US embassy cable - 05BAGHDAD2107

C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 002107 
 
SIPDIS 
 
STATE PASS TO USAID, STATE PASS TO NEA-ROBERT SILVERMAN, 
STATE PASS TO EB-DAS LARRY GREENWOOD/TOM ENGLE, TREASURY 
PASS TO OLIN WETHINGTON 
 
E.O. 12958: DECL: 05/19/2015 
TAGS: ECON, EFIN, PREL, IZ 
SUBJECT: DEPUTY FINANCE MINISTER AZEZ'S LAST WORDS ON 
DISCUSSIONS WITH THE IMF, CBI, AND DEBT 
 
Classified By: CLASSIFIED BY ECONOMIC MINISTER-COUNSELOR ANNE E. DERSE 
FOR REASONS 1.4 (B) AND (D) 
 
1. (SBU) SUMMARY. Deputy Finance Minister Azez Hassan said 
Iraq's reporting on fiscal data to the International Monetary 
Fund (IMF) has improved significantly and is now strong.  MOF 
is ready to close the books on 2004 and Azez said he expects 
the Budget Department to finalize by the June 6 Article IV 
consultations the fiscal data for at least the first two 
months of 2005 and "probably" through the end of March.   He 
identified four key challenges to a successful Article IV 
discussion and eventual negotiation of a Stand-By Arrangement 
(SBA) in 2005: (1) Fuel subsidy reform; (2) Food subsidy 
reform; (3) Reform of state-owned enterprises; and (4) 
controlling inflation.  Based on his knowledge of the new 
cabinet members of the Iraq Transitional Government (ITG), 
Azez is not optimistic that the first three reforms are 
politically feasible.  Azez said inflation would actually be 
negatively impacted by the success of these reforms, 
especially with the Central Bank's lack of effective monetary 
policy tools.  Azez's main concern, however, is that with his 
forced resignation (septel) there is no one who can 
competently manage Iraq's relationship with the IMF. Azez 
also said he told new ITG Finance Minister Ali Allawi that 
former FinMin and current Vice President Adil Mahdi needs to 
be included in debt negotiations with Gulf creditors because 
he laid down the current base. It is our impression from a 
recent meeting with the Charge that Mahdi agrees with Azez. 
END SUMMARY. 
 
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REPORTING ON 2004 AND FIRST QUARTER 2005 
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2. (C) Deputy Finance Minister Azez Hassan told us on May 16 
that the Ministry of Finance (MOF) Budget Department was 
finally prepared to close the books on 2004 fiscal data. 
Azez said he worked closely with the IMF last month in 
Washington to identify gaps in the MOF's first data 
submission and his staff told him earlier in the day that the 
data is now complete.  In addition, Azez said he expects the 
Budget Department to finalize by the June 6 Article IV 
consultations in Bahrain the fiscal data for at least the 
first two months of 2005 and "probably" through the end of 
March.  One significant factor missing from the 2005 data is 
any information from the Kurdish Region. Prior to 2005, the 
MOF treated the Kurdish Region as a transferred expenditure 
from within MOF's budget.  Thus, the transfer of funds from 
the line item in the MOF budget to the Kurdish Region 
(Suleymaniyah and Irbil, which also covers Dohuk) was the 
only required reporting.  According to Azez, the Kurdish 
Region insisted the 2005 budget treat the Kurdish Region as 
two independent spending units just like all of the line 
ministries.  As a result, the Kurdish Region is now required 
to provide a detailed spending plan and report their 
expenditures and revenues just like every other line 
ministry.  Azez said MOF has yet to receive any information 
in 2005.  (Note: We later learned that officials from the 
Kurdish Region provided their detailed budget spending plan 
for 2005 to MOF on May 16, but they have yet to report any 
actual expenditure or revenue detail for 2004 or 2005. End 
Note.)  Azez agreed the Minister of Finance should contact 
Kurdish leaders Massoud Barzani (KRG Prime Minister) and 
Jalal Talabani (ITG President) in writing to formally request 
the required expenditure information. 
 
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SBA IS DEAD WITHOUT FUEL PRICE REFORM 
------------------------------------- 
 
3. (SBU) Azez reiterated what we have heard from various 
sources, including the IMF, in that unless the ITG acts on 
fuel price reform there is no chance of an SBA.  Azez said 
the IMF expects ITG action on both the opening of the import 
market to the private sector and the raising of domestic, 
state-controlled prices for at least the two high-end 
petroleum products (high octane fuel and low-sulfur diesel). 
Azez said there are two views on how to raise prices: (1) one 
shot with some sort of compensation or (2) gradually without 
compensation.  Azez favors the gradual approach without 
compensation, which he said is the same approach favored by 
the IMF.  Azez said under the gradual approach, the goal 
would be to eliminate the subsidy within two to three years. 
(Note: Iraq's commitment to the IMF is to phase out the fuel 
price subsidy by 2009. End Note.) 
 
4. (C) Azez confirmed the Cabinet and National Assembly would 
both have to approve any significant fuel price reform.  He 
is not optimistic about passing this reform in 2005 given the 
current make-up of the ITG Cabinet.  In particular, Azez is 
concerned about the new ITG Minister of Oil, Ibrahim Bahr 
Al-Uloum, who, according to Azez, was the main obstacle in 
the Iraq Governing Council that prevented the Coalition 
Provisional Authority from taking action on fuel price reform 
back in February 2004.  (Comment: In our initial discussion 
with Bahr Al-Uloum (septel), he recognized that the ITG will 
need to reform Iraq's fuel price subsidy system both for the 
benefit of the Iraqi budget and the negotiation of an SBA 
with the IMF, and the new Electricity Minister told us May 18 
that Bahr Al-Ulooum supported the reform, as he does. 
Finance Minister Allawi and Planning Minister Barham Saleh 
are strongly in favor of significant reform.  Prime Minister 
al-Jafari's position remains tenuous.  End Comment.) 
 
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NEED AT LEAST A PLAN FOR FOOD AND SOE REFORM 
-------------------------------------------- 
 
5. (C) Azez said he told Minister Allawi in a recent briefing 
on commitments to the IMF that the ITG must at least approve 
plans to address Iraq's food distribution system and 
state-owned enterprises (SOEs).  Azez did not know whether 
the Privatization Commission established by former Prime 
Minister Iyad Allawi still exists under the new government. 
He was once again not optimistic about approval of either of 
these reforms since he does not think the new Cabinet will 
take the political risk. 
 
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INFLATION AND THE CENTRAL BANK 
------------------------------ 
 
6. (SBU) Azez explained that the proposed fuel, food, and SOE 
reforms would all have an inflationary effect on prices 
(liberalization of fuel prices, monetization of food basket, 
and privatization of SOEs).  The Central Bank of Iraq (CBI) 
does not have any working tools to manage inflationary 
pressures, according to Azez.  Azez said the IMF will 
continue to look hard at inflation during the SBA 
negotiations. 
 
7. (C) KPMG is currently in Iraq attempting to finalize the 
International Advisory and Monitoring Board (IAMB) audit on 
the Development Fund for Iraq (DFI). The Ministry of Finance 
has been working to identify discrepancies between the draft 
IAMB audit and the Ministry's figures.  Several of the 
figures used by KPMG in the audit are the same figures 
available to CBI from the Federal Reserve Bank in New York 
(FRBNY).  However, no one in the Central Bank, according to 
Azez, would certify the DFI balances presented by KPMG.  Azez 
said the "records of the Central Bank are a shame -- what is 
happening at the Central Bank is shameful".  He wasn't sure 
if the cause was incompetence or corruption.  In reference to 
the possibility of continuing to work on Iraq's debt 
negotiations as an advisor to CBI, Azez responded that that 
would be impossible; he "knows the inside((and) cannot stand 
the CBI." 
 
8. (C) In the context of discussing the extent of his 
(former) responsibilities at MOF, Azez said the CBI recently 
tried "in a devious way" to bring US dollars (USD) to Iraq 
for the daily currency auction. The Minister learned of a 
request for a USD 3 billion cash transfer from the FRBNY to 
the CBI vault in Baghdad and called Azez for an explanation. 
Azez said he was unaware of the transaction. He said he 
immediately called Governor Shabibi to stop the transfer. 
Azez found out the following day, May 15, that the Ministry 
had requested a USD 2.3 billion cash transfer to the CBI 
vault and the CBI requested an additional USD 700 million 
cash transfer from the CBI's independent account in the 
FRBNY. MOF officials explained to Azez that the transfer was 
necessary to fund letters of credit (LCs) and to buy Iraqi 
Dinar (ID) from the CBI for normal government operations. 
Azez explained that he previously set up a system with the 
CBI by which MOF would order the CBI to pay LCs directly out 
of the DFI account in the FRBNY, rather than shipping cash to 
Iraq then back out again to fund the LC.  To fund normal 
government operations, MOF should tell the CBI how many ID 
are required and the CBI should provide them.  CBI would then 
simply transfer USD from the DFI account in the FRBNY to the 
CBI account in the FRBNY to pay for the ID.  MOF does not 
need to transfer USD into Iraq.  Rather, only CBI requires 
USD for the daily currency auction.  Azez said CBI "probably 
wanted to make MOF pay for the cost" of transporting the USD 
to Iraq. 
 
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VP MAHDI AND DEBT NEGOTIATIONS 
------------------------------ 
 
9. (C) Azez told us that he told Allawi he "needs to include" 
former FinMin and current Vice President Adil Mahdi in 
negotiations with Gulf creditors. Azez said when Allawi 
questions why, Azez said Mahdi "laid down the base." 
Everyone in the Cabinet needs to be included in these 
negotiations, according to Azez. 
 
10. (C) VP Mahdi told the Charge in a May 12 meeting that 
negotiations with the Gulf creditors is a "political isse". 
He continued, "I don't think the Saudis want USD 800 million 
from us(they want contracts, assistance, etc."  Mahdi said 
the ITG still needed to "start" negotiations with the Gulf 
States. (Allawi also told us this week that the ITG has yet 
to begin to discuss a strategy on approaching Gulf 
creditors).  Mahdi was planning to meet with Allawi after 
Allawi returned from Brazil to "draw up a strategy."  Mahdi 
hoped the ITG would have a strategy by the end of the month 
(May). Mahdi suggested the ITG might use the Brussels 
Conference on June 22 as leverage to at least push for 
responses from Paris Club members to previous MOF letters 
requesting bilateral deals better than Paris Club terms.  "So 
far no positive responses((they are) all sticking with 80 
percent."  Mahdi said the ITG would send a "good team" to 
Brussels, led by Foreign Minister Zebari and including FinMin 
Allawi and Deputy Prime Minister Rowsch Shaways. They plan to 
have "something to say on commercial and Gulf creditors," 
according to Mahdi.  He expects the ITG to have a "vision of 
all the claims" by the end of this year. 
 
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COMMENT 
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11. (C) One day after submitting his resignation, Azez was 
noticeably more pessimistic about Iraq's progress on key 
reforms necessary for the negotiation of a SBA with the IMF, 
especially if he was not going to be involved in the process. 
Azez said the IMF's invitation to Allawi to participate in 
the Article IV consultations June 6-12 in Bahrain stated, 
"Azez must come," according to Azez. IMF (non)- resident 
representative Ibrahim Tigani called us after hearing of 
Azez's resignation to say the IMF is now considering what to 
do about the June 6 Article IV consultations.  He said the 
IMF will probably write to Allawi re-transmitting the 
questionnaire that must be completed for the meeting to go 
forward.  Without Azez in attendance, the ITG will need to 
impress upon the IMF during Article IV consultations that 
they are capable of providing the data and making the 
political decisions necessary to negotiate and fulfill the 
commitments associated with a SBA. 
Jeffrey