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MENA Quarterly Economic Brief, January 2015: Plunging Oil Prices The over-50% decline in world oil prices—from US$115 a barrel in June 2014 to less than US$50 today—will have significant consequences for the economies of the Middle East and North Africa (MENA) region. This report titled " Plunging Oil Prices", focuses on the implications of low oil prices for eight developing countries, or the MENA-8 (oil importers: Egypt, Tunisia, Lebanon and Jordan and oil exporters: Iran, Iraq, Yemen and Libya) and the economies of the GCC (Gulf Cooperation Council), who play a major role in providing funds in the form of aid, investment, tourism revenues and remittances to the rest of the countries of the region. Page 18...IRAQ...from the Link in the article Plunging Oil Prices... IRAQ A positive development was the ending of the long-standing dispute over distribution of oil revenues between the central government of Iraq and the semi-autonomous region of Kurdistan. Under the new agreement effective January 2015, Kurdistan will export 250,000 barrels of oil a day while the disputed province of Kirkuk will sell 300,000 barrels a day. Though good news for Iraq, the agreement will add to the downward tailspin in the oil market, with the additional barrels expected from Kirkuk adding to the already ample supply in the market. The central government’s payments to the Kurdish region, accounting for 17 percent of the state budget, will resume with additional payment of $1 billion towards salaries and equipment of the Kurdish peshmerga forces fighting the Islamic State in Iraq and Syria (ISIS). Despite the current turmoil, Iraq’s oil exports have increased, reaching an average of 2.9 mb/d in December 2014, their highest level since 1980 (Figure 9) However, due to lower oil prices, oil receipts were much lower during this period compared to the early months of 2014. This has exacerbated the fiscal deficit, projected at 7 percent of GDP in 2014. It has come at a time when spending is higher than usual as the government battles to regain ground from ISIS. Current spending in Iraq accounts for more than 30 percent of GDP while capital expenditure is as much as half of that figure. Iraq’s oil export revenues fell sharply in the second half of the year as a result of declining oil prices. Between May and November 2014, Iraq’s monthly oil export value declined from $8 billion to $5.4 billion. This sharp decline mainly reflects the Iraq oil export price (which discounts to international benchmarks) declining from $100.7 to $70.4 during the same period. The prevailing insecurity has seriously hampered reconstruction and investment, which resulted in lower-than-foreseen oil production growth and hence slower economic growth. Figure 9. Iraq: Economic situation Source: World Bank. 0 1 2 3 0 4 8 12 16 10Q1 Q1 Q1 Q1 14Q1 GDP Crude oil exports (RHS, mb/d) GDP Growth (%)MENA Quarterly Economic Brief Issue 4 January 2015 19 A draft 2015 budget was presented to the Cabinet at the end of November based on an oil price of $70 per barrel and prioritizing salaries, military spending, and humanitarian relief. The budgetshowed a deficit of $39 billion, or 17 percent of GDP. As this was considered infeasible, the government is revising the budget and has focused instead on a freeze in hiring and rooting out the most glaring expenditure abuses (notably with the identification of 50,000 “ghost soldiers”). The rapprochement with the Kurdish Regional Government (KRG) on northern oil exports, both for KRG own-sourced oil exports and transit through KRG for oil from Kirkuk, will also relieve some pressure. From the perspective of the global oil market, the reopening of the northern export route adds 550,000 barrels per day of crude supply, though part of this figure represents existing KRG exports moving out of the grey market, as well as changes in the composition of Iraq’s total exports. The impact of falling oil prices: The major impact will be seen on fiscal and current account balances: The World Bank estimates that the fiscal deficit will rise to about 20 percent of GDP in 2015 from about 6 percent of GDP in 2014; and the oil trade surplus will be 14 percent of GDP. Real GDP growth will decline to about 1.5 percent in 2015, remarkably low for a country that should still be in reconstruction-driven growth. Given Iraq’s lack of capital-market access and existing debt service obligations, the current account deficit implies a large financing gap, assuming unchanged policy on central bank reserves. As of December 2014, Iraq’s gross international reserves amount to $69.1 billion. Government spending: The most likely impact of lower oil prices on government spending would be through a reduction in capital spending by restricting the number of investments, which would return the public-sector borrowing requirement to the 2014 range (i.e. 4-8 percent of GDP). The government would seek to increase reliance on external financing for its capital program (especially through export credit agencies and bilateral/multilateral finance and aid from donors on humanitarian grounds). The government has sought a delay in its final reparation payments to Kuwait, which would defer nearly $5 billion of commitments. Even under optimistic external funding scenarios, none of these options can sustain the full capital program. The remaining financing buffers are central bank reserves, the domestic banking system, and the state pension fund. Tapping any of these sources (more than they are currently doing) raises fundamental questions about the integrity of already weak fiscal institutions. Poverty: As various consumer prices remain administered in Iraq, the impact on poverty will be mainly through the fiscal impact. Since northern Iraq is the main land transit route to the entire country, the increase in transport costs as a result of the ISIS crisis is affecting most non-oil merchandise trade. In particular, the cost of the universal Public Distribution System (PDS) (“food ration”) is expected to increase. Since this program is seen as non-negotiable, the food price increase will be reflected in the fiscal impact. Exchange rate: Iraq pursues a policy of a de facto peg to the U.S. Dollar, and therefore monetary policy is constrained in tackling the current shock. The Central Bank of Iraq (CBI) had kept the Dinar steady through January 2009. In 2014, the nominal exchange rate in the official market remained stable against the U.S. Dollar at 1,166 IQD/1 USD, but the rate in the parallel market increased. The CBI has recently taken steps to simplify foreign exchange market regulations, but has not eliminated all existing exchange restrictions and the multiple currency practice. With the peg, fiscal policy carries the burden of macroeconomic stabilization, but in this case does not have the space to do so.