BAGHDAD'S ECONOMIC TRANSITION

C O N F I D E N T I A L SECTION 01 OF 04 BAGHDAD 003803

SIPDIS

SIPDIS

E.O. 12958: DECL: 11/17/2017
TAGS: KDEM PGOV PINR IZ
SUBJECT: BAGHDAD'S ECONOMIC TRANSITION

Classified By: Deputy Political Counselor Greg D'Elia, for Reasons 1.4
(b) and (d).


1. (U) This is a Baghdad PRT reporting cable.


2. (C) SUMMARY: Reforms to educational institutions, the
banking system, the civil service, state-market relations,
and inter-governmental coordination has the potential to
contribute significantly to private sector development in
Baghdad province and hasten Iraq's transition to a mature
market economy. These reforms may also lure more businesses
into the formal sector; currently, the lack of a strong
formal economy both reflects and compounds the Government of
Iraq's (GoI) poor delivery of essential services and its
inability to facilitate sustainable economic development in
Baghdad. Doing business in Baghdad remains expensive and
risky because the city's residents have limited access to
credit, commercial insurance, and legal protections. Private
and state-owned banks in Baghdad suffer from an uncertain
security situation, scarcity of adequate capital markets,
shortage of demand for value-added services, lack of access
to technology, and a long history of low standards of
transparency and accountability. As the GoI begins to
implement reforms, militia activities and government
corruption continue to stifle progress. For the Iraqi
government to help spur economic growth, unprecedented
agreement and coordination among the major ministries must
occur on all fronts: security, services, rule of law,
infrastructure, investment, and education. Where government
officials have forged effective partnerships with Iraqi
Security Forces and the private sector, they have facilitated
the revival of commercial centers and traditional markets in
Baghdad. In another notable development, business owners
report that rental rates are rising significantly and now
represent an even higher expense in Baghdad's cash economy.
End summary.

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There is an Economy, but What Kind?
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3. (U) The lack of a formal economy in Baghdad both reflects
and compounds the government's poor performance in providing
the security, services, and infrastructure necessary to
facilitate sustainable economic reconstruction and
development. A formal economy, in which businessmen pay the
government (through taxes and fees) to provide public goods
(such as security, law enforcement, and electricity) exists
in Baghdad, but many locals ignore or bypass it in favor of
the informal sector, where they do not engage with, support,
or benefit from government-regulated institutions, such as
banks. Tens of thousands of businesses appear to be
operating in spaces as large as modern office buildings and
as small as kiosks, according to members of the Baghdad
Chamber of Commerce and Iraqi-American Chamber of Commerce.
PRToffs have observed an increase in business activity during
trips throughout the city and meetings with local contacts.
It remains unclear, however, how many of these businesses
have licenses or pay taxes. As long as the government
largely fails to deliver essential public services and to
punish tax evasion, citizens in Baghdad will continue to lack
an adequate incentive to participate in the formal economy.


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Doing Business in Baghdad is Expensive and Risky
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4. (SBU) In Baghdad, like other areas in Iraq facing
uncertainty and semi-permissive environments, the cost of
doing business is expensive. To navigate Baghdad's complex
and shifting market environment, business owners in Baghdad
must employ entrepreneurial acumen. Business owners and
investors face the potential for significant loss from
corruption, theft or breach of contract because they cannot
rely on legal institutions to protect their interests, and
most do not have access to commercial insurance. The vast
majority of residents must pay cash to start a business in
Baghdad because they have limited access to loans or other
financial instruments. With enough U.S. dollars, residents
can purchase the goods and services that the government does
not provide equally to all the city's residents, including
security, permits, licenses, electricity (through
generators),transportation, office equipment, and even
government and private contracts. Among the important
business expenses in Baghdad's cash economy, rent is the most
significant rising cost, as reported by several business
owners and NGOs that focus on economic issues. They report
that rental rates are climbing for the first time in recent
memory.


5. (SBU) Several business contacts told PRToff that Baghdad
residents are increasingly willing to pay the rent increases.

BAGHDAD 00003803 002 OF 004


For those willing to take the necessary security risks or to
pay the asking price for property, goods and protection,
Baghdad can be a very profitable place to do business. Walid
Sharif, Executive Manager of the Small Business Development
Center (SBDC) in Baghdad, told PRToff that the improved
security conditions - which he largely attributes to the
surge in Coalition Forces - have helped thousands of existing
and new small businesses to resume or start activity in
district markets and commercial centers throughout Baghdad.
Sharif said he has also seen a marked increase in the number
of participants in SBDC's classes on how to start small
businesses and those taking advantage of USAID's Izdihar
microfinance program to fund their business start-ups. The
Coalition Forces' microgrant program has further contributed
to this momentum, spurring small businesses to open in
neighborhood markets across the province.

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Banking Sector Antiquated
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6. (SBU) Private and state-owned banks in Baghdad are
antiquated and in desperate need of modernization. These
banks and their respective branches cover the city, but they
currently suffer from an uncertain security situation,
scarcity of adequate capital markets, shortage of demand for
value-added services, and a lack of transparency and
accountability. Dictatorship, war and sanctions have
isolated the banking sector from the benefits of updated
international technology, standards, and business practices
for approximately thirty years. Bank managers have little
experience and limited opportunities to operate their banks
as competitive entities, and do not offer essential products
and services that current and potential customers require.
The lack of a dependable electricity supply hinders internet
reliability and prohibits routine banking operations, such as
the transfer of electronic funds. The Central Bank of Iraq
has taken steps to improve the overall banking regulatory
climate and the Ministry of Finance has finally begun
restructuring the state-owned banks Rafidain and Rashid, but
limited services, reduced capital bases, restricted customer
reach, outdated technologies, and inadequately trained staff
continue to hamper the banking industry. Even well-known
international private banks such as HSBC (majority-owner of
Baghdad-based Dar El-Salam bank),which have the capacity to
perform banking functions at international standards, are
waiting for the sector to improve dramatically before
introducing extended service menus and commercial loan
programs.

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Sustainable Job Creation Lacking
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7. (SBU) Small business development in any free market
economy, but especially in Baghdad, is critical to
sustainable private-sector led growth, with the potential to
generate as much as two-thirds of all new jobs, according to
the Center for International Private Enterprise (CIPE),an
affiliate of the U.S. Chamber of Commerce. USAID's Community
Stabilization Program is helping to fill the short-term job
creation gap in critical areas in support of the Baghdad
Security Plan. However, the GOI, provincial leadership and
the private sector are only just beginning to comprehend the
concepts of development in a market economy and the kind of
economic analysis required to target sectors with the
greatest potential for job creation in the short- and
medium-terms. According to various members of local business
associations, one of the key stumbling blocks to job creation
in Baghdad is the inability of the GOI and the private sector
to move citizens efficiently from educational institutions
into the economy ) from high school to either university,
vocational training or military service, and then to the
public or private sector. Many locals attribute this problem
to GoI officials' broader inability to implement economic
support initiatives, such as the Public Distribution System,
and to a lack of technical experience in strategic planning,
implementation, monitoring and evaluation of programs, such
as the Ministry of Labor and Social Affairs micro-loan
program. (COMMENT: The statements of many Iraqi citizens
indicate that they do not differentiate between a
facilitative role for the government in job creation, and a
direct government role in providing long-term subsidies to
businesses and placing people in private sector positions.
END COMMENT.)

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Civil Service Underperforming
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8. (SBU) Iraqi business leaders and small business owners
note that many, if not most, civil servants lack technical,
administrative, financial and organizational skills. (NOTE:

BAGHDAD 00003803 003 OF 004


Many qualified civil servants have fled the country since

2003. END NOTE.) Anecdotal evidence indicates that the
civil service is rife with nepotism, favoritism, and
improvised hiring and firing practices. The most deficient
areas include budget execution, essential service delivery,
and support for private sector development. Although Baghdad
has one of the best records in the country for budget
execution, further improvement could significantly advance
the reconstruction and development of infrastructure, such as
roads and communication links, which businesses require to
survive. Lack of access to essential services such as water
and electricity prohibit many businesses from functioning
effectively. These deficiencies will continue to slow
economic growth in Baghdad unless GoI leaders and officials
begin to improve the connection between Iraq's civil service
and private sector growth.

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Corruption Endemic
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9. (C) Baghdad citizens frequently bemoan corruption among
government officials at all levels. According to
Transparency International's 2007 Corruption Perception
Index, Iraq ranks last in the Middle East and 178 out of 180
countries worldwide. The chairman of one economic reform
institute in Baghdad listed the government officials he would
have to bribe to get the permits, property and goods
necessary to start a business and keep it operating. In
addition, he said that he would need to pay for security, to
run a generator to keep lights on and equipment running, and
to obtain fuel by waiting in long lines or purchasing it from
the black market. According to Kamal Shabibi, Baghdad
Provincial Council (PC) member and Chairman of the Economic
Committee, corruption is deep-rooted in the province. He
said that the PC has addressed the issue by establishing an
Integrity Committee and adopting a code of ethics, to which
all provincial employees must adhere. The Integrity
Committee is empowered to investigate all allegations of
fraud, abuse, waste and misconduct, up to and including the
PC Chairman, Mayor and Governor. (NOTE: During a side
conversation, the Integrity Committee Chairman suggested to
PRToff that while by-laws grant the Committee this authority,
a PC member would take great security and political risks by
bringing charges against high-level officials. Such a course
of action is simply unrealistic at this time, he implied.
END NOTE.)


10. (C) While conceding that it is a first step, Shabibi
believes that the PC has at last begun to address openly the
fundamental principle of transparency. Shabibi added that he
sees the oil sector as very vulnerable to corruption due to
high profit margins, noting that the black market in Baghdad
primarily survives on fuel. He said that he is aware of
instances of oil products being smuggled into Iraq and resold
by militias in Baghdad. The Provincial Council began this
winter to play a major role in kerosene distribution
throughout Baghdad, in a public attempt to undermine black
marketeers and militias in Baghdad. (NOTE: PRT Baghdad will
follow this initiative closely as many PC members have close
ties to militias. The PRT is also involved in a USG
inter-agency pilot project designed to support GoI efforts to
counter militia influence on kerosene delivery in Baghdad.
END NOTE.)

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Early Efforts at Economic Reform
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11. (SBU) GoI officials at the national and provincial
levels have finally begun to institute economic reforms.
They have passed an Investment Law which includes mechanisms
for accountability, transparency and fee structures in the
National Investment Commission and Provincial Investment
Commissions. The 2007-2010 National Development Strategy
reflects a more coordinated and forward-looking approach to
economic development, as does the recent passage of the
Provincial Development Strategy by the Baghdad Provincial
Council (reftel). A new civil service law seeks to create a
professional civil service that can more effectively carry
out the functions of the state; the law requires officials to
pass professional examinations to determine expertise and
competency to carry out assigned functions. (NOTE: One
effort by the Baghdad PRT aims to connect professional
associations with civil servants, thereby creating a
professional development mechanism to increase awareness and
improve performance in both the private sector and government
ministries. END NOTE.) On November 14, at the Baghdad
Forum, government officials from all levels touted Baghdad's
security gains, called for foreign investment, and emphasized
the need to improve Baghdad's essential services and
infrastructure.


BAGHDAD 00003803 004 OF 004


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Doura Market Revival ) Hope?
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12. (C) The successful revival of commercial centers and
markets in Baghdad - such as Doura market in Rashid district,
Abu Nuwas Street in Rusafa district, and Haifa Street in
Khark district - provide encouraging examples of how the
Baghdad economy can thrive in the face of formidable
challenges. Doura Market sits astride a fault line between
Sunni, Shia and Christians in a heavily contested area of
Rashid district. It contained 905 shops until 2006, when
violence increased significantly and precipitated the closure
of 895 shops. The 4/1 ID Brigade made reviving the market a
major priority. The Brigade established a Combat Outpost
(COP) in the market and Iraqi Police and Iraqi army units
helped to provide security. The District Council established
a Doura Market Committee which worked with the Brigade to
develop and implement plans to clean out the market, operate
a generator, build a fence, construct T-walls around the
area, install street lights, paint store fronts, and place
awnings on the shops. Store owners, initially reluctant to
engage with the military and embedded PRT (E-PRT) officers,
increasingly allowed them into their shops to discuss
business ideas and microgrant assistance. As security
increased, the market area began to stabilize. Doura Market
now houses roughly 432 shops and operates for up to six hours
a day. At the same time, other large and small market areas
in Baghdad have recently begun to revive, most notably in the
Karada peninsula, Adhamiya, Ameriya, and Ghazaliya.

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Comment
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13. (C) To advance the transition toward a stable market
economy, the GOI must strengthen the capacity and integrity
of their administrative, economic and legal infrastructures
by building a professional civil service, addressing endemic
corruption, advocating adherence to the rule of law, and
improving links between educational institutions and the job
market. Private sector leaders such as business owners,
business associations, economic reform think-tanks and
bankers have begun to pressure government officials to take
steps toward reform. End Comment.
CROCKER