Economic Crisis in Iraq: Consequences and Available Choices for Al-Kadhimi’s Government

EPC | 28 May 2020

With the major lockdown of living and economic fields due to the spread of the COVID-19 virus, experts expect a major economic recession in the world that would be the worst since the Great Depression of the 1930s. Iraq is one of the countries of the world that suffer from the implications of both the health and economic crises because of the corona epidemic, in addition to the financial crisis as a result of the fall in oil prices. All this coincides with exceptional conditions experienced by Iraq since the outbreak of protests at the beginning of October 2019 and the escalation of the US-Iranian conflict on its soil last year.

This paper sheds light on the dimensions of the economic crisis experienced by Iraq, and discusses the options before the new Kadhimi government to counter this challenge.

The general budget dilemma

It is known that the government of former Prime Minister Adel Abdul-Mahdi failed to submit the draft federal budget to Parliament for approval before the beginning of the current year as stipulated in the Constitution. Today, the country lacks a law that estimates the size of the revenues and expenses and determines the funds allocated to every ministry and official institution. While the estimates included in the draft budget were based on an oil barrel price of nearly 60 dollars, the huge decline in the barrel price to below 30 dollars led to the disruption of many investment plans and projects for fear of the continuation of that decline, especially that the new oil prices amount to a decline in Iraq’s net income by 65 percent for 2020 compared to last year’s income.

The governor of Iraq’s Central Bank Ali al-Allaq told Agence France-Presse that officials were still closely reviewing the 2020 draft budget, one of Iraq’s largest budgets ever at around 164 trillion Iraqi dinars (nearly 137 billion dollars). He indicated that more than 75 percent of the budget has been set aside for salaries and other running costs, with the rest being spent on capital investments.

According to official Iraqi quarters, based on initial deficit estimates in the bill for the 2020 federal general budget of nearly 50 trillion dinars, and excluding the now remote high oil prices, the deficit will double in case spending in the 2020 budget remains at the current initial level estimated at 164 trillion dinars.

In March 2020, Parliament, through the Economic Committee, asked the Abdul-Mahdi government to implement a number of recommendations to deal with the financial crisis, namely:

1- Immediately stop investment spending and reduce operating expenses in all aspects of government activity.

2- Agree with creditors to defer payment of Iraq’s internal and external debts pending improvement of the financial situation.

3- Collect the state’s dues from mobile phone and telecommunications companies.

4- Stop payment to investors in the electricity sector.

5- Work on enhancing government revenues and support the Treasury with the value of the exports of Kurdistan Region from crude oil and border outlets.

6- Revise exchange rates at the Iraqi Central Bank to ensure that prices do not affect the citizen while securing the salaries of civil servants.

7- Form a higher committee to impose management of funds of the Iraqi Treasury and trace the ministries, commissions and institutions that lag in paying the funds they are mandated to collect for the Public Treasury.

Parliament hopes that the new government, led by Mustafa al-Kadhimi, would be able to enact a budget that takes into account the ongoing changes and whose priorities would be to provide the salaries of public sector staff and workers and maintain food security before everything else.

Available information indicates that the new government might prepare a budget for six months only entitled “Emergency Budget” based on an oil barrel price of 30 dollars. This would only focus on providing the operational budget and countering the corona epidemic. It would not deal with matters such as investment and reconstruction. This means that the new Prime Minister will not be easily capable of holding the previous government to account or at least review the spending chapters all along the previous period. It is noteworthy that the Iraqi Parliament failed to approve the “final budgets” for years due to the pressure of former Prime Minister Nouri al-Maliki who used to fear the review of government accounts at the end of every year.

Iraq and the OPEC+ agreement

On 12 April 2020, countries of the Organization of the Petroleum Exporting Countries (OPEC) reached an agreement with Russia and other non-OPEC countries to cut oil production by 9.7 million barrels per day as of May 2020 with the aim of restoring oil prices to their previous levels. Iraq’s share of the reduction was one million barrels per day during the initial stage of the agreement, to be reduced at subsequent stages.

After the agreement, which is unprecedented in terms of cut size, the Iraqi Ministry of Oil said that it is “in the process of rescheduling the operations of crude oil production in the oilfields of the Basra Oil Company and the oilfields of foreign companies operating in Iraq to correspond to Iraq’s production and export commitments”.

According to experts, Iraq’s commitment to the OPEC+ decision under the current prices amounts to the following:

1- Undertaking to export nearly 3.5 million barrels per day during the initial stage of the agreement. This figure is a little below the average daily production of the National Oil Company (SOMO) over the last four months. However, this figure would be higher with the addition of the oil production of the Kurdistan Region estimated at around 250 thousand barrels per day. That is, the agreement will not have a big effect on Iraq except for the figure which could affect the relationship between Baghdad and Erbil.

2- In case the export rate of the Kurdistan Region is higher than the one announced and Iraq’s total exports exceed by far 4 million barrels per day, especially that the slowdown in production over the last four months was an exceptional case due to the spread of coronavirus in countries of east Asia which are the largest consumer of Iraqi oil, this means that Iraq will cut its production by one million and 61 thousand barrels per day during the initial stage of the agreement, according to Iraqi Ministry of Oil sources.

3- Iraq will sustain heavy losses due to its complete reliance on oil exports in its budget, difficult economic conditions, and the high cost of oil extraction imposed by the foreign companies operating in Iraqi oilfields.

4- Iraq pays nearly 3 billion dollars to oil companies every four months. Payment is done in oil rather than money which means that if prices continue below the required level, Iraq will pay most of the oil production to those companies. According to Reuters news agency, Iraq proposed that the international oil companies cut their spending by 30 percent on the condition that this would not affect production (based on Alhurra website, 25 April 2020).   

As a result of the above, some political quarters, especially Shiite and Kurdish ones, argue for non-commitment to the OPEC+ agreement and continued export of oil without reduction. The chairman of the Parliamentary Energy Committee Haibat Al-Halbousi criticized the performance of the Iraqi delegation taking part in the OPEC meeting. He said in a tweet on Twitter that “Iraq has agreed to a reduction of one million barrels per day although it is in need of every additional barrel”. Furthermore, the State of Law bloc, led by former Prime Minister Nouri al-Maliki, asked the government to be patient in implementing the OPEC+ agreement.

Presently, the Iraqi government does not have further options. Either it will be committed to the agreement, cut production and seek to increase financial resources from non-oil sources, or it will maintain the current production rate and accept low prices. Excluding Iraq from the agreement would amount to acceptance by the producing countries of greater cuts in their oil exports, which is illogical in light of the global economic crisis that is expected to last for a long time.

Expected economic implications

Due to the restrictions imposed on movement as a result of the coronavirus and the decline in oil prices, during the upcoming period, Iraq is expected to experience a number of economic problems and implications, mainly:

1- Incapability by the government to pay the salaries of civil servants for the coming months. It may need to borrow from the Central Bank and other banks. Yet this solution is hampered by the absence of a budget that would allow legally resorting to the reserve of government banks. Otherwise, resorting to external borrowing would be the last solution in case the new government fails to pass the general budget law.

2- Iraq’s monetary reserve amounts to 30 billion dollars, half of which is in the form of US Treasury bills. Resorting to those funds during the economic crisis would lead to a decline in the rate of Iraqi dinar against the US dollar, increase of domestic inflation, and slowdown of monetary circulation.

3- Halting of investment contracts and projects as was the case during the previous economic crisis that coincided with the occupation of Mosul by ISIS in the period 2014-2017 when most foreign companies operating in different fields left Iraq and the government stopped dealings with Iraqi private companies.

4- Incapability by the Ministry of Trade to provide the materials of the ration cards in full, leading to a rise in the prices of foodstuff and commodities, a slowdown in the domestic and foreign tourism, agriculture and industry sectors, and perhaps the layoff of a great number of staff and workers of private companies and factories.

5- Incapability by the government to pay damages, particularly pertaining to the State of Kuwait as a consequence of the invasion of Kuwait by the previous regime in 1990. Iraq is expected to ask the Kuwaiti authorities to delay the payment of damages to between two to three years.

6- The escalation of the crisis between Baghdad and Erbil and the collapse of the oil agreement between both sides which requires the delivery of 250 thousand barrels per day from the Region’s oil to the National Oil Company (SOMO) in return for the undertaking by the federal government to pay the salaries of the Region’s officials. The federal authorities will not be able to pay those salaries. Besides, the cut in oil production could extend to the Kurdistan Region as well.

Iranian electricity: an additional crisis

It is known that Iraq imports nearly 7 thousand megawatts of Iranian electricity for nearly 1.5 billion dollars per year. Iraq also imports Iranian gas to operate thermal power generation plants. On 26 March 2020, the US extended for 30 days the period of Iraq’s exemption from the sanctions for dealing with Teheran. In the beginning of May 2020, the US granted Iraq a new extension period of four months as a kind of US support to the government of the new Prime Minister Mustafa al-Kadhimi. This means that Iraq has to search for an alternative for the energy it imports from Iran before the end of the four-month period.

However, the unstable political conditions, in addition to the economic crisis because of the decline in oil prices in light of the corona crisis, do not allow for action to find alternative solutions. Iraq’s options in this crisis are as follows:

1- Negotiating with Washington to obtain a new period (after the four-month period) for exemption from the sanctions imposed on the entities that deal with Iran. However, Baghdad will not be able to pay Iran as it used to in the past due to the large deficit stemming from the new oil prices. Payment will be either on the account of the assumed operational budget or by deferred payment.

2- Continuing to import Iranian energy and embarrassing the US administration that does not want to impose sanctions on Baghdad at this timing and lose an important ally such as Iraq in light of the escalating conflict with Iran, especially that militias loyal to Teheran do not hesitate to do anything to end the relationship between Baghdad and Washington and seek to drive US forces out by all means to satisfy Iran’s leaders.

3- Searching for alternatives to Iranian energy from the Gulf countries, specifically Saudi Arabia. The spokesman for the Iraqi Ministry of Electricity Ahmed al-Abadi had underlined that plans for the electric networking with the Gulf (especially Saudi Arabia) do exist but their implementation is always disrupted due to the unstable security conditions, and recently due to the spread of corona epidemic. In addition, there is a ministry proposal to receive an authorization from the premiership to launch a new round of licencing for foreign companies for investment and the rehabilitation of gas extraction projects from Iraqi wells. This would secure the gas necessary to operate the thermal power generation plants. It is noteworthy that former Iraqi Minister of Electricity Qasim al-Fahdawi said in a televised statement on 10 April 2020 that “the Iraqi government under the former Prime Minister Haider al-Abadi received an offer from Saudi Arabia to provide the gas needed by Baghdad at prices lower than global prices”. He added that Riyadh undertook to deliver a shipment of the gas via Kuwait within less than 24 hours, in addition to another quantity that would be delivered from Riyadh within six days, and that the Kingdom offered to send a team from Aramco company to extract Iraqi gas, but Iranian pressures prevented the signature of this agreement with Saudi Arabia.

Possible scenarios regarding the Iraqi economic crisis

First scenario: slowdown of the Iraqi economy due to the oil price crisis, the huge lockdown caused by coronavirus, the collapse of existing investment projects, especially in the fields of energy and rehabilitation, and perhaps the increase of the country’s indebtedness if the government resorts to external borrowing due to its incapability to pay the salaries of civil servants. The reasons that support this scenario include the following:

1- Teheran’s continued depletion of the Iraqi economy, especially in terms of smuggling foreign exchange from Iraq to Iran, domination of the official decision to prevent the operation of the industrial sector, and obstructing agricultural development projects to force Iraqi tradesmen to import Iranian goods.

2- Weakness of the government’s potential and its inability to upgrade the industrial, agricultural and service sectors that have been declining since 2003 due to the spread of corruption and lack of seriousness in implementing development plans.

3- Continued fall in oil prices and lockdown due to the corona epidemic for a long time, and the uncontrollable deterioration of conditions.

4- Adoption of unfeasible methods to handle the crisis, including resorting to external borrowing and increasing the debts and interests to be incurred by Iraq or implementing a currency printing plan to make up for the shortage of liquidity. This was warned against by regulatory authorities as the existence of a deficit in the balance of payments and its closure without a cover (of foreign exchange or gold) would lead to a rise in inflation and a decline in the exchange rate of the Iraqi dinar.

5- Insistence on implementing the economic agreements with China signed by the resigned Prime Minister Adel Abdul-Mahdi in September 2019 and the non-withdrawal of the amounts deposited in the Chinese banks to benefit from them in solving more urgent problems, including the problem of salaries and covering government expenses.

This scenario seems the most likely as of now due to the absence of practical plans to counter the economic crises, the control by corruption cartels and militias over the state apparatus in a manner that would render any reform effort or project futile, at least in the foreseeable future, and increased reliance on non-strategic and temporary solutions, such as borrowing, loans and printing currency.

Second scenario: Iraq’s success in overcoming the current economic crisis with the least damages thanks to its capability to deal with its implications in the right way and in a manner that would ensure food security and non-deterioration of the service and health sectors. This scenario assumes that the government will implement a number of measures, in addition to the success of the OPEC+ agreement in gradually restoring oil prices to their previous levels. These measures include:

1- Subsidizing local industrial and agricultural products to meet as much as possible of the citizens’ needs during the crisis period.

2- Searching for other sources of energy. Former Oil Minister Thamer al-Ghadban had said that the Ministry of Oil is committed to optimum investment in the gas accompanying oil operations with a view to meeting the local need, including supplying power generation plants, and stopping energy import from abroad to compensate for the decline in oil prices. While the projects for the utilization of the accompanying gas require an infrastructure that is currently unavailable and require years, the Ministry of Oil expects that the gas extracted from the ongoing projects and the introduction of foreign companies to develop gas fields will contribute to providing the necessary amounts for the operation of power plants.

3- Reducing government expenses, offering a part of the government’s assets and projects for sale or investment, resorting to launching bonds for domestic offering, and launching government bonds with a view to securing the largest amount possible of financial liquidity and closing the deficit in the operational budget (salaries).

4- Taking decisions that would ease the citizen’s burden, including tax exemption for one year, delaying the collection of fees for electricity, gas and other government services, in addition to enhancing the ration card and accelerating steps to solve the issue of social security for the poor and low-income people.

5- Re-visiting the economic agreements with neighbouring countries, especially Iran, and the agreements by which many of its goods exported to Iraq have been exempted from customs duties.

Conclusions

Through its associated parties and militias, Iran controls the Iraqi economy with a view to continuing to support its sectarian and military activities in the region and depleting Iraqi resources. This is the main reason for the disruption of industries, investments and even agricultural projects in the country. Teheran adopts a strategy that is based on ruining the Iraqi economy and rendering it always dependent on Iranian goods and products. This leads to the continued reliance by the successive Iraqi governments on oil and making it the main resource in the general budgets and remaining in the circle of rentier economy.

If Iraq wants to adopt strategic solutions for its economy, through the diversification of income sources, opening up to economies of countries of the region and attracting foreign investments, it has first to get rid of Iranian control and then fight the scourge of financial and administrative corruption. Until then, the situation will remain without change, if it was not already heading for the worse.

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