Iraq’s economy running on financial fumes

Iraq’s monetary problems are compounding its political and military woes. The country needs to resolve issues with its budget and oil production if it hopes to make it through the war intact.

Baghdad’s income relies on the export of oil, which in turn allows it to support domestic commerce. Essay Al Sudani / Reuters

BAGHDAD // One of the few things that has kept Iraq together is money, but as the country struggles to maintain oil exports and fragile internal negotiations, it finds itself running out of that commodity.

Now, with the onslaught of ISIL, dwindling income and a widening deficit, Iraq is at risk of sinking into further turmoil. Will it stay together as the United States and its allies hope to see, or does the country have a breaking point?

This year’s budget, passed a few weeks ago, was based on exporting 3.3 million barrels of oil per day at a price of US$56 per barrel, and foresaw a $20 billion deficit. While the price of crude has risen back up to the $60 mark, Iraq only managed to export an average of 2.53 million bpd last month, creating a $1.2bn budget shortfall in the first month alone. The forecast for February is not much better.

“Iraq is in a financial crisis at the moment,” says Majid Jafar, the chief executive of Crescent Petroleum. “[The prime minister Haider] Al Abadi has been open about that.”

While speaking at the World Economic Forum in Davos last month, Mr Al Abadi said the country was sustaining two campaigns – one economic to meet its funding requirements, the other military to rid the country of ISIL.

The extremist group brought an abrupt end to any hopes of economic prosperity in Iraq when it captured the city of Mosul last June. Trade came to a near-halt overnight, parts of the country became no-go zones and the number of internally displaced people eventually exceeded 2.2 million, according the United Nations. All of this cost the state close to $6bn.

“We have the cost of financing the war,” says Luay Al Khatteeb, a non-resident fellow at the Brookings Doha Centre. “In a low-case scenario that is about $10bn. With the costs of funding all security forces, including the Peshmerga, volunteers and national guard, this could increase to $27bn.”

The conflict is drastically draining the state’s resources to the point that it may be forced to dip into its federal reserves, which would affect the value of the Iraqi dinar.

“Any deficit that is not resolved soon will result in further national debt and push inflation,” says Mr Al Khatteeb.

The main reason for the economic challenge is political, rooted in institutional and constitutional problems.

“All of Iraq’s revenue now is 2.5 times its revenue 11 years ago, but the bureaucracy in managing a viable state, the security issues and legacy practices that need to be resolved have added significant challenges on the budget,” says Mr Al Khatteeb.

Towards the end of the 24-year rule of the late Saddam Hussein, Iraq became one of the most isolated countries in the world, and since his fall in 2003 it has it has struggled to modernise. Its mindset regarding the energy sector is still limited to an era of sanctions and state control. While the Kurdistan Regional Government (KRG) to the north has adopted a private sector approach, the central government adopted a state-controlled model and in the process cut itself and the international oil companies a raw deal.

“There are now talks about renegotiating those deals, all without a federal oil law or revenue-sharing law,” says Mr Jafar. “Iraq is close to producing 4 million bpd, which is higher than the 1970s, despite the lack of legislation and failure to agree on policies and the war against ISIL. It just shows what could be achieved if Iraq got its act together.”

But the lack of income is still preventing the government from finding viable solutions. The agreements it made with the KRG in Erbil in December seem likely to unravel if a compromise cannot be reached.

Under the terms agreed, Baghdad said it would send Erbil 17 per cent of the total federal budget, which is estimated at just over $100bn, in return for Kurdish oil exports. But in a meeting held last week, Mr Al Abadi told the KRG prime minister Nechirvan Barzani that the government could only send $300 million in its first instalment, half of what was agreed.

The Kurds are still struggling to pay government employee salaries, a result of Baghdad stopping budget payments in February last year during the administration of the prime minister at the time, Nouri Al Maliki.

Baghdad is now also struggling to pay salaries. The companies owned by the ministry of industries are four months in arrears with employee payments. There are about 5.6 million workers on the state’s payroll, which includes public servants and those who have retired.

“The issue of money is serious, as it will impact the population, and if it continues we cannot rule out civil discontent,” says Farhad Alaaldin, a political adviser to the president.

Along with the low oil price, the terrorist crisis has aligned the interests of the KRG and Baghdad governments and forced the different factions of Iraq’s political field to the negotiating table.

At a recent conference in London, the KRG’s oil minister, Ashty Hawrami, said that for the first time he felt hopeful about the relationship between the two governments.

“In a sense, the low oil prices might force different parties to come to an agreement,” says Mr Jafar. “In the short term there is shock, but in the medium term the benefit is that the different parties will realise they need each other – more so than if oil was at a very high price.”

When the oil price was high, production thrived and the KRG forged deeper relations with Turkey. Last year it began exporting oil through the pipeline that runs from Kirkuk in Iraq to Ceyhan on Turkey’s Mediterranean coast independently of Baghdad. But these deepened ties with Turkey came into question when Ankara failed to come to the KRG’s aid quickly enough to repel ISIL.

“The KRG will most probably continue to cooperate with both [Baghdad and Ankara]. Strategically, it is the best option,” says Semra Dogan, a researcher at the research institute Ehess in Paris.

“Oil prices will not stay low forever and it is not the sole factor of the equation. The cards are now on the table, and ISIL has proved that the game can be very dangerous for everyone.

“It is not a matter of Baghdad against Erbil or Ankara against Baghdad – they are all interdependent. This emergency situation has negative impacts on the economy and erases the much-needed capacity of planning the future,” she says.

But for now, Baghdad is a crucial ally for Erbil. Historically, that has not played out so well.

“Iraq tried its luck with high oil prices and rich budgets, but unfortunately the politicians and political deals all failed to unite Iraq,” says Mr Al Khateeb.

“The oil became more of a dividing factor rather than uniting.”

Experts hope that this time crude will form a tie that binds.

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