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, BAGHDAD 00003364 002 OF 003 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 BAGHDAD 00003364 003 OF 003 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