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Iraq’s federal budget: some insights

After the Parliament of Iraq failed in 2014 to pass the federal budget, the MPs in Baghdad achieved a political milestone by agreeing and approving the 2015 budget on January 29, in the first month of the fiscal year—instead of it falling into protracted partisan discussions. The final budget of around $100 billion went through several revisions in order to make compatible a higher expense, required to combat ISIS as well as provide humanitarian assistance, with a lower revenue due to decreasing oil prices.

Security and defense rose as the most crucial area for Iraq and the budget allocates $26 billion in this category. Slightly more than half of the budget accounts for the public payroll and a 17% share is reserved for the Kurdistan Regional Government. Subsidies to energy and fossil fuels accounted for 13% of Iraq’s revenue in 2013 and, since no large reform has been undertaken, they still absorb a significant share of the budget. All in all, this leaves a tiny room for investment and reconstruction, even though Baghdad has deferred some outstanding payments, such as war reparations to Kuwait.

Hit on revenues, deficit on the rise

With oil prices hitting a 6-year record low, government revenues are expected to be extremely affected. The Ministry of Oil announced that sales of oil, which fund the budget almost entirely, were worth $5 billion during December, a month where the oil prices moved from $75 per barrel to $55. This means a 33% drop in revenue from where it was during the first half of 2014, where the government earned $7.5 billion a month with the same export levels.

The government has planned to raise some additional revenue by levying taxes on imported cars, cigarettes, and phone and internet cards. The Parliament has also encouraged relevant ministries to actually start collecting fees from the public services provided to citizens. However, at first glance, the impact of this fiscal reform suggest that it will not make a significant difference in terms of revenue but it will impose a significant burden on users at difficult times.

The budget leaves an expected deficit of $21 billion—based on an oil price benchmark of $56. This represents a fiscal deficit of slightly below 10% of Iraq’s GDP. How is the government planning to finance the gap? Government bonds and borrowing from local and international banks is a clear option. Iraq still holds a robust credit position with levels of government debt relatively low. However, especially noteworthy is the agreement with the Central Bank of Iraq by which the Bank will facilitate $5 billion to fund the deficit—an action away from orthodox economics.

Loosening up the monetary policy

Although it went much unnoticed in the financial media, the Central Bank of Iraq also announced a significant shift in the country’s monetary policy. Iraq is planning to undertake its own quantitative easing, as done in the United States and intermittently in the European Union, to compensate for a restrictive fiscal policy. To this effect, the Bank will adopt expansionary measures such as providing additional liquidity to the banking system, with the aim to extend the credit. It will also have a larger presence in the secondary capital markets by purchasing treasury bonds.

This loose monetary policy puts extra pressure on inflation but also, most importantly, on the exchange rate of the Iraqi dinar. An increase in the availability of money in the economy is automatically followed by a devaluation of the local currency value against other benchmark currencies. Therefore, the Central Bank will be forced to spend part of their foreign exchange reserves to defend the peg with the dollar at 1,200 dinars per dollar that was established in 2008. Although reserves have been declining for some time—now at $67 billion—it still does not pose an insurmountable obstacle in the short term. The CBI should be able to fulfill its duties in the absence of a disturbing crackdown, although it leaves its position weak to confront the same situation for the next year..

A wrong feeling that this is cyclical, not structural

In conclusion, this budget seems a good compromise under such a constrained context, with the country being at war and the public policy limited by low oil prices. The financial position seems robust enough to support an exceptional year. However, some factors suggest there is a political feeling in Baghdad that these circumstances are just a cyclical issue and that life—and economic policy-making—will be back to business as usual as soon as next year. A first factor is that the benchmark oil price used is quite higher than the market price, as Iraqi policy-makers allegedly rely on an unlikely price rebound by end of year. A second element is that the tax reform introduced is of very little weight, having no profound impact on public finance.

With Baghdad politicians deeming that the budget challenges are merely a cyclical phenomenon, the much needed structural reforms may be dangerously put back on the shelf. Without reforming public finances on both the revenue and spending side, Iraq’s economy will remain subject to the volatility of the international markets. Iraq will resist the current shock, but it casts some doubts it if the current phenomenon is not cyclical but, as should be expected, a ‘new normal’.

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About MERI:  The Middle East Research Institute is Iraq’s leading policy-research institute and think tank. It is an independent, entirely grant-funded not-for-profit organisation, based in Erbil, Kurdistan Region.  Its mission is to contribute to the process of nation-building, state-building and democratisation via engagement, research, analysis and policy debates.

MERI’s main objectives include promoting and developing human rights, good governance, the rule of law and social and economic prosperity. MERI conduct high impact, high quality research (including purpose-based field work) and has published extensively in areas of: human rights, government reform, international politics, national security, ISIS, refugees, IDPs, minority rights (Christians, Yezidis, Turkmen, Shabaks, Sabi mandeans), Baghdad-Erbil relations, Hashd Al-Shabi, Peshmarga, violence against women, civil society. MERI engages policy- and decision-makers, the civil society and general public via publication, focused group discussions and conferences (MERI Forum).

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