During its initial assessment in 2004, the IMF optimistically forecast oil production in Iraq to double in five years while the country's ministry of oil was expecting to at least treble its production levels. Those years have passed all too quickly. According to the ministry, crude production in Iraq this year has averaged 2.4 million barrels per day (bpd), no different from the levels reported in February 2003. The grim reality is, oil production in Iraq has not increased in more than a decade. Then again, neither has electricity.
The ministry now plans to increase production to 6 million bpd in the next four years and double once more in a decade - making it a leading producer in the Gulf. Even this seems unrealistic. The output expansion deadlines do not allow enough time to build the pipelines, ports and other facilities needed to transport enormous amounts of oil. Despite this, there are some very good reasons as to why Iraq hasn't managed to achieve its goals, starting with the most obvious: violence.
According to the government, last month at least 500 people were killed in acts of insurgency and more than 1,000 wounded. As a marker for intensity, commentators have hastened to add the death toll is significantly lower than the 4,000 in the same month in 2006 and 2007. It is no secret that security risks make Iraq a difficult environment to operate in. The second most compelling reason is the exodus related to the violence. Almost all of Iraq's middle class escaped the violence by seeking refuge in neighbouring Arab states. The result was a breakdown in normal life in Iraq.
Every Iraq budget since that of Jerry Bremer, the US diplomat appointed administrator to Iraq from May 2003 until limited Iraqi sovereignty was restored on June 2004, has been approved late. The capital budget has typically been under-executed while the recurrent budgets have been hugely overspent. In other words, it has been easier to pay salaries than spend on large-scale infrastructure projects.
This leads to the third reason: institutional capacity. Not spending on capital projects could be attributed to a lack of know-how or lack of practical experience. Iraq's last major construction project was the Doura power plant in 1987. There are also other types of budget quick-sand. Almost all the government-led corporations are still mired in the subsidy-led industrialisation attempts of the 1970s.
The ministry of industry and minerals controls some 70 companies in six sectors that do not have auditable accounts or turn profits. There has been an understandable interest in privatising them all. Other ministries control an additional 100 state-owned enterprises with the same predicament. The risk for the investor is that state-owned companies come bonded with employees who need to be managed.
A fourth reason is that investment in Iraq requires supporting legislation. There are tangible benefits such as a significant three-year exemption from import fees and no taxes for two years with the opportunity to repatriate investment and profits. On the flip side, Investment Law 13, passed under the current government, suggests that projects greater than US$50 million (Dh183.6m) be proposed for the scrutiny of the National Investment Commission and then the relevant provincial investment councils.
Precious time can also be lost in figuring out what to do - the World Bank ranks Iraq 175th for time taken to start a new development, with an average of 215 days to get construction permits compared with a MENA average of 160 days. Roads, railways, the electricity grid and ports need investment. The fifth factor is the cost of doing business. Shipping containers of cargo to Iraq costs $3,900 per unit compared with an average in the MENA region and countries of the Organisation for Economic Co-operation and Development, including the US, UK and Australia, of about $1,200. This problem could be solved over the next few years: to facilitate the flow of goods Kuwait has committed itself to a $1.1 billion port development of Boubyan Island, near the Iraqi border, which it is hoped will reduce the import costs substantially. The first four berths are expected to be commissioned around 2015.
To feed Iraq's hunger for cement, France's Lafarge has recently launched a joint-venture with MerchantBridge to spend $200m on the renovation of an Iraqi cement plant near Karbala in the south to boost production. Construction material prices in Iraq could fall as trade links with the Gulf strengthen. The sixth reason is limited borrowing options. In February, the IMF approved a $3.64bn loan, disbursing about $450m immediately as the government struggles to plug financing needs of $5bn until the end of next year. This follows a satisfactory performance for the IMF Stand-By Arrangement (SBA)programme, approving the last tranche of 20 per cent debt relief last year.
There remains, however, a final 20 per cent for Iraq to repay to lenders belonging to the Paris Club, whose permanent members include Australia, Canada and France. Kuwait and Saudi Arabia have also yet to finalise their debt-deals with Iraq, which could also ease the burden by an estimated $30bn to $40bn. The situation is proving difficult and comes on the back of an Iraq budget deficit last year of about $3.6bn.
Given the progress in reducing debt, conventional wisdom suggests that Iraq should be able to borrow to fund its reconstruction efforts. The way the IMF reform was carried out, however, impedes the likelihood of this happening within the next five years. In keeping with the monetary tradition, the Iraqi dinar has appreciated more than 20 per cent to control inflation. This price-level correction also drove up the cost of the public services by the same percentage through higher salaries.
Now, there is virtually no room for further appreciation. In tandem with maintaining an artificially strong Iraqi dinar, the external position deteriorated substantially last year. According to the IMF the overall balance of payments shifted into large deficits of about 20 per cent of GDP. So what does this all mean? The disputed election and extended political paralysis create further uncertainty in the country.
The economic risk is that the creeping erosion of confidence among Iraqis may provide fertile ground for a return to increasing violence. With a weak government that struggles to deliver, a return to shortages and inflation rates as seen in 2006 is not impossible to imagine. Oil production is unlikely to increase markedly any time soon and with large-scale borrowing off the agenda, the Iraqi government may find itself offering more concessions to shore up investors. That said, investors are likely to wait to see how the cards fall after the troop withdrawal.
Ikaraam Ullah is an economist and writer based in Abu Dhabi