IMF Report 2-26-10

Current Program Status
Two-year Stand-By Arrangement (SBA) in the amount of SDR 2.38 billion (about US$3.64 billion), approved by the IMF’s Executive Board on February 24, 2010.
Background
With the world’s third-largest oil reserves, rising oil production enabled Iraq to reach middle-income status in the 1970s and develop a modern infrastructure, as well as good education and healthcare systems. Since then, however, Iraq has suffered through three devastating wars, a long period of economic and financial mismanagement, and stifling international sanctions imposed during the 1990s. These events traumatized the population, severely damaged political and economic institutions, and undid earlier economic and social gains. By 2004, per capita GDP had fallen to less than US$800, and the country suffered from a crippling debt burden.

The task of rebuilding the country after 2003 was immense and made harder by sectarian politics and prolonged violence. Iraq’s reconstruction required not only the rebuilding of its infrastructure, but also of its economic and social institutions, and the creation of a business environment that would attract capital and bring with it new technology and skills to modernize the economy. Iraq’s huge oil reserves could, in principle, provide the resources needed to finance the reconstruction, but with the oil industry in disrepair and subject to attacks by insurgents, translating these resources into revenues was not easy.

Role of the IMF
The IMF has been closely engaged with Iraq since 2003. Initial work focused on providing policy advice, mainly on monetary and fiscal policies, and technical assistance to rebuild essential economic institutions. In September 2004, the IMF approved Emergency Post Conflict Assistance for Iraq, which—in combination with a debt sustainability analysis—paved the way for an agreement with Paris Club creditors, providing substantial debt relief. Since then, Iraq successfully completed two (precautionary) Stand-By Arrangements (SBA), whose main objectives were to achieve macroeconomic stability, promote growth, and continue with the process of structural and institutional reform. The last precautionary SBA expired on March 18, 2009.

New Program
On February 24, 2010, the IMF’s Executive Board approved a new two-year SBA in the amount of SDR 2,376.8 million ($3.6 billion), equivalent to 200 percent of Iraq’s quota, to cover Iraq’s balance of payments needs. Following a strong economic performance in 2008, the Iraqi economy was seriously affected by the drop in oil prices from their peak levels in mid-2008. As a result, Iraq’s external position deteriorated substantially in 2009, with both the external current account and the overall balance of payments shifting into large deficits of about 20 percent and 10 percent of GDP, respectively. With oil export receipts accounting for about 85 percent of government revenues, the lower oil prices had a similar impact on the fiscal position, with the government budget estimated to have recorded a deficit of about 23 percent of GDP in 2009.

Iraq’s medium-term economic outlook remains favorable because oil prices and production are projected to increase in the coming years, as domestic and foreign investment in the sector starts to bear fruit. Based on conservative oil price assumptions, however, the current account and overall balance of payments are expected to remain in deficit in 2010 and 2011. Similarly, Iraq’s fiscal position is projected to record large, albeit declining deficits in both years.

Against this background, the authorities have designed an economic program for the period through end-2011 and requested the IMF to support it with a new two-year SBA. The new program has been designed to provide a sound macroeconomic framework during a period of high economic and political uncertainty. The authorities’ fiscal program seeks to contain current spending while making room for investment to address the country’s large rehabilitation needs and improve public service delivery. The budget deficit is targeted to decline to 19 percent of GDP in 2010 and further to 6 percent in 2011, before shifting back into surplus in 2012. Monetary and exchange rate policies will continue to aim at keeping inflation low.

The new program will also help to move forward the structural reform agenda, which focuses on modernizing Iraq’s public financial management to improve the allocation, execution, transparency, and accountability of the mobilization and use of public resources; creating a transparent oil sector to fully account for oil and financial flows between the oil sector companies and the budget; and developing the financial sector so that banks start extending credit to the private sector, which is essential for medium-term growth and poverty reduction.

The new program will provide access to IMF resources, if needed. Based on conservative oil price assumptions and full execution of the government’s capital budget, Iraq would have a temporary financing need of almost $5 billion through end-2011. However, oil prices may turn out higher than envisaged and capacity constraints may result in under-execution of the capital budget. If either of these developments were to imply that there is no longer a financing need, the authorities intend to treat the SBA as precautionary. If drawing on IMF resources becomes necessary, the authorities intend to use the domestic counterpart to finance the budget deficit, thus avoiding central bank financing of the government and preserving the independence of the Central Bank of Iraq.