REVISED 2009 BUDGET ENDORSED BY COUNCIL OF

UNCLAS SECTION 01 OF 04 BAGHDAD 004077 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: PGOV EFIN IZ SUBJECT: REVISED 2009 BUDGET ENDORSED BY COUNCIL OF MINISTERS: REALITY OF LOWER OIL PRICES BITES SENSITIVE- PLEASE HANDLE ACCORDINGLY ¶1. (SBU) Summary and Comment: A further revised proposed GOI budget for 2009 endorsed by the Council of Ministers on December 23, reflects the reality of lower oil prices. Revenues are projected to be USD 42.5 billion based on exports of 2 mbpd at USD 50 per barrel, expenditures planned to be USD 59.5, leaving a deficit of USD 17 billion. The budget will be submitted to the Council of Representatives for consideration when it reconvenes January 10. ¶2. (SBU) Total expenditures in this latest version of the proposed 2009 budget are lower than the USD 79.8 billion initially agreed by the Council of Ministers and lower even than the USD 67 billion in the IMF-agreed revised budget submitted to the Council of Representatives as the price assumed for oil slid from USD 80 per barrel to USD 62.50 to USD 50. ¶3. (SBU) The Finance Minister's budget transmittal message indicates that security is the top priority but it is to be balanced with capacity building in the government and capital investment in critical areas such as oil, electricity and infrastructure. He urges more attention to efficient implementation of investment projects, recognizes the need for foreign investment to help develop Iraqi oil production, and expresses the intention to broaden the revenue base and promote the private sector. ¶4. (SBU) Tracking this proposed budget in the Council of Representatives should prove interesting as there are likely to be many contentious points, such as revenue distribution, allocations to provinces, and the oil price/export assumptions. From a broader perspective, the current 2009 proposed budget is not out of line with the initial 2008 budget, before higher oil prices provoked a supplemental budget which, in the end, was not fully executed and did not lead to a sustainable budget path. A tighter budget adds to the pressure on the GOI to pursue greater efficiencies in government programs, reduce waste, and put greater attention on ways to encourage foreign investment to help GOI achieve its reconstruction and development goals. The Minister's budget message echoes these goals, but without commitment and dedication by all GOI Ministries and provincial authorities, it is the sound of one hand clapping. End Summary and Comment. Headline Figures: Popping the Oil Price Bubble -------------- -- ¶5. (SBU) The Iraq budget proposal for 2009 that was submitted to the Council of Representatives in November after consultations with the IMF was withdrawn by the GOI earlier this month. With further sharp declines in oil prices since the summer, that budget looked increasingly unrealistic. After reworking the proposal, and with the advice of the High Economic Council, the Ministry of Finance submitted a revised proposed budget to the Council of Ministers, which was endorsed on December 23, 2008. The Ministry will submit this new proposed budget to the Council of Representatives for consideration when it reconvenes on January 10. ¶6. (SBU) The new revised proposal forecasts revenues of USD 42.5 billion and expenditures of USD 59.5 billion, establishing a budget deficit of USD 17 billion. It is based on an average oil price of USD 50 per barrel and average exports of 2 million barrels per day. This latest draft proposal follows previous 2009 versions with expenditures of USD 79.7 billion and USD 67 billion based on oil prices at USD 80 and USD 62.50 per barrel, respectively. See tables at QUSD 80 and USD 62.50 per barrel, respectively. See tables at the end of this message. General Principles: Security First but Striking a Balance -------------- -------------- ¶7. (SBU) The introductory section of the Finance Minister's transmittal message presents general foundations and principles upon which the proposed 2009 budget was prepared. Generally, priority was given to security and supporting national reconciliation and improved operation of the ministries (capacity building to deliver services, prepare budgets, and improve operations and budget implementation). More specifically, the budget seeks to improve capacity in the areas of security, national defense, oil sector, electrical power, services, basic infrastructure, unemployment, and human rights. In doing so the budget aims to achieve a balance between operating and capital expenditures. Capital expenditures sustained at 2008 base levels will help with reconstruction and infrastructure projects which can help attract investment and promote job creation, according to the Minister's message. Revenues: Slick Oil Assumptions -------------- ¶8. (SBU) Oil revenues are budgeted to account for 86 percent of total revenues. The budget assumes an average oil price BAGHDAD 00004077 002 OF 004 of USD 50 per barrel with sales averaging two million barrels a day. Finance Minister Jabr acknowledges that, with current oil prices in the high -USD 30,s, this may seem optimistic. He has seen some forecasts of prices in the high USD 40s, but also admits that he has seen forecasts in the USD 20,s. Oil: The Need for More -------------- ¶9. (SBU) The Minister's budget transmittal message recognizes that the GOI will remain dependent on oil revenue to finance investment projects. Accordingly, he suggests that the production and export of oil be increased through: (a) continuing budget allocations for oil sector investment; (b) accelerating project implementation; and (c) ratifying the legal framework to open the way for foreign investment. Non-Oil Revenue: Great Expectations -------------- ¶10. (SBU) Revenue from non-oil sources is projected to be USD 6 billion, a rather large leap from the USD 2.6 billion collected in 2007. The Minister's budget message, noting the need to expand the revenue base beyond oil, mentions the possible introduction of a customs tariff law and sales tax as well as improvements in tax administration. (Comment: A customs-tariff bill, which will raise duties, has been stuck in the Finance Ministry for months. It will be possible -- but optimistic -- to expect it to pass in 2009. Even more optimistic is the expectation that a Customs Service that lacks experience and training and does not currently use a modern, internationally recognized valuation system -- and is widely held to be riddled with corruption -- will be able to implement any new law quickly enough to make an impact on 2009 customs receipts. End Comment.) In practical terms, the major revenue generators for the state are expected to be transfers from state owned corporations * oil, banks, and telecommunications. Such transfers would total USD 2.5 billion. The flat 5 percent 8reconstruction fee8 on imports is expected to increase to 10 percent "after the legislation to amend the fee" is passed to yield USD 431 million in revenue, a 25 percent increase from 2008. The Minister's message also notes the need to accelerate the use of grants from donor countries. Expenditures: Salaries and Security for Today, Investment Tomorrow -------------- --- ¶11. (SBU) Expenditures are programmed to total USD 59.5 billion. Operating costs in the proposed budget would account for 79 percent of total expenditures compared to 70-75 percent in the 2007 and 2008 budgets. ¶12. (SBU) Operational expenditures reflect recent salary increases, resulting in almost $21 billion, or 35 percent of total expenditures, dedicated to employee compensation and pensions. The Minister's budget transmittal message warns that the government should avoid making public service a "subsidy or refuge for the accumulation of staff" which would turn the budget into an 8income redistribution plan.8 To avoid this, the Minister encourages investment programs driven by the private sector and labor training that meets the needs of the marketplace. ¶13. (SBU) Security services, the proposed budgets of the Ministry of Defense and Ministry of Interior, would account for 18.5 percent of expenditures, a higher share than in the 2007 (17.5 percent) and 2008 (17 percent) budgets. The Minister's message notes that the 2009 budget will ensure adequate funding for the security services to reduce their reliance on MNF-I which, he noted, has been decreasing for Qreliance on MNF-I which, he noted, has been decreasing for several years. ¶14. (SBU) Investment expenditures are projected to be USD 12.1 billion in 2009 accounting for 21 percent of total expenditures as compared with 25-30 percent in the last two years. In absolute terms the proposed budget would be slightly less than the base 2008 budget of USD 13.3 billion (without the supplemental),and a step up from 2007,s USD 10.1 billion. ¶15. (SBU) The Minister points out that "public investment programs are one of the most important tools of economic policy aimed at accelerating economic growth." To combat the low implementation rate of capital spending the Minister suggests that the GOI (a) develop comprehensive indicators of investment projects; (b) undertake projects that have had feasibility studies completed; (c) complete projects on time; (d) emphasize the importance of local firms implementing the contracts; and (e) give priority to projects in the oil, electricity, public service areas. ¶16. (SBU) Another major expense is the payment of 5 percent of oil revenues to the United Nations Claim Commission to settle claims in Kuwait. The Minister's message points out that this cost is not within the control of the MOF but is 8within the political framework.8 BAGHDAD 00004077 003 OF 004 PDS: Reducing the Items in the Basket? -------------- ¶17. (SBU) Government support of the Public Distribution System (PDS) food basket (ration card),services such as electricity, water and sewage, and agricultural inputs are a &significant burden8 on the budget, according to the Minister's transmittal statement. He suggests reducing support in 2009, noting, in particular, that it may be 8appropriate to work on reducing some of the ration card items8 while still supporting materials such as flour, baby milk, rice and tea. Nonetheless, the PDS has a proposed budget of USD 3.6 billion, which is slightly higher than the original 2008 budget request of USD 3.3 billion, but significantly lower than the budgeted 2008 PDS outlay of USD $5.8 billion, which includes the 2008 supplemental. (Comment: PDS officials add, separately, that lower worldwide food commodity prices will not fully offset the significant projected reduction to their 2009 budget. We predict that any GOI decision to implement sharp cuts to the PDS ration -- for the first time in decades -- during an election year will face significant opposition. End Comment.) Provincial Allocations: Lower -------------- ¶18. (SBU) Allocations to the provinces other than the KRG are programmed to be USD 2.2 billion for development and reconstruction. This is a significant decline from the USD 3.3 billion contained in the base 2008 budget. MOF officials confirm that they will retain using 17 percent as the KRG,s share of the budget pending results of the national census that they expect to be completed in August 2009. Deficit: To Be Funded, Somehow -------------- ¶19. (SBU) The projected deficit of USD 17 billion is substantially greater than that of previous years. The Minister's message does not mention how the deficit will be financed. COMMENT -------------- ¶20. (SBU) Some observations about the new proposed budget are warranted: -- Somewhat More Realistic: Comparing the current revised proposed budget to the initial budget of September is unwarranted. The initial proposal was based on sustained high oil prices and, therefore, was never realistic. Thus, no one has lost in the revision process because there was never the money to match their aspirations. The new budget is more realistic, although projected revenues remain optimistic given current oil prices and declining export levels. -- In Line: Broadly speaking, the new proposed budget is roughly in line with moderate growth from previous year's budgets (disregarding the 2008 supplemental that was based on extraordinarily high oil prices); spending would steadily rise from USD 41 billion (2007) to USD 51 billion (2008) to USD 59.5 billion (2009). -- Economic Performance: One rationale for keeping spending high by running a deficit is to keep Iraq's economic growth on track. The GOI accounts for half of domestic consumption and the bulk of domestic investment. There is a fairly broad GOI consensus -- with the notable exception of CBI Governor Sinan Shabibi -- that the GOI should not be overly concerned at the inflationary portent of high GOI spending that is funded, if need be, by drawing down reserves. -- Deficit: Whether the 2009 deficit will actually be USD 17 billion will depend not only on oil prices and exports, but also whether the GOI fully executes their entire 2009 budget. Financing of the deficit will rely on GOI own resources in the Development Fund of Iraq, MOF balances with Qresources in the Development Fund of Iraq, MOF balances with the Central Bank of Iraq, and MOF balances in the banking system that remain unspent after the 2008 budget closes. -- Focus: A tighter budget could help focus GOI attention on increasing efficiencies and drawing upon external resources, such as direct foreign investment, to achieve some of their development and reconstruction goals. -- Execution: We note that the projected investment budget for both the Iraqi central government and the provinces is about what they were able to spend in 2008. Greater effectiveness from the end products of this capital spending, rather than simply pushing more money through the system (a.k.a. execution) will be a key goal, as Jabr noted. We will still need to press the Iraqis for speedier in addition to better capital budget execution as this relatively austere budget was presented to the COR so late in the budget cycle. The COR will have to accept difficult compromises, which are certain to stimulate contentious debates before a final budget is passed. BUDGET FIGURES (in M/USD): -------------- -------------- 2007 2008 2008/supp 2009 BAGHDAD 00004077 004 OF 004 Total Revenues 35.7 43.0 $70.1 $42.5 Oil 33.1 36.0 0.1 36.5 Other 2.6 7.0 7.0 6.0 Oil Exports(mbpd) 1.7 1.9 1.9 2.0 Price /barrel (USD) 50 62 91 50 -------------- -------------- Total Expenditures 41.1 50.7 72.2 59.5 Operating 31.0 37.5 51.1 47.3 Capital 10.1 13.3 21.1 12.2 Operating Min. of Defense 4.1 4.8 4.9 4.6 Min. of Interior 3.1 3.8 5.2 5.4 Capital Min. of Oil 2.4 2.0 2.3 2.2 Min. of Electricity 1.4 1.3 2.3 1.1 Other Mins and KRG 4.2 6.7 10.1 6.3 Non-KRG Provinces 2.1 3.3 6.4 2.6 CROCKER