SCENESETTER FOR OPIC PRESIDENT AND CEO MOSBACHER'S

C O N F I D E N T I A L BAGHDAD 001389

SIPDIS

SIPDIS

STATE PASS OPIC:DZAHNISER AND RMOSBACHER, JR.
USDOC FOR 4530/ITA/MAC/IIRTF/SHAMROCK

E.O. 12958: DECL: 05/04/2018
TAGS: ECON ETRD EFIN EINV EAID OPIC IZ
SUBJECT: SCENESETTER FOR OPIC PRESIDENT AND CEO MOSBACHER'S
VISIT TO IRAQ

REF: BAGHDAD 148

Classified By: Economic Minister Charles Ries for reasons 1.4 (b) and (
d).


1. (C) Welcome to Iraq. Despite sustained senior level
economic engagement with Iraqis during the period of the
security surge, security gains have not been cemented in
place with jobs and investment. Much is required on many
levels to make this happen.

Major Barriers to Investment
--------------


2. (C) Four obstacles to investment are emblematic of much
broader questions. First is the absence of effective
financial intermediation in the middle market where retail
banks and their customers -- the average Iraqi -- live.
Second is the continued absence of a legal and regulatory
framework within which investors can make decisions of risk
and return with any degree of confidence.


3. (C) Third, Government of Iraq (GOI) decision makers are
for the most part preoccupied with questions of security --
personal, communal, sectarian, and political -- as are their
ostensible constituents. The grinding daily repetition of
violent death, even at the much reduced rates of the last
several months, makes it difficult to conclude that Iraq is a
country that is "open for business" outside the
ultra-lucrative oil and telecommunications sectors. A fourth
significant barrier is a knee-jerk default setting within the
GOI for statist solutions to economic questions.

A Greater State Role
in Mortgage Lending?
--------------


4. (SBU) You have asked to meet with officials of the Trade
Bank of Iraq (TBI) to discuss a proposal to enter into a
partnership with TBI to establish a pilot program to provide
long term mortgage financing. We understand that the
outlines of this facility would include an OPIC
capitalization on the order of $100 million, contingent upon
matching funds from the GOI; an additional GOI contribution
in the form of subsidies aimed at creating affordable
loan-to-income ratios for the borrowers; lending would be in
dollars, with a probable target market of GOI employees.


5. (C) Such a facility raises questions on several fronts.
First, there is an already existing Iraqi Housing Fund (IHF)
that operates through the Ministry of Construction and
Housing, originally capitalized at $200 million with upwards
of $80 million still available. We should be careful about
creating new, additional state-centric solutions to Iraq's
problem of a severe lack of financial intermediation.


6. (C) Second, lending in dollars undermines the Iraqi dinar
and the Central Bank of Iraq's (CBI) monetary policy. The
CBI loses income from seigniorage, and its policy to reduce
dollar circulation is actively undercut. The on-going
depreciation in dollar cross-rates, and the CBI's policy of
dinar appreciation results in the lending bank experiencing
balance sheet loses. The lending bank takes on exchange risk
as borrowers will repay in dinars; because the Iraqi
institution has low dollar liabilities (deposits),the bank
must take long open dollar positions without suitable hedging
instruments.


7. (C) Third, TBI has no presence in retail lending, and no
staff trained for this kind of activity. The Coalition
Provisional Authority created TBI for the primary mission of
issuing letters of credit for cross-border trade. TBI has no
core banking system, and is not branched well throughout
Iraq. The Central Bank of Iraq (CBI) -- the banking
regulatory body -- has expressed concern over the quality of
TBI's monthly accounting reports; Ernst and Young has been
unable to complete TBI's 2006 audit, with the knock-on effect
that the 2007 audit is blocked as well. Also problematic are
concerns that TBI operations suffer from a lack of
transparency that has led to suggestions that some activities
would not stand up well to sustained legal scrutiny. One
example has been TBI's use to increase the bank's capital of
interest accrued from Development Fund for Iraq (DFI) funds
deposited for letters of credit -- in direct contravention of
a CPA order that required the TBI to return the interest.
These issues should be addressed, if possible, in your talks
with the TBI.


8. (SBU) Fourth, the establishment of one or more public

institutions in the mortgage market risks having at least a
marginal crowding-out effect on the development of effective
private retail banking. Mortgage assets derived from Iraq's
only significant employee base -- its two million strong
government workers -- should be highly attractive to private
banks, and provide a strong incentive to them to work hard in
attracting the deposits necessary to generate those assets.
An OPIC-financed facility that cherry-picks that clientele
would play a part in further delaying the development of
effective retail financial intermediation in Iraq; Iraqi
implementation therefore will need to be closely monitored,
and any matching funds contingency perhaps should include
provisions to encourage utilization of private sector
financial intermediation.

Are There Private Banks?
--------------


9. (C) To be certain, there are several prior conditions
that must be met before existing private banks are in a
position to pursue borrowers. There are significant market
distortions in the housing and construction sector that have
deterred investors in this regionally lucrative industry. It
will take more than good lending terms to convince the middle
market of Iraqi salary earners to routinely deposit funds
into banks -- and keep them there as savings that can be lent
on. The creation of GOI-backed deposit insurance is
certainly a necessary, though not sufficient, element.
Potential depositors must develop confidence in the banks
themselves, finding some reason to believe that they will be
sufficiently liquid to meet access to funds needs. Such
confidence might be bolstered if the public were to believe
that the banking regulatory system is robust and effective.
The CBI is expected to have a new regulatory framework in
place by July 2008 (in keeping with performance criteria
under Iraq's IMF Stand-by Arrangement). Unfortunately, the
track record of the CBI has been not to enforce any
regulation other than the reserve requirement. It is
possible that OPIC involvement, correctly executed, could
help Iraqi officials to take needed steps to fill this
regulatory gap.

Investment Climate: Iraq Is Not
Yet Open for Business
--------------


10. (SBU) The status of Iraq's legislative framework
governing investment remains today as characterized in our
January 2008 Investment Climate Statement for Iraq (reftel).
The GOI's Council of Representatives (CoR) passed a National
Investment Law in October 2006, and the law was published in
the Official Gazette as Law No. 13 of 2006 on January 17,

2007. The National Investment Commission (NIC) has not yet
been formed, nor has the CoR confirmed a Chairman of the
commission. Implementing regulations have been written but
are not yet approved nor promulgated. Thus, the law is not
in force, nor the chairman of its commission in place: Iraq
does not have a legal basis on which investors may call to
understand the terms under which investments may be made.
This absence of legal framework obviates any hope of recourse
through the courts should some instance of Iraqi governance
challenge an investor's activities, militating for
international arbitration clauses in most cases, at the
minimum. Similarly, Iraq has no tariff regime in place that
might encourage investment (other than an across-the-board 5
percent 'reconstruction levy'). A fully articulated tariff
schedule is in the works as part of Iraq's WTO accession
process, but there's no indication that it will be debated in
the Council of Representatives or implemented anytime in the
near future.


11. (SBU) You have asked to meet with the most recently
nominated NIC Chairman, Dr. Ahmed Ridah. He is seen as
having a great deal of regional experience in attracting
foreign investment, but he has not yet been confirmed by the
appropriate Iraqi authorities (in particular the Council of
Representatives). This has not stopped the OECD from signing
an MOU on technical cooperation with him, nor the USG in
various instances from accepting his word that he has the
full backing of the Prime Minister to engage the GOI and its
resources at his discretion.


12. (C) We stress, however, that decisions made by or
agreements with Dr. Ridah cannot be considered to have legal
force. Even if he were eventually confirmed it is
questionable whether any prior decisions or agreements in
which he were to have been involved would be retroactively
validated unless the question is specifically addressed by
the confirmation process. Nominated in the first week of

December 2007, Dr. Ridah now stands as having waited longer
for confirmation than any of the two prior nominees for the
job (who withdrew their candidacies when their confirmation
hearings failed to make it onto the CoR's agenda).

State-Owned for Now
--------------


13. (C) We are seeking a meeting for you with Minister of
Industry and Minerals Fawzi F. Hariri, whose responsibilities
include the preparation of state-owned enterprises (SOEs) for
investor participation. His 2005-2007 attempt to groom 13
companies for joint venture agreements based on production
sharing schemes resulted in three cement factories finding
strategic partners in January 2008. Two of these agreements
have been finalized; the third has fallen through in the last
stages of negotiations. Hariri has compiled a new list of
some 50 SOEs looking for partners; the ministry's brochure
states that the prospective investor would "take control of
production, sales, and company management" -- but not
ownership, or even significant equity positions, nor even the
right of first refusal if privatization were to eventually
happen. Problems endemic to SOEs include inability to obtain
or generate adequate electricity, lack of fuels of all sorts,
prohibitively expensive inputs, and the unlikelihood that the
products they produce can compete anywhere against highly
competitive low-cost producers in the world market. The only
market for many Iraqi SOE products is the GOI itself, and
then only if the GOI were to decide to purchase
uncompetitively priced goods as an employment generator. GOI
officials speak of plans for eventual privatization -- but no
timeline is given that would seem to include the foreseeable
future.

Uncertainty
Means Risk
--------------


14. (C) The security climate in Iraq underwent a significant
shift during the period from August 2007 through March 2008.
Putting aside the debate as to whether the catalyst was the
USG's security surge, or decisions taken by Iraqi sectarian
and tribal leaders, or a combination of the two, it is clear
that incidences of violence of virtually all types fell. And
yet insurgent, sectarian, and political violence has not
stopped, claiming between 700 and 2,500 Iraqis per month for
the same period. Indeed, there has been a sharp increase in
casualties among Iraqis since March 25. Such violence has a
paralyzing effect on investment in productive industry.
While some firms are expressing initial interests in
investing in Iraq, it is not yet clear that the potential
returns on investment outweigh Iraq's risks.

COMMENT
--------------


15. (C) Aggressive investment promotion in Iraq seems
premature, absent GOI ability to focus sufficiently on issues
other than personal, communal, sectarian, and political
security to address questions of the implementation of their
legislation, the establishment and enforcing of robust bank
regulation, and the embracing of a truly private sector
approach to restructuring or closing SOEs. If the USG is
going to itself be an investor, it should invest in ways that
have a reasonable prospect of encouraging development of
sustainable, private sector enterprises. It should not
further empower those within the GOI keen to have the public
sector displace such businesses. END COMMENT.
CROCKER