Struggling to pick up the pieces

Aug 17th 2005
From The Economist Global Agenda

A new report from the International Monetary Fund says that Iraq’s economic growth is stalling because of the deteriorating security situation. Political progress, too, seems to have slowed, with the government struggling to produce a new constitution. Without substantial improvement in one of these areas, the future of Iraq looks grim

IN IRAQ these days, officials are constantly confronted with the conundrum of the chicken and the egg. If the government can get the struggling economy back on its feet, rising incomes will sap the supply of desperate insurgents. But as a new report from the International Monetary Fund (IMF) makes clear, it will be devilishly hard to get the economy back on track without first stemming the tide of the insurgency, which is devastating efforts at reconstruction.

Iraq’s all-important oil industry is the most obvious victim of this. After GDP growth of nearly 50% last year, the IMF’s new forecasts cut projected growth from 16.7% to just under 4% this year, a good rate for a rich industrialised nation, but pitiably slow for an oil-rich country recovering from years of war and mismanagement. This slump in expectations is caused by the unexpectedly low volume of oil production, which is now predicted to reach an average of just 2m barrels per day (bpd) this year, nearly 20% less than the 2.4m bpd originally forecast, and still well below the 2.5m bpd that Iraq was pumping before the 2003 American-led invasion. The report attributes this to the insurgency, which has made Iraq’s oil infrastructure one of its primary targets.

The insurgency is hobbling development efforts in other ways. The threat of violence has deterred investment in the country; to date, says the report, none of the foreign banks granted licences in 2003 has yet opened up shop. It has also required donors and the government to divert an increasing share of funds meant for rebuilding Iraq to protecting its workers and equipment. Security and insurance reportedly make up 30-50% of total reconstruction costs.

The result is economic insecurity that undoubtedly makes recruiting easier for the insurgents. With 96% of households receiving monthly food rations, the United Nations Development Programme says that nearly half the children under five are malnourished. Infant mortality is over 10% of live births, compared with 3% in neighbouring Jordan; and 193 out of every 100,000 births in Iraq end with the mother dying, against 41 in Jordan. Most estimates of unemployment are in the 30-40% range, though one study from the University of Baghdad put that figure at 70%.

Public services, which help form people’s opinion of the government, remain patchy and unreliable. Last week Muqtada al-Sadr, the Shia cleric who at one time headed his own insurgent force, began calling for protests against the poor level of water and power services. While virtually all of Iraq’s households are hooked up to the electric grid, and most of them have access to piped water, many report that the reliability of supply is very poor.

These problems are less likely to be fixed while Iraq’s politics remain testy and fractured. The Sunni Arabs ran the country under Saddam Hussein, despite making up only around 20% of the 25m-27m population. They have since lost influence to the majority Shia (roughly 60% of the population) and the Kurds (20%), and most of the insurgents are thus drawn from their ranks. If the main Sunni groups could be brought into the government, this might take some of the sting out of the insurgency, freeing up donors and the government to concentrate on improving public services and oil infrastructure.

But while hopes were raised when Sunni clerics began talking about participating in the political process, talks on a new constitution have become deadlocked, with negotiators asking for an extension of the August 15th deadline. The Kurds and Shia, who occupy the territory where the oil is, are in favour of devolving power—and funds—to the provinces. The Sunnis, unsurprisingly, are fiercely opposed to any such plan, and have threatened to veto a federalist constitution.

The dismal scientists face grim realities

Meanwhile, the country’s economic team struggles on as best it can. The IMF highlights several areas of concern, chief among them the parlous state of Iraq’s budget. Problems in the oil sector have deprived the state of much-needed revenue for reconstruction. Oil exports, which the government had expected to reach 1.8m bpd by now, averaged only 1.4m bpd in the first five months of 2005, the same as 2004. So far, this has been made up for by high oil prices (see table). But spending pressures have grown too, especially since the government does not yet have adequate budgetary controls to help it get a grip on what it is spending, and where.

The IMF is urging Iraq’s economic team to begin phasing out domestic subsidies for petroleum products, which are a drain on the budget; Iraqis can buy petrol at a mere 1.3 American cents per litre. These subsidies are estimated to cost the government nearly $8 billion each year. Ministers seem to agree that ending them is a good idea, but they know that this will not be popular.

Monetary policy is also fraught with difficulties. Consumer price inflation was over 30% in the year to December 2004. The IMF’s Emergency Post-Conflict Assistance programme had envisioned inflation of only 7% that year. The Fund attributes the difference to increased violence in the months leading up to the January 2005 parliamentary elections, which raised the prices of key commodities like gas and food.

The Central Bank of Iraq recently broadened the range of tactics it uses to mop up excess liquidity in the system and maintain the dinar’s de facto peg to the dollar, which, given the primitive state of Iraq’s financial system, is the best mechanism the bank has to keep prices stable. Inflation fell in the five months to May, but the IMF gives a warning that much more needs to be done, and thinks that inflation may surge again in the coming months to produce an average of as much as 20% for 2005.

Overall, Iraq’s economic team seems to be saying the right things. It has plans to modernise the undercapitalised banking system, which currently has no facilities for electronic payments and only a rudimentary process for cheque-clearing. It is working to reduce Iraq’s external debt, which even after a round of debt forgiveness will stand at an excruciating three times GDP. And it is trying to put in place the fiscal and monetary mechanisms that will let the government piece the country back together. Until the insurgency wanes, however, things may fall apart faster than even a crack economic team can pick up the pieces.

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