Iraq - Fiscal Policy - Nov 10 2011

BMI View: Iraqi Finance Minister Rafi al-Eisawi's plan to reduce the budget deficit by two-thirds, which relies on increasing oil exports and privatising state-owned enterprises, is feasible but will require a significant degree of political will in order to reform the business environment. Given our view that political instability will retard the pace of reforms, we maintain our budget deficit forecasts of 2.7% and 2.6% of GDP in 2012 and 2013 respectively.
The Iraqi government's goal of reducing its budget deficit by two-thirds by the end of 2014 is achievable, though will require a high degree of political will. On October 22, media sources quoted Finance Minister Rafi al-Eisawi as stating that the government planned to reduce the budget shortfall by increasing oil production and privatising state-owned enterprises (SOEs). Given the high degree of political instability in the country, we expect the business environment reforms necessary to attract foreign investment into SOEs will take a significant amount of time to enact (and therefore lead to but a few acquisitions, if any, over the medium term). Therefore, we maintain our budget deficit forecasts of 2.7% and 2.6% of GDP in 2012 and 2013 respectively. 

Hydrocarbons Are The Easier Route

Fiscal revenues are set to increase dramatically over the coming years, mostly due to advances in hydrocarbon production that will allow for greater exports. Our Oil and Gas research team projects oil production to rise from an average of 2.8mn barrels per day (b/d) in 2011 to 7.5mn b/d by 2016, with export volumes rising from 2.0mn b/d to 6.6mn b/d over the same period. Although we foresee declining international energy prices over the medium term, from an average OPEC basket price of US$102 per barrel (/bbl) in 2011 to US$99/bbl in 2012 and US$97/bbl in 2013, the effect of rapidly rising oil production, and in turn exports, will cause oil revenues to rise sharply (see accompanying chart). 

Hydrocarbon Revenues To Pour In
Iraq - Forecasts For Value Of Petroleum Exports
Hydrocarbon Revenues To Pour In - Iraq - Forecasts For Value Of Petroleum Exports, US$mn

Source: BMI

Privatisations Entail Greater Complexity

Privatisation is another potential source of revenues, according to Eisawi, but we see several obstacles to successful sales of SOEs. Reforming the economy from a state-centric system to a market-based one is a high priority for the government, and there is certainly a large pool of potential assets available for privatisation (with 177 state-owned firms in the country). Approximately 43% of all Iraqi state-owned firms (a total of 76 enterprises) fall under the authority and supervision of the Ministry of Industry and Minerals (MIM), with ownership of 250 factories. Sectors span the areas of agriculture, transportation, telecommunications, utilities, construction, hydrocarbons, and financial services, among others, and given the high rates of growth that the country is projected to see (see our online service, November 8, 'Double-Digit Growth Ahead'), many of these could be attractive targets for investors. 

A Large Pool Of Potential Assets For Sale
Iraq - Breakdown Of Number Of SOEs By Ministry
A Large Pool Of Potential Assets For Sale - Iraq - Breakdown Of SOEs By Ministry

Source: BMI, Iraq Task Force For Economic Reforms/UN/World Bank

That said, we note that there a number of obstacles to the privatisation plans, and a high degree of political will would be required to ensure that the business environment is attractive enough for investors to bid. The lack of a favourable environment has proven to be a decisive factor in previous failed attempts by the MIM to establish public-private partnerships (PPPs) between SOEs under its authority and investors, according to the US Special Inspector General For Iraq Reconstruction (SIGIR). 

A series of laws have yet to be updated in order to address potential legal issues of privatisation, and while an Economic Reform Law is currently being developed, changes also need to be made to the country's Companies Law and Investment Law. Furthermore, investors would need assurances that they would not receive any legal backlash from laying off workers (as many SOEs have excessively large payrolls). However, there are significant concerns regarding political stability in the country, which will slow down the pace of reforms and dampen investor interest (see our online service, October 19, 'Mounting Challenges To Stability'). 

Success Would Help On P&L

Should Baghdad succeed in spinning off even a few of its SOEs, we would expect to see substantial benefits. First, the government would see a large (albeit temporary) source of new revenue. Second, and more importantly, fiscal expenditures related to maintaining state-owned firms would decrease, boding well for the budget. Many SOEs have suffered heavy damage to their assets, rendering the firms inoperable and therefore unable to earn revenues, yet workers are kept on payrolls and paid from government coffers. Others are able to function but have a bloated workforce. These firms collectively employ over 633,000 workers, and employee compensation expenses took up 41.5% of total fiscal expenditures (US$22.8bn out of total expenses of US$55.0bn) in 2010. Thus, privatisations would have a major impact on both revenues and expenses. 


2008 2009 2010 2011 2012 2013 2014 2015 2016
Fiscal revenue, IQDbn 2 80,252.0
69,521.0 e 104,192.9 f 139,873.7 f 187,050.4 f 220,897.2 f 258,395.4 f 304,708.9 f
Revenue, % of GDP 2 51.6
45.0 e 51.2 f 56.8 f 62.5 f 64.7 f 66.7 f 68.8 f
Fiscal expenditure, IQDbn 2 59,403.0
64,351.0 e 104,425.2 f 146,436.1 f 194,760.0 f 228,577.7 f 261,439.3 f 291,748.0 f
Expenditure, % of GDP 2 38.2
41.7 e 51.3 f 59.5 f 65.1 f 66.9 f 67.4 f 65.9 f
Budget balance, IQDbn 2 20,849.0
5,170.0 e -232.3 f -6,562.4 f -7,709.6 f -7,680.5 f -3,043.9 f 12,960.9 f
Budget balance, % of GDP 2 13.4
3.3 e -0.1 f -2.7 f -2.6 f -2.2 f -0.8 f 2.9 f
Primary balance IQDbn 1,2 21,757.0
5,988.3 e 3,745.7 f -2,584.4 f -2,912.6 f -2,680.5 f 1,956.1 f 17,960.9 f
Primary balance % of GDP 1,2 14.0
3.9 e 1.8 f -1.0 f -1.0 f -0.8 f 0.5 f 4.1 f

Notes: e BMI estimates. f BMI forecasts. 1 Fiscal balance stripping out interest payments on government debt; Sources: 2 CBI/BMI.

Posted by Mr Thx Tuesday, April 10, 2012


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