Plummeting Oil Revenues, Hand-to-Mouth State Budget Hobble Fight Against Insurgents
Nov. 5, 2014 6:47 p.m. ET
BAGHDAD—Another crisis is percolating in Iraq beneath the onslaught of Islamic State militants: a shrinking economy and a widening fiscal deficit that politicians and analysts worry will further undermine the country’s ability to fight off the insurgents.
Iraq’s economy is set to shrink by 2.75% in 2014, the International Monetary Fund said last week, its first contraction since 2003, the year the U.S.-led invasion of the country.
Meanwhile, on Wednesday the finance committee of Iraq’s fractured parliament decided to stop the 10-month debate over the 2014 budget, which was to have applied to the fiscal year that ends on Dec. 31. Without a budget in place, the government has been running an unwieldy hand-to-mouth fiscal policy that has arrested further investments in the critical oil sector, which accounts for 93% of Iraq’s budget.
With global oil prices having declined by about 25% since Islamic State began its furious assault on Iraq in June, Iraqi politicians are scrambling to cut a budget that was already overextended before the country was thrust into a full-scale war.
Iraqi policy makers and economic analysts warn that the financial stress will heap more challenges on Iraq’s ability to reverse Islamic State’s hold on about a third of the country, and strain its capacity to pump cash into its state-centered economy.
“In Iraq, essentially the government is the main economic player. Everything depends on government spending,” said Carlo Sdralevich, the mission chief for Iraq in the Middle East and Central Asia department, who added that the decline in oil prices “puts the government under more pressure and it will make it more difficult for them to devote [certain] resources to fighting Islamic State.”
As the government has redirected funds toward security, Prime Minister Haider al-Abadi, who took office in September, has taken some austerity measures. Much of his policy, however, has meant pushing costs onto the 2015 budget, which Iraq’s cabinet has yet to send to parliament despite an Oct. 10 deadline, according to finance-committee lawmakers.
Mr. Abadi’s cuts have pushed budget expenditures this year down to 137 trillion Iraqi dinars ($118 billion) from a projected outlay of 171 trillion dinars.
The cuts have been painful. Plans were scrapped to hire some 37,000 new government employees—including doctors and teachers—and raises were delayed for existing ones. The government has also postponed plans for new student loans and scholarships, said Majda al-Tamimi, who represents the government-allied Sadrist bloc on the finance committee.
There is even talk in parliament of cutting spending on orphans and on elementary-education projects, according to some lawmakers.
Even with the cuts, Iraq is still 27.6 trillion Iraqi dinars over budget, Ms. Tamimi said. Mr. Abadi’s office didn’t respond to requests to comment.
“The expenses that were supposed to be spent became much bigger than they expected,” Ms. Tamimi said. “But because of these circumstances, and the spending that we started doing, we came to a situation in which all the money that we were getting we were spending.”
For the most part, expenses have flowed into new arms purchases, payments for fresh recruits and a plan to begin paying salaries to Sunni tribal fighters and Shiite militias who have so far done much of the fighting against Islamic State, she said. The Iraqi state is also struggling to pay for the country’s nearly two million internally displaced refugees.
Without a budget in place, Iraqi policy makers say they are mostly reacting to the country’s economy rather than planning it.
The greatest barrier in the negotiations has been a dispute with the northern Kurdish Regional Government, a semiautonomous region that has its own oil wealth and ambitions for statehood.
The KRG capital of Erbil has angered Baghdad with its recent overtures toward independence. But the impasse started long before that, when Baghdad refused to transfer a constitutionally mandated 17% of Iraq’s budget to the three Kurdish provinces, in what it claimed was a reaction to the Kurds’ moves to export oil directly rather than through Iraqi state oil authorities.
As a result, Kurdish government employees haven’t been paid for months, sparking protests in Erbil.
The IMF’s grim assessment of Iraq’s economic plight was made even without factoring in the 25% drop in oil prices in recent months. The IMF’s prediction of 1.5% growth in 2015 was made without considering declining oil prices, which fell below $80 per barrel for the first time in two years on Monday.
Mr. Sdralevich and others say the structure of Iraq’s top-down, state-centered economy means it will be several months before Main Street businesses begin to suffer. But even if the government is able to keep financing its massive defense outlays, the funds redirected away from much-needed infrastructure projects will cause medium- to long-term pain, he said.
Iraq will get little relief from its once robust oil industry. The northern Kirkuk-Ceyhan oil pipeline has been shut down since early March, blocking oil exports from the north of the country. Pumping in the south, home to most of Iraq’s reserves, increased to fill the gap, but a lack of investment there means that Iraq’s oil production has already started to decline.
Oil exports have been stuck at 2.4 million barrels per day this year, the same as in 2013.
Given the scale of the conflict with Islamic State, the IMF has revised its expectations for oil exports downward to 4.4 million barrels per day by 2019; an assessment in the spring predicted 5.6 million barrels per day by then.
Even with the potential collateral of Iraq’s substantial oil reserves—the fifth largest in the world—Iraqi politicians such as Mr. Abadi seem to prefer austerity to borrowing.
Emad Mostaque, an expert on Middle East economics and politics, said the aversion to borrowing comes from ugly memories of former President Saddam Hussein ’s crippling debts. But that reluctance could prevent Iraq from finally developing a dynamic, non-petroleum-based economy, he said.
“Austerity is the wrong thing,” said Mr. Mostaque. “If you see the budget cut back, that’s when you’ll see the real impact.”