US Special Inspector General for Iraq Reconstruction: Qtrly Report April 2011 Financial Sector Developments

This quarter, the IMF approved disbursement of the second tranche of a $3.77 billion Stand-By Arrangement to help ensure the country’s macroeconomic stability and provide a framework for structural reforms. The payment of $471 million brought the amount Iraq has drawn under the arrangement to about 1.7 billion. The disbursement followed an IMF review of Iraq’s economic performance that drew an overall positive appraisal. The review concluded, “Iraq has maintained macroeconomic stability under difficult external and internal circumstances, while making efforts to rebuild economic institutions.” the IMF noted that “decisive efforts” to rebuild key economic institutions were “critical” for private sector development. The IMF also noted that a recently constituted Bank Reconciliation Unit (BRU) was working with an external audit firm and IMF staff to remove Saddam-era liabilities from the balance sheets of the country’s two largest lending institutions, the state-owned Raidain and Rasheed Banks. The GOI has recognized the liabilities as external debt and made them part of Iraq’s external debt restructuring. Restructuring the two banks is necessary to better support private sector development. the BRU is also working on a plan to relieve both banks of non-performing loans made to now-defunct SOEs. Financial Management System In a process described as “lengthy” and “challenging,” the GOI plans to establish a Financial Management and Information System (FMIS) to improve its cash management and fiscal controls and reporting. The GOI plans to develop core functional requirements for such a system by the end of May, working closely with the World Bank and the IMF. The step comes after work ended on the U.S.-funded Iraq Financial Management Information System (IFMIS), a $37.4 million project that was not fully delivered and lacked critical functionality. Audit reports by SIGIR and USAID’s Office of Inspector General have cited the system’s many deficiencies. Central Bank of Iraq The GOI and IMF this quarter both expressed support to maintain the independence of the CBI. On March 3, Minister of Finance Rai al-Eissawi and CBI governor Sinan al-Shabibi signed a letter to the IMF stating, “We remain committed to maintain the independence of the CBI.” In mid-March, Iraq’s Higher Judicial Council issued a clarification of a January ruling that placed the CBI and other independent bodies under the supervision of the CoM—rather than the CoR. the clarification, which came amid worries about the bank’s ability to act free of political pressure, declared “supervision” does not undermine the bank’s independent work. The IMF welcomed GOI steps to safeguard the CBI’s independence, calling it “critical for maintaining confidence in the Iraqi dinar.” Macroeconomic Developments: Progress and Challenges U.S. and GOI officials who briefed SIGIR this quarter on the state of Iraq’s economic development noted several positive trends that augur well for continued growth: • IMF support. According to the Chairman of the Trade Bank of Iraq, the conditions imposed by Iraq’s two Stand-By Arrangements with the IMF have improved fiscal prudence. • Currency stability Inflation has remained largely in check since 2003. Several GOI officials involved in economic policy making noted that despite the prolonged delay in forming a new government, price stability was the rule rather than the exception in 2010. • Uninterrupted government functions. Embassy officials observed that the GOI continued to perform during 2010 despite the prolonged period of political uncertainty following the March elections. • Private-sector activity Although Iraq’s private sector was all but destroyed under the Ba’athist regime, U.S. officials noted that entrepreneurial activity appears to be on the rise. As February’s attack on Iraq’s main refinery at Baiji made clear, maintaining security remains a prerequisite for continued economic progress. But several other factors limit Iraq’s economic development: • Archaic laws Many of Iraq’s current commercial laws and regulations relfect Ba’athist, statecentric biases, making opening a new business a costly and lengthy process. Of 183 countries ranked by the World Bank in terms of the ease of doing business there, Iraq comes in 166th place overall, and last among countries in the Middle East. • Poor public services U.S. and GOI officials were unanimous in their opinion that electricity shortages deter investors from committing to Iraq for the long term. DPM for Services Salih al-Mutlaq stressed to SIGIR the need to improve the GOI’s capacity to provide clean water and reliable power for all Iraqis. • Inefficient state-owned enterprises (SOEs) According to Embassy officials, Iraq’s SOEs employ more than 600,000 people, making any sudden and dramatic changes in their operations potentially destabilizing. With assistance from the UN, the GOI has embarked on a long-term restructuring plan for 176 SOEs, which will take more than 20 years. Reliance on outdated technologies and practices makes it uncertain whether these enterprises can be successfully transformed into profit-making businesses. • Isolation from the global marketplace U.S. diplomats told SIGIR that it will be years before Iraq is able to join the World Trade Organization, citing the anticipated difficulties in enacting the necessary legal and financial reforms required for accession • Tight credit. Because it lacks a stable revenue base and an internationally recognized sovereign risk rating, Iraq is unable to borrow funds at a reasonable cost from overseas via public-debt of erings. This increases the already profound degree to which the GOI depends on current oil revenue to finance its operations. According to Embassy offi cials, these financing challenges may preclude the GOI from funding essential improvements to its aging hydrocarbon infrastructure. Embassy officials are monitoring four key economic areas this year—modernization of the oil industry, declining agricultural yields, continued electricity shortages, and SOE restructuring—stating that the degree of progress Iraq makes on these issues will largely determine its near-term economic prospects. http://www.sigir.mil/files/quarterlyreports/April2011/Report_-_April_2011.pdf#view=fit