The FINANCIAL — On July 29, the Executive Board of the International Monetary Fund (IMF) concluded the 2015 Article IV consultation1 with Iraq.
Iraq is facing a double shock arising from the ISIS insurgency and the plunge in global oil prices. In 2014, real GDP contracted by 2.1 percent mainly due to the impact of the conflict, while oil production and exports increased slightly compared to 2013. This year, overall economic activity is expected to see a modest recovery of 0.5 percent thanks to oil sector expansion, while non-oil activity is expected to contract further, according to IMF.
The decline in oil prices has driven the decline of Iraq’s international reserves (including the Development Fund for Iraq) from $84 billion at end-2013 to $67 billion at end-2014. Fiscal pressures are intensifying, with the government deficit expected to expand from 5.3 percent of GDP last year to 18.4 percent of GDP in 2015 due to continuing weak oil prices and rising humanitarian and security spending.
The authorities have appropriately maintained the exchange rate peg. Liberalization steps taken by the Central Bank of Iraq led to a decline in the parallel market spread to less than 2 percent by end-2014. The imposition of new restrictions triggered significant market volatility and a sharply wider spread in the first months of this year, but their recent removal has helped narrow the spread back to 4 percent by July.
Medium term growth prospects remain positive, though less favorable than before the crisis. Growth will be driven by the projected ramp-up in oil production and the rebound in non-oil growth supported by the expected improvement in security and implementation of structural reform. Risks remain very high, however, arising primarily from an escalation of the conflict, political tensions, and poor policy implementation.
The Fund is supporting Iraq through a disbursement under the Rapid Financing Instrument in the amount of SDR 891.3 million ($1.242 billion), equivalent to 75 percent of quota.
Executive Board Assessment
Directors noted the severity of the double shock facing Iraq as a result of the continuing ISIS insurgency and the global oil price decline. The risks remain very high, emanating from an extension of the conflict, political tensions, weak policy implementation, and further shocks from oil markets. In this context, Directors noted that the steps taken by the authorities are in the right direction, but urged further determined efforts to address the large financing gap and maintain the momentum for reforms.
Directors welcomed the 2015 budget as a good step toward addressing pressures from lower oil revenues amid higher humanitarian and security spending, and commended the introduction of new revenue measures. While recognizing that the current adjustment plans may be socially and politically challenging, Directors saw a need for additional measures to help close the large financing gap and build fiscal buffers. Some Directors expressed disappointment over the delay in implementing the electricity tariff reform. In this regard, Directors welcomed the authorities’ commitment to implement the reform as soon as possible or adopt compensatory fiscal measures. They also recommended expenditure rationalization while safeguarding priority social and capital spending and making social safety nets more efficient. Directors urged the authorities to tap domestic markets and seek further external financial support, while avoiding the buildup of domestic and external arrears. Over the medium term, strengthening public financial and debt management will be crucial.
Directors noted that indirect central bank financing of the government is necessary at this juncture given the lack of other sources of financing, but stressed that this should not become a recurring source of financing. They, therefore, welcomed the authorities’ intention to firmly limit such support and clarify the terms of the related financial operations between the central bank, the state-owned banks, and the government. Directors supported the authorities’ commitment to maintain the exchange rate peg, which has served as a sound nominal anchor for Iraq. They also welcomed the steps taken to liberalize the foreign exchange market and urged the removal of remaining exchange restrictions and multiple currency practice as external conditions evolve.
Directors underscored the risks from rising tensions in the banking system arising from the impact of the crisis on the assets and activity of private banks, and the increasing role of state-owned banks in financing the government. In this regard, they welcomed the steps taken to strengthen banking supervision and the authorities’ commitment to press ahead with the restructuring of Rasheed and Rafidain banks. Directors emphasized the importance of bringing Iraq’s frameworks for combating corruption, money laundering, and terrorism financing in line with international standards and implementing them effectively.
Directors welcomed the authorities’ recognition of the need to maintain the momentum on restructuring the economy despite the current difficulties, and emphasized the importance of staying committed to reforms. They highlighted the need to diversify the economy and improve the resilience and inclusiveness of economic growth. They supported the focus on strengthening fiscal institutions, completing the transition to a market economy through further private banking sector development and state-owned enterprise restructuring, and improving the business environment, governance, and the labor market. In this context, they noted the need for Fund technical assistance in strengthening Iraq’s institutions. Recognizing the difficult circumstances, Directors agreed that a realistic implementation timeline is important, while pressing ahead with high-priority reforms. Looking ahead, a forward-looking policy framework could help the adjustment process and allow the authorities to build a track record of strong policy implementation.