US-IRAQ DIALOGUE ON ECONOMIC COOPERATION: A PROGRESS

UNCLAS SECTION 01 OF 03 BAGHDAD 003364

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: ETRD EFIN EINV IZ
SUBJECT: US-IRAQ DIALOGUE ON ECONOMIC COOPERATION: A PROGRESS
REPORT

REF: A)BAGHDAD 0643, B)BAGHDAD 1061, C. BAGHDAD 3067,
D)BAGHDAD 3097

SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY.


1. (SBU) SUMMARY / INTRODUCTION: In preparation for the early
November U.S.-Iraq Dialogue on Business and Investment Climate, this
cable looks back at the February 2008 Dialogue on Economic
Cooperation (DEC); reviews what was agreed then; and takes stock of
what has been achieved in the interim. At the February DEC, the USG
and GOI agreed that:

-- the GOI needed to fully implement the 2006 National Investment
Law (NIL); create the legal protections for investors; and stand up
the National (NIC) and Provincial Investment Commissions (PIC);

-- progress on an OPIC International Investor Agreement (IAA) and a
Trade and Investment Framework Agreement (TIFA) was a necessary
prerequisite to attracting U.S. investment;

-- the GOI needed to create an action plan for bank restructuring as
a means of encouraging private banking;

-- the GOI should create a national energy strategy and seek
investment in the oil and gas sectors;

-- the GOI would move toward reform of the Public Distribution
System (PDS) and fold it into a social safety net program; and

-- the GOI would improve budget execution.

Seven months later, the GOI has made decent progress on some DEC
agenda items, but little or no progress on many others. In
particular, there has been little improvement in the investment
climate, and relatively little new investment, despite the security
gains. The Embassy therefore views the planned November 1 dialogue
on business and investment as a critical opportunity for us to press
the GOI to take urgent action in this area. This can help set the
stage for a large-scale DEC in spring 2009. END SUMMARY.

Status Report: Seven Months After the DEC
--------------

2. (SBU) The U.S.-Iraq Dialogue on Economic Cooperation (DEC) is a
bilateral forum aimed at improving Iraq's trade and investment
regime, helping Iraq attract badly needed foreign direct investment
(FDI),and fostering bilateral business. The most recent DEC took
place in Baghdad in February 2008. At that time the DEC identified
several important action items for both the GOI and the USG. Below
we list those action items and offer an assessment of the progress
made.

Investment Law Implementation
--------------

3. (SBU) The 2006 National Investment Law (NIL) is a well-drafted
law that provides the basis for a modern legal structure to protect
foreign and domestic firms. It offers special incentives to certain
types of investments (in the health care, education, scientific and
tourism sectors),and is not designed to limit or restrict others.
While the NIL is good, the GOI has failed to issue the required
implementing regulations. Of greatest concern is the lack of
procedures to govern the registration of foreign firms in Iraq.
Nearly five months ago, the Ministry of Trade (MOT) suspended all
new registrations while an internal working group compiled the new
procedures. While we have not yet seen it, we understand that the
working group's draft provides for rather heavy-handed government
control over foreign companies and, more alarmingly, may contain
Arab League Boycott (ALB) language. Clearly, if such provisions
make it into the final draft, these regulations would discourage,
rather than attract, U.S. firms. And in the meantime, some 30
foreign firms, including six US companies, have had their
registrations held in limbo for more than four months while the
regulations -- regardless of what they contain -- languish in the
Council of Ministers.

Investment Commissions: Some Progress
--------------

4. (SBU) The bright spot on the investment front has been the
formation of the National and Provincial Investment Commissions (NIC
/ PIC). Since the DEC, the GOI has boosted staffing of the NIC, and
regional authorities have formed PICs in all of Iraq's provinces
barring Baghdad (although we understand Baghdad is close). PRT
reporting indicates that in general PIC members appear eager to
bring investment to the regions, although their potential capacity
to do so varies widely. On the national level, NIC
Chairman-Designate Ahmed Ridha has actively courted foreign and
domestic investors, pushed ministries to promulgate
investor-friendly legislation, and helped establish the PICs.
However, the fact that the Council of Representatives (COR) has not
confirmed Ridha -- and that the Council of Ministers (COM) has not
pushed -- leaves an important part of the NIC set-up unfinished.
Once confirmed, Ridha will gain "junior minister" status in the COM,

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a position that we hope will increase his effectiveness in promoting
investment and moving implementing regulations for the NIL forward.
On the negative side, the PICs and the NIC still do not have clear
implementing regulations for their activities, and the longer they
delay the greater the potential for problems and disputes. For
example, the NIC has begun offering incentives and guarantees to
potential investors that might not ultimately have the force or
protection of law. In addition, the NIC and all PICs face serious
capacity problems; we have launched a three-tranche training
program, but capacity building will remain a long-term need.

TIFA and IIA: No Progress
--------------

5. (SBU) The GOI has made no progress in these areas. A letter from
USTR was sufficient from the U.S. side to begin the TIFA
negotiations, but on the Iraqi side it requires parliamentary
ratification. As for the IIA, the GOI has not made procedural
notifications to OPIC that have been pending since July 2005,
despite another formal Embassy request in June 2008.

Bank Restructuring Moves Forward
--------------

6. (SBU) The restructuring of the Iraqi state-owned banks (Rafidain
and Rasheed) is moving forward according to the MOU signed in
December 2006. We anticipate that the banks will achieve their
benchmarks as outlined in the action plan by the end of 2008,
including an operational audit and the strategic restructuring plan
-- the two highest MOU priorities. Ernst & Young (E&Y) has already
circulated a draft of its financial and operational audit for
Rafidain and Rasheed, and this will be finalized as soon as E&Y
receives the banks' responses. As for the restructuring, Rafidain
and Rasheed are preparing their Strategic Operational Restructuring
Plan, which we expect by the end of 2008.

Energy/Petroleum: No Hydrocarbon Law or Energy Strategy
-------------- --------------

7. (SBU) In July, PM al-Maliki directed the PM Advisory Commission
to form a "High Committee," chaired by the PM or DPM, to prepare a
National Energy Strategy. The High Committee membership would
include the relevant line ministries -- Oil, Electricity, Water,
Planning, and Finance. (Comment: Although the Ministers of Oil and
Electricity reportedly agreed to the approach, we are unsure about
the level of GOI commitment.) The World Bank plans to approach GOI
leadership to encourage a strong, high-level commitment to
development of a strategy. Without such a strategy, the GOI cannot
make the best judgments regarding, inter alia, how to spend oil
revenues to implement regulatory reform, rebuild its electric power
infrastructure, and develop its petroleum sector further.
Electricity Minister Karim has expressed interest in developing his
ministry's concept regarding an energy strategy. Both the
Electricity and Oil Ministries have developed rudimentary investment
plans for the future.


8. (SBU) Various GOI officials have indicated that the hydrocarbons
legislation will not be considered until the GOI is ready to tackle
the broader questions on relations with the Kurdish Regional
Government, including the status of Kirkuk. Even in the absence of
hydrocarbons legislation, however, Oil Minister Shahristani has been
moving forward on commercial arrangements with foreign oil
companies. On August 27, the Oil Ministry announced that the Iraqi
Cabinet had approved a $3 billion Technical Service Contract (TSC)
with the China National Petroleum Corporation (CNPC) to partner with
the Ministry of Oil's North Oil Company to develop the Ahdab
oilfield in Wasit Province. The CNPC contract was quickly followed
with a September 7, 2008 announcement of Cabinet approval and the
September 22 signing of a Heads of Agreement between Shell and South
Gas Company. The Ministry of Oil earlier approved 35 companies to
bid in the first licensing round for oil and gas contracts, expected
later this year. Shahristani presented the proposed contracts for
the first licensing round at an October 13 conference in London.


9. (SBU) Iraq has formally committed to joining the Extractive
Industries Transparency Initiative (EITI),and issued a declaration
on this in advance of the spring meeting of the International
Compact for Iraq in Stockholm. EITI officials visited Baghdad in
early October for discussions on next steps; both sides said they
are satisfied with the pace of progress.

Budget Execution: Some Progress over 2007
--------------

10. (SBU) The GOI has continued to step up the pace of its budget
execution despite facing serious capacity deficiencies and systemic
obstacles. The most recent comprehensive spending data cover the
first half of the year. Through June the GOI had spent $19.1
billion, or 38 percent of $49.9 billion originally budgeted for

2008. This represents an 84 percent increase over the $10.4 billion
the GOI spent in the first half of 2007. Of total expenditure
through June 2008, $2.5 billion had been spent or committed for
capital projects. This represents 28 percent of the original 2008
capital budget of $13.0 billion. These figures do not include the
$22.3 billion in the supplemental budget passed by the Council of

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Representatives in August. Yet the lack of capacity at all levels
of the Iraqi government, coupled with deficiencies in key
infrastructure, including in the banking/finance system and
communications, and outmoded centrally controlled processes all
continue to hamper efficient budget execution. The Embassy
established an internal Public Finance Management Action Group
(PFMAG) in June 2008 and is assisting the GOI to make progress
identifying and addressing key budget bottlenecks.

PDS Reform: Political Sensitivity Halts Progress
-------------- ---

11. (SBU) At the DEC, the GOI reaffirmed commitments it made to the
International Compact for Iraq (ICI) to press forward with PDS
reform. However, proposed reforms are extremely sensitive, and the
initial steps -- beginning with means testing of all beneficiaries
which was scheduled to begin in November -- has been delayed,
perhaps by as much as a year. The Ministry of Trade has created a
reasonable "road map" to remove the wealthiest Iraqis from the
beneficiary rolls and -- over the long term -- to monetize the
system and fold it into a social safety net. However, a special
Prime Ministerial advisory group recently proposed an entirely
different reform plan. This rival plan reflects the deep concerns
Iraqi politicians attach to PDS reform, and will further slow the
process.

The Road Ahead
--------------

12. (SBU) We do not want the November 1 session to devolve into the
U.S. side overwhelming the Iraqis with the laundry list of
unfinished business from the February DEC. However, the GOI has
shown little if any commitment to improving its investment climate
(with the possible exception of standing-up the NIC and the PICs),
and we need to use the Dialogue to focus GOI efforts on this area.
GOI leaders believe the Dialogue and similar high-profile visits
will, of themselves, lead to significant new foreign investment.
Our goal for this Dialogue is to make clear that it is essential for
the GOI to move beyond the conference room and create the
environment that will make new investment possible.


13. (SBU) The GOI remains committed to the DEC process. We should
aim for a full-scale DEC in the spring, once appointments of senior
USG economic officials are complete. We expect the GOI will want to
include a significant business/investment component to such an
event. The November 1 session should be framed in the context of
the DEC. And we should make explicit to the GOI our hope that they
will take concrete steps to improve the investment climate in the
months leading up to a spring DEC.
CROCKER