US embassy cable - 05BAGHDAD3805

C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 003805 
 
SIPDIS 
 
E.O. 12958: DECL: 09/14/2015 
TAGS: EFIN, ECON, ELAB, PGOV, PINR, IZ, ECON Development, National Assembly, IMF 
SUBJECT: SCENE-SETTER: FINANCE MINISTER'S CHALLENGES TO 
BUDGET REFORM 
 
REF: BAGHDAD 3453 (NOTAL) 
 
Classified By: CHARGE D'AFFAIRES DAVID M. SATTERFIELD FOR REASONS 1.4 ( 
b) AND (d). 
 
1. (C) SUMMARY: After his fellow ministers rebuffed the 2005 
budget supplemental, Finance Minister Allawi is trying to 
commit the next government to a 2006 budget that will pass 
muster with both the IMF and the Transitional National 
Assembly (TNA).  This task will not be easy, but much is at 
stake including over 120 billion dollars in debt forgiveness. 
 At the heart of Allawi's strategy is a decision to "starve" 
subsidies while working for better and cheaper alternatives, 
such as an oil trust fund that would pay cash to Iraqis. 
Once such an alternative is available, Allawi would eliminate 
food and fuel subsidies altogether.  Beyond subsidies reform, 
Allawi's "top-down" approach to budgeting aims to make room 
for substantial increases in funding for security and for 
revenue-generating investment, particularly in the oil 
sector.  He seems confident that the TNA will pass this sort 
of budget for 2006.  Given its preoccupation with the 
upcoming constitutional referendum and elections, however, 
the TNA is unlikely  to support bolder economic reforms 
(e.g., large fuel price increases) that would carry negative 
political repercussions.  END SUMMARY. 
 
2. (C) Minster of Finance Allawi faces multiple challenges as 
he struggles to provide funding for critical government 
operations this fiscal year.  As reported reftel, the Council 
of Ministers failed to pass the supplemental because Allawi 
had sought to use a 2005 budget request as a vehicle to 
commit this government to reforming fuel price subsidies.  In 
the face of the Council of Ministers rejection and the Prime 
Minister's reluctance to tackle fuel prices (which remain at 
5 cents/gallon for gas and 3 cents/gallon for diesel), Allawi 
moved to use the 2006 budget process to commit this 
government -- and the next government -- to reforming both 
fuel prices and the public distribution system (PDS).  His 
game plan is to have this government commit to a 2006 budget 
that will permit the GOI to sign an IMF SBA by year's end. 
Allawi expressed concern that the next government might be 
even less likely to undertake needed economic reforms unless 
palatable alternatives can be found.  To develop such 
alternatives, he wants assistance to explore establishing a 
national oil trust and/or a new needs-tested welfare system 
that would replace the current food and fuel subsidies 
programs. 
 
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Economic Challenges 
------------------- 
 
3. (C) The GOI economic team faces difficult challenges: 
 
--  Insurgent attacks on power lines, oil pipelines, and 
refinery pipelines remain constant and negatively affect the 
Iraqi economy.  Earlier 2005 GDP growth projections of 15 
percent have been revised downward to about 4 percent. 
 
-- Daily Iraqi oil exports that had been consistently above 
1.5 million barrels per day (MB/d) from August 2004-March 
2005 have drifted consistently below 1.5 MB/d in March 
2005-August 2005.  While increased oil prices have 
compensated in terms of revenue for lower overall exports, 
limited refining capacity means that Iraq has to import 
gasoline at world market prices -- only to sell most of it 
domestically at a loss, given a pump price of about 5 cents 
(US) per gallon.  This has created a paradoxical situation in 
Iraq of a major oil-exporting country with long gas lines and 
fuel shortages. 
 
-- Unemployment (active job-seekers and long-term unemployed) 
continues to climb, from 22.5 percent at the beginning of the 
year, according to some estimates, to an estimated 28 percent 
in August.  2005 inflation is currently running at about 33 
percent annually. 
 
-- This summer the average hours of electric power is 12 
hours/day nationally, and about 7 hours/day in Baghdad. 
Repeated polling data has highlighted that these electric 
cuts remain a major source of anger and discontent toward the 
government.  Naturally, power cuts also have a wide economic 
impact on the country. 
 
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Weak Government Structure 
------------------------- 
 
4. (C) Any government would find managing an economy under 
such circumstances a daunting task.  Complicating the GOI 
response is that, while there are a number of capable 
ministers in the Cabinet (Finance and Planning come to mind), 
at the critical Director General level and immediately below, 
many ministries are filled with staffs who are content to 
fall back on the familiar laws and regulations of the Saddam 
era.  (COMMENT: In other ministries (Transportation is an 
example), ministerial leadership is incompetent, ineducable, 
or simply suspicious of economic reform -- e.g., anything 
that hints at privatization.  Finally, a last group of 
ministers is already looking to their political careers and, 
as such, do not want to be seen as taking controversial or 
unpopular actions.  END COMMENT.) 
 
5. (C) When the ministers meet as the Council of Ministers, 
they do, nonetheless, constitute am important body that can 
pass decrees that bypass the National Assembly (TNA).  One 
recent example is the GOI decision to start rationing 
gasoline in Baghdad.  Ultimately, though, the GOI budget has 
to be approved by the TNA.  Thus, had the Council approved 
the 2005 supplemental, TNA approval would have been necessary. 
 
---------------------- 
Moving the 2006 Budget 
---------------------- 
 
6. (C) Currently, the Council of Ministers has approved the 
proposed structure of the 2006 budget as presented to them by 
the Ministry of Finance.  Allawi told us that this budget 
structure contains a strategy to take on fuel price and food 
basket subsidies (reftel), as well as what he believes is a 
credible approach to increasing oil production through 
increased spending for infrastructure protection.  Currently, 
the MoF is working to elicit budget requests from the 
ministries.  Once these requests are received, the MoF will 
work with the Ministry of Planning to present a draft annual 
budget to the Council for its approval.  Once approved, the 
budget will go to the Council of Ministers and TNA for 
approval.  Allawi told us that he expects the TNA to pass the 
2006 budget in mid-November.  NOTE: The TNA, operating under 
budget processing rules developed by the CPA, has the right 
to reallocate spending and to increase overall expenditures. 
The TNA has until the end of the calendar year to pass the 
budget.  If the TNA does not do so then the MoF can approve 
sequential monthly spending units based on 1/12th of the 
previous year's budget.  END NOTE. 
 
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The Distractions of the Political Calendar 
------------------------------------------ 
 
7. (C) The current political class remains transfixed by the 
referendum on the Constitution and the December elections. 
Discussion in the TNA of unrelated matters has come to a 
near-halt.  One example is the proposed legislation to 
liberalize gas imports for reselling at non-subsidized 
prices.  That would usefully legalize the robust market in 
black market fuel sales, opening them for revenue collection 
and halting the subsidy hemorrhage.  While some ministries 
are thinking about market liberalization, attracting foreign 
investment, and privatization, much of this comprises 
studies, conferences and meetings -- often in Amman, to the 
chagrin of some ministers who would prefer that conferences 
on marketing opportunities take place in Iraq. 
 
8. (C) COMMENT: It is difficult to see any economic area in 
which the current Council of Ministers, the Prime Minister, 
or the TNA might want to assert themselves by any concrete 
steps or decisions for the rest of the year.  The one 
exception is passage of a 2006 budget.  It is a tribute to 
the Minister of Finance that he is willing to pitch against 
this political calendar and drive, first, the Council of 
Ministers, and then the TNA to approve it.  We note that this 
political bravery seems to be accompanied by considerable 
personal bravery as well, as the Minister's convoy has been 
hit twice in the past several months and many of his Personal 
Security Detail (PSD) killed.  END COMMENT. 
 
9. (C) Allawi feels that recent Article IV consultations with 
the IMF went reasonably well.  He is well-aware that the 
Paris Club expects Iraq to reach agreement with the IMF for 
new Standby Arrangements by year-end.  He appreciates the 
importance of reducing fuel subsidies by at least USD 1 
billion, passing regulations for implementing the Financial 
Management Law, auditing the Central Bank of Iraq (CBI), and 
developing good-quality and timely financial and fiscal 
reporting.  The IMF is also looking at many other issues, 
including the adoption of plans for state-owned bank 
restructuring; a commitment to consider some state-owned 
enterprises (SOE) for privatization; implementation of 
international auditing and accounting standards; the 
development of a functioning payments system; and full 
implementation of a financial management information system. 
On these issues Allawi will be prepared to discuss progress 
achieved so far, while offering constructive ideas for what 
more needs to be done.  He is likely to offer also a frank 
appraisal of this government's limited ability to do much 
more than act on the budget in the economic realm. 
 
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Comment 
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10. (C) While a few of the ministers "get" the importance of 
the 2006 budget for the IMF SBA and the relationship between 
a SBA and debt forgiveness, this has not yet emerged as a hot 
topic in Iraq.  Allawi has privately told us that his 
strategy is to attempt to lock-in reforms by tying them to 
IMF conditionality -- thus setting the stage for a classic 
"blame the IMF" as the basis for securing political approval 
for necessary changes.  The challenges facing the Minster are 
manifold.  The economic situation is extremely difficult, 
making many hesitant to take actions that would further fray 
the social safety net, no matter how dysfunctional it might 
be in its current state.  Those tough decisions have taken an 
even more formidable appearance as the end of this 
government's tenure approaches.  Finally, the political 
calendar continues to focus the government's energy and time 
on the constitutional debate and ratification process.  That 
should culminate on October 15, with intense political 
campaigning for the December 15 elections following in short 
order.  END COMMENT. 
Satterfield