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Iraq in 2018 … What lies ahead?

By Padraig O’Hannelly.

The year just gone by has seen many changes in Iraq, including the successful routing of the so-called Islamic State (IS, ISIS, ISIL, Daesh), the holding of a controversial vote on Kurdish independence, and a long-awaited improvement in relations with Saudi Arabia.

The latter part of the year also saw a steady and welcome increase in oil prices, which, coupled with record oil export volumes, has helped to prop up the country’s finances.

As we publish our first newsletter of the new year, we’d like to say a special word of thanks to all of our contributors, including our panel of Expert Bloggers, who have given us the benefit of their wisdom and observations over the past twelve months:

We look forward to reading more from them in the coming year.

We’d also like to thank all our readers and well-wishers for making Iraq Business News the must-read publication for everyone with an interest in Iraq, and we ask you to please support our valued advertisers, who make all of this possible.

It is also important to remember two Iraq-focussed charities that are doing amazing and much-needed work in the country:

Any donations made to them will make a big difference to the lives of so many vulnerable people in Iraq.

Having welcomed a new year, many of us will have hopes and dreams for the twelve months ahead. What do you wish for Iraq in 2018, and what are your predictions for the state of the country one year from now? Whatever your connection with Iraq, we’d love to read your opinions in the comments section below.

With another challenging but potentially rewarding year to come, Iraq Business News will be with you every step of the way, wishing all of you a happy, peaceful and prosperous 2018.

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Suli Forum 2017

Beyond Da’esh: An Inconvenient Truth

By Mark A. DeWeaver.

Last week I had the pleasure of attending the American University of Iraq’s fifth annual Sulaimani Forum. This time the theme was “Beyond Da’esh: Ending the Cycle of Conflicts, Toward Durable Solutions.” Speakers included Iraqi Prime Minister Haider al-Abadi, KRG Deputy Prime Minister Qubad Talabani, Yezidi author and Da’esh survivor Fareeda Abbas, and Francis Fukuyama, best known for his 1992 book The End of History and the Last Man.

The panel discussions covered a wide range of topics. We heard about the human cost of war (horrific), the progress of the Mosul operation (good), political and economic reform (urgently needed), and the latest moves in the regional “great game” (more inscrutable than ever with Trump as US president). Not surprisingly, there were more questions than answers. There was unanimous agreement on the need for reconciliation among factional rivals, better governance, and economic diversification. Exactly how these objectives might be realized was naturally less clear.

One issue in particular struck me as worthy of more attention. In his inaugural address, the Prime Minister noted that infrastructure worth US$ 35 billion has been destroyed as a result of the conflict. In addition to the destruction of buildings in places like Mosul, where entire neighborhoods are being razed to the ground, many roads and bridges have been damaged and there has also been widespread looting of industrial facilities, reportedly at the hands of both Da’esh and government-allied militia groups.

How is the reconstruction of all this infrastructure going to be paid for? The government has recently had notable successes in raising money through bond issues and import tariffs, but these new funds are needed to reduce the fiscal deficit resulting from the 2014 oil-price crash. At this point, the international market for Iraqi bonds may well be tapped out. There is also little room for further increases in domestic government debt, which has risen by 300% in just the past three years—from the equivalent of US$ 10 billion in 2014 to $40 billion today.

Barring a big jump in oil prices, the inconvenient truth is likely to be that it won’t really be possible to finance $35 billion in reconstruction costs. In which case, even if the laudable goals highlighted at this year’s Suli Forum can be achieved, large areas of Iraq—including Mosul, the country’s third largest city—will lie in ruins for years to come.

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Making Ends Meet in Iraqi Kurdistan

By Mark DeWeaver.

Last November I was back at the American University of Iraq’s Institute of International and Regional Studies in Sulimaniyah, researching a report on the KRG’s latest economic reform initiatives. I was surprised to find that the KRG now has some promising programs underway to increase revenues and cut expenses. Given the dire state of the regional economy, this is an important development.

Readers of my research on “Kurdistan’s Great Recession” (available here ) will recall that Kurdistan is now in the midst of an unprecedented economic downturn. Following the cutoff of payments from Baghdad to the Kurdistan Regional Government (KRG) in the first half of 2014, its budget was subsequently dealt a mortal blow by the 2014 crash in world oil prices, which fell by over 50% in the second half of that year.

The resulting collapse in KRG revenue led to an abrupt reversal of the rapid growth the region had previously enjoyed and left it in a state of crisis from which it has yet to emerge.

Erbil’s response initially seemed to consist mainly of making ends meet by not paying its bills. Over the last year, however, the budget deficit is increasingly being considered in the context of a long-term effort to reform Kurdistan’s state sector. By this point, the KRG has eliminated most of its former refined product subsidies, thereby making more barrels of oil available for export.

Last October, it began a biometric registration program for state employees with the goal of reducing fraud and abuse in the disbursement of public-sector salaries. It is also moving toward a more rational and efficient system for corporate tax collection.

While these reforms are clearly a step in the right direction, it remains to be seen how effective they will be. The removal of subsidies is already providing a significant boost to the KRG’s finances but the other two programs are just getting started and will make considerably greater demands on Erbil’s limited administrative capacity.

There may well be a considerable gap between how the new policies are supposed to work in theory and how they actually turn out in practice.

For more on this topic, check out my latest IRIS Iraq Report: “Making Ends Meet: Economic Reforms in the Kurdistan Region of Iraq.”

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cash economy_1

A Case for Cash

By Mark DeWeaver.

Nowadays one reads with increasing frequency that high-denomination bank notes should be eliminated. (Take this NY Times editorial as just one example.) Hundred dollar and five-hundred euro bills, it seems, are for cocaine cowboys and terrorists. Honest people use credit cards and checks or maybe their mobile phones. Some commentators even look forward to the eventual elimination of cash altogether.

Such claims tend to overlook the essential role that bank notes play in places like Iraq, where the absence of effective banking supervision and the rule of law makes it difficult for deposits to play their normal role as a medium of exchange and store of value. In conflict and post-conflict economies, hoards of hundred-dollar bills don’t primarily serve the needs of criminals. They provide the primary means of effecting payments and storing wealth for the vast majority of individuals and private sector companies.

Last month I did a project with the AUI-S Institute for Regional and Institutional Studies that looked at the operations of the two main players in Iraq’s cash-based economy—the money transfer companies (MTCs) and non-state banks. It was easy to see that their main business is not money laundering but rather the operation of payment systems.

They can also be thought of as the essential elements of a fully reserved monetary system. The banks generally hold most of their deposits in the form of vault cash or central bank reserves while the MTCs’ “reserve backing” effectively consists of bank notes stored in their customers’ own homes and businesses.

Surprisingly, it turns out that Iraq’s cash economy bears a close resemblance to the banking schemes that Austrian economists have proposed as a means of eliminating boom-bust investment cycles. But the Iraqi version is only a last resort, the best that can be achieved in the absence of reliable public governance.

It is also, however, one of the outstanding success stories of the Iraqi private sector—a means of keeping economic activity from collapsing in an environment with few effective legal safeguards or government regulations. The main result of eliminating cash in Iraq would be reversion to a barter economy, not the reduction in criminality that Western pundits have imagined.

For more on this topic, check out my latest IRIS Iraq Report, which shows how fully reserved banking has become the norm in Iraq’s private financial sector, describes the business models of the money transfer companies and privately owned banks, and considers some policy implications.

Posted in Investment, Mark DeWeaver on Investments and Finance 8 Comments

Kurdistan Recession

Kurdistan’s Great Recession

By Mark DeWeaver.

In October I had the good fortune to spend some time in Sulimaniyah, at the American University of Iraq’s Institute for International and Regional Studies, where I worked on a research project with a group of student assistants. Our objective was to document the effects of the KRG budget crisis on the Kurdish economy.

The situation in Kurdistan turned out to be even worse than I had imagined. We found that consumer spending has collapsed, property prices have crashed, occupancy rates at four and five star hotels have plummeted, and work on many projects has come to a virtual standstill.

Capacity utilization at cement plants is falling, car dealerships are struggling, income at banks and insurance companies is down sharply, and sales of big-ticket electronics items are slumping. Businesses that only two years ago were making record profits are now fighting for survival.

Most of the business people we interviewed characterized this year as the worst that their companies had ever experienced. “Only during the civil war was the situation worse than it is now,” one told us—referring to the mid-1990’s conflict between the two main Kurdish political parties. “We had a very pessimistic business plan but weren’t able to achieve half of it,” said another. “Things are getting worse every week,” said a third.

This is truly a great recession by any definition of the term.

Interested readers can find more details in our report , which includes sections on oil and gas, construction, consumer demand, property development, hotels, and private investment and concludes with a discussion of possible directions for government policy.

Posted in Investment, Mark DeWeaver on Investments and Finance 9 Comments

ScreenHunter_03 Jun. 26 17.04

A Wild Ride for the Dinar

By Mark DeWeaver.

This has been quite a year for the Iraqi dinar. From a level of IQD 1,217: USD 1 at the end of 2014, the market rate for the currency weakened steadily during the first quarter, penetrated a key support level at 1,290 in late April, and reached a low of 1,379 on June 16. By that point the dinar had lost 11.7% year-to-date and appeared to be in free fall.

Last week, however, the exchange rate rebounded sharply. As of June 25, it was back at 1,258, bringing the year-to-date loss to just 3.3%. (See chart. Exchange rates are from the CBI and Rabee Securities.)

Like the currency’s last big moves in 2013 and 2014, this year’s action seems to have been driven primarily by changes in the rules for the central bank’s dollar auctions, where qualifying buyers (e.g. importers making wire transfers to vendors) can buy the dollar for IQD 1,166. (This rate has been unchanged since the beginning of 2014.)

The last two times, the rule change involved new measures to combat money laundering. This time the trouble resulted from an attempt to collect income and customs taxes directly from outgoing remittances, combined with a reduction in the daily supply of dollars auctioned (an apparent attempt to conserve the CBI’s dwindling forex reserves).

Collecting taxes directly from importers’ payments to their suppliers sounds like a good idea in theory. Rather than trying to collect these amounts at border crossings, where there will be many ways for importers to avoid paying, why not simply add an extra charge—8% of the total—to their wire transfers and have their banks remit this to the government?

If importers were going to be stuck with this 8% charge regardless of how it was collected, it would have no effect on the exchange rate at all. Apparently many of them aren’t used to paying anything, which meant they were facing a de facto 8% deprecation in the auction rate—from 1,166 to 1,259.

Had the market rate remained at the year-end 2014 4.4% premium to the auction rate, it would have peaked at 1,314. But the central bank’s decision to limit the supply of dollars available to auction participants put the currency under even greater pressure. The resulting dollar shortage ended up pushing the dinar to its lowest level since 2006.

In the end, the government was forced to give up on the scheme to collect taxes on remittances. On June 18 the CBI announced that it was cancelling the 8% charge, at which point the dinar appreciated rapidly, regaining the 1,250 level by June 21.

Since 2011 there have been four major peaks in the IQD/USD exchange rate. The last three times, the dinar eventually returned to IQD 1,200: USD 1. This time the outcome is less certain. The 8% charge may have been cancelled but the CBI’s forex reserves are still falling. As of April 23 (the last reported date) they had dropped to USD 68 billion, down from USD 83 billion at the end of April, 2014, mainly as a result of lower oil prices and increased imports of military hardware. Until this trend reverses, the currency will continue to be weak.

The dinar’s wild ride may not be over yet.

Posted in Investment, Mark DeWeaver on Investments and Finance 14 Comments

ScreenHunter_1820 Jun. 12 18.03

Oil and the ISX: Cause and Effect?

By Mark DeWeaver.

Given the importance of oil for Iraq’s economy, you might think that the price of this commodity would be a key driver for Iraqi stocks. Strangely, this has not always been the case—most notably during the global financial crisis. From July to December, 2008, even as the oil price fell by a terrifying 76%, the Rabee Securities’ RSISX index was practically unchanged, moving serenely sideways as though nothing were happening. (See left chart. The oil price index is based on front-month Brent futures.)

Based on this precedent, I have long believed that ISX investors have nothing to fear from oil price crashes. Politics and the security situation have always seemed to be the main things to watch. The bear market that started in June of last year, for example, looked like an obvious consequence of the fall of Mosul (see this post). And, as I argued here, a turnaround on the battlefield would likely mark a rebound in stocks.

Looking at the price action in oil and the ISX over the past year, however, I’m no longer so convinced that the former can be safely ignored. Once again oil prices have crashed, dropping 58% from June 2014 to January 2015, and this time the RSISX is down big as well. The index fell 45% before finally rebounding in March of this year. (See right chart.)

Have Iraqi stocks and oil prices started to move together in a way that they didn’t before? Looking at my two charts it would be easy to draw that conclusion, but unfortunately there’s not really enough evidence to be sure. It would be premature to claim a cause-and-effect relationship on the basis of a single episode.

But suppose just for the sake of argument that oil is the dispositive factor for Iraqi stocks at this point. The question then becomes, does the oil price rally that started at the beginning of this year still have legs?

The most convincing research I have seen on this question was a note from the Research Center at Miller Tabak. Their analyst found that “in 12 of the 13 major tops/bottoms” since 1998, longer-dated oil futures prices were above spot prices at bottoms and below them at tops. (Traders call the former situation “contango,” the latter “backwardation.”) And as of the June 12 close, December 2021 WTI futures are at a 16% premium to the July 2015 contract, making the crude curve look quite a lot like it did at the 2008 bottom.

If oil really is now driving Iraqi stocks, this finding suggests that the trend for the RSISX, in the short term at least, should continue to be up.

Posted in Investment, Mark DeWeaver on Investments and Finance 7 Comments

Will the CBI Try Dinar QE?

By Mark DeWeaver.

This year the Ministry of Finance (MoF) is set to sell IQD 11 trillion in new debt to the state sector banks, thereby partially filling the hole in the central government budget left by the recent collapse in oil prices. The new issuance should bring total treasury bills outstanding to IQD 18 trillion, a 156% increase over the end of last year and more than double the previous peak level of November, 2010.

T-bill issues of this magnitude could potentially provide a sizable boost to money supply growth. Consider what would happen if the state banks didn’t keep any of the new bills on their balance sheets but instead sold all of them to the CBI (Central Bank of Iraq). The central bank would pay the banks by crediting their reserve accounts, thereby monetizing the increase in government debt by “printing” new money. (Such operations are allowed under Article 26, Section 2 of the CBI Law.)

The resulting IQD 11 trillion increase in base money (commercial bank reserves + cash in circulation) could increase Iraq’s M2 money supply by as much as IQD 15 trillion (assuming the current M2 multiplier of 1.37 times). (M2 includes base money and commercial bank deposits.) That would be a 17% jump, a dramatic acceleration from December’s year-on-year M2 growth of just 3.3% to growth rates last seen in 2013. (See Chart.)

Engineering a monetary stimulus of this magnitude might be a good policy for the government to pursue. With GDP growth at a multi-year low (see my last post) and year-on-year inflation dropping to -0.41% in January, why shouldn’t the CBI attempt its own version of “quantitative easing?”

Yet it is far from clear that the government has any such plan.

This year’s T-bill sales will not be unprecedented. From April, 2009 – April 2010, total T-bills outstanding rose by IQD 7.2 trillion—the same 17% of initial base money that IQD 11 trillion would represent today. And none of those earlier T-bills were sold to the CBI. In fact, the central bank hasn’t had any T-bills on its balance sheet since March, 2006.

If this precedent is repeated, this year’s new issuance will have no impact on the money supply at all.

Posted in Investment, Mark DeWeaver on Investments and Finance 16 Comments

GDP Forecasters See 2015 Rebound

By Mark A. DeWeaver.

Last month Barcelona-based economics consultancy FocusEconomics launched an interesting new product—a survey of professional forecasters for the Middle East and North Africa (MENA) region. The section on the Iraqi economy is particularly useful given the lack of attention this subject normally receives. It includes consensus projections for 25 macro variables going out to 2019 along with numbers from each contributor for this year and next.

All but two of the ten participants in the Iraq survey expect faster GDP growth this year. The consensus forecast calls for 3.5% growth in 2015, following a mere 0.1% for 2014, with a return to 5%+ growth rates in the 2016-2019 time frame. (See chart.)

This ‘V’-shaped recovery scenario is plausible for three reasons. First, Parliament is now expected to pass a federal government budget for the first time in well over a year. While the recent fall in oil prices has imposed new constraints on spending, restarting projects that had been halted during last year’s budget impasse is bound to provide a significant economic stimulus.

Second, progress in the fight against ISIS is also likely. This will not only have a positive effect on business sentiment but may also help to stimulate domestic and international trade by making truck travel safer on the major highways heading north and west of Baghdad.

Finally, oil exports continue to grow despite the security situation. December shipments reached 2.94 mn barrels per day (bpd), a level last seen in 1980. A further increase to 3.2 mn bpd is expected this year—a 31% increase over the 2014 average of 2.45 mn bpd that will partially mitigate this month’s price collapse.

The FocusEconomics panel’s call for a GDP rebound in 2015 is a good one. Increased government spending, improved security, and higher oil exports should make this a year of recovery for the Iraqi economy.

Posted in Investment, Mark DeWeaver on Investments and Finance 14 Comments

Banks Signal Drop in Iraqi GDP

By Mark A DeWeaver.

As of November 6, 18 of the 21 ISX listed banks have reported third quarter earnings. The numbers aren’t pretty. Rabee Securities’ latest corporate profits report shows bank-sector aggregate profits for the first nine months down 17% year-on-year. Taking out BUND, an obvious outlier with earnings growth of 115%, the decline for the remaining 17 banks was 25%.

2014 will certainly be the worst for listed bank earnings growth since the end of the sectarian civil war in 2008. This year’s dismal performance compares to double digit growth for all of the last six years with the exception of 2009, which saw a 3% contraction.

M2 money supply growth is telling a similar story. (M2 includes cash in circulation and commercial bank deposits.) Unlike the earnings statistics, which cover only the listed banks, M2 also covers the state-owned lenders that account for the majority of Iraqi bank assets. As of the end of July, this aggregate was up only 4% year-on-year, down from 16% growth for year-end 2013.

These trends in M2 and bank profits are obvious warning signs for the Iraqi economy as a whole. To get some idea of what they might be telling us, I tried using them to forecast annual GDP growth. This is a somewhat suspect exercise due to the limited number of data points, but the forecasts at least fit well “in sample” (see chart).

Assuming full-year growth in M2 and bank profits of -20% and -4%, respectively, the 2014 forecast is for a GDP decline of 1.7%, not much better than the IMF’s -2.7% projection (see this article). If this is accurate, the banks are signaling the first year of negative economic growth since the US invasion in 2003.

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