Supporting Iraq’s Economic Reform Program

Mitigating the Fiscal Effects of Oil Price Volatility

April 30, 2013

When the rapid decline of international oil prices in 2009 resulted in an unusual financing need and fiscal adjustment in Iraq, the World Bank helped the Iraqi authorities to improve fiscal sustainability prospects during December 2009 to March 2011 through this development policy lending (DPL) operation. The DPL supported actions to improve budget management policy and implementation and reform the financial sector through the institutional and operational restructuring of two state-owned commercial banks.

Challenge

Involved in various conflicts over the last 30 years, most recently since March 20, 2003, Iraq faced substantial development challenges. Chief among these was the need to rebuild its infrastructure and institutions after a tragic history of authoritarian rule followed by war and occupation, a task made difficult by the prospect of political instability and the excessive dependence on one commodity, crude oil, for its revenues.

Revenues from crude oil exports account for about two-thirds of the country’s gross domestic product (GDP) and for almost all of its export and fiscal revenues. Volatility of international oil prices translates into volatility of Iraq’s oil export and as a result, into a high volatility of its fiscal revenues. The rapid decline of the international oil price in 2009 resulted in an unusual financing need and fiscal adjustment in Iraq.  A considerable financing gap—in the order of US$4.9 billion—had emerged for the period 2009-2011. The dependence of Iraq’s fiscal position on a volatile oil price, coupled with the dependence of the economy on the state, put into question the sustainability of the early reconstruction successes and an emerging political consensus around it, if the required fiscal adjustment could not be mitigated.

Solution

The main objective of the DPL was to mitigate the impact of the fiscal crisis on Iraq’s economy and to support its medium-term economic reform program, thereby helping the country improve fiscal sustainability and reducing its fiscal and socioeconomic vulnerability to sudden drops in oil revenues.  The specific areas supported were (i) public financial management; (ii) financial sector reform; and (iii) reforms to the social protection system to increase its efficiency and fiscal sustainability. These reforms were either helping fiscal consolidation and rationalization/reprioritization of Iraq’s public expenditure program (social safety net, public distribution system, and pension reform), or helping to revitalize private sector growth, including through financial sector reforms based on a reform program endorsed by government in February 2009.

Results

Progress was made in the area of budget management in terms of policy and implementation, including:

  • As of December 2011, monthly budget execution reports are now issued no later than 60 days after the end of the month.
  • The Board of Supreme Audit (BSA) has completed the audits of the 2006 and 2007 government accounts and begun work on the reports for 2008 and 2009.
  • Since December 2011, a summary of federal budget data is publicly available on Iraq’s Ministry of Finance website.

Progress has been made in reforming the financial sector through the institutional and operational restructuring of the two state-owned commercial banks.  Key results include:

  • Improved the provisioning level at two state-owned commercial banks, increasing the reserves-to-non-performing loans (NPLs) ratio from 10 percent in June 2008 to 20 percent in October 2011.
  • The ratio of loans to the private sector to GDP increased from 4 percent in 2008 to 6 percent in October 2011.
  • Major reduction in the processing time of payment transactions by (i) applying the Real Time Gross Settlement System (RTGS), and by (ii) extending the number of banks participating in the RTGS from 16 in 2006 to 44 in 2011.  The number of daily transactions also increased from 120 in 2006 to 500 in 2011.

Efforts at reforming the Public Distribution System (PDS) have been initiated, but progress has been uneven.  

  • The National Board of Pensions (NBP) has been established as the unifying body of the mandatory pension schemes.
  • The NBP houses the newly established State Pension Fund (SPF), which provides pension benefits to public sector workers retiring on or after January 17, 2008.
  • The existing Social Security System, the private sector pension scheme, is to be transferred under the authority of the NBP.

Bank Group Contribution

The International Bank for Reconstruction and Development (IBRD) financing consisted US$250 million.

Partners

The operation was part of a broader support package that included an International Monetary Fund (IMF) Stand-By Arrangement with a total amount of US$3.7 billion. At project closing, about US$1.7 billion had been released by the IMF in three disbursements.  The Bank team worked in partnership with the IMF team under the parallel programs. In addition to the IMF, the U.K. Department for International Development (DFID) and the U.S. Department of the Treasury also provided assistance in the development and refinement of budget preparation toolkit and procedures. 

Moving Forward

Although the operation was programmatic and designed with two operations, the economic situation in Iraq improved significantly after 2009 with the rise in international oil prices and the increase in oil production in Iraq and there was no financing need to justify the second operation under the present DPL guidelines.

Beneficiaries

The Central Bank and two state-owned banks were key beneficiaries of the financial reform activity.  Meanwhile, the public at large, and especially vulnerable groups, were indirect beneficiaries of the program through support to budget management that was aligned with the Poverty Reduction Strategy, as well as through improving the efficiency of the social protection system.