COVID-19, the oil price collapse and the Iraqi economy

Zeinab Shuker | 21 Oct 2020

The OPEC+ member states, led by Saudi Arabia and Russia, agreed in April 2020 to slash oil production by 9.7 million barrels per day (mbpd) in May and June – the deepest cuts ever agreed by the world’s oil producers. They aim to stabilize both oil markets and prices, which reached their lowest level in almost two decades due to the coronavirus. Iraq – the second largest oil producer after Saudi Arabia – agreed to a cut of 850,000 barrels per day (bpd).[1] However, as with some other producers in the region, Iraq faces both the short-term challenges to its crisis-ridden economy posed by COVID-19 and those that necessitate fundamental long-term changes to its oil-dependent economic structure.

The oil price collapse

Earlier this year, as COVID-19 cases began to rise globally and countries rushed to “lock down” their societies, oil prices – which were already on a downward trajectory amid an all-out price war between Russia and Saudi Arabia – hit their lowest point in 18 years. The massive drop in oil prices, combined with the storage shortage created by the Russia–Saudi oil war, pushed the West Texas Intermediate crude benchmark into negative territory, closing out the day on April 30 at -$37.63 per barrel.[2] Thereafter, OPEC+ reconciled to address the emerging crisis by introducing the output cuts outlined above. Iraq fell significantly short of its 850,000 bpd pledge, cutting only 11,000 barrels per day in July; but in the face of mounting pressure has since agreed to cut output by an extra 400,000 bpd on top of its previous commitment.[3] 

While demand is improving, including from some of the biggest oil-consuming markets that have eased their lock-down regimes, notable risk remains in the market. Even though voluntary cuts have stabilized the market for the time being, there are still large quantities of oil in tank farms that can potentially flood the market and generate a new crisis. Furthermore, any form of economic recovery in 2020 is becoming increasingly unlikely; as infection rates rise again, many countries are reintroducing localized lockdowns, further hindering economic growth and employment.

In OPEC’s monthly report, published on September 14, the organization responded to the weaker than expected recovery in India and many Asian countries by announcing a further cut in oil production to an average of 90.2 mbpd.[4] Looking ahead, it predicts a further slowing of oil demand during the first six months of 2021. Revenues from oil products for 2020 are predicted to be around $313 billion for the Gulf countries (including Iraq) and $338 billion for the MENA oil producers (including the Gulf states and Iraq), compared to $447 billion and $538 billion, respectively, in 2019.[5]

However, local and regional lockdowns and constraints on travel and work, combined with a general stagnation in economic life in many countries worldwide, have amplified the existing crisis in the global oil economy. In the past few years, overall demand has decreased, partly due to growing investments in alternative and green energy for environmental reasons, but also as a consequence of attempts to shift energy dependency away from the MENA region, given its political instability.[6]

The impacts of the pandemic, combined with this broader shift in the energy sector, will hit oil and gas producers in the MENA region hardest. In the long term, these nations can expect increasing poverty and income inequality, as well as general economic deterioration. In the short term, oil price declines will affect nations differently based on their budgets, foreign investments and diversification plans, etc. For example, a decline in oil prices will impact Iraq’s ability to invest in and increase its oil production operations, forcing it to borrow from and/or provide further concessions to foreign oil corporations – a situation large oil producers in the Gulf, such as the UAE and Kuwait, will be able to stave off for longer. The UAE, for example, can accommodate an oil price revenue decline of 34 percent in the Gulf states including Iraq, and 37 percent decline in the MENA region, including the Gulf states and Iraq s (from 2019 levels) for roughly 25 years, Kuwait for ten years, Qatar for five years and Saudi Arabia for three and a half years. Iraq, meanwhile, can only accommodate a crisis of this nature for a mere four days.[7]

Iraq’s existing economic fragility

Pre-COVID, Iraq suffered poor political and economic institutional capacity. The country’s high dependency on the oil sector, combined with the overbearing presence of the state in economic activity, undermined the successful development of the private sector, leaving around 12.86 percent of the predominantly young population unemployed in 2018 and leading to poverty rates of about 20 percent.[8]  More than a fifth of young people in the country were neither employed nor in education and women represented only 12 percent of the labor force in 2018, according to the World Bank (13 percent according to the Iraqi Ministry of Planning).[9] Furthermore, the country has faced significant humanitarian challenges. Iraq was ranked at 120 out of 189 countries in the 2019 Human Development Index, with 1.4 million internally displaced people and over 286,000 refugees. Economic growth in 2019 – around 4.4 percent based almost entirely on the oil and agriculture sectors – was insufficient to meet the level of population growth in the country. Indeed, Iraq has outperformed countries in the MENA region in terms of population growth, with a fertility rate of 4.1, yet GDP per capita has barely grown in the past few years to account for the growing population. The high rates of unemployment among young people – many of whom are educated – combined with rampant corruption and failing institutions, have generated large-scale protests across the country.[10]

Iraq’s economic fragility in the COVID era

Having entered the year in a fragile position, Iraq is notably under prepared for a prolonged decline in oil demand. At the height of the oil price decline in April, oil export revenues generated only $1.4 billion, compared to $6.1 billion in January. This drastic decline in the state’s budget left Al-Kadhimi’s government with a fiscal crisis and a limited ability to meet its obligations in terms of governance, let alone salary and pension payments. Even with a partial recovery in May, revenues still only reached $2.1 billion, which is significantly lower than the amount needed to keep the country running. According to one of Al-Kadhimi’s economic advisors, the government’s accounts had been reduced to around $300 million. There is therefore little hope for a recovery without an increase in oil prices.

The decline in oil prices has also affected domestic commerce. Private consumption accounts for around 60 percent of GDP in Iraq, but with salary reductions and the cancellation of government capital projects, household consumption will likely be hit hard. It is also likely that the inflated Iraqi dinar peg will further undermine the state’s ability to pay salaries.

In addition to its economic problems, the country is also reeling from an overwhelmed healthcare system that is ill prepared to contain a crisis such as that presented by the pandemic. As of October, there have been 367,000 COVID-19 cases in the country.[11]

This combination of global pandemic and declining national salaries will impact Iraqi households in four key ways. First, sick family members – and those recovering – will be unable to reenter the domestic job market for some time; this will lead to a decline in household earnings from wages and self-employment. Second, currency inflation will reduce non-labor household incomes. Third, a global economic crisis will impact supply chains for food and basic necessities, leading to price increases. Finally, despite the need to mobilize resources to benefit healthcare and education systems, disruptions in the global economy and falling oil revenues will erode the state’s ability to allocate sufficient funds  to these struggling systems, further undermining access by the population.

The dual effect of changes in food prices and low incomes will hit Iraqi households hard; indeed, the impacts can already be seen. The country is experiencing high levels of unemployment, particularly among those under the age of 25. Around 4.5 million Iraqis (11.7 percent) are living below the poverty line – an increase in poverty rate of 31.7 percent in 2020 from 20 percent in 2018 – while approximately 42 percent of the population faces a high risk of deprivation.[12] Poverty rates remain high among internally displaced citizens, yet the most significant portion of new poor are households that have not faced any of the usual shocks of the past, such as displacement, etc. As a result, the World Bank has predicted that Iraq’s economy would contract by nearly 10 percent in 2020. Furthermore, the IMF has forecasted that the country’s economy will experience the largest deficits in the world.

For Iraq, political divisions have only served to aggravate its worsening economic and humanitarian challenges. Al-Kadhimi’s government has inherited a fiscal crisis, perpetuated by inflated public spending that monopolizes half of all government outgoings.[13] Despite his commitment to tackle this problem, the absence of a solid political base in parliament has undermined such efforts. Al-Kadhimi’s initial focus has been on cutting spending in order to free up funds with which to sustain the country’s basic functions. Government salaries are typically composed of basic wages and allowances (such as danger pay and costs of security personnel for elite governmental officials and MPs). Al-Kadhimi’s original plan was to target the allowances – which amount to $23 billion compared to the $12 billion spent on salaries. As expected, there was little support from parliament for such a plan, given that MPs would be those most affected. The second plan was to apply income tax on allowances, which is expected to generate around $300 million each month. The plan met with such resistance that pensioners impacted individuals were reimbursed within days.[14] A third option was to utilize revenues generated by import customs and tariffs; however, owing to extensive corruption, only a fraction of these revenues find their way to the state’s treasury. The final option for the government, which received the blessing of parliament, was to borrow up to $13 billion from state-owned banks and a further $5 billion from international sources.[15] However, borrowing is not a sustainable plan in the long run, especially given Iraq’s existing debt of $128 billion dollars.[16] No economy depending on exports of a single commodity for the majority of its budget – even those of the better prepared Gulf states – can rely on borrowing as a long-term economic strategy for survival, let alone economic growth.

Like other MENA countries, Iraq is dealing with this price shock the way rentier economies usually do – by cutting public spending and borrowing money in the hope that prices will eventually recover. However, unlike the 2014–2016 price drop, there is no end-date to this crisis on the horizon. Furthermore, the demand for oil products was in decline even before the spread of COVID-19, pushing some of the Gulf rentier states to speed up their ambitious economic diversification plans (such as Saudi Vision 2030). However, in order to diversify, these countries require economic growth and revenue from oil exports; therefore, the recent price declines have undermined these diversification plans – and Iraq is no exception in this regard.

A long-term collapse in oil prices will not only impact Iraq economically and socially. As a rentier state, the country is faced with the reality of not being able to fulfill the “social contract” with its population, which affords it a level of economic and political – albeit not democratic – stability.[17] In rentier economies, political stability is based on a quid pro quo system where the government engages in massive social spending, usually funded by oil revenues. In exchange, the population tolerates the rulers’ authoritarian tendencies. However, with the collapse of oil prices, which are expected to persist to some degree into the long term, this quid pro quo system may also collapse.

Furthermore, since 2003, Iraq’s political system has comprised multiple “states with a state.” Different political parties have taken ownership of specific ministries and branches of government. Fueled by high levels of corruption and minimal oversight of the massive oil revenues entering the country, these political parties have established a system of patronage and clientelism, selling ministerial posts and funding their own personal economic activities with stolen oil wealth. As oil revenues decline, so will the income to these groups and political parties. To fund their operation, therefore, many will closely align themselves with foreign powers such as Iran.

One of the goals of Al-Kadhimi’s government – and of the United States – is to wean Iraq slowly from its dependency on Iran. An extreme economic crisis may achieve just that, by increasing the collaboration between Iraq and other Gulf countries like Saudi Arabia. However, many of these political groups were originally created and funded by Iran and therefore remain strongly aligned with its regime. The already tense partnership between Al-Kadhimi and these different groups will therefore be strained, potentially leading to a new political crisis. 

Possible outcomes

In the MENA states, COVID-19 is but one of many crises that have impacted the region in recent years. The 2011 Arab Spring, the 2014–2016 oil price collapse and the recent waves of protest in Iraq and Lebanon have highlighted both the many structural inequalities that exist in rentier states, as well as their subsequent vulnerability to economic and political shocks. With COVID-19 showing no signs of abating and oil prices still under threat, even the best prepared rentier economies are facing a bleak future.

Following years of political conflict, failed economic policies and a war with ISIS that has drained the economy even further, Iraq is on course to face further political instability and an increasingly frustrated, unemployed and alienated population. This will increase the dependency of the various competing political factions on foreign powers such as Iran. The combination of these events will put the country on a disastrous path. In the short-term, the government must prioritize an economic solution, even when met with resistance from parliament. Furthermore, in alliance with dominant political groups, it must provide space for disenfranchised youth to express their legitimate concerns and further engage in political and decision-making processes.  Looking beyond an immediate remedy to the crisis, Al-Kadhimi’s government must also prioritize economic reform by promoting private sector-led participation and diversification in sectors like the digital economy. These long term reforms must be combined with efforts to address rampant corruption, improve human capital outcomes, achieve fiscal sustainability and establish a more stable business environment.

References

[1] Al-Ansary, Khalid, and Javier Blas (2020). “OPEC+ pressures Iraq to take deeper cuts as non-compliance continues” World Oil. Retrieved October 1, 2020 (https://www.worldoil.com/news/2020/8/7/opecplus-pressures-iraq-to-take-deeper-cuts-as-non-compliance-continues).

[2] BBC (2020). “US oil prices turn negative as demand dries up.” Retrieved October 1, 2020 (https://www.bbc.com/news/business-52350082).

[3] Al-Ansary and Blas, op. cit. 

[4] Organization of the Petroleum Exporting Countries (OPEC), (2020). “Monthly oil market report.” Retrieved September 19, 2020 (file:///Users/zeinab/Downloads/OPEC_MOMR_September_2020.pdf).

[5] Merza, Ali (2020). “The impact of Corona pandemic in the global oil market and the expected consequences on the producing nations in the MENA region.” Iraqi Economists Network. Retrieved September 20, 2020 (http://iraqieconomists.net/ar/wp-content/uploads/sites/2/2020/08/Merza_Corona__Oil-1.pdf).

[6]  OPEC (2020). “OPEC basket price.” Retrieved September 20, 2020 (https://www.opec.org/basket/basketDayArchives.xml).

[7] Merza, Ali (2020). “The impact of CORONA pandemic in the global oil market and the expected consequences on the producing nations in the MENA region.” Iraqi Economists Network. Retrieved September 20, 2020 (https://bit.ly/3dJf2pe).

[8] WB (2020). “Unemployment data.” Retrieved September 20, 2020 (https://data.worldbank.org/indicator/SL.UEM.TOTL.NE.ZS?locations=IQ).

[9] Republic of Iraq, Ministry of Planning (2019). “Iraq's first national voluntary report on sustainable development.” Retrieved October 1, 2020 (https://mop.gov.iq/en/activities_minister/view/details?id=770).

[11] Worldmeter (2020). “Coronavirus cases-Iraq.” Retrieved October 1, 2020 (https://www.worldometers.info/coronavirus/country/iraq/).

[12] UNICEF (2020). “Assessment of COVID-19 impact on poverty and vulnerability in Iraq: Poverty and vulnerability in Iraq.” Retrieved September 20, 2020 (https://uni.cf/37ttosH).

[13] Al-Mawlawi, Ali (2019). “Public payroll expansion in Iraq: Causes and consequences.”  LSE Middle East Centre Report. London School of Economics and Political Science, London, UK.

[14] Al-Mawlawi, Ali (2020). “Economic reform in Iraq: The need for focus and persistence.” ISPI. Retrieved September 20, 2020 (https://www.ispionline.it/en/pubblicazione/economic-reform-iraq-need-focus-and-persistence-27273).

[15] Owls, Khaled Yacoub, and Mina Aldroubi (2020). “Iraq government gets parliament's nod for massive borrowing.” The National. Retrieved September 20, 2020 (https://www.thenational.ae/world/iraq-government-gets-parliament-s-nod-for-massive-borrowing-1.1039314).

[16] Saleh, Mazhar Muhammad (2020). “Flashnotes on the Iraqi debt in 2020.” Iraqi Economists Network. Retrieved September 20, 2020. (https://bit.ly/35mVq6u).

[17] Hamilton, A. (2020). The Political Economy of Economic Policy in Iraq. LSE Middle East Centre Paper Series 32 (http://eprints.lse.ac.uk/104086/).

 

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