Iraq's economic outlook

The Iraqi economy is undergoing a transition from one tightly controlled by the government to a free market economy. Significant political, economic, and social changes are taking place, which should open up new opportunities for the rapid economic development of the country.

A US-led Iraqi interim government was set up and is expected to take sovereign power in June 2004. This interim government has played a critical role in supporting the rebuilding initiatives.

During the last three decades, Iraq has suffered from persistent state intervention, costly militarization, three wars, and over a decade of international sanctions.

Even without taking into account reparation claims, Iraq is amongst the most heavily externally indebted countries in the world. This makes the rebuilding of Iraq in no way an easy task and a collective effort will be needed to scrape together funds to fulfill the heavy price tag associated with reconstruction.

With tremendous amounts of interest channeled towards succeeding in rebuilding the devastated nation, the situation has advanced considerably. Although far from becoming the regional powerhouse it has the potential to be, remarkable steps to reshape and rebuild the ruined economy have transpired in the wake of the liberation.

Advances have been made on all fronts entailing the humanitarian, political and economic arenas. A US-led Iraqi interim government was set up and is expected to take sovereign power in June 2004. This interim government has played a critical role in supporting the rebuilding initiatives many times deemed doubtful by skeptics.

The reconstruction efforts are however being hampered by the continuing attacks on US troops and the lack of security in the country. A large part of the funds required for reconstruction will be obtained from crude oil exports.

International aid in the form of grants and loans are also expected to meet a significant portion of the costs of reconstruction. A joint UN and World Bank report estimates the overall stock of medium-term reconstruction needs to be on the order of US$36bn, US$9bn of which would be needed in 2004.

These figures cover physical reconstruction, technical assistance, and training needs, plus additional operational and maintenance costs associated with new investments.

In addition, critical sectors that have been identified outside the UN/World Bank scope, including security and oil have been estimated by the CPA to cost an additional US$20bn over the coming years. Thus the total estimated cost of reconstruction amounts to around US$56bn.

On the humanitarian front, the international community, led by the United Nations has been able to respond to the needs of the Iraqi people. Electric power has returned to slightly below pre-war levels, while hospitals, health clinics and schools have reopened across the country.

A wide range of goods and services are available in the markets. Food, water and medical necessities from the international community have been made available to Iraq's needy, which has helped stave off a potential humanitarian crisis. On the political front, many issues have been resolved although several still remain.

On the economic front, the Iraqi government, recognizing the importance of capital inflow to the nation and to encourage much-needed capital investment, adopted a liberal regime for foreign direct investment.

It permits foreign firms to establish wholly owned companies or to purchase 100% of Iraqi firms. Foreign firms may remit profits and capital freely. Also, the Banking Law has been an important complement to the foreign investment law, allowing foreign banks to enter Iraq as branches, subsidiaries, representative offices or through joint ventures with local banks.

The passing of these two legislations, should pave the way for the inflow of international funds for the reconstruction of the country. The reconstruction effort has seen giant leaps forward.

The few authorities which are organizing and awarding contracts (USAID, Iraq Interim Government, various Ministries) have taken effective measures at assessing and tackling the most significant infrastructure projects and awarding contracts to rehabilitate those segments.

Although oil production has been erratic during 2003, production has been gathering steam. The Iraqi economy, which is heavily dependent on the sale of crude oil should see further improvements in 2004 as both the CPA and the Ministry of Oil have set out the aim of expanding production to pre-war levels.

The CPA has also set the aim of achieving some level of fiscal discipline and has established a budget for the coming period, which highlights a number of issues.

One of the key issues highlighted is the continued dependency of the government on oil revenues, with about 89% of revenue budgeted to come from oil. The budget also points to the inevitability of a heavy fiscal deficit.

On the positive side though, the deficit does not rely on increased borrowing or printing money, instead the deficit will be financed using unspent Oil for Food Program (OFFP) funds and other assets confiscated from the previous regime.

The Iraqi economy has experienced continuous deterioration since 1980. In terms of per capita GDP, Iraq may be classified as one of the few Least Developed Countries (LDCs). EIU estimates real GDP to have declined by nearly 20% in 2003 over the previous year due to the fall in oil production and export levels.

Iraq's oil output is expected to recover to pre-war levels by the second half of 2004, and the non-oil sector is projected to expand rapidly as aid and reconstruction spending flows into the economy. Real GDP is estimated to grow by 19% and 15% in 2004 and 2005 respectively.

A strong recovery in economic growth levels is projected for 2004, subject to the restoration of adequate security, proper functioning of public services (particularly electricity), and the availability of external resources for reconstruction.

The oil sector will continue to be the driving force behind economic growth in Iraq, with securing pipeline security the main impediment. At the same time, significant political, economic, and social changes will continue to take place that would open up new opportunities for economic activity.