Iraqi-Chinese Economic Agreement: a Debate on Objectives and Benefits

EPC | 20 Feb 2020

Shortly before its resignation at the end of November 2019 amid wide protest movement, the government of former Iraqi Prime Minister Adel Abdul Mahdi signed a framework agreement for economic cooperation with China that envisages the financing of major infrastructure projects from Iraqi oil exported to China. The agreement stirred a political, economic and even popular debate triggered by the government's failure to present the deal to the parliament and keeping some of its clauses untold.

This paper sheds light on the context of the agreement, reviews some of its known clauses, addresses political positions thereon, and discusses claims that the deal actually serves Iran.

The Agreement: Political Context

The signing of the Iraqi-Chinese agreement on September 23, 2019 in the Chinese capital, Beijing, came at a time when Iraq was sinking in a wide protest movement demanding political reform, stronger crackdown on corruption and ending the chaos of arms. This agreement sparked a dispute between the government and the main political groups in the country. Soon thereafter, the debate moved to business and popular circles, which were divided between supporters, opponents and those casting doubts over the real purposes this deal is intended to deliver. The debate was primarily driven by the fact that the previous government did not present the agreement to the parliament and the media and withheld some of it clauses, some of which were leaked later. The issue raised significant concerns over what was considered a lack of transparency and a government desire to hide the risks arising from entering into a strategic commercial partnership with a superpower known for its dealings with corrupt political regimes around the world.

In his trip to China, the former Iraqi Prime Minister, Adel Abdul Mahdi, led a senior delegation comprising most members of his cabinet and about 14 out of the country's 18 governors. Abdul Mahdi was keen to promote the deal as the first of his plans to revitalize the Iraqi economy. Also, the government ensured that the agreement becomes a primary focus of the media by suggesting that the deal will create investments in excess of $500 billion. In fact, this amount exceeds all the investment expenditures that successive Iraqi governments have allocated for post-2003 infrastructure projects, and most of this spending was squandered by political and financial corruption networks. Needless to say, by promoting the agreement, Abdul-Mahdi was seeking to shore up his government's precarious position ahead of a series of parliamentary grilling requests threatening a number of his cabinet members. Further, Abdul-Mahdi had to deal with a by-end-of-year deadline set by the leader of the Sadrist movement to achieve tangible achievements in improving citizens living conditions, before taking out to the street and leading a protest movement to topple him and his government. Noteworthy, the agreement was originally reached by the government of former Prime Minister Haider al-Abadi, and it was formally signed by the Iraqi Deputy Minister of Finance and the Chinese Minister of Finance on May 11, 2018, without drawing the attention or objection of any of the political parties.

Constitutionally, no external economic agreement at this level shall come into effect unless it is approved by the House of Representatives, but the government of Adel Abdul Mahdi followed in the footsteps of its predecessors in circumventing this obstacle. In this regard, the government has included the projects to be implemented under the agreement in the General Budget Law of 2020, with the aim of protecting it against the usual political bargaining, and forcing parliament to pass it under the pressure of demands to launch more job openings in the public sector, pay the dues of companies, contractors, farmers, and vendors, pay off internal and external debts, which all depend on passing the general budget law.

The Agreement: What We Know

In brief, the agreement, as disclosed by Adel Abdul Mahdi’s Economic Adviser Dr. Mazhar Mohamed Saleh after the debate it triggered between political forces, the media and public opinion escalated, is a Chinese credit loan of $10 billion to be paid through depositing the revenues of 100,000 barrels of crude oil exports Iraq to China in a special account in a Chinese bank. The value of these revenues is about $2 billion a year at today's prices, estimated at $55 a barrel. The agreement has a term of 20 years. In general, the agreement is devoid of any penal provisions, and it falls within the friendship agreements. In the event of a dispute, the parties to the deal may resort to international arbitration bodies. Further, the agreement may be extended if the Iraqi side wishes to. The agreement entails several things, including:

  1. Establishing an Iraqi government-supervised Iraqi-Chinese reconstruction fund by the Iraqi government through the Central Bank and the Chinese government, with the guarantee of the China Export and Credit Insurance Corporation, known as Sinosure, in which the revenues of 100,000 barrels per day of Iraqi oil sold to China are reserved, in exchange for the Chinese government providing a $10 billion loan under a subsidized interest rate. 
  2. If the first package of projects succeeds, and Iraq desires to increase investments, the ceiling for Iraqi oil sales revenue will be raised to 300,000 barrels per day, and in return, China will increase the lending ceiling to $30 billion. The amount is then deposited with China’s CITIC bank, which will subsequently transfers to the Iraqi account in the US Federal Reserve in New York (which oversees the total Iraqi oil sales), before transferring the amount to a new account called the "investment account". Another account called “debt servicing” is created, dedicated to subsidize the interest rate, and its amount is deducted from the investment account.
  3. Target projects: The fund is set to cover several infrastructure projects, including: airports, schools, highway construction, railways, water pollution treatment, housing compounds construction, energy projects, and others as requested by the Iraqi government. If the cost of one of these projects is one billion dollars, then the amount is taken from the fund at "$850 million from China and $150 million from Iraqi oil sales."
  4. Iraq has the right to choose international "European or American" companies to be partners with China, according to the type of project.

According to the terms of this agreement, there are several accounts that undertake the process of managing the stages of the agreement, namely:

  1. The Settlement Account: This is the account where 10% of the net monthly oil export revenues of 100,000 barrels per day is deposited for two Chinese companies "which have not been named" within Iraq's share in OPEC and not outside it.
  2. The Hedge Account: In this account, there will be amounts corresponding to the future debt servicing needs when borrowing from Chinese banks, which will ensure the financing of reconstruction projects in Iraq. It is necessary to inject reserve amounts in this account equal to a minimum of 150% of the value of the debt service due on projects loan covering a minimum of next 6 months. These loans are also guaranteed by China's Sinosure Corporation.
  3. Repay account: This account will include the Iraqi side’s contribution as a percentage of loan amounts, which it will borrow from Chinese banks. The sums to which Iraq will contribute will be deposited in the "repay account" at 15% of the value of each loan and will be transferred from the third or the second accounts. This means that Iraq can obtain credit facilities equivalent to $1.8 billion, if needed, within the $10 billion credit tranche, in which Iraq contributes 15% to be deposited, as explained, in the repay account, to pay off interest and installments on the outstanding debts, and that the remaining 85% represents the loan provided by the Chinese side.
  4. The Investment Account: In this account, excess Iraqi funds are deposited and will be at the disposal of the Iraqi government, whether to finance projects in Iraq by Chinese companies or international companies, or for processing.

Controversy

No event, as important as signing the agreement between Iraq and China, could have gone through without sparking the usual political debate. Part of the controversy is driven by the lack of information and the government's blackout over the details of the agreement. The debate is further heated by a chronic public mistrust of the political class, which neither lacks the desire nor the motives to extort the government for a share of the prospective projects. But it should be noted here the incomprehensible and rapid shift in the positions of political forces and parties between supporting and opposing the agreement and vice versa. The following is a review of the two main positions on the agreement:

1. The Opponents: Those who oppose the Iraq-China framework agreement, as we know it, say it is tantamount to mortgaging Iraqi oil to a country whose record is replete with drawing poor countries or those with corrupt regimes such as successive Iraqi governments, to what is known as the “Chinese debt trap” under the cover of cooperation agreements. They believe that such agreements ended up in some countries pledging their oil wealth to China such as Uganda, or losing the bulk of the ownership of the facilities that China helped them build. They cite Pakistan's Gwadar Port, Kenya's Mombasa Port, Sri Lanka's Hambantota Port and Djibouti's Doraleh Port as examples. These precedents raise the concerns of those who oppose the agreement for a number of considerations:

  1. Opponents of the agreement believe that Chinese loans will most likely be wasted on non-urgent projects such as the Grand Al-Faw Port, while the country already has six other ports that meet the need. On the other hand, China will have an opportunity to acquire the port as it happened with other countries, and tighten its grip on the Dry Canal Project that Iraq was planning to build in order to link the Arab Gulf and Europe via a road and rail network, as well as gas and oil pipelines.
  2. The debt resulting from the agreement will lead to a long-term Chinese mortgage of Iraqi oil. If the total amount of the loans reach $100 billion at an interest rate of 6% on a ten-year period as a minimum, their repayment will cut off a major chunk of the Iraqi state’s general budget. This is if we assume that Iraqi oil will remain at the same price it is now sold, but if prices fall, Iraq will be obligated to increase the amount of oil exported to be able to pay off the debt, which risks depleting the country's primary economic resource.
  3. There is no guarantee that the projects will be implemented according to the required specifications, in light of the wide influence enjoyed by Iraqi political parties' economic committees, especially Shiite armed factions that will not hesitate to impose their subsidiaries as secondary contractors, or even introduce themselves as subcontractors.
  4. The fact that Chinese companies are not obligated to employ Iraqis in the project they will carry out, which means that unemployment rates will not be affected by these projects, given the Chinese labor's monopoly over all stages of work.
  5. The risks of Iraq falling into the trap of receiving the proceeds of oil exported to China in the "Yuan" in case it is late in paying the debt installments, which means that a third of Iraq's oil exports will be held by China.

2. The Supporters: This team considers the agreement one of the most important the modern Iraqi state has signed in the second half of its age. They view it as a key lever for economic advancement and nationwide development after decades of successive wars. They back up their support for the agreement with the following:

  1. The 100,000 barrels per day, whose revenue will be reserved in the agreement's financing fund, do not constitute a large portion of the total Iraqi oil exports, currently at about 4 million barrels per day expected to increase by nearly 2 million barrels in the next decade.
  2. The proponents of the agreement argue that the Chinese funds are not loans, but concessional financing facilities, a better alternative to traditional financing methods. They say the new financing mechanism will remove government bureaucracy in Iraq, which has long caused delays in the approval of projects, hampered the disbursement of appropriations, and led to unclear extensions. According to the new modus operandi, major contracts will be directly awarded by a mini ministerial committee or a reconstruction council.
  3. The agreement does not include penal conditions or economic requirements such as reducing the deficit or curtailing spending or scrapping fuel subsidies, which are usually required by the World Bank and the International Monetary Fund. The agreement also includes a provision to resort to international arbitration bodies in the event of a dispute, whether between Iraq and Chinese companies, or with China as a country.
  4. The interests China will levy on its loans to Iraq are very low compared to other countries, international financial institutions or international banks. This is due to the low credit rating of Iraq by credit rating agencies such as Fitch and Moody's, due to the high risk of non-payment to a country suffering from near-permanent instability, such as Iraq.
  5. The fact that the agreement will last for 20 years with small repayments will leave no significant impact on the state's budget. Also, it will help save time and avoid any project delays which usually double the financial and human costs resulting from the lack of infrastructure, service and investments.

Full Shiite Support

Sunni lawmaker and businessman Muhammad Abdullah al-Kharbit described the Iraq-China agreement as "the worst deal in history". This position is considered a reflection of the view held by the "Sunni" Iraqi Forces Coalition, led by Parliament Speaker Muhammad al-Halbousi. It is also worth noting that Chairwoman of the Parliament's Committee on Energy, Haybat al-Halbousi, and a member of the coalition, demanded the government to send a copy of the agreement to parliament in mid-January amid a rising debate over its content.

On the other hand, the Shiite political parties, especially those close to Iran, have shown great interest in the Iraq-China agreement. They have been relentless in dismissing suspicions over the agreement and calling for its total approval. In fact, Shiite political groups called for introducing the commitment to the agreement as a prerequisite for endorsing the Prime Minister-designate. This was openly expressed by leader of "Asaib Ahl al-Haq", Qais Khazali, in a tweet on January 27, 2020, which included seven conditions, the sixth of which was: "[the prime minister] must pledge to implement the Iraqi-Chinese agreement." After only one day, the Hezbollah Brigades (Kata'ib Hezbollah) announced its conditions for endorsing the new prime minister, which included the implementation of the agreement with China. These stances have further fueled suspicions that Tehran was pushing Iraq to sign the agreement for several reasons, the most important of which include:

  1. The agreement is a means of financing the Iranian economy, which is already reeling under a major crisis due to escalating U.S. sanctions. This is something that Jamal Karbouli, the leader of the National Movement for Development and Reform party, referred to in a tweet reading: "Simply stated, the China agreement is an economic rescue plan put by a neighboring country and imposed on the Iraqi government to finance the economy of that country from Iraqi money from under the table, as it has done for years, and it seeks with all its capacity to extend the life of the caretaker government to ensure the implementation of this agreement." This tweet carries a reference to Iran, which is likely to grab its share of the agreement by introducing its companies as secondary contractors.
  2. The agreement may be used as an outlet to ship Iranian oil to China permanently and stably under Iraqi shipping documents, as has been going on a small scale for months. This was indicated by "Independent Arabia" on January 30, 2020, which quoted responsible Iraqi sources as saying: "Iran directed Iraqi militia leaders to implement this agreement because it provides an ideal cover for the export of Iranian oil as Iraqi oil." Therefore, it seems that the oil which will exported to China will be Iranian, not Iraqi, provided that Baghdad pays its price to Iran in cash or by supplying it with materials and equipment that will be imported into Iraq as part of the requirements for implementing the projects listed in the agreement.

Why Iraq?

Iraq will have to grapple with several major risks in the coming years, including a sustained record growth in the population and a continued paralysis of the productive economy. Iraq's swinging relationship with the U.S. is another major area of concern as pro-Iranian factions continue to pressure the government to expel the U.S. forces from the country disregarding President Donald Trump's threats of harsh economic sanctions. Iraq with its deep economic and financial problems provides an opportunity for China to boost its presence in the country and penetrate the Iraqi, as well as the Iranian, oil and gas sectors. Indeed, this provides China with a golden opportunity to leverage the U.S. economic sanctions imposed on Iran to obtain energy supplies at reduced prices. It will also help Beijing push towards the implementation of the penultimate section of the second northern axis of the new Silk Road, which connects western China to the Mediterranean, via a railway, making the use of trains to transport goods to Europe easier, faster and less expensive. The agreement may also enhance China's chances of gradually placing its hand on Iraqi ports, within the framework of expanding the scope of the "Madinat al-Hareer" project which it will implement in five Kuwaiti islands. The future of this last project appears to be dependent on its transformation into a link between the Maritime Silk Road and the Berlin–Baghdad railway, which makes the rehabilitation of the Iraqi railway network according to Chinese standards a top priority for Beijing's ambitions in the region.

Although China avoids presenting itself as a substitute for the U.S., in Iraq in particular, the events indicate that it is willing to fill the void that the Shiite forces are pushing for by insisting on Iraq's total disengagement with the U.S. in favor of a strategic relationship with China. It is the only logical explanation to understand the enthusiasm for linking Iraq to large and long-term lending arrangements with China, although it [Iraq] still maintains comfortable cash reserves of hard currency, and huge reserves of oil and gas, which can be used as a guarantee in more balanced and diversified agreements with world superpowers instead of falling into a potential Chinese lending trap. 

The Agreement: Future Scenarios

First Scenario: Moving Forward with the Iraq-China Agreement. This scenario assumes that the Prime Minister-designate (Muhammad Tawfiq Allawi or any other PM in case Allawi fails to form a government), will implement the Iraqi-Chinese agreement in the same formula that was agreed upon with the previous government. This scenario is supported by a number of facts, the most prominent of which are:

  1. Some practical steps have been already taken to implement the agreement. Local media outlets have recently leaked an official document indicating that Iraq deposited funds for oil shipments, exported under the Iraq-China agreement, in an account with the US Federal Reserve, exceeding $400 million dollars, for the months of October and November only.
  2. The great interest shown by pro-Iran political parties and factions which consider the agreement the only way to prove their eligibility to lead the country in the next stage, instead of the traditional Shiite forces that have become an example of corruption and failure.
  3. The country's need to rebuild aging and decrepit infrastructure damaged by wars and poor operation and maintenance.
  4. The need to achieve rapid accomplishments that reduce popular discontent, especially among the youth who are desperate to obtain educational opportunities, work and a better quality of life, the main driver of the current protest movement that has become faster and more violent than before.
  5. Iraq’s vital role in the success of the mega China-Kuwait "Madinat al-Hareer" project, which is envisaged to link the marine axis in the “Belt and Road” initiative and the second northern land axis, through a network of railways which Iraq has reportedly agreed to link with Kuwaiti ports. This comes despite strong opposition by Iraqi transportation experts, who labeled this scheme as a “conspiracy” against the future of Iraqi ports, especially the Grand Al-Faw Port, which would not be in China's interest to expedite its completion without obtaining incentives that exceed those obtained from Kuwait.

Second Scenario: The Failure to Implement the Agreement. This scenario assumes that the current political conditions in Iraq prevent the implementation of the agreement in the manner that was planned, as a result of several considerations, most notably:

  1. The U.S. administration, especially President Donald Trump, does not hide its discontent with the enormous financial costs incurred by the U.S. in the "Iraq liberation" war and the war against ISIS, and Trump's outright demand for compensation from Iraq. Consequently, he will not stand idly by while the Iraqi government gives preference to China in reconstruction projects and trying to end U.S. influence in Iraq. This risks imposing economic sanctions on Iraq in the event that it does not find a way to satisfy Washington by expediting the signing of the "South Integrated Project" to develop the giant " Nahr Bin Umar and Artawi" oilfields by a coalition comprising "Exxon Mobil" and "PetroChina", on terms and profit ratios satisfactory to the American side. This latest scenario is unlikely given Iran's ideological allies', namely Al-Fatah Coalition and the Sadrist Movement, control over the political decision in Iraq.
  2. The lack of a unified position of the political forces vis-à-vis the major powers. Some view the U.S. as the most important partner, while other people believe that Iraq has not gained anything from its relationship with the U.S. and has to approach other global powers, especially those that do not follow the U.S. line, such as Russia, China and perhaps India. A third opinion calls for building a balanced partnership that guarantees cooperation with all influential powers to achieve greater results.
  3. Although the agreement does not require special legislative permission, the projects it contains cannot be started without the General Budget Law, which has long been subjected to bargaining by political blocs which delayed the release of funds for long periods that sometimes exceeded half of the fiscal year.
  4. The deteriorating security situation, which has entered a new and more sophisticated stage with the continuation and escalation of the protest movement, especially in the southern region which is home to the bulk of the Iraqi oil wealth and a number of the most vital facilities such as ports and airports.

 

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