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Measuring Stability and Security in Iraq


June 2007
Report to Congress
In accordance with the
Department of Defense Appropriations Act 2007
(Section 9010, Public Law 109-289)


Section 1-Stability and Security

1.2 Economic Activity

Several positive economic developments emerged during this reporting period, most notably the launch of the International Compact with Iraq, continued progress on reducing inflation, and a favorable IMF Standby Arrangement review. Nonetheless, significant challenges remain and economic performance continues to be spotty. For example, improved ministerial budget execution is needed to address shortfalls in delivery of basic services to all Iraqis and to revitalize the oil sector.

During the past quarter, oil production remained constant at about two million barrels per day due to poor infrastructure and inadequate security. Iraq-with the thirdlargest proven oil reserves of any country in the world-will require an economic and legal framework that spurs investment and stability and security to keep project costs and risks competitive and attractive to investors to achieve long-term development. Passage of the hydrocarbon law should attract foreign investment in the oil sector. In addition, implementation of the Foreign Investment Law passed in 2006 could encourage foreign direct investment in the non-oil sector to diversify the economy and create private sector jobs. Iraq will also require a plan for investing oil revenues into other sectors of the economy to promote diversification.

Government of Iraq Economic Commitments

As part of the New Way Forward, the Iraqi government has reinforced its commitment to key economic reforms. These commitments recognize that, in order to build public confidence in the government, improvements in security must be reinforced by improvements in the standard of living for all Iraqis. The focus of these efforts is on growing the Iraqi economy and improving the provision of basic services. The Iraqi Government has committed to fully executing its 2007 budget, which includes $10 billion in reconstruction and infrastructure projects to further economic development and provide essential services.

Budget Execution

The infrastructure ministries play a dominant role in Iraq's economy, and execution of their capital budgets is a requirement for delivering essential services. Recently available data indicate that the Iraqi government executed 67% of its total budget in 2006. Although it effectively paid salaries, wages and pensions, the government executed only 22% of its capital investment budget and only 3% of its oil sector investment budget. In an attempt to increase budget execution, during this reporting period the GoI provided the Department with about US$1.7 billion to be spent through U.S. Foreign Military Sales (FMS) cases. For the 2007 budget year, the government also instituted procurement and contracting reforms to improve budget execution rates. In addition, the Minister of Finance (MoF) allowed early release of the first 10% of each ministerial and provincial allocation in February. Ministries that do not obligate 25% of their capital budget by the end of June face potential reallocation by the MoF of unspent funds.

The U.S. Government has been assisting the Iraqi ministries in improving the ability to execute their budgets by providing experienced contracting officers, forming a new budget execution monitoring unit, and implementing a National Capacity Development Program through USAID to improve public administrative skills at the ministerial level. This three-year, US$165 million program supports eight training programs in procurement and budgeting.

Sixty-five million dollars has been obligated to date to develop the curricula, and the staff of 45 international professionals has trained 117 civil servants from 14 ministries through at least one level of instruction. The PRT program has also provided technical expertise to improve Iraqi project planning and execution at the regional and local level.

Additionally, the DoD Task Force to Improve Business and Stability Operations (TF-BSO) in Iraq is working with the Joint Contracting Command Iraq/Afghanistan, the U.S. Department of Treasury, and the Department of State (DoS) to enable the GoI to effectively execute its national budget. These agencies bring together subject matter experts in a Procurement Assistance Program to work with ministries and provincial governments to train local nationals and execute Iraqi projects using Iraqi procurement laws and processes. The Task Force is providing two teams to work primarily with the Ministry of Planning: one in Baghdad and one at a satellite location where it will work with the Kurdish Government.

Another method in which the U.S. is assisting the GoI to execute its budget is through utilizing USG contracting and acquisition capacity. For example, ministries other than MoD and MoI are seeking to procure goods and services through FMS cases using 2007 budget funds, enabling them to more effectively execute their budgets. In addition, the DoS has authorized the DoD to negotiate and conclude an agreement with the GoI under Section 607 of the Foreign Assistance Act of 1961, as amended, to furnish commodities and services (such as infrastructure construction for the ministries or fuels for importation into Iraq) using GoI funds. There were some additional positive developments on the international economic level such as the International Compact.

IMF Standby Arrangement

The International Monetary Fund (IMF) Standby Arrangement (SBA) for Iraq promotes macroeconomic stability, paving the way for sustainable growth and external debt relief. The SBA ensures that Iraq maintains sound fiscal, monetary and financial policies and requires important reforms such as fuel price increases, fuel import liberalization, pension reform, census of public employees, state-owned bank restructuring, and recapitalization of the Central Bank of Iraq (CBI). On March 12, the IMF Executive Board held the third and fourth combined reviews of Iraq's performance under the SBA, and having found Iraq's performance satisfactory, granted the program a six-month extension. One example of how the SBA is changing longstanding policies is the elimination in the 2007 government budget of funding for refined fuel product imports for resale to the public at subsidized prices. In 2006, the GoI spent US$2.6 billion on such imports.

Iraq must maintain satisfactory performance on its SBA to qualify for relief from the final US$7.7 billion tranche of the US$43 billion it owes to Paris Club members. The previous regime incurred an estimated US$135 to US$140 billion in foreign liabilities. An estimated US$72 billion of this debt is owed to non-Paris Club countries that have not concluded bilateral debt relief agreements with Iraq. Progress on reducing this portion of the debt has been slow, but the May 3 International Compact meeting has provided a boost.

Indicators of Economic Activity

Economic Growth

For 2007, the IMF projects that the economy will grow by over 10% and that the non-oil sectors will grow by approximately 7%. If low oil production or export prices prevent Iraq from meeting its growth and revenue targets, the government will have less ability to implement its planned investment program for essential services.

Inflation

The Central Bank of Iraq (CBI) has maintained tighter monetary policy in 2007, including continued gradual appreciation of the dinar, resulting in a decline in first quarter 2007 inflation compared to the same period in 2006. Year-on-year inflation in March was 33.6%, compared with 66.4% in January and a peak of 76.6% in August 2006. The yearon- year rate of core inflation (i.e., excluding fuel, transport and rent) correspondingly declined to 23.0% from a peak of 39.2% in July 2006. Recognizing the need for vigilance, the CBI has indicated its commitment to continued use of monetary policy measures to maintain price stability.

Unemployment

The Iraqi government's Central Statistical Organization (COSIT) estimates 17.6% unemployment and 38.1% underemployment. A non-sectarian job creation strategy could help to improve the legitimacy of the government. Consequently, the Maliki government is undertaking efforts to create permanent, sustainable jobs with U.S. assistance. The GoI has begun a pilot micro-credit program to promote small business development and address high rates of unemployment.

DoD is helping the Iraqi government revitalize selected state-owned enterprises (such as bus, cement, and leather factories) and spur related private sector activity to boost employment and contribute to the stabilization of the country. Working with other U.S. Government agencies, U.S. business executives and industrial experts, military commanders and planners, as well as the GoI, TF-BSO assessed additional Iraqi industrial facilities since the last quarterly report, bringing the current total to 59. From these opportunities, the TF-BSO has driven demand or has pending orders for a dozen facilities translating into the creation or sustainment of hundreds of jobs. A series of additional factory restarts will are expected this year. Recently, TF-BSO partnered with USAID and the Treasury Department to complete an initial assessment of the current state of Iraqi banking infrastructure and has initiated pilot projects to establish automated financial transaction processing in Iraq.

Promulgating regulations for the Foreign Investment Law passed in 2006 could improve the prospects for attracting investment and reducing unemployment. The National Investment Commission, which began to form in February 2007, will focus on fully implementing the Foreign Direct Investment legislation and have responsibility for designing implementing regulations. The Commission is not yet fully formed, however, and the Chairman recently resigned, citing lack of support from the government.

Oil Infrastructure Integrity

The USG spent US$1.6 billion on oil sector reconstruction in the past four years but these efforts have not offset the GoI's failure to execute several billion dollars of its own funds in oil sector capital investments. In 2006 for example, the Ministry of Oil (MoO) executed only US$90 million of its US$3.5 billion capital budget. Because MoO is not subject to market pressures to stay in business, it has little incentive to invest its full capital budget. Lack of legislation governing the hydrocarbon sector, non-industry standard procurement policies, lack of skilled technocrats at MoO and corruption also contribute to underinvestment. The 2007 government budget allocates US$2.38 billion to the Ministry of Oil (MoO) for investment in infrastructure. This amount is less than half of what MoO sought, based on

Attacks on oil infrastructure, limited availability of electricity from the government grid, limited investment, fires, wear and tear resulting from poor maintenance, and lack of spare parts have hindered increased production of refined product and crude oil for export. Crude oil production from January to April 2007 was 1.97 million barrels per day (mbbl/d) compared with 1.95 mbbl/d in the same period in 2006. Crude oil exports were 1.4 mbbl/d, falling short of the government's goal of 1.65 mbbl/d. Achieving these goals, which is necessary to meet planned government budget revenue targets, will be hindered by the continued shutdown of crude exports through Turkey this quarter until early May, 2007 due to numerous interdictions. Although pre-war oil production in northern Iraq accounted for about one quarter of Iraq's total capacity, northern oil exports totaled only US$1B in 2006-compared with US$30B from the South-due to sabotage against northern pipelines.


Iraqi Oil Production January - April 2007

National refined product stock levels remained critically low because of inadequate refining capacity, lack of security for crude pipelines and for trucks that deliver refined fuels to areas in need, and inadequate funding for imports. Refineries suffer from old equipment, poor maintenance practices, lack of spare parts, unreliable electricity supplies, interdiction of pipelines, lack of storage, poor distribution practices, lack of an efficient private-sector mechanism to supply imported refined fuels, and criminal infiltration and theft. The Ministry of Oil has also yet to develop implementing regulations for the Fuel Import Liberalization Law that are consistent with international standards and would enable a larger private sector role in fuel importation. Since January, black market fuel prices have leveled off, decreasing in some areas of the country based on consumer demand and the availability of official sources of fuel; however, they remain at least three to five times the "official" price.

A variety of criminal, insurgent, and militia groups engage in the theft and illicit sale of oil to fund their activities. This denies the GoI a significant portion of revenue and contributes to the shortfalls in fuel allocation that ministries rely upon to operate vehicles, generators, and other equipment. Elements of the MoD's Strategic Infrastructure Battalions and the MoO's Oil Protection Force, tasked with protecting infrastructure, are sometimes suspected of being complicit in interdiction and smuggling. As much as 70% of the fuel processed at Bayji was lost to the black market-possibly as much as US$2 billion a year. In February 2007, the Iraqi government, in coordination with U.S. forces, launched Operation Honest Hands, a crackdown on oil smuggling at the Bayji refinery. The Iraqi Army assumed control of the entire Bayji refinery, and equipment is being installed to prevent siphoning.


U.S. Iraq Relief and Reconstruction Fund (IRRF)

Essential Services

Improving the availability of basic services such as electricity, water, and healthcare could improve the Iraqi public's confidence in the government. Over the past quarter the Iraqi government has made little progress. The USG's Iraq Relief and Reconstruction Fund (IRRF) is now 95% obligated, and the authority under which the two U.S. organizations established to manage Iraq reconstruction in the post-sovereignty period-DoS's Iraq Reconstruction Management Office (IRMO) and Department of the Army's Project and Contracting Office (PCO)- expired on May 10, 2007, as scheduled. The GoI must now take the lead in funding reconstruction to improve essential service delivery. Substantial U.S. expertise remains available to assist the Iraqi government, and on May 10, 2007, most IRMO functions, including managing remaining IRRF programs and building capacity at some ministries, were assumed by the Iraq Transition Assistance Office. PCO functions were transitioned to the Army Corps of Engineers, which will continue to operate in Iraq.

Electricity Infrastructure Integrity

About US$4 billion in U.S.-funded electricity sector projects are either completed or underway and, to date, have added about 1,500 to 2,000 megawatts (MW) of capacity. However, this capacity has been more than offset by continued deterioration in preexisting capacity, poor upkeep and growing consumer demand. As U.S. reconstruction projects are completed, the Ministry of Electricity (MoE) will have to assume the lead for funding its own requirements to supply more electricity by adding and rehabilitating capacity and improving operations and maintenance practices. At this time, the GoI does not have a long-term strategic plan for the electric sector.


Electricity Supply and Demand - 2003 to Present

Peak state-provided electricity production for January through April 2007 averaged 3,973 MW, compared to 3,898 MW during the same period in 2006. Beginning in April, average (vice peak) power production, demand, and equivalent hours of power are being reported. This method provides a more accurate view of both the overall performance of the Iraqi power sector and the actual amount of electricity available to the Iraqi consumer. Based on the average daily demand and power generated, government-produced electricity was available nationwide for an average of 14.5 hours per day in April, while Baghdad received an average of only 8.4 hours per day. Power production is hampered by the MoE's inability to deploy repair teams to work on the frequently attacked 400 kV transmission grid, continued degradation of legacy power generation stations, severe shortage of proper fuels for power generation units, inadequate security, and ineffective operations and maintenance practices across the generation and transmission infrastructure. It is important to note that at least 2,000 MW are provided off-grid by private owners of small generators, supplying a substantial portion of the needs of Iraqi businesses and residents that are not being met by state-generated power.


Average Daily Hours of Electrical Power per Province (April 2007)

Water and Sewer

Over US$1.7 billion in USG-funded projects have rehabilitated and constructed water treatment facilities across Iraq, providing capacity for supplying potable water to approximately 2.5 million citizens who previously did not have access. Attaining the U.S. goal of potable water for 8.4 million persons will require completing all projects currently under construction. The USG's goal of providing 5.3 million Iraqis with sewage service has been achieved.

Nutrition and Health

The World Food Program continues to provide assistance through an emergency operation targeting the most vulnerable groups in Iraq. These programs serve as an alternative to the Public Distribution System (PDS) begun by the previous regime to assist an estimated 3.7 million Iraqis through provision of meals to the poorest families. Officials administering the PDS report that materials on hand are sufficient to meet current needs. Standard operating procedure is to restock local warehouses just prior to monthly distribution to enrolled citizens.

Although healthcare infrastructure has improved compared to the extreme neglect of the former regime, access to healthcare continues to face numerous challenges due to increases in demand due to violence, shortages in electricity and medical supplies, and intimidation and kidnapping of doctors and nurses, as well as reports of theft and corruption. There have also been reports that Sunnis are routinely denied medical care at hospitals administered by the Ministry of Health (MoH), a Sadrist-run ministry.

Recognizing the need to address the past neglect to the healthcare system, the U.S. has completed construction of 35 of 136 planned Primary Healthcare Centers (PHCs) and 19 of 26 planned hospital rehabilitation projects. However, almost all of the US$816 million in IRRF available for projects in the healthcare sector has been obligated.

Food and Agriculture

The current security environment makes it difficult for Iraqi farmers to acquire agricultural inputs, and the disrepair of the nation's irrigation system has lead to increased soil salinity and low crop yields. The 2007 USAID contract, although not complete, is expected to be focused on the development of agri-business. The new USAID program, known as INMA (Arabic for 'Growth'), is scheduled to begin in June 2007.

The USDA is developing the Iraq Agricultural Extension Revitalization Program (IAER), linking a consortium of five U.S. universities led by Texas A&M with six Iraqi universities. The IAER hosted its first conference in Amman, Jordan in March 2007. The principal objective of the conference was to develop a working document for an agriculture extension program in Iraq. As a result of the conference, a training curriculum is being developed for the Iraqi universities. U.S. extension specialists will teach the Iraqi trainers.

Conclusion

The Iraqi economy is expected to continue to grow this year. Although this growth remains highly dependent on the oil sector, the government continues to struggle to execute capital projects required to strengthen the oil sector and sustain this growth. In addition, with the major portion of the U.S. reconstruction effort drawing to a close, the GoI will need to make more progress executing infrastructure capital projects and approving the hydrocarbon law and other economic reforms to attract foreign investment needed to develop the oil sector and diversify the economy.



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