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Measuring Stability and Security in Iraq


September 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

Some positive economic developments continued during this reporting period, most notably improvements in budget execution by the central government, some provinces, and the successful review by the International Monetary Fund (IMF) of Iraq’s Stand-By Arrangement (SBA). These improvements are not yet translating into broadly measurable improved living conditions. Oil production, which generates almost all of the government’s budgetary revenues, remained constant at about two million barrels per day. The budget execution rates for Iraq’s US$10 billion 2007 budget, mainly for capital investments in infrastructure to improve essential services, have sharply improved over 2006 and are expected to significantly surpass 2006 results by the year’s end. Even if the full amount is obligated, spending units will not likely execute all of these funds by the end of 2007. Lack of oil investment and security remain the primary obstacles to economic growth. Fundamental structural problems remain to be rectified to enable sustained progress, and the GoI will have to maintain and accelerate its economic reform program, build a strong private sector, and attract greater foreign investment to achieve long-term economic stability.

Budget Execution

To support economic growth and improve delivery of essential services, the GoI will need to make significant investments in the oil sector, public works, and agriculture. The government ministries’ ability to spend their investment budgets is a key determinant of whether all Iraqis receive essential services. The GoI’s ability to execute its capital investment budgets remains hindered by lack of capacity in contracting, timely release of funding, and convoluted guidance in execution instructions, but the overall trend continues to be positive. Recently available data indicate that, by the inclusion of Iraqi-funded U.S. Foreign Military Sales (FMS) cases and the Accelerated Reconstruction and Development Fund, the Iraqi government executed 78% of its total budget in 2006. In 2006, although it effectively paid salaries, wages and pensions, the government executed only 22% of its non-provincial capital investment budget and only 3% of its oil sector investment budget. Most provinces are making significant progress in committing capital spending, with an average commitment rate of 47% through August, but those with security challenges still lag.

Full implementation of the Iraqi Financial Management Information System (FMIS), which is designed to provide real-time data and improve the GoI’s budgetary management and transparency, had been previously projected for the end of 2008. Suspension of U.S. support for FMIS in reaction to the GoI's passive rejection of the program will delay implementation, and the GoI will return to manual bookkeeping.

In the previous quarter, the U.S. Government discussed with the GoI using 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. The GoI does not, however, intend to enter into a Section 607 agreement at this time, citing the need to develop GoI capability to execute these functions without relying on USG contracting assistance.

IMF Stand-By Arrangement and Debt Relief

The IMF extended Iraq’s Stand-By Arrangement (SBA) to December 2007 during a review concluded by the IMF Executive Board on August 1, 2007. The GoI continued to reform subsidies in line with its commitments under the SBA, and most of the Directors praised the GoI’s compliance with the SBA under such trying conditions, while voicing concerns about the lack of data provision from the Kurdish region. On July 1, 2007, the Ministry of Oil implemented fuel price increases for regular gasoline, blended gasoline, and diesel. The regulated price of regular gasoline in Iraq increased from about 300 dinars (~US$0.23) to 400 dinars per liter, while premium gasoline increased from 400 dinars to about 450 dinars (~US$0.35) per liter. Iraq must maintain continuous coverage and satisfactory performance under this and successor SBAs with the IMF to qualify for relief from the final 20% tranche of debt relief at the end of 2008. Iraq has already earned two 30% tranches of debt relief under its agreement with the Paris Club for a total of 80% in debt reduction. Iraq’s debt reduction agreements with non-Paris Club members are patterned on Paris Club terms. The previous regime incurred an estimated US$115 billion in foreign official liabilities, of which about US$43 billion and US$72 billion were owed to Paris Club and non- Paris Club countries, respectively. The only Paris Club member that has not reached a bilateral debt deal with Iraq is Russia, which holds about US$6 billion in Iraqi debt. Nine non-Paris Club members have agreed to reduce Iraq’s liabilities totaling about US$4 billion. The bulk of the remaining debt is owed to Iraq’s Arabian Gulf neighbors.

Indicators of Economic Activity

Economic Growth

For 2007, the IMF projects that the overall economy will grow by 6.3% and that the non-oil sectors will grow by approximately 5%. 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

Year-to-date inflation as of June 2007 is 8.5%, compared to year-to-date inflation through June 2006 of 22.5% and 5.7% in 2005. Year-to-date core inflation is 4.6%, and excluding fuel and transportation, Iraqi prices declined in June. But overall inflation increased if fuel and transport prices are included. Official fuel prices rose by 22.1% in June as part of the government’s policy to reduce subsidies in compliance with the SBA. The Central Bank of Iraq remains committed to containing inflation in 2007.

Unemployment

Updated unemployment and underemployment rates were not available during this reporting period. The Iraqi government’s Central Organization for Statistics and Information Technology (COSIT) official estimates of unemployment and underemployment remain at 17.6% and 38.1%, respectively. The USG continues to assist the Maliki government in creating permanent, sustainable jobs. In order to help reduce poverty, promote small business development, address high rates of unemployment, and stabilize Baghdad neighborhoods, the Prime Minister approved a US$30 million Rafidain Bank loan to the Ministry of Labor and Social Affairs (MOLSA) for a pilot micro-credit program providing businesses loans up to US$8,000. Eligible recipients are college graduates, returnee families, the disabled and wardamaged business owners. The program has approved US$965,000 for 185 applications, but funds have not yet been disbursed.

The DoD Task Force to Improve Business and Stability Operations (TF-BSO) continues its work with the Government of Iraq (GoI) and U.S. Government agencies to increase re-employment of Iraqis. The TFBSO estimates that during the last quarter, at least six factories were restarted or significantly aided due to TF-BSO efforts. Additional contracting actions with Iraqi factories are in process. During this reporting period, the TF-BSO has been heavily focused on executing its US$50 million program to restart factories in close coordination with U.S. military commanders in Iraq and the GoI. Outcomes during this reporting period ranged from contracts inside Iraq for items as diverse as Iraqimade sheep dip tanks and armored buses, to orders for export from Iraq for items ranging from handmade carpets to clothing made for, and competitive in, the international marketplace. TF-BSO’s collaboration with the Joint Contracting Command- Iraq/Afghanistan (JCC-I/A) to promote an “Iraqi First” approach to contracting continues to bear fruit and also contributed to increased employment of Iraqis. During the first three quarters of FY07, DoD contracts awarded to Iraqi firms increased from US$99.2 million as of October 2006 to US$191.3 million by the end of June 2007.

Integration into the Global Economy

Integration into the global economy is important to the long-term success of Iraq and for developing a more diversified economic base. Finalizing implementation 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 has responsibility for designing implementing regulations. A Chair of the National Investment Commission has been nominated, which is a positive step toward implementing the recently passed National Investment Law. The Iraqi delegation to the WTO Working Party meeting in Geneva held productive bilateral meetings on May 25, 2007, with U.S., Arab, and European delegations. Iraq’s Trade Minister participated in the sessions that were considered a successful start to the WTO accession process. The next Working Party meeting could take place in early 2008.

Oil Infrastructure Integrity

Aging infrastructure, attacks on pipelines in central and northern Iraq, and poor maintenance continue to impede near-term increases in oil production and exports. Crude oil production for the May - July 2007 quarter averaged 2.06 million barrels per day (mbbl/d) compared with 2.22 mbbl/d in the same period in 2006. Crude oil exports increased to 1.58 mbbl/d, short of the GoI’s goal of 1.7 mbbl/d, though higher oil prices are projected to overcome this shortfall to meet planned government budget revenue targets. Revenues will, however, be hindered by the shutdown of crude exports through Turkey for most of this year to date due to numerous interdictions.

Iraq continues to experience critically low levels of refined product because of scarce refining capacity, inadequate security for crude pipelines and for trucks that deliver refined fuels, and under-funding of imports. Refineries suffer from antiquated equipment, limited maintenance, lack of manpower, spare parts shortages, irregular electricity supplies, inadequate storage, poor distribution practices, absence of an efficient privatesector mechanism to supply imported refined fuels, and criminal infiltration and theft. Six companies have been licensed by the Ministry of Oil (MoO) under the Fuel Import Liberalization Law (FILL) to import fuel products into the Kurdistan region. This is an initial step toward the implementation of the law, which was passed in October 2006. Gray- and black-market trade in fuels continues to deny the GoI a significant portion of revenue and contributes to the shortfalls in fuel allocations that ministries rely upon to operate vehicles, generators, and other equipment. USGfunded hardening projects intended to secure both the Bayji Oil Refinery and the supporting infrastructure have begun. Iraqi and Coalition forces, through Operation Honest Hands, have recently implemented new security and loading measures at the refinery to reduce theft and corruption.

The Iraqi government intends to triple oil production by 2015, and indications that the legislature is making progress, although slowly, on the hydrocarbon legislation have prompted increased interest by foreign oil companies in Iraq’s oil reserves. Russia and China have expressed interest in reviving their previous Saddam-era oil contracts, and the Czech Republic has recently signed a contract with the MoO to supply equipment for the country’s oil refineries. This equipment, if delivered, would assist in the production of an additional 70,000 barrels of refined fuels daily.5


Essential Services

The Iraqi government’s improvements in budget execution have not yet translated into improved delivery of essential services such as electricity, water, and healthcare. With the USG’s Iraq Relief and Reconstruction Fund (IRRF) now 96% obligated, Iraq must fund most reconstruction requirements.

Electricity Infrastructure Integrity

Peak state-provided electricity output has not increased since the last reporting period. Production for June through August 2007 averaged 4,928 megawatts (MW), almost equal to production rates for the same period in 2006 and 55% of the estimated average peak demand of 8,881 MW. Power production continues to be hampered by the inability of the Ministry of Electricity’s repair teams to repair 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. Although the Ministry of Electricity (MoE) has produced over 5,000 MW of daily peak power for a third of the days during the past three months, overall state production of MW hours for this reporting period has remained similar to last year. During this same period, Iraqi consumers have continued to demand more electricity by purchasing increasing numbers of air conditioners, refrigerators, satellite TV’s and other electrical appliances and equipment. Because state-provided electricity is not subject to market pricing, consumers have little incentive to economize use of appliances. To meet ever-increasing demand, at least 2,000 MW are provided off-grid by private owners of small generators.


The shortfall between state-produced electricity supply and consumer demand is aggravated by the use of suboptimal fuels, which keeps approximately 1,000 MW off the grid. As a result, government-produced electricity averaged 12.8 hours per day over the reporting period (April though June 2007) and 12.4 hours per day for the month of August, the last full month for which data is available. The quarterly average exceeded the target goal of 12 hours per day nationwide. Baghdad, however, averaged only 7.9 hours of power per day this quarter and 9.2 hours during August, with most households receiving substantially less than average amounts of power. This fell short of the goal of 12 hours, due largely to interdiction of high-voltage transmission lines, lack of rapid repair capability, and limited state-owned electrical generation capacity in the Baghdad area. In addition, the central government’s failure to enforce the MoE’s electricity distribution allocations on provincial authorities has resulted in multiple network black-outs, significant system degradations, and a shortchanging of power to Baghdad.


Water and Sewer

As of July 1, 2007, IRRF-funded projects have added or restored 1.7 million cubic meters per day of potable water treatment capacity, which is sufficient to serve about 5.9 million Iraqis. The end-state goal for U.S.-funded projects is to add or restore 2.37 million cubic meters per day of treatment capacity to produce potable water, which is sufficient to serve 8.4 million Iraqis. As of July 1, 2007, IRRF-funded projects have added or restored 1.2 million cubic meters per day of sewage treatment capacity, which is sufficient to serve around 5.2 million Iraqis. During this quarter, Baghdad experienced one of the worst water shortages in years because of insufficient power to pumping stations and water treatment plants and attacks on infrastructure. While Shi’a areas are often affected by water shortages, the problems this year are also cutting supplies to some Sunni neighborhoods that are normally not affected. Only one sewage project remains to be finished, the Fallujah sewer project, which will serve an additional 200,000 Iraqis. Poor security conditions have caused delays in completion of the Sadr City R3 water treatment plant, Sinjar water supply project, and Balad Ruz water supply project. The poor security environment and lack of payment by the Iraqi Government of legacy Development Fund for Iraq (DFI)-funded contracts initiated in 2003 and 2004 continue to hinder completion of the Fallujah sewage project. Poor contractor performance and cost increases of equipment for the Mosul Dam enhanced grouting program have contributed to a oneyear delay in its completion. The US$270 million Nassariyah water supply project, which is substantially complete and ready for turnover to the Ministry of Municipal and Public Works (MMPW), currently lacks sufficient qualified staff to operate and maintain the treatment plant. It will likely operate on only one shift per day until the remaining 60 of 120 needed employees can be hired and trained. The USG is providing Operations and Maintenance (O&M) support for IRRF-funded essential service projects while GoI officials receive training to ensure project sustainability.

Healthcare

The United States has completed construction of 69 of 142 planned Primary Healthcare Centers (PHCs), and 51 have been turned over to the Ministry of Health (MoH) with 21 currently open to the public. The PHC program is expected to be completed by January 2008 and remaining IRRF-funded hospital rehabilitation projects are scheduled for completion by February 2008. Almost all of the US$816 million in IRRF available for projects in the healthcare sector has been obligated.

Food and Agriculture

On June 24, 2007, USAID officially kicked off the Iraqi National Markets and Agribusiness (INMA) program in Baghdad. INMA (meaning “growth” in Arabic) is a comprehensive three-year program (with two option years) to promote economic diversification and job creation with an emphasis on the growth of the agriculture and agri-business sectors in the provincial and sub-provincial economies. Projects will include production activities focused on technical assistance to farmers and expanding private processing in Anbar, Diyala, and Mosul. One project that had a significant impact on the Iraqi agricultural community over the past two years was the MNC-I/MNF-I-supervised ground and aerial agriculture spraying operation. This year was the first time, since the fall of Saddam, that the Iraqis were able to organize and complete this program themselves; the focus of this operation was on Iraqi date palm crop spraying in the central provinces, Baghdad and Diyala. 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) and 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.

Conclusion

The Iraqi economy continues to slowly progress despite various challenges. Budget execution is improving and oil prices are increasing; however, oil production remains constant. In addition, Iraq has made efforts to re-integrate into the global economy, which is important to attracting investment. The GoI will need to continue to make further progress with economic reforms and budget execution to sustain its economic growth and diversify the economy.



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