BABIL'S INDUSTRY: PRIVATE SECTOR GUARDEDLY OPTIMISTIC, SOE

UNCLAS SECTION 01 OF 03 HILLAH 000096 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EIND ELAB IZ SUBJECT: BABIL'S INDUSTRY: PRIVATE SECTOR GUARDEDLY OPTIMISTIC, SOE FUTURE UNCERTAIN REF: HILLAH 92 HILLAH 00000096 001.2 OF 003 ¶1. (U) Summary: Babil's private sector manufacturers struggle with access to reliable power and credit, but say their sector is improving, especially for companies making construction materials. SOEs employ over 30,000 workers in the province, but most only show up to collect paychecks. SOEs have focused on creating jobs, not profits, and face an uncertain future. A Questionable Future -------------- ¶2. (U) Babil's manufacturing industry presents a patchwork of small struggling private sector factories with about 10,000 workers and large non-functional State-Owned Enterprises (SOEs) with over 30,000 employees. According to official statistics industry generates 14 percent of provincial GDP. Salah Hassan Bahaya, Director of the Babil Center for Business Community Development thinks the figure might be a few points higher since the recent building boom (reftel) has generated an increased need for locally-produced construction materials. Still, in conversations with dozens of public and private sector business actors all unanimously expressed concern about the future of Babil's industry. Private Sector Optimistic Despite Infrastructure Credit Concerns -------------- -------------- ¶3. (U) According to Bahaya there are about 200 medium and large private sector factories in Babil concentrated in food-processing and manufacturing construction supplies. The average plant has 10-20 workers but some employ hundreds. In addition, there are close 5,000-7,000 craftsmen working in small 1-3 person shops mainly producing metal and wood products. Productivity and quality are generally low, and competition with imports is a problem. Nonetheless, in a recent survey of Babil's private sector manufacturers the majority said the sector was improving. Companies supplying the construction industry with bricks, cement, and wood-products are doing particularly well. ¶4. (U) The survey pointed to two significant problems: lack of reliable electricity and difficulty in obtaining credit. Electricity has been gradually improving over the past year, and the Provincial Council Energy Committee member Hassan Hamza has predicted that the installation of new generating units and transformers will lead to significant improvements in electricity by mid-2009. ¶5. (SBU) The root of the credit problem is that fact that banks make more depositing money with the Central Bank than by making business loans, according to Layla Adnan Yehia, regional manager for the Bank of Baghdad. Yehia told Econoff that her bank makes a small number of business loans, usually at rates between 10-12 percent, but only when it believes the borrower, or their family and associates, will ultimately deposit more money than they borrow: money that the bank can then put in the Central Bank. ¶6. (SBU) Improved regulatory regimes can create new private sector niches. Al-Wind Pharmaceutical, a major South-Central medicine importer-distributor for 40 years, wants to develop a manufacturing plant in Al-Hillah. CEO Murthda Bahya explained to Econoff that as the GOI began regulating the quality of imported medicine, which constitutes 90 percent of medicine sold in Iraq, the price skyrocketed -- in some cases tripling. The PRT worked with Bahya to develop a business plan and find a foreign pharmaceutical company for a license agreement to manufacture medicine. Al-Wind has now begun a USD 3.5 million project to produce intravenous solution and distilled water -- using its own funds -- that will employ close to a hundred skilled workers. Still, plans to build a drug manufacturing plant are on hold while the company tries to obtain a USD 4.5 million loan. The SOE Production Problem -------------- ¶7. (SBU) Babil's 20 SOEs are intended to create jobs -- not profits -- and were never competitive, according to Dr. Mejbel Rafia Merjan, Dean of the Economic Department of the University of Babil. They produce cement, bricks, textiles, automobiles, machinery and chemicals under the auspices of the Ministries of Industry, Trade, and Agriculture. Provincial SOEs range from a few hundred employees to almost 6,000 employees on huge facilities covering dozens of acres. Still, on any given day less than 10-20 percent of employees can actually be found working. ¶8. (SBU) Because the GOI funds SOEs they do not need to make a profit. This means the input cost of SOE-produced goods often outweighs the price they are sold for. Jabar Lool, Director-General of Al-Furat Chemical SOE, gave EconOff an example: woven plastic bags cost Al-Furat over 1,000 ID to produce, but can only be sold for 500-600 ID. Increased production is therefore not a metric of industrial success, and HILLAH 00000096 002.2 OF 003 can actually mean an SOE is losing more money. All Warp But No Weft -------------- ¶9. (SBU) Lack of market incentive means SOEs have little reason to plan. When asked why Al-Furat's dozens of weaving machines lay inactive, Lool explained that while they had materials to weave warp lines, they had been out of materials for weft lines for the past six months. An executive at the Al-Hillah textile factory said the general practice was to wait until they ran out of raw materials before trying to find the resources to purchase more. Delays in obtaining supplies can be compounded by the fact that many raw materials come from other SOEs: so there may be a long wait even once money for a purchase has been located. ¶10. (SBU) SOEs have a reduced incentive to sell products. A nearby garment SOE spent USD 1.5 million buying materials to make 12,000 business suits more than a year ago. Yet a visit to the factory reveals over 90 percent of finished suits stored in a warehouse: management would not lower prices to a market competitive level because they said it did not matter when they sold them. Even if SOEs do sell their product, market issues may be largely irrelevant as the GOI or another SOE is often the customer. Lool does not have to worry too much about being competitive in the market because he knows that, at least for now, he sells most of his plastic bags to other SOEs. SOEs: A Looming Social Catastrophe ? -------------- ¶11. (SBU) Even though the majority of SOE employees rarely show up for work they still expect to get paid: earlier this year when the GOI temporarily froze salary raises that SOE employees had been promised, they demonstrated in the streets for days until being assured that they would receive their raises at the beginning of the year. Provincial Council Planning Committee Chairman Quesay Nadi Ali Hummadi called SOEs a looming social catastrophe. He told Econoff that SOEs showed that Iraq's economic evolution had not kept pace with its democratic transformation. He worried that if the GOI phases-out SOEs, either by shutting them down or privatizing them, without adequate plans for workers, then it could lead to significant social disruption. ¶12. (SBU) Sabah Al-Khafaji, Director-General of a 5,800 person SOE and chairman of the local Nahia council in Iskandria, discussed the possibility of an SOE phase-out. He told us that when he wears his DG hat he does worry about a phase-out, but when he puts on his politician hat, and reflects on the political problems a phase-out could create particularly with upcoming elections, then he thinks it is highly unlikely that the GOI will phase-out SOEs in the foreseeable future. Still, Al-Khafaji said he plans to focus USD 30 million the GOI recently promised his SOE to improve profitability and sustainable employment. Helping Stand-Up SOEs: A Litmus Test -------------- ¶13. (SBU) SOE management recognizes that their companies are not currently economically sustainable and require continued government subsidies. They have told us they understand their SOEs need to become more competitive by: breaking monolithic SOEs into separate independent units with their own management and fiscal control, creating products that meet market demand, increasing manufacturing efficiency with technology upgrades, and enhancing worker productivity through training and incentives. The PRT has worked with five local SOEs that collectively employ 20,000 workers. ¶14. (U) Creation of an independent 425-person Velvet Production unit within the 3,800 strong Al-Hillah Textile SOE represents a litmus test. The PRT has worked Al-Hillah Textile management to try to develop a profitable factory-within-a-factory. Management chose to make velvet because it builds on existing fabric design and production expertise and because there is strong local demand for velvet for upholstery, drapes and women's clothing. ¶15. (U) The new unit purchased state-of-the-art Belgium velvet weaving machines and sent teams to Belgium for training sessions using USD 3.6 million from the GOI (including a USD 1.8 million bank loan against a MIM guarantee) and USD 3 million from the task force to improve Business and Stability Operations (BSO). The PRT organized a three-day class for management covering basic management principles. If the unit, scheduled to begin production in January 2009, turns a profit, then workers will receive bonuses. Management hopes that if the unit turns a profit it will set an example that other units in the SOE will emulate, particularly once unit workers begin receiving bonuses. HILLAH 00000096 003.2 OF 003 ¶16. (SBU) Comment: While the power outlook is improving, access to credit remains a problem. We plan to work with the Tijara USAID programs for small-medium business credit and microcredit to develop innovative ways to facilitate loans, possibly by helping cover the interest spread between what borrowers can pay and what banks will accept -- an idea Yehia is eager to explore. Still, SOEs remain the figurative elephant in the room, and unless some way to make them sustainable is found, they may soon face extinction. The future of the Velvet Production unit represents a test case: if the combined efforts of the GOI, USG, plant management and PRT are not able to make it economically viable, then it is difficult to figure out how most SOEs will ever turn a profit. HILLAS