EVENTS

Date:	Wednesday, October 6, 2004
Time:	9:15 AM -- 10:30 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

October 2004

A Conversation with Adel Abdul Mahdi, the Iraqi Minister of Finance

Many questions about the future of Iraq remain unanswered, but while concerns about security dominate the news, a concrete plan for economic recovery and development will also be crucial to ensuring a peaceful, democratic future for the Iraqi people. Revitalization of the petroleum sector--which was expected to provide an economic cushion for post-Saddam reconstruction efforts--has been slower than was hoped, and Iraq's $120 billion foreign debt will continue to weigh down the Iraqi budget. France and Germany have been reluctant to agree to forgive the majority of Iraq's $40 billion Paris Club debt; without their assent, a similar gesture from Iraq's neighbors (to whom Iraq's debt is $80 billion) will be unlikely. On October 6, AEI hosted Adel Abdul Mahdi, who was appointed Minister of Finance by interim Prime Minister Ayad Allawi in June 2004, to discuss the Iraqi economy and prospects for the future.

The Honorable Adel Abdul Mahdi
Iraqi Minister of Finance

Although relations between Iraq and the World Bank and International Monetary Fund were interrupted for two decades, this week important steps were taken toward economic reintegration. On September 29, the IMF's executive board approved emergency post-conflict relief funding for Iraq. This action illustrates the IMF's endorsement of Iraq's post-Saddam financial and economic path. There are several initiatives and programs in place in Iraq to bolster economic integration, but an international agreement on Iraq's external debt will be crucial to the economic recovery.

Iraq's current economic climate. Iraq has a sound macroeconomic framework and has made progress on a broad range of structural and legal reforms. This has enabled the country to begin the transition from a centralized to a free-market economy. But the high unemployment rate, the large percentage of enterprise that remains state-owned, an infrastructure badly in need of repair, and massive foreign debts are problems that must be addressed. Continued attacks from insurgents and foreign terrorists may hinder economic progress in the period leading up to the elections in January.

Building a macroeconomic framework. A major accomplishment since the end of the conflict has been the establishment of a solid macroeconomic framework. Saddam's legacy of economic mismanagement could have caused currency collapse, inflation, and economic meltdown in the post-war period, but the new system has succeeded in maintaining stable consumer prices and a stable exchange rate despite heavy trading. This stability forms the foundation for the rest of the economy, which is projected to grow by 50 percent in 2005.

Crucial reforms/initiatives. Economic reforms have helped Iraq emerge from under the legacy of state control and government ownership. A new currency has increased consumer confidence and facilitated day-to-day transactions. A new Central Bank, which prohibits extending credits to the government, has been established. The Central Bank conducts daily foreign exchange auctions. It has taken steps to monitor and regulate banking operations, such as requiring commercial banks to strengthen their capital base. The Ministry of Finance now holds treasury-bill auctions, demonstrating extensive domestic savings in Iraq. Liberalized interest rates have led to increased direct foreign investment. In October 2003, four foreign banks were licensed to operate in Iraq.

Commerce and trade. The oil sector continues to dominate Iraq's economy, accounting for 75 percent of total economic activity. But the agricultural sector is showing signs of revival. The streets and bazaars are filled with goods, reflecting increased regional trade facilitated by drastically reformed trade policies. This includes a flat and fixed 5 percent duty on imports and the creation of the Trade Bank of Iraq. The trade bank has issued letters of credit valued at more than $1 billion and has earned observer status in the World Trade Organization.

Regional trade and relations. Major trade partners include states in the Middle East, such as Turkey, UAE, Iran, Jordan, and Saudi Arabia. There is also trade with Europe and the United States. Kuwait has shown willingness to assist the Iraqis in debt relief and will help bolster the Central Bank, along with Jordan, the United Kingdom, Egypt, and the United States.

The November Cairo Conference is of special importance. The conference will allow Iraq to meet and work with the Gulf States, the Arab League, and other Islamic organizations, with a purpose of forming a common policy concerning Iraq. It will help Iraq avoid being in the crossfire of its neighbors or involved in their economic conflicts.

Debt relief. One of the most pressing issues is the reduction of external debt, which was largely accumulated during the period of international sanctions placed on the old regime. Iraq's foreign debt is currently six times its GDP. In order for the new regime to achieve higher standards of living and stability for the new political system, it is crucial that almost all of this debt be excused. Neither partial reduction of the debt nor increased taxation is an adequate solution: paying even some of the debt would require money to be diverted from areas where it is desperately needed, and imposing a heavy tax system would stifle private-sector activity.

People believe Iraq's oil reserves will produce enough revenue to finance the debt. But under the former regime the standard of living deteriorated significantly: the average household income dropped from $30,000 in 1990 to less than $1,000 today, adult literacy remains around 60 percent, and housing standards are extremely poor. Also, while the oil reserves have great potential value, private investment and capital will be required to develop these reserves. This investment may not be forthcoming if Iraq remains confined by major debt.

Deep debt reduction is also in the interest of the greater Middle East. Iraq's sustained economic growth, political stability, and integration into the international economy will be a strong regional asset.

The security climate. Although the media draws a grim picture, it is important to remember that the economic, political, ethnic, and security situation was much worse under Saddam. Many Iraqi citizens died as a result of torture or the three wars Iraq has been involved in over the past twenty years. The transition has been difficult, especially since four generations lived under Saddam's regime. However, there are signs that the situation is improving and will continue to do so. Markets are filling up with goods, and restaurants and cafes are also coming back into business. Although the country was governed by a minority dictatorship for decades, there are now diverse political actors. Members of many political parties, religious factions, and ethnic groupings participate in the transitional government. The media is liberalized, with 250 newspapers in circulation and several television stations broadcasting. The situation has improved greatly since the transfer of sovereignty to the Iraqi people. The brutal methods and violent publicity stunts employed by insurgents and terrorists are signs of their desperation and imminent defeat, but security must be guaranteed.

Future concerns. One of the top priorities in the future will be fiscal stability. Heavy dependence on the oil industry is a cause for concern. Iraq must succeed in diversifying its economy. By reforming the tax code and trading regime, Iraq will be more hospitable to commercial interests in areas other than the oil sector. A national oil company may still be the best solution, but Iraq must also look to foreign investment.

The Finance Ministry must also take steps to keep government expenditures reasonable. In addition, the Ministry of Finance's infrastructure and transparency of operation must be improved. The Ministry plans to publish its internal budget for 2004 and establish a framework of accountability based on international best practices.

Further structural reforms will also be necessary to facilitate job creation and private sector growth. The question of food and oil subsidies must also be decided. While the Ministry plans to continue to distribute food as part of a social safety net, it will eventually switch to a cash-based system. Although domestic prices for oil products are currently below international market rates, Iraq will try to end oil subsidies by the end of the year.

AEI interns Johanna Dennehy and Elizabeth Steiner wrote this summary with research program manager Molly McKew.