Identifier
Created
Classification
Origin
05BAGHDAD3805
2005-09-14 17:53:00
CONFIDENTIAL
Embassy Baghdad
Cable title:  

SCENE-SETTER: FINANCE MINISTER'S CHALLENGES TO

Tags:  EFIN ECON ELAB PGOV PINR IZ IMF 
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C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 003805 

SIPDIS

E.O. 12958: DECL: 09/14/2015
TAGS: EFIN ECON ELAB PGOV PINR IZ ECON IMF
SUBJECT: SCENE-SETTER: FINANCE MINISTER'S CHALLENGES TO
BUDGET REFORM

REF: BAGHDAD 3453 (NOTAL)

Classified By: CHARGE D'AFFAIRES DAVID M. SATTERFIELD FOR REASONS 1.4 (
b) AND (d).

C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 003805

SIPDIS

E.O. 12958: DECL: 09/14/2015
TAGS: EFIN ECON ELAB PGOV PINR IZ ECON IMF
SUBJECT: SCENE-SETTER: FINANCE MINISTER'S CHALLENGES TO
BUDGET REFORM

REF: BAGHDAD 3453 (NOTAL)

Classified By: CHARGE D'AFFAIRES DAVID M. SATTERFIELD FOR REASONS 1.4 (
b) AND (d).


1. (C) SUMMARY: After his fellow ministers rebuffed the 2005
budget supplemental, Finance Minister Allawi is trying to
commit the next government to a 2006 budget that will pass
muster with both the IMF and the Transitional National
Assembly (TNA). This task will not be easy, but much is at
stake including over 120 billion dollars in debt forgiveness.
At the heart of Allawi's strategy is a decision to "starve"
subsidies while working for better and cheaper alternatives,
such as an oil trust fund that would pay cash to Iraqis.
Once such an alternative is available, Allawi would eliminate
food and fuel subsidies altogether. Beyond subsidies reform,
Allawi's "top-down" approach to budgeting aims to make room
for substantial increases in funding for security and for
revenue-generating investment, particularly in the oil
sector. He seems confident that the TNA will pass this sort
of budget for 2006. Given its preoccupation with the
upcoming constitutional referendum and elections, however,
the TNA is unlikely to support bolder economic reforms
(e.g., large fuel price increases) that would carry negative
political repercussions. END SUMMARY.


2. (C) Minster of Finance Allawi faces multiple challenges as
he struggles to provide funding for critical government
operations this fiscal year. As reported reftel, the Council
of Ministers failed to pass the supplemental because Allawi
had sought to use a 2005 budget request as a vehicle to
commit this government to reforming fuel price subsidies. In
the face of the Council of Ministers rejection and the Prime
Minister's reluctance to tackle fuel prices (which remain at
5 cents/gallon for gas and 3 cents/gallon for diesel),Allawi
moved to use the 2006 budget process to commit this
government -- and the next government -- to reforming both

fuel prices and the public distribution system (PDS). His
game plan is to have this government commit to a 2006 budget
that will permit the GOI to sign an IMF SBA by year's end.
Allawi expressed concern that the next government might be
even less likely to undertake needed economic reforms unless
palatable alternatives can be found. To develop such
alternatives, he wants assistance to explore establishing a
national oil trust and/or a new needs-tested welfare system
that would replace the current food and fuel subsidies
programs.

--------------
Economic Challenges
--------------


3. (C) The GOI economic team faces difficult challenges:

-- Insurgent attacks on power lines, oil pipelines, and
refinery pipelines remain constant and negatively affect the
Iraqi economy. Earlier 2005 GDP growth projections of 15
percent have been revised downward to about 4 percent.

-- Daily Iraqi oil exports that had been consistently above
1.5 million barrels per day (MB/d) from August 2004-March
2005 have drifted consistently below 1.5 MB/d in March
2005-August 2005. While increased oil prices have
compensated in terms of revenue for lower overall exports,
limited refining capacity means that Iraq has to import
gasoline at world market prices -- only to sell most of it
domestically at a loss, given a pump price of about 5 cents
(US) per gallon. This has created a paradoxical situation in
Iraq of a major oil-exporting country with long gas lines and
fuel shortages.

-- Unemployment (active job-seekers and long-term unemployed)
continues to climb, from 22.5 percent at the beginning of the
year, according to some estimates, to an estimated 28 percent
in August. 2005 inflation is currently running at about 33
percent annually.

-- This summer the average hours of electric power is 12
hours/day nationally, and about 7 hours/day in Baghdad.
Repeated polling data has highlighted that these electric
cuts remain a major source of anger and discontent toward the
government. Naturally, power cuts also have a wide economic
impact on the country.

--------------
Weak Government Structure
--------------


4. (C) Any government would find managing an economy under
such circumstances a daunting task. Complicating the GOI
response is that, while there are a number of capable
ministers in the Cabinet (Finance and Planning come to mind),
at the critical Director General level and immediately below,
many ministries are filled with staffs who are content to
fall back on the familiar laws and regulations of the Saddam
era. (COMMENT: In other ministries (Transportation is an
example),ministerial leadership is incompetent, ineducable,
or simply suspicious of economic reform -- e.g., anything
that hints at privatization. Finally, a last group of
ministers is already looking to their political careers and,
as such, do not want to be seen as taking controversial or
unpopular actions. END COMMENT.)


5. (C) When the ministers meet as the Council of Ministers,
they do, nonetheless, constitute am important body that can
pass decrees that bypass the National Assembly (TNA). One
recent example is the GOI decision to start rationing
gasoline in Baghdad. Ultimately, though, the GOI budget has
to be approved by the TNA. Thus, had the Council approved
the 2005 supplemental, TNA approval would have been necessary.

--------------
Moving the 2006 Budget
--------------


6. (C) Currently, the Council of Ministers has approved the
proposed structure of the 2006 budget as presented to them by
the Ministry of Finance. Allawi told us that this budget
structure contains a strategy to take on fuel price and food
basket subsidies (reftel),as well as what he believes is a
credible approach to increasing oil production through
increased spending for infrastructure protection. Currently,
the MoF is working to elicit budget requests from the
ministries. Once these requests are received, the MoF will
work with the Ministry of Planning to present a draft annual
budget to the Council for its approval. Once approved, the
budget will go to the Council of Ministers and TNA for
approval. Allawi told us that he expects the TNA to pass the
2006 budget in mid-November. NOTE: The TNA, operating under
budget processing rules developed by the CPA, has the right
to reallocate spending and to increase overall expenditures.
The TNA has until the end of the calendar year to pass the
budget. If the TNA does not do so then the MoF can approve
sequential monthly spending units based on 1/12th of the
previous year's budget. END NOTE.

--------------
The Distractions of the Political Calendar
--------------


7. (C) The current political class remains transfixed by the
referendum on the Constitution and the December elections.
Discussion in the TNA of unrelated matters has come to a
near-halt. One example is the proposed legislation to
liberalize gas imports for reselling at non-subsidized
prices. That would usefully legalize the robust market in
black market fuel sales, opening them for revenue collection
and halting the subsidy hemorrhage. While some ministries
are thinking about market liberalization, attracting foreign
investment, and privatization, much of this comprises
studies, conferences and meetings -- often in Amman, to the
chagrin of some ministers who would prefer that conferences
on marketing opportunities take place in Iraq.


8. (C) COMMENT: It is difficult to see any economic area in
which the current Council of Ministers, the Prime Minister,
or the TNA might want to assert themselves by any concrete
steps or decisions for the rest of the year. The one
exception is passage of a 2006 budget. It is a tribute to
the Minister of Finance that he is willing to pitch against
this political calendar and drive, first, the Council of
Ministers, and then the TNA to approve it. We note that this
political bravery seems to be accompanied by considerable
personal bravery as well, as the Minister's convoy has been
hit twice in the past several months and many of his Personal
Security Detail (PSD) killed. END COMMENT.


9. (C) Allawi feels that recent Article IV consultations with
the IMF went reasonably well. He is well-aware that the
Paris Club expects Iraq to reach agreement with the IMF for
new Standby Arrangements by year-end. He appreciates the
importance of reducing fuel subsidies by at least USD 1
billion, passing regulations for implementing the Financial
Management Law, auditing the Central Bank of Iraq (CBI),and
developing good-quality and timely financial and fiscal
reporting. The IMF is also looking at many other issues,
including the adoption of plans for state-owned bank
restructuring; a commitment to consider some state-owned
enterprises (SOE) for privatization; implementation of
international auditing and accounting standards; the
development of a functioning payments system; and full
implementation of a financial management information system.
On these issues Allawi will be prepared to discuss progress
achieved so far, while offering constructive ideas for what
more needs to be done. He is likely to offer also a frank
appraisal of this government's limited ability to do much
more than act on the budget in the economic realm.

--------------
Comment
--------------


10. (C) While a few of the ministers "get" the importance of
the 2006 budget for the IMF SBA and the relationship between
a SBA and debt forgiveness, this has not yet emerged as a hot
topic in Iraq. Allawi has privately told us that his
strategy is to attempt to lock-in reforms by tying them to
IMF conditionality -- thus setting the stage for a classic
"blame the IMF" as the basis for securing political approval
for necessary changes. The challenges facing the Minster are
manifold. The economic situation is extremely difficult,
making many hesitant to take actions that would further fray
the social safety net, no matter how dysfunctional it might
be in its current state. Those tough decisions have taken an
even more formidable appearance as the end of this
government's tenure approaches. Finally, the political
calendar continues to focus the government's energy and time
on the constitutional debate and ratification process. That
should culminate on October 15, with intense political
campaigning for the December 15 elections following in short
order. END COMMENT.
Satterfield