Inflation, which spiked at 65 percent at end-2006, was sharply reduced with a policy package that included exchange rate appreciation, monetary tightening, and fiscal discipline. These policies, together with measures to reduce fuel shortages that resulted in declining black market fuel prices, limited the increase in consumer prices to less than 5 percent during 2007. Core inflation, which excludes fuel and transportation prices, fell to about 12 percent from 32 percent in 2006. Because of security conditions, however, the implementation of the public investment program fell short of budget plans, and oil output and economic activity in general did not expand as much as was hoped. Before oil exports through the northern pipeline to Turkey resumed in the last quarter of 2007, oil production hovered around 2 million barrels per day (mbpd). The shortfall in oil production was offset by higher world market prices.Iraq’s international reserves position has continued to strengthen, allowing the country to repay in advance the full amount outstanding from a 2004 loan under the IMF’s Emergency Post-Conflict Assistance, which preceded the first Stand- By Arrangement.
Aside from improving macroeconomic stability, Iraq also made progress on structural reforms. The authorities significantly increased the initially very low domestic official fuel prices to levels that are in line with those in the region’s other oil-exporting countries. Direct subsidies on fuel products, which amounted to almost 13 percent of GDP in 2004, were eliminated in 2007, except for a small subsidy on kerosene. This has released much-needed resources for reconstruction and reduced the incentives for smuggling fuel products out of the country.
Other achievements include amending the new pension law to make the pension system fiscally sustainable and modernizing the payments system.
Aiming for stability
Maintaining macroeconomic stability remains a key objective of the authorities’ program for 2008. The Central Bank of Iraq will gear its monetary and exchange rate policies toward achieving this objective. Fiscal policy will help contain inflation by keeping current spending, notably the wage and pension bill, in check to limit pressure on Iraq’s small non-oil economy. The envisaged increase in government investment, in view of its high import content, should have only a limited impact on inflation. In light of Iraq’s large reconstruction needs, the government has prepared an ambitious investment program for 2008. It is taking steps to speed up projects that could not be undertaken in previous years, in particular to rebuild infrastructure and improve the provision of electricity, water and sanitation, education, and health care. Provided that further security improvements allow execution of the public investment program and a return to a more normal functioning of the economy, economic activity outside the oil sector should pick up.
Raising oil production will be crucial to provide the resources needed for reconstruction over the medium term. The authorities’ program will also focus on the oil sector and the need for higher investment to raise output and for greater transparency. Raising oil production will be crucial to provide the resources needed for reconstruction over the medium term. Projects to increase production and export capacity in the south and better protect the northern export pipeline are either under way or planned. With continued exports through the north, oil production is projected to increase to 2.2 mbpd in 2008, helping to boost economic growth overall to about 7 percent.
Following the installation of a metering system in the Basra export terminal, metering systems in other ports and oil installations are also being put in place... Under the new program, restructuring Iraq’s banking sector will be a major challenge. The sector is dominated by state-owned commercial banks, which account for 90 percent of the banking sector’s total assets (70 percent for Rafidain and Rasheed banks alone). The banks lack expertise in commercial banking and market finance. There is very little extension of credit to the private sector, and the banks’ asset composition is heavily tilted toward government securities.
Outlook hinges on security
Iraq’s medium-term outlook is favorable, provided security continues to improve... Significant progress was made in stabilizing the macroeconomic environment and in advancing the structural reform agenda. Continued progress, however, will depend on the success of efforts to stabilize the security situation and strengthen political consensus.
The authors are in the IMF Middle East and Central Asia Department.
International Monetary Fund, IMF Survey Magazine, Vol.37, No. 3. March 2008. pp. 42-43. Excerpts from the article were chosen by www.memrieconomicblog.org.