VOL. XLV

No 35

2-September-2002

 

IRAQ

 

Shabibi On Recovery Of Iraqi Economy

 

In testimony to the US Senate Committee on Foreign Relations on 1 August, UNCTAD consultant and Iraq expert Sinan al-Shabibi urged the US not to attack Iraq and its infrastructure despite the fact that the Iraqi people would like to end dictatorship, pointing out that the country’s economy and social situation are already precariously unstable and that growth has been non-existent (if not negative) since the Gulf War in 1990. He went on to detail to the Senate committee hearing on the future of Iraq the current economic and social problems suffered by the country and to highlight steps both Iraq and the international community must take in order to arrest the country’s current socio-economic decay. Currently, noted Dr Shabibi, Iraq is suffering from a huge resource deficit due to international sanctions, a negative or low growth rate (in the non-oil sector), a very weak/collapsing exchange rate, rampant inflation, large external debt and hefty war reparation payments.

 

Restoring Economic Stability

Consequently, before it can resume growth, Iraq must first restore economic stability through raising the external value of the dinar and controlling its high inflation rate. To manage such a feat, Dr Shabibi said, substantial financial resources must be mobilized on international, regional and domestic levels, noting that after the lifting of sanctions Iraq should be allowed to reach or approach its maximum oil export capacity. Its re-entry into the oil market should be accommodated without adversely affecting the oil price – a move which would require maximum cooperation by the other OPEC members. While many of them are themselves suffering from budget deficits, they realize that Iraq’s economic and political stability will have favorable repercussions on regional security. Accordingly, an agreement on Iraq’s new oil production level should be negotiated with other OPEC members in order to facilitate Iraq’s re-entry into the regional and international community.

 

Dr Shabibi argued that Iraq should be granted a standstill on debt and reparations payments, or else its budget will remain in deficit. While sanctions are currently causing the resource deficit, debt and reparations payments may later replace them, he cautioned, noting that “experience shows that high debt service payments engender economic instability and fuel inflationary pressures.” Furthermore, the regional and international community should extend substantial financial assistance on concessional terms or, preferably, in the form of grants. This would take on greater importance if Iraq’s re-entry into the oil market was only partially accommodated and/or if no standstill is forthcoming on the payment of debt and reparations.

 

The amount of financial assistance needed will depend on the evolution of the Iraqi balance of payments, which in turn depends on the extent to which Iraq is granted relief from its external claims. Iraq’s external debt is estimated at $100bn, $60bn of which belongs to non-Gulf creditors. If this debt is to be paid in 20 years, the country needs to allocate $3bn per year. Interest payments for the next five years would then be around $2bn (on the assumption that interest rate equals 4%). Gulf debt payments equal about $2bn annually. Thus debt service amounts to $7bn. Reparations (25% of petroleum exports) will be $3bn at the minimum. Thus annual external claims excluding reconstruction costs will amount to $10bn, which is on average two-thirds of petroleum exports. If the country needs about $12bn of imports, which is a very modest assumption, then the deficit will be $7bn a year. This is more or less what Iraq needs annually if nothing is done about the external claims, but the situation will greatly improve if Iraq is granted relief from debt and reparations. While there is no estimate of reconstruction costs, Iraq has lost about $155bn in oil exports since 1980 and a similar amount in the non-oil sector, which represents on average half of the economic output, according to Dr Shabibi, who noted that the recovery steps suggested will go a long way towards helping Iraq to recoup its losses.                

 

While success in the mobilization of resources depends on Iraq’s creditors in and/or outside the region, the UN and other oil-exporting countries, on the domestic level Iraq should complement their actions by refraining from money printing to finance its expenditures, since in the short term it does not have the productive capacity to back this additional money supply. Money printing can, however, be tolerated if foreign exchange flows into the country, but it should be carefully synchronized with the growth in domestic production and foreign exchange, cautioned Dr Shabibi.

 

While government expenditure should be tightly controlled, support for agriculture and other essential services will remain important during the period when stability is being restored. Agriculture, for example, as a labor-intensive sector could provide substantial employment when a large part of Iraq’s army is demobilized. Iraq should use the initial resources it receives for imports, especially for consumer goods and food. This might appear to conflict with a policy of supporting domestic agriculture, but given that demand for agricultural products and food is so large, in the short term supply from both imports and domestic production will be needed.

 

The country should also direct resources towards the provision of social services, especially in the fields of health and education, given that UN reports stress the poor state of hospitals, shortages of medicine and medical equipment, and of school materials. Funds should also go to reconstruction and rehabilitation of infrastructure, especially power and water plants, sanitation, sewage facilities and telecommunications. Also key would be technological rehabilitation and training so that Iraq can bridge its information technology gap.

 

The steps could be implemented rapidly because they do not depend on production or trade, said Dr Shabibi, noting that “in correcting their external payments position, many countries resort first to external financing, which provides a breathing space to start longer-term adjustment policies.”

 

Maintaining Economic Stability

Once economic stability is achieved its maintenance will depend more on domestic efforts and macroeconomic policies than on financial resources. At this time Iraq should cooperate with other oil producers to secure stable and predictable prices which guarantee a good level of revenue without hurting consumers. Dr Shabibi believes that having agreed with its creditors and the UN on a temporary payment obligations freeze, Iraq should then propose renegotiation.

 

He warns that a solution to the problem of external obligations should be found, otherwise Iraq could return to a resource deficit resulting in a resurgence of inflation and macroeconomic instability. He points out that many Latin American countries experienced hyperinflation because of debt crises in the 1980s and that Germany’s hyperinflation in the 1920s was partly the result of having to lower exchange rates to generate a huge trade surplus to meet reparations payments. A solution to external obligations could be found through negotiations and agreements with the international community and the UN, although it is not in the interest of Iraq to take unilateral action.

 

While the immediate objective is to restore and maintain economic stability, Iraq must also work on designing policies for implementation at a later period. It needs to draft a new constitution and laws to ensure democratic rule, including electoral and press-freedom legislation. Also, solutions are needed for the huge social problems caused by wars, sanctions, displacement and re-allocation of the military workforce to the civilian economy. While these programs must be vigorously implemented once economic stability is attained, this does not preclude, even at this later stage, the direction of financial resources to agriculture and the social sector, because of their obvious contribution to future stability. However, the most efficient solution for the displaced population and military workforce is the growth of the civilian economy, which will expand Iraq’s capacity to absorb additional labor.

 

Planning For The Resumption of Growth

When stability is attained and Iraq is reintegrated into the world economy and community, it can proceed to implement a development strategy to ensure faster growth. There is a pressing need to increase the efficiency of the non-oil sector so that its contribution to overall output and growth is increased. The emphasis should therefore be put on developing effective policies for resource development and the redefinition of production structure and ownership. In the past, state intervention in Iraq was driven by ideologies which led to a confrontational relationship with the private sector, and the state was unable to realize the advantages that could be reaped through combining ample resources with good macroeconomic policies, said Dr Shabibi.

 

The objective of fiscal policy should be, in the long run, to diversify the structure of government revenues in order to reduce dependence on the oil sector. On the revenue side, the government will have to reform the tax system, government expenditure itself will have to be rationalized and the ratio of military to total expenditure reduced substantially. Monetary policy needs the right infrastructure, in particular reform of the financial and banking system and, more importantly, independence of the Central Bank, or it could end up financing the budget deficit. However, the independence of the Central Bank should not prevent the adoption of a development-friendly monetary policy. Regarding exchange rate policies, Dr Shabibi warned that an oil-dominated, overvalued rate may be detrimental to the growth prospects and competitiveness of the non-oil sector.

 

He suggested that the private sector should play a leading role in the development process, noting that the government has limited choices in this respect, since it will be burdened by the payments of debt (public in Iraq’s case) and of reparations if relief does not materialize. While privatization is key, he cautioned that it should not follow the pattern of the second half of the 1980s when such schemes were undertaken but were driven by the need to finance the war with Iran, with efficiency considerations taking second place. Any strategy governing development of the private sector will therefore need to be evaluated with a view to putting efficiency first.

 

Development of the agricultural sector should save the country substantial amounts of foreign exchange, a precious resource in a future Iraq. In the industrial sector, light industry, especially food processing, should receive priority because of existing domestic demand and its export potential. Development of other sectors should be based on careful market studies that take into account domestic and foreign demand conditions and existing supply capacities in the region. Dr Shabibi noted that the development of industries which can generate in a short time the required foreign exchange could also be financed by foreign direct investment from Arab and multinational corporations, because domestic resources may not be sufficient to meet both consumption and development needs, adding that Iraqi expatriates were another potential source of finance.

 

Dr Shabibi said that Iraqis “are very much aware and cognizant of the fact that they have lost a lot of opportunities in terms of simple economic development and growth, since the beginning of the 1980s and even before.” He went on to explain that apart from legitimate defense considerations, Iraqis would like to concentrate in future on economic development. “Basically, they would like to follow, on a smaller scale, the example of Germany and Japan after the Second World War.”