ATTACHMENT I. IRAQ: LETTER OF INTENT
September 18, 2010
Mr. Dominique Strauss-Kahn
Managing Director
International Monetary Fund
700 19th Street, N.W.
Washington, D.C. 20431
Dear Mr. Strauss-Kahn:
In February 2010, the International Monetary Fund (IMF) approved a Stand-By
Arrangement (SBA) for Iraq, to help us address the challenges created by the deterioration of the
external environment, including the sharp drop in international oil prices from their peak in 2008
and the slowdown in the global economy. In addition, the program also aims to accelerate the
pace of structural reforms, in particular to improve the management of public resources and to
develop the financial sector. This arrangement is providing us with needed financial support and
a valuable anchor during a period of political transition and considerable uncertainty with regard
to the global economic outlook.
We remain, of course, committed to implementing the policies described in our Letter of Intent
dated February 8, 2010 and the Memorandum of Economic and Financial Policies attached to
that letter. This supplementary Letter of Intent provides information on our recent efforts and
achievements, as well as on additional policy measures we plan to undertake during the
remainder of 2010 to help ensure that the objectives of the SBA will be met.
Overall economic performance so far in 2010 has been favorable, aided by oil prices that were
higher than we had conservatively assumed in our 2010 government budget. Export prices of
Iraqi crude oil averaged $75 per barrel in the first half of the year, compared to a budgeted price
of $62.50 per barrel. Oil export volumes averaged 1.88 million barrels per day (mbpd), however,
in the first half of the year, falling short of our target of 2.10 mbpd for 2010. This was due
mainly to adverse weather conditions that delayed tanker loadings at our main export terminals
in the Gulf, but also reflecting difficulties in securing an increase in oil exports from the northern
oil fields. Nevertheless, with the higher-than-budgeted oil prices, government oil revenues were
slightly higher in the first half of the year than projected. As a result, fiscal performance has been
strong and while the pace of budget execution has been relatively strong also, the budget deficit
in the first half of the year is estimated to have remained below its ceiling. Similarly, the balance
in the Development Fund for Iraq (DFI) has exceeded the program floors through end-June 2010.
Inflation continues to be in the low single digits so far in 2010 and the exchange rate has
remained stable. With core inflation hovering around 3 percent, the Central Bank of Iraq (CBI)
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lowered its policy interest rate further to 6 percent (from 7 percent) and reserve requirements to
20 percent (from 25 percent) effective April 1, 2010. With continued strong demand for foreign
exchange in the foreign exchange auctions and somewhat lower than expected transfers from the
DFI to the Ministry of Finance’s accounts with the CBI, the CBI’s international reserves
declined to $41 billion by end-June, falling below program targets. Our combined international
reserves (the sum of the CBI reserves and the balance in the DFI), however, remained broadly
stable during the first half of 2010, an outcome that was significantly better than projected.
In the remainder of 2010 and in 2011, we plan to continue with our fiscal and monetary policies
as set forth in our letter of February 8, 2010. We hope to be able to fully execute the 2010
government budget, in particular the investment budget, and we are working hard to improve
administrative capacity. The 2011 government budget will again be based on conservative
assumptions with regard to oil prices and export volumes, and will aim for a substantial
reduction in the budget deficit with a view to returning to a sustainable fiscal position, while
addressing the large rehabilitation needs of the country. Monetary policy will continue to aim at
keeping inflation low, predominantly through a continuation of our exchange rate policy.
We have also made steady progress in advancing our structural reform agenda and most of the
structural benchmarks through end-June were fully or largely observed. In the area of program
safeguards, the external audits of the CBI’s 2008 and 2009 financial statements were completed,
as well as a special audit of the CBI’s net international reserves as of end-December 2009. The
CBI has also started to report on its international reserves in line with IMF recommendations. In
the area of fiscal reporting and transparency, the final fiscal accounts for 2008 were submitted to
the Board of Supreme Audit (BSA), while the BSA completed the audit of the 2005–07 fiscal
accounts and submitted these to the parliament. Publication of these audited accounts requires a
decision from parliament. Government spending units have improved their monthly financial
reporting, although some difficulties remain, while the processing of this information is
hampered by capacity constraints at the Ministry of Finance resulting from the repeated attacks
on the ministry. The budget circular issued to line ministries in June for the preparation of the
2011 government budget included ceilings for each ministry for current and capital spending that
aim to substantially reduce the size of the budget deficit in 2011. In the area of oil sector
transparency, Iraq became a candidate member of the Extractive Industries Transparency
Initiative in February 2010. Furthermore, we have submitted an action plan to the UN Security
Council to prepare for a post-DFI mechanism. In this regard, we remain committed to
maintaining a single oil export revenue account that is subject to the same principles of
transparency and accountability as the DFI currently.
The review of all accounts in the banking system that are classified as central government
accounts proved to be more difficult than expected, given the vast number of accounts. We have,
however, been able to identify which of the accounts reported by banks as central government
deposits truly belong to the government, and also clarified the ownership of the bulk of the
remaining accounts. As we had expected, the accounts which do not belong to the central
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government include mainly the pension fund, state-owned enterprises, and various agencies and
funds that operate at arm’s length of the central government. The CBI is working with the banks
to ensure proper differentiation between central government (budget) accounts and other public
sector accounts.
Similarly, little progress was made in the restructuring of the balance sheets of the two largest
state-owned banks, Rafidain and Rasheed. With the assistance of the IMF, however, we have
now developed a way forward to remove the legacy items of the Saddam-era regime from the
balance sheets of these banks. More specifically, we will establish a Bank Reconciliation Unit
(BRU), with participation at a technical level of staff from these two banks, the CBI, the
Ministry of Finance, the BSA, and experts of Ernst & Young (who were the agents of the
Ministry of Finance in the external debt restructuring process) to: (i) deal with all legacy external
liabilities taking into account the government’s actions in the context of Iraq’s external debt
restructuring (ii) indentify and propose to write-off nonperforming loans to defunct state-owned
enterprises; (iii) propose a course of action for other remaining unreconciled accounts; and (iv)
after the balance sheets have been cleaned up, revalue the remaining foreign currency
denominated balance sheet items. The BRU will work under the supervision of the Restructuring
Oversight Committee (ROC), consisting of the Minister of Finance, the Governor of the CBI,
and the Chairman of the BSA. The BRU will send its recommendations for final approval to the
ROC to ensure that the restructuring of these banks’ balance sheet has the necessary support and
authorization. Through this process, we aim to complete the restructuring of the balance sheets
of Rafidain and Rasheed by end-June 2011 (a new date for the completion of this structural
benchmark).
Meanwhile, the Ministry of Finance will continue to modernize these banks by moving ahead
with the plans for their operational restructuring, and these banks will operate on a fully
commercial basis, on market terms. Decisions on the recapitalization of Rafidain and Rasheed
will not be made until the restructuring of their balance sheets has been completed and adequate
progress has been made in their operational restructuring, especially by establishing an
appropriate governance structure and strengthening risk management and control functions.
More generally, given the vulnerabilities these (and other) banks face due to operational risks,
the CBI will continue to improve its oversight systems and monitor closely the activities of the
banks, particularly during the transition process.
We are working to address the remaining safeguard risks at the CBI identified by the IMF’s
safeguards assessment that was completed in June 2010. The CBI will contract a multi-year
co-sourcing agreement with a reputable accounting firm by end-December 2010 (a new
structural benchmark under the program), with the external consultant to work alongside its
internal audit staff to review and improve the internal audit function. In addition, the CBI Board
has adopted a decision to transform the Internal Control Committee into an Audit Committee
that will be headed by one of the CBI’s deputy governors, but otherwise will consist of a
majority of
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non-executive members and will have a comprehensive mandate to exercise effective oversight.
This committee will be effective in this new format no later than end-October 2010 (also a new
structural benchmark under the program). Furthermore, the CBI will continue to have an external
auditor conduct reviews of its net international reserves and also of its net domestic assets for
each test date under the SBA (with the exception of end-March), with the review for
end-June 2010 to be completed by end-October 2010 (another new structural benchmark under
the program), and with the scope of the NDA review expanded to include a review of the
operations of the Memorandum of Understanding between the CBI and the Ministry of Finance
with regard to IMF disbursements and debt service obligations and the operational controls over
government accounts.
We are also making additional efforts to strengthen public financial management. We will
shortly finalize and distribute to all spending units a new accounting manual that will help to
improve the implementation of the new Chart of Accounts (a new structural benchmark for end-
December 2010). In addition, to further improve the fiscal reporting by spending units, we have
issued a circular instructing them to provide additional information on advances and letters of
credit. The collection of information for the census of civil service employees is proceeding
slowly, but we still hope to be able to gather all the necessary information by end-December
2010. Meanwhile, we will also review, with the assistance of the World Bank and the United
Nations, the new Civil Service Law that is currently with the Shura Council in view with
international best practices and to ensure effective implementation.
We have met all the performance criteria for end-March 2010, with the exception of the floor
under the CBI’s net international reserves. We have also met all of the performance criteria for
end-June 2010 that can already be assessed, again with the exception of the floor under the
CBI’s net international reserves. We request a waiver of nonobservance for the missed
performance criterion for end-June and also request a waiver of applicability for the end-June
2010 performance criterion related to the central government current spending bill for which
data is not yet available and for which there is no evidence that it was not observed.
Furthermore, due to the delay in completing the first review, we request rephasing of the
disbursements under the SBA. The second review is expected to take place on or after October
30, 2010 and the third review on or after May 31, 2011.
Overall, our economic program is off to a good start and we believe that our policies set forth in
our letter of February 8, 2010 and supplemented by the policies described in this letter are
adequate to achieve our objectives. In support of our policies, we request the Executive Board of
the IMF to complete the first review and approve the second disbursement under the SBA of
SDR 475.36 million. We are fully aware of the many challenges ahead and we are prepared to
take additional measures if necessary. We will consult with the IMF on the adoption of these
measures and in advance of any revision to the policies contained in our economic program, in
accordance with IMF policies on such consultation. The Iraqi government and the Central Bank
of Iraq will continue to provide the IMF with the necessary information for assessing progress in
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implementing our program and will maintain a close policy dialogue with IMF staff. We
authorize the IMF to publish this Letter of Intent and its attachments, as well as the related staff
report on the IMF’s website following consideration of our request by the IMF’s Executive
Board.
Sincerely yours,
/s/ /s/
Mr. Baqir S. Jabr Al-Zubaydi Dr. Sinan Al-Shabibi
Minister of Finance of Iraq Governor
Central Bank of Iraq
http://www.imf.org/external/pubs/ft/...10/cr10316.pdf
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