Iraqs Economic Abyss

Three years since the fall of Saddam, and US$21 billion later, Iraq’s economy is in chaos. Massoud A. Derhally reports.

There is little that is encouraging in Iraq these days. The words "civil war" hang in the air like a fearsome but inevitable spectre. Three years on since the fall of Saddam Hussein’s statue at Firdous Square, and the promises of economic development espoused by the US, remain just that: promises. To most Iraqis, the dividends of the war are yet, if ever, to be realised.

Much of the Iraqi population has seen no palpable benefits in the way that they live their lives. And both those inside and outside Iraq point to a deterioration in pre-war standards. Some would even argue that the vast majority of Iraqis are poorer today. And, with rampant unemployment estimated to be as high as 40%, there is little to dissuade Iraqis from joining the ranks of a bloody insurgency.

“Economics has a lot to do with helping Iraq settle down and get on with a better life. Without jobs and without some economic development Iraq will be locked in its furore and depression longer than needs be,” says Paul Sullivan, a professor at the National Defense University and Georgetown University.

“It has been very difficult to make any realistic progress either with physical reconstruction or with any kind of administrative or economic reform programme with the security situation so fraught,” says David Butter of the Economist Intelligence Unit (EIU). “The programmes that were envisaged in the early part of the post war period have all been very difficult to implement and there has not been that much that has come through to replace them.”

The US has spent more than US$220 billion on the war and just over US$20 billion on the reconstruction process of the country. Much of the money has gone towards security and training of Iraqis. The infrastructure still suffers with limited access to electricity in the capital.

“Reconstruction is slow because of ad hoc planning, corruption, and a non-holistic and non-developmental way of approaching the whole problem. The banking system is not up to task,” explains Sullivan, who believes those in authority should focus on microcredit programs and help start small enterprises. “Small is beautiful and could work in many parts of Iraq. All of these ‘showcase' mega-projects are targets and may not solve any of the real problems that Iraq needs to solve to get moving truly forward.”

However, some aspects of the institutional framework appear to be functioning. The Iraqi Central Bank has been able to marshal some US$9 billion in reserves and the stock market actively trades shares in 85 companies. The Trade Bank of Iraq, set up by a consortium of financial institutions, has worked relatively efficiently in terms of managing imports.

But the Iraqi dinar, which lost much of its lustre under the Saddam era, has yet to find firm ground. The currency is relatively stable but, as in most volatile hotspots, the US dollar remains the preferable choice of commerce. Inflation, which was nearly 500% under Saddam Hussein, is still markedly high at about 30%.

Structural reform moves, such as the reduction of fuel subsidies, encouraged by the IMF have not been welcomed by most Iraqis. Two relatively small reductions have proven to be quite unpopular and caused some political fall out in the government. Because of that political tension and also due to rising popular discontent stemming from the fact that there isn’t a system in place to compensate the poorer Iraqis for the weakening of that subsidy, it appears unlikely that major further reductions in oil or other subsidies will take place for some time.

“They need to have a form of safety net otherwise there is recognition that it's political dynamite to reduce subsidies even further,” says Neil Partrick of the EIU.

The 19 creditor nations that make up the Paris Club agreed in late 2004 to a programme of writing off most of Iraq’s debt. The first two phases are now applied but a further phase is subject to various prequisites regarding Iraq's economic policy. However, it seems unlikely that the complete Paris Club debt write-off will be in place by 2007, according to the EIU.

And even then, such a write-off represents only around a third of what Iraq is estimated to owe to its external debtors. Some put the country's total debt as high as US$130 billion when the regime changed.

The debt that will remain outstanding after such a write off is largely held by GCC countries, private lenders and former members of the Eastern bloc.

While, on the one hand, some progress has been made in this area, a significant question remains over the issue of the GCC debt (US$40 billion), which is the larger portion of the total Iraq debt.

Ironically, the country with the world’s second largest crude oil reserves suffers from queues at petrol stations. Iraq used to pump 2.5 million barrels of oil per day (bpd) before the war and has a capacity to pump 3.5 million - which it did before the first Gulf War - but it has only been able to muster 1.7 million barrels so far.

In a letter of intent to the International Monetary Fund last year, the Iraqi government mapped out its rather ambitious macroeconomic objectives. It wants to accelerate real GDP growth from 2.6% in 2005 to 10% in 2006. That strategy is inherently driven by the assumption that oil revenue will increase to 2.3 million bpd in 2006 and be uninterrupted, and inflation would be reduced to 15% and international reserves increase to nearly US$11 billion.

But such plans seem rather unrealistic. The stubborn insurgency that stretches from the southern tip of the country to the north, with varying fierceness from one region to the next and much of the violence concentrated in Baghdad, has managed to consistently sabotage oil pipelines.

“The Kirkuk-Ceyhan pipeline, as well as oil product pipelines, are continuously attacked by insurgents, disrupting exports of crude oil to Ceyhan and vital product flow inside Iraq, creating fuel shortages,” says Herman Franssen, president of International Energy Associates.

“As long as there is no strong central government, no security and no petroleum laws, no foreign oil companies other than fly-by-night operators will invest in the upstream of the Iraqi oil industry - assuming that is what the Iraq government wants. This will reduce chances for a speedy upturn in production if, and when, political problems are solved,” he adds.

But that in itself is not the only underlying cause of the country’s paralysis. Many of the oil refineries were neglected by the Saddam regime and need to be upgraded. The country, which has the capacity to produce around 8.2 million bpd, needs between US$30 billion and US$40 billion to restore and develop new fields, according to some assessments.

Franssen believes the situation in Iraq’s oil patch has gone from bad to worse, owing to a number of reasons. “In the first place there is little security in the field, making it difficult for oil services companies to service producing oil wells, let alone drill new wells or develop new fields,” he claims.

Franssen cites the serious damage done to the two major producing oil fields in Iraq, in Kirkuk and Rumaila. “During the sanctions period, not only was well-servicing inadequate, but a heavy fuel oil was also dumped into oil wells, and untreated water was used for water injection into the Southern fields," he says.

"Corruption is rampant and is probably as bad as under the old regime. To put Ahmed Chalabi in charge of the oil sector is not exactly good governance and does not create confidence abroad. The neocons in the US had been convinced by Ahmed Chalabi that, following the liberation of Iraq, the new government would privatise the oil sector and foreign and Iraqi oil companies would together be able to increase production to 5 million bpd by 2010, reducing the role of Saudi Arabia. Everything went wrong after May 2003, particularly with the ascent of Paul Bremer.”

Basil Rahim, a London-based Iraqi banker and managing director of Merchant Bridge, who was optimistic three years ago and thought the country had a chance of privatising state-owned enterprises and creating a sound financial sector, pulls no punches when it comes allocating blame.

“Obviously there was no economic plan going into Iraq and that has been to the detriment of the country and the economy. If you look at the size of the economy, before the war it was estimated at around US$20 billion,” he says. “In the last three years, the economy has grown to US$50-60 billion. Had they put a proper economic plan in place, and had there been some security, you could have had an economy that was twice the size by now, because this is a country that has the potential.”

This catch-22 paints a grim picture. Though the country has oil, it cannot produce enough, and whilst there may be money available for reconstruction, security remains its Achilles' heel.

Partrick believes the main challenge is to maintain and expand the security of oil exports. The expectations of the government have not been achieved, and weak exports in the last few months prove this.

“It’s basically a security issue. If Iraq can maintain and expand its exports then more money can come into the country. But you also have the issue of the ability of the government to distribute those oil revenues effectively, and the ability of the wider economy to absorb some of that spending. Ideally Iraq should be increasing, not struggling to maintain, existing levels and that’s their major problem at the moment,” explains Partrick.

Another problem lies in a political process that lacks the consent of key parties, and a lack of proper support and commitment from those who appeared to be in favour of the political process in the early stages. The fissures along sectarian lines appear to be becoming more pronounced.

“You have various partial interests by different groups that are undermining the prospects for stability. Oil is absolutely fundamental to economic prospects going forward and it’s unsurprising that that would remain the case in Iraq for a very long time to come. It’s not just the oil sector, it's also the further stimulation that those oil revenues can have,” says Partrick.

One encouraging sign within the political context would be the extent to which there is a willingness amongst reasonably represented Sunni Arab players to reach an agreement on a government, and negotiate over some of the issues that most upset this key part of Iraq.
The problem is, unless this political process can not only form a government, but be the basis of real compromises, then it's safe to say that the increasingly violent militia activity will continue.

But as Partrick says, “at least you have an opportunity here to try and tie in Sunni Arabs more into the political process, and they have been the most alienated from what has happened, in terms of the change of regime.

“The flipside is a number of key actors, both Shiite and Sunni Arabs, continue a parallel process where they fight for territory and influence in their own community through the use of the gun.”