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Iraq financial crisis prompts emergency action


TexasGranny
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Iraq financial crisis prompts emergency action

 

Iraq financial crisis prompts emergency action

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Iraqi Prime Minister Haider al-Abadi addresses the session 'A Vision for Iraq' at the World Economic Forum in Davos, Switzerland, on Jan. 23, 2015. (RUBEN SPRICH/Reuters)
 
By Ben Ven Heuvelen, Ben Lando and Staff of Iraq Oil Report

Published Thursday, February 5th, 2015

 

Iraq is pursuing a series of emergency measures to finance its 2015 budget, following years of poor governance and unchecked spending that led to a financial crisis now made worse by low oil prices and high military spending demands.

 

The government is planning to indirectly borrow from the country's foreign currency reserves, in a plan described Wednesday in Baghdad by Central Bank Governor Ali al-Alaq. The move could create a risk to the credibility of the Central Bank of Iraq (CBI) and the stability of Iraq's currency, according to international economists who have long monitored Iraq's finances.

 

The Oil Ministry is also trying to negotiate with international oil companies (IOCs) to reduce its immediate payment obligations, according to Thamir Ghadhban, the former oil minister who is now a senior economic advisor to the prime minister. The negotiations apparently have the potential to alter the basic structure of IOC contracts.

 

"There are serious and constructive dialogues with [iOCs] to connect what is paid with the price of a barrel of oil, whether it decreases or increases," Ghadhban said.

The extraordinary measures underscore the severity of Iraq's financial crisis, which was created by years of unsustainable budgeting practices and poor fiscal management during former Prime Minister Nouri al-Maliki's administration. The oil price collapse and the rise of the so-called Islamic State (IS) group have aggravated those pre-existing problems and made them more difficult to solve, despite the efforts of Prime Minister Haider al-Abadi's new government.

 

"The issue of the budget is fundamentally linked to the massive dysfunction of the government," said former Iraqi Finance Minister Ali Allawi. "We've had people in charge of a boat that was barely seaworthy, and they don't know anything about navigation."

 

Iraq's 2015 budget, which passed Parliament at the end of January, authorizes more than 119 trillion Iraqi dinars (more than $99 billion) in spending. Eighty-five percent of revenue (nearly 79 trillion dinars, or nearly $66 billion) is to come from oil exports, based on an assumption that an average of 3.3 million barrels per day (bpd) will be sold at $56 per barrel. Although such rates are technically feasible, Iraq is falling short so far this year.

 

Even if those oil sales are achieved, there will still be a deficit. After making politically difficult spending cuts and efforts to raise non-oil revenues, the government is still anticipating a deficit of more than 25 trillion dinars (nearly $21 billion), most of which is supposed to be financed by borrowing.

 

Those plans are not realistic, according to several western officials involved in Iraq's financial sector. They spoke on the condition of anonymity because of the sensitivity of the topic.

 

For example, they said, Iraqi commercial banks simply do not have enough capital to lend the amounts called for in the budget; all told, the government's actual ability to borrow could fall more than $10 billion short of the budget's assumptions.

 

"These [borrowing] numbers are way too big," said one official. "The idea [for much of the financing] is to sell bonds to the banks. But the banks essentially don't have any money left."

 

In previous years, Iraq has had a financial backstop in the form of the Development Fund for Iraq (DFI), an Iraqi-controlled account at the Federal Reserve Bank of New York that collects the country's oil revenue and has functioned as something of a national savings account.

 

At the beginning of 2013, the DFI held $18 billion, according to the International Monetary Fund (IMF). But government spending was so high that, even with the price of oil above $100, the budget deficit was large. Rather than make cuts or seek financing, Iraq used about $12 billion of its savings to pay the bills that year; at the same time, the Maliki administration allowed a World Bank program to lapse that could have helped provide financing and make structural reforms.

 

"Basically, the budget is put together without any coherence, without any understanding as to its implications and significance on macroeconomic policy," Allawi said. "It is just an accounting mechanism for the government to distribute its largesse. Things got out of control because of this underlying illusion that this revenue stream is continuously on the upswing. The facts of history have not really borne that out."

 

The DFI fell to just $6 billion by the end of 2013, according to the IMF and other experts intimately monitoring Iraq's finances, and has continued to be drawn down.

In the current atmosphere of crisis, Iraq has been living week-to-week, with virtually no rainy-day fund; now the DFI has dipped to $1 billion, according to two officials with access to the data.

 

Raiding the foreign currency reserves

 

The CBI's lending plan appears to be a response to these constraints. Under the policy outlined by Alaq on Wednesday, Iraqi commercial banks will buy government bonds and then sell them to the CBI on secondary markets. The cash infusion from the CBI will then allow the banks to give more cash to the government, in exchange for more bonds.

 

"The CBI, according to its law, is not able to give the government any loan," Alaq said. "But if we can buy the bonds issued by the government to the other banks… then those banks will have the liquidity to support the budget."

 

One western financial expert characterized the plan as a "triangle scheme" that was functionally equivalent to a direct loan from the CBI to the government.

"They're hoping to make it less obvious that what they're doing is using their foreign currency reserves to finance their budget, but everyone knows that's what they're doing," said another official familiar with Iraq's financial situation.

 

Central banks typically avoid using their foreign currency reserves to directly support government spending because they are needed to support the sovereign currency. Iraqi dinars have value largely because the CBI will accept them in exchange for dollars; if the CBI's reserves shrink too much, it would risk losing the ability to make the large currency transactions required to stabilize the dinar's value, which has barely fluctuated since 2007.

 

Iraq's foreign currency reserves dropped from $77 billion at the end of 2013, according to the IMF, to about $65 billion at the end of 2014, according to several officials with access to the data. The officials said the reduction was a result of ballooning imports, mainly weapons: because many big purchases were made abroad, that currency was never brought into Iraq, which meant the CBI was taking in fewer dollars than it was using to buy dinars. The falling reserves were a byproduct of the government's changing spending patterns.

 

By contrast, the new CBI bond-buying plan is a large step closer to using currency reserves to actively support government spending.

 

The $65 billion in currency reserves is a level that many international economists consider healthy. For now, the CBI can likely absorb a further hit to its reserves without much impact on the broader economy.

 

"If you were to contain it to a one-off operation, the risks would be limited," said one western financial expert. "The danger is that such an operation could undermine the credibility of the central bank. You do it once, why shouldn't you do it twice or three times? Then the reserves will go down to such a level that you can no longer protect the dinar."

 

Iraqi and western financial experts worry that such CBI intervention will be repeated partly because some Iraqi leaders do not understand the possible consequences.

"Some people think the Central Bank's reserves are government savings," Allawi said. "There is very, very poor – catastrophically poor – economic understanding on the part of government, Parliament, policymakers. You would be shocked how poor it is."

 

Even so, Iraq might not have a choice. The 2015 budget is already 16 percent smaller than the 2013 budget, which also governed state spending for 2014 due to political disputes that prevented passage of last year's budget.

 

The government needs to fund a massive military effort against a well resourced insurgency and provide for millions of displaced people and refugees. It also must contend with a legacy of fuel, food and electricity subsidies, a bloated public-sector payroll, and growing distributions of money to fractious local governments – all of which are impossible to reverse without risking political upheaval and broad instability.

 

"Cutting more is not a good solution. Borrowing from the CBI is not a good solution," one of the western financial experts said. "They only have bad solutions."

 

Negotiating with oil companies

 

Oil executives have begun to worry that Iraq's cash flow problems will cause payment delays, which have the potential to undermine the financial models that the projects are based on and render them uneconomical.

 

"The way the contract is structured, you invest money and then get paid back the following quarter," said one IOC executive. "This [contract model] was all about, 'We pay you a small margin but you get cost recovery quickly.'"

 

Iraq's technical service contracts appear to be especially vulnerable to the collapse in oil price. They require Iraq to quickly turn around payments, which are linked to the level of production rather than overall project revenue. As a result, even though Iraq's oil proceeds have fallen, its dues to oil companies have actually risen slightly along with production.

 

"As the oil price goes down they have to give us more and more cargoes," said an official from an IOC working in Iraq. "Costs won't go down. Production isn't magically going to ramp up; in order to make that happen, they have to pay IOCs the costs, at least."

 

This has prompted Deputy Oil Minister Fayadh Nema and other top oil officials to open discussions to renegotiate contracts with oil companies, according to both Ghadhban and a western official familiar with the talks.

 

"When the price of oil changes, whether it decreases or increases, the payment would change, too," Ghadhban said.

 

Yet any changes that link IOC payments to revenues – rather than a flat fee for production – has the potential to significantly change the contract.

 

"If they want to delay payment and alter how the risk-reward structure goes, I think the companies would be up for it," the IOC executive said. "But that's a big negotiation… it's a very fundamental negotiation."

 

The 2015 budget also authorizes the prime minister to borrow $12 billion that could be used to pay IOCs. But even if the government can secure such loans, the underlying practices of fiscal management are hardly sustainable.

 

No easy solutions

 

Iraq is no stranger to financial shocks. When the price of oil crashed in 2009, revenues dropped and the government was forced to spend far less.

But when prices began to recover, the Maliki administration raised spending to match. In Iraq's atmosphere of perpetual crisis, there have always been urgent justifications to delay painful reforms.

 

"No one knows what the economic policy of Iraq is," Allawi said. "As much as the budget is central to it, there is no idea of what the priorities are. It just becomes an arithmetic game of adding the demands of various ministries and seeing who has the ear of the prime minister."

 

As a result, Iraq has descended into a cycle of poor governance, one-dimensional economic activity, and corruption that is characteristic of the so-called "resource curse," a phenomenon documented by economists in which great resource wealth functions to stymie a country's development.

 

In Iraq, revenues from rising exports and record oil prices and were not set aside in a sovereign wealth fund. Rather than create a diversified economy, the government continued to grow its payroll, enabling citizens to indirectly live off state oil proceeds.

 

"This huge expansion of the operational budget, the current expenditures, salaries, wages and pensions and so on – they are used generally, at the margin, to basically buy off people, elements of the population that may need to be bought off," Allawi said.

 

In this patronage system, there is great opportunity for corruption.

 

"The heavy dependence on oil… means that the authorities face little or no incentive to build strong budgetary institutions and transparency, encouraging instead a top-down fiscal policy where public scrutiny of expenditure and accountability is weak," said a 2014 World Bank report on Iraq's public expenditures.

 

These factors reinforce one another in a vicious cycle, which has now been compounded by not only falling oil prices but also the rise of the IS militant group.

Abadi's government appears to be making some serious efforts. Iraq's 2015 budget of $99 billion is vastly more realistic than the 2014 draft budget, which slated expenditures at $140 billion.

 

Likewise, the predicted oil exports are more realistic than in 2014, when the draft budget anticipated 3.4 million bpd of oil exports – nearly 900,000 bpd more than Iraq actually achieved. By contrast, the 2015 budget goal of of 3.3 million bpd is lofty but technically feasible, due to development of oil fields and a cooperative oil and revenue deal between the federal government and the autonomous Kurdistan region.

 

The new budget also benefited from a cut of unnecessary spending on multi-billion defense purchases, though some of the funds were redirected to refugees and to fund the Shia militias that have been at the forefront of the fight against IS militants. Kuwait also agreed to defer more than $4 billion in Saddam Hussein-era reparations payments due this year.

 

In addition, Ghadhban said, next week Iraq will begin to publicly outline steps to selling off state-owned enterprises, many of which are staffed but unprofitable if not inoperable.

 

These tactical maneuvers appear to be helping Iraq avoid insolvency, but the country's unrealistic deficits are ultimately the symptom of a deeper problem.

 

"What’s most concerning here is not so much the fact that they can’t balance the budget," said one of the western officials involved in the Iraqi financial sector. "What’s most concerning is that they are unable to manage their budget process. That’s a sign of the complete dominance of the internal Iraqi politics over how to administer their resources. That’s what’s really worrying."

 

Ben Van Heuvelen and Ben Lando reported from the United States. Iraqi staff reporting from Baghdad are anonymous for their security.

 

 

 

:cowboy2:

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Thanks TexasGranny for this article - Very interesting to say the least - My thought is why would theu pass/approve a budget with all of these issues?  Should these issues been resolved before passing/approving the budget for 2015?  I mean something just not adding-up....Do they need to RV their curreny and stop making all of these excuses???

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there are so many holes and misperceptions in this "western" article as usual.  first of all,, loans from the WOrld Bank and IMf along with many countries are on the way, once the new monetary policy kicks in.  There are several countries that are frothing at the mouth to loan IRaq money...so this Iraq is in trouble and taking money from the CBI is total BS.  They are using the DFI funds for some collateral....that's it. western media need to stick to their poor coverage of our news and quit screwing up Iraq's

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there are so many holes and misperceptions in this "western" article as usual.  first of all,, loans from the WOrld Bank and IMf along with many countries are on the way, once the new monetary policy kicks in.  There are several countries that are frothing at the mouth to loan IRaq money...so this Iraq is in trouble and taking money from the CBI is total BS.  They are using the DFI funds for some collateral....that's it. western media need to stick to their poor coverage of our news and quit screwing up Iraq's

 

Just a little FYI: The Iraq Oil Report has this on their About page.

 

About

Iraq Oil Report is the world leader in providing business, political and security news and analysis on Iraq. Through our network of analysts and journalists located in Iraq, we provide the most up-to-date information on all current and future developments in the country. With years of experience in Iraq, the Iraq Oil Report team knows the decision makers and policy influencers in the country. We work closely with key individuals from Iraq’s oil and energy ministries, as well as other government and business leaders, providing unparalleled access to information on the country’s most important sectors.

The Team Ben Lando | Iraq Bureau Chief

Ben Lando is founder and Iraq Bureau Chief of Iraq Oil Report, the best source for news, analysis and information about the country's energy, political, security and society. He manages a network of local and international reporters and researchers, as well as the company's news, custom research and photo divisions. Ben has briefed public and private investor groups, diplomats and American and other political leaders about Iraq. Ben has reported from a dozen countries on energy, political and security issues, and has been published in The Wall Street Journal, The Economist, and Time Magazine, and is currently a Contributing Editor at Platts. He has been based in Baghdad for over three years, and travels throughout Iraq.

Ben Van Heuvelen | Managing Editor

Ben Van Heuvelen manages our editorial team, coordinating Iraq Oil Report's news coverage and reporting frequently from Iraq and the region. His reporting and analysis also frequently appears in the Washington Post and Foreign Policy. Ben has briefed investors, diplomats, and NGOs on Iraq's political and business environment. Prior to joining Iraq Oil Report, Ben was a research fellow at the New America Foundation in Washington, DC., and the chief researcher for two-time Pulitzer Prize winning author Steve Coll’s new book “Private Empire: ExxonMobil and American Power”.

Patrick Osgood | Kurdistan Correspondent

Patrick Osgood is Kurdistan Correspondent, focusing on the development of the region's energy industry and related issues. He is based in Erbil. He previously reported on upstream oil and gas in the GCC countries, Iraq and North Africa for a Oil & Gas Middle East magazine and website, based in Dubai. Patrick originally trained as a lawyer in the United Kingdom.

 

 

Sounds like they might be "on the ground" in Iraq and Kurdistan.

 

:cowboy2:

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If Iraq does have this cash problem like they are saying it does make you wonder why they passed the budget and now they don't have the funds....first and foremost go after the money mr potatoe head stole from the country then again seems allawi ,Sadar,Maliki,and all the over leaders have sucked that country dry.....ive made some money on my dinars since 2004 but I'm beginning to wonder if we will ever see big gains...I am so ready for this ride to be over one way or another ....rant over....:)

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my friends i know information like this is hard to receive because we are all hoping for the best outcome with iraq.  truth of the matter is this information is spot on.  it is not the western media not understanding iraq's situation.  fact is maliki kicked this country in the tail....he simply did.  take a look at the report i posted in the opinions section and you will see for yourself.  iraq's financial sector is in shambles, the world bank came in to help them straighten out the situation, but maliki was sure to keep resources away from the project.  

 

as far as "why would they post a budget", it is because they have to if they are to gain any respect at all and show evidence of taking ownership to right their ship.  there must be transparency.  there must be actual numbers showing to all (the world, iraq, and would-be-investors) what it will take to run this government and where they are either surplussed or running a deficit.  abadi is doing everything possible to straighten out the financial framework of the country.  HECK these banks don't even have modern day regulations governing them.  they are bringing in Ernest and Young for a reason......to help them develop modern day bank accounting regulations.  don't forget they just had one of the greatest bank scandals hit under maliki where 28 of 30 banks were implicated for stealing close to $100B.  

 

private banks have been edged out by the state run banks.  private banks weren't even allowed to conduct "letters of credit".  LOC could only be done by the state run Trade Bank of Iraq.  do people really know the implications of that?  (i am really considering doing a multi-post piece on iraq banking to help people understand where we really are in this investment).  this means that private banks are kept from conducting trade between foreign and iraqi entities.  on top of that all payments to the government must come from checks written through state owned banks.  non-bank financial institutions have a difficult time being profitable as well.  

 

abadi is working to get the financial sector at least up to respectable modern day levels.  how on earth can iraq's current financial infrastructure support an economic boom??  in its current state, it simply cannot.  that is why we are now seeing so much information on transparency, accountability, and reform.  they are preparing for a new iraq.  over the last 8 years, this country was stalled or sputtering at best.  the only thing being accomplished was maliki and his regime lining their pocket with billions of dollars.  they cared nothing about establishing a true economy and building anything lasting.  

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I just dont see Abadi going out making statements to the world that they are still trying to find solutions to advert a financial crisis, if an RV would solve all these problems. That is not building world financial confidence in Iraq... I HOPE I AM WRONG, but an RV may not be on the horizon..  :angry:

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Trinity out of most posts yours sounds spot on ,abadi is a breath of fresh air for Iraq and I think he will do a great job turning Iraq around so long he stays alive,I also think it's not western translation issues with these articles I think Iraq has been sucked dry by mr potatoe head and his goons and they have a mountain to climb to get where they want to be....I don't see a rate change anytime soon jmo.

I've nearly sold my dinars half a dozen times but swinging by to dinar vets every now and then kept me in the game and I'm in it till the end whatever the outcome....

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Abadi made the speech on January 23rd, before the budget passed.  Oil today is beginning to turn around or at least make a slight rebound in price.  IF, if oil continues the price increase per barrel and production increases, Iraq will be in good shape.  

 

Personally, I think that the previous administration is being "poked in the eye" and the advances now, under the leadership of the present administration (Abadi's) is beginning the process of turning everything around.  Yes, there are still difficulties that need to be overcome and additional problems on the horizon, but they can and will be overcome.  

 

If anything, this is a financial "state of Iraq" address by a man who understand the reality of where Iraq stands financially.  Had he addressed the financial situation with overflowing rhetoric of a glorious future, his credibility would be in question.  

 

IMO Iraq is still moving forward with sound leadership.  We just need to be confident in where WE are and have additional patience.   

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Cutting their projected oil production from 3.4 million bpd to 3.3 million bpd may help them to more realistically figure their income, but it sounds so like the US fiat currency, and borrowing at anything more than 0% interest is just "kicking the can down the road" and burdening the country even more.

 

Iraq is a "one trick pony" with oil being about 79% of their source of revenue. That being said, lower their projections even more, cut expenditures further and do every thing possible to beat the 3.3 bpd production rate. Make it number one on the agenda to dig out of this situation caused by the failure to incorporate a true, sustainable budget. When they do that, maybe they can offer the US some tips on how we can do the same.

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Thank you TG!  This reminds us that when you involve the media be it in country or out, you also open up the opinion of the writer and editor.  There will always be a slant based on the opinions mentioned.

 

I find it refreshing to note that we get our own opinion from multiple articles and not from one alone.  If you live by emotion in the Dinar world, you will always experience the ups and downs.  Don't do it!  Get the emotion out of the equation and you will have a better life and more sanity as you read these news articles.

 

God bless you all and pray for those who have to make the decisions that they have wisdom and they can stand on there own two feet sooner rather than later.  

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