quantitative performance criteria and establishment of quantitative performance criteria proposed in the third SMEFP for end-September 2007. - Rescheduling and redefinition of the missed performance criterion on completion of the census of all public service employees, as described in the third SMEFP. - Recent macroeconomic developments and policy actions (selected): - Inflation developments: - Annual consumer price inflation came down to 46 percent in June 2007, after reaching about 66 percent in January 2007. - Core inflation (excluding fuel and transportation) came down to 19 percent. - Real GDP growth: - Estimated at 6¼ percent in 2006, compared to 10½ percent projected at the outset of the program. - Lower-than-expected crude oil production averaged 2 million barrels per day (mbpd) in 2006 (target 2.3 mbpd). - Crude oil production averaged 1.9 mpbd in the first four months of 2007 (source text uses "1.9 mpbd" spelling). - Non-oil real GDP growth estimated at 7½ percent in 2006; expected at 5 percent in 2007. - Central Bank of Iraq (CBI) actions: - Appreciated exchange rate to ID 1,250 per dollar at end-June 2007 (a 15 percent appreciation since mid-November 2006). - Net international reserves reached $19.7 billion at end-April 2007. - Policy interest rate raised in two steps to 20 percent as of early January 2007. - Fiscal and budgetary stance: - Government of Iraq (GoI) ran a fiscal surplus through March 2007 because of underspending; budget execution accelerated in April 2007. - Oil revenue broadly on target (lower volumes offset by higher prices). - Mechanism of funding fuel imports through revolving credit to the Ministry of Oil worked well; disbursement from Ministry of Finance exceeded the indicative target. - GoI will continue keeping current spending within 2007 budget limits, resist undue wage and pension increases and bonuses, and strictly limit hiring to keep the wage bill within budgeted amounts. - Direct subsidies on fuel products will be avoided (except for a small subsidy for kerosene); domestic prices of regular and blended gasoline and diesel were raised as of July 1, 2007. - Investment and oil sector: - Focus on increasing investment, notably in the oil sector, to achieve growth objectives and maintain fiscal sustainability. - Measures to increase investment implementation: cabinet sub-committee on investment accelerated approval of large projects; procurement period reduced from 60-90 days to no more than 30 days; thresholds for projects approved at line-ministry or governorate level raised; timely budget allocations to line ministries. - Expectation: average crude oil production in 2007 to increase to 2.1 mbpd. - Program commitments: - Will consult with Fund staff in advance of revisions to policies contained in the third SMEFP. - Will provide the Fund with information requested on policy implementation and achievement of program objectives. - Consent to publication of the extension request letter, the third SMEFP, Addendum to the Technical Memorandum of Understanding, and the staff report on the 2007 Article IV consultation and the fifth review under the SBA. - Intention to initiate negotiations in the fall for a successor arrangement to achieve macro-economic stability, continue economic reform program, and reach the third and last stage of the 2004 Paris Club debt reduction agreement. *Source: IMF staff report text and accompanying tables from the Iraq SBA background documents (text and tables as provided).* ### 10. These policies, and taking account of the effect of a further appreciation of the ### _cr07301 - 10. These policies, and taking account of the effect of a further appreciation of the ### Fiscal policy and deficit management - Target to keep the overall government budget deficit below 10 percent of GDP. - Contingency: in case of a sizable shortfall of oil revenues or need to reallocate capital expenditure, the GoI intends, in consultation with Fund staff, to submit a supplementary budget to the Council of Representatives (CoR) to adjust government spending and keep the overall deficit in line with the level targeted in the 2007 budget. - By the end of 2007, aim to hold the equivalent of about ID 6 trillion in assets in the Development Fund for Iraq (DFI). - To preserve the option of domestic financing and maintain a market indicator for interest rates, plan to step up bi-weekly issuance of treasury bills to ID 150–200 billion. - SOMO will continue to use a revolving credit with a ceiling of ID 400 billion provided by the MoF to finance its imports of fuel products. ### Monetary policy, exchange rate, and inflation - Commitment to further reduce inflation through appropriate management of the exchange rate; the CBI will continue to allow the exchange rate to appreciate gradually in the coming months. - The CBI will closely monitor the effect of appreciation on dollarization and inflation and will adjust the pace of appreciation as needed. - The CBI’s exchange rate is considered the main policy instrument to bring down inflation; the CBI stands ready to further increase its policy interest rate if required. - Government support for anti-inflation policies includes avoiding excessive demand pressures and taking further measures to reduce commodity shortages, in particular of fuel products. ### Oil sector, fuel pricing, and private imports - GoI will facilitate private sector imports of petroleum products; about 20 licenses have been issued to private importers of fuel products and more are expected. - Private sector will be provided storage facilities and pump stations and the GoI will respond to impediments to private importation; security concerns limit private imports outside the Kurdish region. - Domestic fuel prices were raised to eliminate direct budgetary subsidies, except for a small subsidy on kerosene (Table 3). - As of July 1, domestic fuel prices: regular gasoline ID 400 per liter, blended gasoline ID 450 per liter, diesel ID 400 per liter. - GoI is willing to consider developing a rule–based mechanism for setting domestic fuel prices and will seek technical assistance on design and implementation. ### Public financial management, accounting, and pensions - Commitment to adopt a new chart of accounts and budget classification consistent with the Fund’s GFSM 2001 within a cash accounting framework (structural performance criterion for end-June 2007). - MoF began trial use of the Financial Management Information System (FMIS) in January 2007; legacy system to continue in parallel while coverage is increased. - Work underway to enter opening balances and budget transfers in FMIS, review accuracy of system output, and develop user requirements for purchasing and budget modules. - Amendments to the new pension law: gradual reduction of replacement rates to fiscally sustainable levels and zero indexation in 2007; creation of an extra-budgetary pension fund to receive all pension contributions but pay out only to new pensioners while the budget pays existing pensioners. - Commitment to manage the extra-budgetary fund in a transparent manner and to seek technical assistance from the IMF and the World Bank. ### Public sector employment census and payroll reform - Census for public sector employees (structural performance criterion for end-June 2007) not yet completed; project more complicated and time-consuming and disrupted by security-related delays to MoF IT Department. - Preparations completed and census questionnaires sent to most relevant government agencies. - GoI envisages completing the data collection phase of the census (completed questionnaires received back from government agencies) by end-November 2007. ### Social safety net and public distribution - Progress in implementing the new Social Safety Net: more than 1 million families identified and received cash payments of up to $80 per month under the program. - Coverage target for this year: extend to 1.5 million families. - Measures taken to rationalize the Public Distribution System, including cancelling eligibility for support for some of the most well-off individuals (ministers, members of the CoR, and others). ### Tax reform and revenue measures - Developing a medium-term tax reform strategy; a Tax Policy Unit has been set up at the MoF and technical assistance is being received from international partners, including the IMF. - Tax strategy to cover the oil sector, personal and non-oil corporate income, consumption taxes, and measures to strengthen tax and customs administrations. - Considering introduction of a sales-tax as a precursor to a value added tax. - Commitment to preserve open trade policies: maintain the 5 percent import duty (reconstruction levy) while significantly reducing the number of exemptions to increase customs revenue. ### Audits, safeguards, and monetary institution reforms - Ernst and Young finalized the audit of net international reserves data reported to the Fund as of December 31, 2006 on May 20; issued an interim audit report of the 2006 CBI financial statements on July 15. The end-May 2007 performance criterion target date was missed by a few weeks. - Intend to implement in full all recommendations from the final audit report of the 2006 CBI financial statements during the course of this year. - Capital of the CBI was increased to the statutory level of ID 100 billion in late February (structural benchmark for end-December 2006). - CBI Board adopted a timetable for full implementation of International Financial Reporting Standards as the CBI’s financial reporting framework by end-2009 (structural benchmark for March 31, 2007). - Structural benchmarks for June 30, 2007 include developing a foreign reserves management policy and investment guidelines. - Steps underway to improve accounting records and control procedures. ### Payments system, banking restructuring, and state-owned enterprises - Progress expanding coverage of the real time gross settlement payment system and the automated clearing house: currently 10 commercial banks’ headquarters and the MoF are connected to the CBI; expectation to cover most banks by the end of the year. - Steps toward restructuring Rafidain and Rasheed banks: memoranda of understanding for operational restructuring and financial restructuring of Rasheed approved by the economic committee of the Council of Ministers in March 2007. - CBI set up the secretariat of the Restructuring Oversight Committee. An international auditor was selected in early June to conduct operational and financial audits of both banks and will be appointed shortly (structural benchmark for end-April 2007); audits to start soon and expected to be completed by early 2008. - Work begun on reconciliation of foreign debt held by both banks and cleaning up large suspense accounts. Later this year, restructuring of the other four smaller state-owned banks will be initiated in consultation with the IMF and the World Bank. - Rehabilitation program initiated for viable public enterprises (cement, textile, pharmaceutical, petrochemical); 21 public enterprises encouraged to submit business plans to Rasheed and Rafidain banks to obtain financing to restart activities on a purely commercial basis. Any future government support will be modest, limited in period, and fully included in the government budget. ### Hydrocarbons sector governance and transparency - GoI will continue developing a competitive and transparent hydrocarbon sector. Draft hydrocarbon legislation will be submitted to the CoR when final agreement between all concerned parties has been reached. - Envisaged legislative package includes: draft oil and gas law, draft law to reestablish the Iraq National Oil Company, draft law reorganizing the MoO, and draft financial management law on sharing of oil revenues. - Steps to enhance transparency and fight corruption in the oil sector: installation of meters at the Basra export terminal completed (most operational but some need certification); comprehensive metering project with Shell and British Petroleum underway. - GoI committed to joining the Extractive Industries Transparency Initiative. MoO will start publishing on its website information on production, export, and processing of crude oil in the next few months. ### External debt resolution, AML, and institutional arrangements - Bilateral agreements signed with all Paris Club creditors except Russia, and with nine non-Paris Club official creditors. Official contacts with key Gulf region creditor countries and China have been made; technical debt reconciliation ongoing. - Special Purpose Vehicle established to facilitate official creditors desiring to securitize their claims while avoiding multiplicity of different securitizations. - Most remaining private creditors’ claims are being reconciled with claims being settled as part of liquidation of Rafidain Bank’s London branch; liquidation expected to be completed by end-2007, enabling completion of resolution of all private claims. - Submitted additional exchange regulations to IMF staff as part of exchange system review and issued new regulations to apply the Anti Money Laundering (AML) Law; new AML office set up within the CBI. - Newly established Committee of Financial Experts (COFE) is fully operational and expected to continue IAMB’s work once IAMB is dissolved; COFE being involved in IAMB’s work and training prior to IAMB mandate expiration at the end of 2007. - Mandate for the DFI expires at the end of this year; GoI hopes to extend the DFI, with help from the international community, for another two years until end-2009. - Immunity of the DFI accounts at the Federal Reserve Bank of New York has been extended for a year through May 22, 2008. ### Technical assistance, international engagement, and program monitoring - Appreciation for IMF technical assistance and request to continue receiving assistance in areas including bank restructuring, banking supervision, monetary policy operations, reserves management, development of secondary markets, tax policy, tax and customs administration reform, public financial management, statistics, and implementation of safeguards recommendations. - As part of SBA extension request by three months, request that the remaining two purchases under the arrangement be rephased accordingly and that the last purchase will be available upon observance of the end-September 2007 performance criteria. - Macroeconomic policy performance to be monitored through quarterly quantitative performance criteria and indicative targets. Quantitative performance criteria under the original program remain unchanged; additional performance criteria set for end-September as specified in Table 1. - The missed structural performance criterion on completion of the census of all public service employees has been rescheduled and redefined as specified in Table 2. - Commitment to submit data to the Fund within agreed time lags in the MEFP and its supplements. *Source: _cr07301 - 10. These policies, and taking account of the effect of a further appreciation of the (IMF PDF).* ### 35. The Technical Memorandum of Understanding is modified in the manner described ### _cr07301 - 35. The Technical Memorandum of Understanding is modified in the manner described ### Addendum summary and scope - All aspects of the Technical Memorandum of Understanding (TMU) of December 6, 2005 and the addenda of July 15, 2006 and February 23, 2007 remain in effect, except for the changes described in the July 17, 2007 addendum. - Quantitative performance criteria for end-September 2007 are added for: - net international reserves of the CBI; - lending to the government and the private sector by the CBI; - central government total financing; - the government wage and pension bill; - revenue of oil related enterprises, including those remitted to the budget; - new medium-and long-term nonconcessional external debt (with original maturities of one year of more) contracted or guaranteed by the government. - The quantitative performance criterion for no external arrears on new borrowing will continue to be monitored on a continuous basis. - Indicative targets for end-September 2007 are also established. - Measurement conventions: - Cumulative flow variables for the quantitative performance criteria will be measured on a cumulative basis from January 1, 2007, except for net international reserves of the CBI and lending to the government and the private sector by the CBI, for which cumulative flow variables will be measured from September 30, 2005. - The indicative targets on the revolving government credit to the State Oil Marketing Organization and the government imports of petroleum products will be measured on a cumulative basis from January 1, 2007. ### Quantitative performance criteria and related reported figures (selected) - Net international reserves of the CBI (floor; in millions of U.S. dollars) — cumulative change from September 2005: - Floor: 8,500 - Program quarterly ceilings/targets shown as: 2/-1,000-1,000-1,000-1,000-1,000000 (table formatting retained) - (Actual) +3,041 +3,635 +3,554+5,252+9,770+8,503 - Note: This will be monitored on a continuous basis.2/ - Lending to the government and the private sector by the CBI (ceiling): - Ceiling shown as: 3/5,100 2/00000000 - (Actual)000000 - Note: Rolling over t-bills does not constitute new lending.3/ - Government primary fiscal deficit (ceiling; deficit [+]/surplus[-]) — cumulative flow from beginning of calendar year: - Program entries include: 4/ 5/...5,4001,9503,6004,8505,300......... - (Actual) -5,102 -819 -4,752 -11,220 -8,947... - Starting in 2007, the budget deficit will be monitored from below the line (i.e., from the financing side).5/ - Central government total financing (ceiling): - Program entries include: 4/ 5/..................3,0005,3505,700 - (Actual) -1,688 - Government wage and pension bill (ceiling): - Program: 4/ 6/...6,6502,4004,7507,1009,5002,5255,0507,575 - (Actual) 7,0692,0513,8985,8757,7921,644 - Excluding salaries paid by ministries of defense and interior.6/ - Revenue of oil related enterprises, including those remitted to the budget (floor): - Program: 4/...9007001,5002,1002,8007501,5002,850 - (Actual) 1,4565091,4542,6513,6111,135 - New medium-and long-term nonconcessional external debt (with original maturities of one year or more) contracted or guaranteed by the government (in millions of U.S. dollars; ceiling): - Program: 4/ 7/...500500500500500500500500 - (Actual) 000000 - This ceiling excludes loans with a grant element of 35 percent or more of up to Yen 350 billion for reconstruction projects to be contracted with the government of Japan in 2007.7/ - External arrears on new borrowing (in millions of U.S. dollars; ceiling): - Program: 8/...00000000 - (Actual) 65300000 - Indicative targets (selected): - Government imports of petroleum products (ceiling) — cumulative: - Program: 4/ 9/...6,0001,7003,4004,0004,200100200300 - (Actual) 4,1281,0451,8843,1204,082104 - Revolving government credit to the State Oil Marketing Organization (ceiling): - Program: ..................300400400 - (Actual) 400 - Notes: - Flows for 12/31/05 are cumulative for 2005. Flows for 2006 and 2007 are cumulative starting 1/1/2006 and 1/1/2007, respectively.4/ - New medium-and long-term nonconcessional external debt and related ceilings monitored as specified above.7/ - Starting in 2007, government imports of petroleum products (indicative target) no longer comprise all imports made directly by the government of Iraq but instead comprise imports of petroleum products financed from the budget.9/ ### Structural performance criteria (selected items, dates, and status) - Avoid administrative measures limiting participation or bids in the CBI's regular auction of foreign exchange other than screening related to anti-money laundering or counter-terrorism: - Date/Status: Continuous / Met - Final audit of CBI 2005 Financial operations and statements: - Date/Status: May 15, 2006 / Waived; Completed on October 1, 2006 - Adoption of fully detailed budget classification and chart of accounts in line with the IMF's Government Financial Statistics Manual (GFSM) 2001, within a cash accounting framework: - Date/Status: June 30, 2007 / Not met. Expected soon - Note: The budget classification and chart of accounts will be deemed in line with GFSM 2001 if consistent with the methodology and high level classification defined in the IMF Fiscal Affairs Department technical assistance report "Iraq Budget Classification Reform" (July 2005).1/ - Completion by Ernst & Young of (a) a final audit of the net international reserves data reported to the IMF as at December 31, 2006, including a full count by Ernst & Young of gold and foreign exchange holdings at the CBI, and (b) an interim audit report of CBI 2006 financial statements in accordance with International Standards on Auditing: - Date/Status: May 31, 2007 / NIR audit completed on time; interim audit report completed on July 15 - Completion of census of all public service employees (central government and military): - Date/Status: June 30, 2007 / Not met; replaced with a new PC (see below) - Completion of the data collection for the census of all public service employees (central government and military): - Date/Status: November 30, 2007 ### Structural benchmarks (selected items, dates, and status) - Implementation of payment system regulations: - Date/Status: June 30, 2006 / Met - Establishment of an audit oversight committee, including participation of independent international audit experts, to continue work of International Advisory and Monitoring Board (IAMB): - Date/Status: September 30, 2006 on or before December 31, 2006 / Met in November 2006; IAMB mandate has been extended to December 31, 2007 - Reform of pension law in line with sustainable pension system: - Date/Status: September 30, 2006 / Underway - Approval by Council of Representatives of law liberalizing private gasoline imports: - Date/Status: September 30, 2006 / Met - Commencement of operation of Real Time Gross Settlement system (RTGS) linking headquarters of commercial banks to the CBI: - Date/Status: August 31, 2006 / Met - Commencement of payments clearing system between the headquarters of commercial banks and the CBI through the Automatic Clearing House (ACH): - Date/Status: November 30, 2006 / Met - Full capitalization of CBI to the stipulated ID 100 billion, based on the 2005 audited financial statements and taking into account restructuring of outstanding claims on the central government that are on the December 31, 2005 balance sheet of the CBI: - Date/Status: December 31, 2006 / Met in February 2007 - Adopt a CBI Board-approved timetable for the full implementation of IFRS as the bank’s financial reporting framework: - Date/Status: March 31, 2007 / Met on April 1, 2007 - Appoint an internationally reputable audit firm to conduct an operational and financial audit of Rasheed and Rafidain banks based on their 2006 financial accounts: - Date/Status: April 30, 2007 / Underway; auditor selected and appointment process ongoing - Address the lack of proper accounting records being maintained by the CBI (issues giving rise to E&Y’s disclaimed audit opinion for 2005): - Date/Status: June 30, 2007 / Underway - Issues to be addressed include: (i) lack of reconciliations of local bank’s current accounts; (ii) unreconciled suspense accounts and interbranch accounts; (iii) unreconciled differences on accounts managed on behalf of the Ministry of Finance, including the DVI; and (iv) insufficient information to support amounts, and to ensure the completeness and valuation of off-balance sheet commitments.2/ - Establish adequate control procedures for reserves management, including developing reserves management policy and investment guidelines: - Date/Status: June 30, 2007 / Underway ### Indicative quantitative benchmarks for petroleum product official domestic prices (Iraqi dinars per liter, unless otherwise indicated) - LPG (per 12 kg cylinder): - Program/Actual sequences shown: 250 600 700 600 800 1,000 900 1,000 1,000 1,000 3,000 3,000 3,000 - Regular gasoline: - Program/Actual sequences shown: 20 100 130 100 155 175 175 175 200 250 300 350 400 - Premium gasoline: - Program/Actual sequences shown: 50 250 300 250 350 350 400 350 450 350 ... ... ... - Note: Starting 2007, premium gasoline is to be sold only by the private sector at unregulated prices.1/ - Blended gasoline: - Program/Actual: ... ... ... ... ... ... ... ... ... 350 400 450 450 - Kerosene: - Program/Actual sequences shown: 5 25 50 25 75 75 90 75 115 75 150 200 150 - Diesel: - Program/Actual sequences shown: 10 90 110 90 125 125 155 150 175 150 350 350 400 - Dates referenced in table: 03/31/06, 06/30/06, 09/30/06, 12/31/06, 03/05/07, 06/30/07. Table title: "Table 3. Iraq: Indicative Quantitative Benchmarks Under the Stand-By Arrangement (In Iraqi dinars per liter, unless otherwise indicated)." ### Performance tables and monitoring - Table 1: Iraq: Quantitative Performance Criteria and Indicative Targets Under the Stand-By Arrangement (SBA), 2005–07 (In billions of Iraqi dinars, unless otherwise indicated) — includes the performance criteria and actuals summarized above. - Table 2: Iraq: Structural Performance Criteria and Structural Benchmarks Under the Stand-By Arrangement — lists structural PCs and benchmarks with deadlines and statuses (selected items summarized above). - Monitoring notes and footnotes are retained as in the TMU and addendum, including references to measurement conventions, exclusions, and auditing requirements (footnotes 1/ through 9/ as presented in the source). ### Public Information Notice excerpt - The IMF Executive Board concluded the 2007 Article IV consultation with Iraq on August 1, 2007. - Background: The last Article IV consultation with Iraq prior to this was concluded on August 1, 2005. A Stand-By Arrangement (SBA) was approved on December 23, 2005 covering through March 22, 2007, later extended through September 28, 2007. The SBA-supported program aims to stabilize macro-economic conditions while implementing structural reforms for sustainable growth. - Economic growth: Following a decline in oil production and real GDP in 2005, economic growth is estimated at 6¼ percent in (statement continues in source). *Source: Attachment III — Iraq: Addendum to the Technical Memorandum of Understanding (July 17, 2007) and accompanying tables and Public Information Notice excerpt.* ### 2006. Average annual crude oil production has remained at about 2 million barrels per day ### _cr07301 - 2006. Average annual crude oil production has remained at about 2 million barrels per day ### Inflation, exchange rate, and monetary policy - Annual consumer price inflation increased to almost 65 percent at end-2006 from 31½ percent at end-2005, mainly due to supply bottlenecks, in particular of fuel products. - Core inflation (excluding fuel and transportation) remained high at about 32 percent in 2006 and decreased to 19 percent by June 2007. - Following policy efforts and some easing of fuel shortages, headline inflation declined to 46 percent in June 2007. - Since November 2006 the Central Bank of Iraq (CBI) has allowed the exchange rate of the Iraqi dinar to appreciate by 15 percent and raised its policy interest rates in two steps to 20 percent. - CBI gross international reserves increased to $18.7 billion at end-2006 (almost 6 months of import cover). - Directors supported the policy of allowing the gradual appreciation of the dinar through end-2007 to further reduce inflation and de-dollarize the economy, and urged the CBI to be ready to accelerate appreciation and tighten monetary conditions if inflation deviates from its downward path. ### Fiscal outcomes and public finances - Following a fiscal surplus of 11 percent of GDP in 2005, the fiscal outturn for 2006 showed a surplus of almost 12 percent. - Surpluses reflected underspending on investment reconstruction projects, including in the oil sector, and contributed to accumulation in the Development Fund of Iraq to a level of $8.6 billion at end-2006. - Key fiscal indicators (2004–07, percent of GDP unless noted) from the table: - Government revenue (including grants): 79.6 (2004), 107.4 (2005), 80.5 (2006), 62.3 (2007 proj.) - Of which: Oil revenue: 69.2 (2004), 76.7 (2005), 65.2 (2006), 51.1 (2007 proj.) - Expenditure: 120.8 (2004), 96.6 (2005), 68.5 (2006), 72.0 (2007 proj.) - Budget balance (including grants): -41.2 (2004), 10.9 (2005), 12.0 (2006), -9.7 (2007 proj.) - Primary fiscal balance: -40.2 (2004), 11.1 (2005), 12.5 (2006), -9.0 (2007 proj.) - Non-oil primary fiscal balance: -88.6 (2004), -49.3 (2005), -41.2 (2006), -52.5 (2007 proj.) - Total government debt (in billions of U.S. dollars): 97.6 (2004), 68.9 (2005), 54.7 (2006), 56.4 (2007 proj.) ### Oil sector, production, and external accounts - Average crude oil production (in millions of barrels/day): 2.0 (2004), 1.9 (2005), 2.0 (2006), 2.1 (2007 proj.). - Total exports of oil and gas (in billions of U.S. dollars): 17.3 (2004), 19.2 (2005), 27.7 (2006), 28.6 (2007 proj.). - Average crude oil export price (in U.S. dollars/barrel): 31.6 (2004), 43.9 (2005), 55.7 (2006), 50.6 (2007 proj.). - Directors noted the expansion of oil production is lagging and stressed the need to strengthen protection of oil installations and advance a new legislative framework for the hydrocarbon sector to attract the large investments needed to increase oil production. - Paris Club debt reduction: agreement on November 21, 2004 equivalent to 80 percent in net present value (NPV) terms to be achieved in three stages (first and second stages each 30 percent NPV reductions went into effect in November 2004 and December 2005; final stage comprises an additional 20 percent NPV reduction and depends on completion by end-December 2008 of the final review of the third year of one or more upper credit tranche arrangements with the Fund). - Central bank gross reserves (in billions of U.S. dollars): 7.9 (2004), 12.0 (2005), 18.7 (2006), 21.3 (2007 proj.); in months of imports of goods and services: 3.2 (2004), 5.4 (2005), 6.2 (2006), 6.9 (2007 proj.). ### Structural reforms, governance, and institutions - Progress reported: - Official fuel prices increased to levels in other oil-exporting countries in the region; private sector importation of fuel products liberalized. - Negotiations on a new legal framework for the oil sector are ongoing. - Interim audit of the CBI’s 2006 financial statements and an audit of its net international reserves finalized. - Development of the financial system: introduction of a payments clearing system and a Real Time Gross Settlement system. - Restructuring of Iraq’s two largest state-owned banks has started. - Ministry of Finance adopted a new chart of accounts and budget classification; census of all public service employees still underway. - Directors urged expeditious implementation of priority structural reforms: - Broaden coverage of the Financial Management Information System. - Modernize and streamline the tax system to expand the tax base and improve incentives. - Press ahead with restructuring of the banking system to increase financial intermediation for the private sector. - Ensure any government financial support to public enterprises is efficient and fully reflected in the budget. - Improve transparency and accountability of public financial management and step up fight against corruption; authorities intend to join the Extractive Industries Transparency Initiative and implement a comprehensive oil metering system as soon as possible. - Strengthen CBI safeguards and address all recommendations of the Fund’s interim safeguards assessment report and the Ernst & Young interim 2006 audit report. ### Executive Board assessment and policy recommendations - Directors commended authorities for: - Keeping the economic program on track and strengthening economic policies despite unsettled political and difficult security environment. - Commitment to pursue prudent fiscal policy and to resist undue spending pressures, including strict containment of wage and pension bill and transfers. - Increasing official fuel prices and considering a future rule–based mechanism for setting domestic fuel prices to prevent re-emergence of budgetary subsidies (except for kerosene), help fight corruption, and free up resources for investment. - Directors urged: - Take measures to speed up reconstruction and increase investment, especially in the oil sector, and to strengthen protection of oil installations. - Amend the new pension law as soon as possible to ensure fiscal sustainability of the pension system. - Continue restraining public spending pressures and step up efforts to reduce shortages by actively supporting private sector fuel imports. - Improve statistical database and conclude debt agreements with remaining official and private creditors expeditiously. - IMF actions and decisions: - Executive Board completed the fifth review and review of financing assurances under Iraq's Stand-By Arrangement and approved a three-month extension of the Arrangement to December 28, 2007. - Board approved waivers for non-observance of structural performance criteria related to the interim audit of the CBI’s 2006 financial statements, completion of a census of public service employees, and adoption of a fully detailed budget classification and chart of accounts, and waivers of applicability of the June 30, 2007 quantitative performance criteria under the Arrangement. ### Key macroeconomic indicators (selected, 2004–07) - Real GDP (annual percentage change): 46.5 (2004), 3.7 (2005), 6.2 (2006), 6.3 (2007 proj.). - Non-oil real GDP (annual percentage change): 14.9 (2004), 12.0 (2005), 7.5 (2006), 5.0 (2007 proj.). - Consumer price inflation (end-of-period): 31.7 (2004), 31.6 (2005), 64.8 (2006), 30.0 (2007 proj.). - Gross domestic investment (percent of GDP): 27.7 (2004), 31.6 (2005), 16.3 (2006), 20.0 (2007 proj.). - Gross national savings (percent of GDP): -9.8 (2004), 31.2 (2005), 27.7 (2006), 14.7 (2007 proj.). - Imports of goods (U.S. dollars, percentage change): 216.7 (2004), -3.1 (2005), 12.4 (2006), 42.6 (2007 proj.). - Current account including official transfers (percent of GDP): -37.6 (2004), 3.9 (2005), 12.3 (2006), -5.5 (2007 proj.). - Total external debt: 378.9 (2004), 219.5 (2005), 110.6 (2006), 90.4 (2007 proj.). - Nominal GDP (in billions of U.S. dollars): 25.8 (2004), 31.4 (2005), 49.5 (2006), 62.4 (2007 proj.). - Local currency per U.S. dollar (period average): 1,453 (2004), 1,469 (2005), 1,467 (2006), 1,275 (2007, January–June). - Real exchange rate (Jan. 2004 = 100): 145.5 (2004), 183.4 (2005), 311.9 (2006), 341.8 (2007, as of May). - Unemployment rate (Iraq Living conditions survey 2004, UNDP): 10.5 (2004), 18.5 (2005). *Source: IMF staff estimates, projections, and Executive Board assessment as presented in the IMF document.* ### 4. Oil production and export volumes in 2006 have been lower than anticipated under ### _cr07301 - 4. Oil production and export volumes in 2006 have been lower than anticipated under ### Fiscal developments and oil revenues - Oil production and export volumes in 2006 have been lower than anticipated under the program, due to the inability to expand capacity. - Higher oil prices more than compensated for the lower output, resulting in oil revenues slightly above the budgeted levels, and triggering a slight overperformance in overall revenue. - Expenditures were substantially lower than planned, essentially due to much lower than anticipated investment spending related to the deteriorating security conditions. - The fiscal outturn in 2006 was therefore very strong and contributed to a sharp increase in the accumulation of foreign exchange resources in the Development Fund for Iraq. ### Investment needs and budget implementation (2007) - Medium-term growth prospects hinge on the capacity to increase investment in infrastructure, notably in the oil sector, which is key to generating sufficient revenues to maintain fiscal sustainability. - Implementation of the 2007 budget is geared toward increasing investment, mainly in the oil sector. - Measures adopted to increase the implementation rate of investment projects include accelerating the approval of large investment projects and reducing the procurement period. - Authorities recognize the effect of a further dinar appreciation on oil revenues and plan to further control current expenditures to fund needed infrastructure investments and commitments relating to security and the social sector. - Current spending in 2007 will be kept within the 2007 budget limits, without the need for a supplementary budget. - Authorities will continue resisting undue pressures on the wage bill. ### Fuel pricing, private imports, and shortages - The government continued to pursue realigning domestic fuel prices with regional levels, in line with the program. - Except for a small subsidy for kerosene, direct subsidies on fuel products will be avoided in 2007. - Authorities are willing to consider developing a rule–based mechanism for setting domestic fuel prices in the future and will seek technical assistance. - Measures to reduce fuel shortages include promoting implementation of the 2006 law authorizing private import of petroleum products. - Private sector imports have so far been limited to the Kurdish region due to prevailing security conditions elsewhere. - About 20 licenses have been issued to private importers to date. - Further steps to encourage private sector imports include making storage facilities and pump stations available to private operators. ### Pension and social safety net reforms - Authorities are making every effort to ensure amendments to the new pension law are enacted by the Council of Representatives as soon as possible. - Amendments provide for a gradual reduction of replacement rates to fiscally sustainable levels and zero indexation in 2007, in line with earlier understanding with Fund staff. - Envisaged changes would allow pension outlays to stay within the budgeted envelope for 2007. - The extrabudgetary pension fund will be managed transparently in line with best practices; authorities will seek technical assistance from the Fund and the World Bank. - Progress on the new Social Safety Net: more than 1 million poor families received cash payments in 2006; coverage is expected to increase to 1.5 million families in 2007. - Efforts to rationalize the Public Distribution System are ongoing, starting with a narrowing of the eligibility criteria. ### Tax strategy and public financial management - A medium-term tax reform strategy aimed at modernizing the tax system to enhance non-oil revenue collection has been initiated. - Authorities are considering introducing a sales-tax as a precursor to a value added tax, and aim at strengthening the tax and customs administration. - Further efforts to improve public financial management are under way, including completion of steps needed to conform the chart of accounts and budget classification with the GFSM 2001. - Coverage of the recently operationalized Financial Management Information System is being expanded to new spending units. ### Monetary policy stance and inflation (since November 2007 into mid-2007 references) - Decisive and mutually reinforcing policy measures since November 2007 contributed to curbing inflation. - The Central Bank of Iraq (CBI) raised its policy interest rate in two steps to 20 percent. - The CBI allowed the exchange rate to appreciate by some 14 percent. - These measures, alongside increases in domestic fuel prices, efforts to reduce fuel shortages, and continued fiscal restraint, helped contain inflationary pressures. - Annual consumer price inflation declined to 46 percent in June 2007 after peaking at about 66 percent in January 2007. - The annual core inflation rate dropped to 19 percent in June, compared to 32 percent at end-2006. - Cash dollarization declined and the demand for dinars picked up, evidenced by expansion in dinar currency in circulation and a substitution at daily foreign exchange auctions in favor of transfers within the banking system instead of cash sales of dollars. ### Exchange rate policy and further monetary actions - Authorities acknowledge inflation needs to be further reduced and are committed to further monetary tightening if needed. - Inflation is essentially supply-driven, linked to the security situation and shortages of key commodities. - To signal commitment to reducing inflation, the CBI plans to allow the exchange rate to gradually appreciate by 1 percent per month until end-2007, while closely monitoring effects. - The exchange rate is the main policy instrument for the CBI to bring down inflation; the CBI stands ready to consider further increasing the policy interest rate, if needed. ### CBI governance, reporting, and payment systems - The CBI is addressing concerns from the interim safeguards assessment and the 2005 audit. - The CBI Board adopted a timetable for full implementation of International Financial Reporting System as the CBI’s financial reporting framework by end-2009. - Capital of the CBI was increased to the statutory level of ID 100 billion in February 2007. - The CBI is improving accounting records, control procedures, and establishing adequate control procedures for reserves management. - Progress achieved in payment systems reforms; the CBI is expanding coverage of the real time gross settlement payment system and the automated clearing house. ### Banking sector weaknesses and restructuring - Effectiveness of monetary policy is hampered by weak monetary transmission channels due to an inefficient banking sector. - Restructuring the banking sector is a major objective and important for economic development. - Important steps taken for restructuring the two largest state-owned banks, Rafidain and Rasheed. - Economic committee of the Council of Ministers approved in March 2007 memoranda of understanding for operational restructuring of both state-owned banks, and a financial restructuring of Rasheed bank. - An international auditor has been selected to conduct these audits, expected to be completed by early 2008. - Later in 2007, authorities intend to initiate restructuring of the other four smaller state-owned banks, in consultation with the IMF and the World Bank, in line with the approach for Rasheed and Rafidain. ### Debt restructuring and claims resolution - Authorities are making best efforts to reach agreements with remaining official creditors, including Gulf countries and China; technical debt negotiation and reconciliation is ongoing. - A Special Purpose Vehicle (SPV) has been established to securitize the debt held by private and public creditors, aimed at creating liquidity for Iraqi debt. - Authorities hope the SPV will facilitate negotiations with other official creditors. - Most remaining private creditor claims are in the process of reconciliation with claims being settled as part of the liquidation of the London branch of Rafidain Bank. - Authorities expect the liquidation to be completed by end-2007, enabling completion of resolution of all private claims. ### Performance under the SBA and requests to the IMF - Iraq continues to make clear progress in implementing the SBA despite adverse circumstances. - Persistently unsettled security conditions caused delays in some structural performance criteria (PC) under the SBA. - All quantitative PCs set for end-March 2007 were met. - On the basis of corrective actions in the Supplementary Memorandum of Economic and Financial Policies (SMEFP) for 2007, the authorities request waivers for nonobservance of certain performance criteria and completion of the fifth review under the SBA. - They request a waiver of applicability of end-June quantitative performance criteria and establishment of quantitative PCs proposed in the SMEFP for end-September 2007, as well as rescheduling and redefinition of the missed PC on completion of the census of all public service employees, as described in the SMEFP. - To ensure continuity during discussions for an envisaged successor arrangement, they request an extension of the current SBA by three months to December 28, 2007. - They intend to continue to treat the SBA as precautionary and remain fully committed to its implementation. - The SBA-supported program will continue to provide the macroeconomic framework for the International Compact with Iraq, formally endorsed by the international community in May 2007, aiming to put in place a medium-term framework for political, security and economic reforms. *Source: _cr07301 - IMF staff report excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07301.pdf_