Iraq hits the spend button
11 May 2023
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After a year of turmoil, Iraq has found itself in a better place economically in 2023, with an improved fiscal and external position on the back of high oil prices and production and two years of budget surpluses.
That is the good news. Analysts fear that this relative strength may lead the government into dangerous territory. A 2023 budget submitted to the Council of Representatives amounts to ID199tn ($153bn) of spending – an unprecedented fiscal programme for Iraq, even if oil revenues look flush.
“Iraq remains vulnerable to swings in oil prices, especially given spending pressures, the difficulty of passing meaningful budget reforms and the shallowness of domestic financing options,” says Toby Iles, head of Middle East and Africa sovereign ratings at Fitch Ratings.
“The proposed budget for 2023 pencils in large spending increases, including for sticky items such as salaries. This would increase Iraq’s vulnerability to oil price volatility.”
Previous episodes of low oil prices, in 2015-16 and 2020, quickly led to financing challenges and recourse to central bank borrowing, notes Iles.
The last time Iraq attempted to push through reforms was after the 2020 collapse in oil prices. But the recovery of prices, together with other factors, removed the immediate pressure for change and snuffed out these attempts. “One could argue that it was a wasted crisis,” says Iles.
Most of the budget is current spending – about three-quarters of it, leaving investment spending at ID49.5tn ($38bn). The budget anticipates a sizeable deficit of ID117.3tn ($89bn).
The deficit would be financed by a mix of funding from the Ministry of Finance’s account at the Central Bank of Iraq and foreign financing of investment projects. This would necessitate domestic borrowing of ID31.5tn ($24bn), according to an analysis by Ahmed Tabaqchali, chief strategist of the AFC Iraq Fund.
Cleared path for spending
The Iraqi authorities’ thinking is that now the political logjams of recent years have, for the most part, been removed, the timing is ripe to open the purse strings.
“They are sitting on $115bn of sovereign reserves, which they haven’t been able to spend for a couple of years,” says Michael Knights, a fellow at the Washington Institute for Near East Policy.
“And now they’ve got a fully empowered government. Soon they’re going to have a fully empowered budget. So they see it as time to splurge all the oil income that’s been built up.”
There is a logic to this. Yet the sheer scale of the financing programme is the issue here. The $153bn budget is one and a half times the last authorised budget in 2021, says Knights.
And if the budget is approved as part of a three-year programme – which remains an option – it leaves the state finances particularly vulnerable should oil prices slip.
“If you play out the numbers, you can see that if they spend at these record high levels for three years, they’ll wipe out the majority of their sovereign reserves. And they’ll be down to very close to import cover levels,” says Knights.
One particular concern is that the government intends to increase the size of the public sector by bringing hundreds of thousands of civil servants on board and paying them more. Public sector salaries and pensions are projected to account for 41 per cent of operating expenditures, according to Tabaqchali’s analysis.
In Knights’ view, this approach falls under “out populist-ing the populists, keeping people happy while the government cements its control over the military, the judiciary and intelligence services”.
Risk-fraught gambit
It may still be risky, given that Iraq struggled with the last major oil price drop in 2020. Having to cope then with the degree of public sector fixed expenses, it could be much harder to carry this off now.
Iraq’s single commodity dependence is more acute than other Middle East and North Africa (Mena) oil exporters. Oil revenue accounts for almost all of the government’s revenue and export revenue.
“This high commodity dependence is the key vulnerability, while weak governance and political risk undermine prospects for a stronger non-oil economy,” says Iles.
The undeveloped banking sector is also an important weakness, hampering non-oil development and limiting government financing options during times of fiscal deficit.
“Buoyant oil prices have improved many of Iraq’s sovereign credit metrics, but the absence of structural, economic or fiscal reforms and persistence of political risk constrain the rating (B-),” says Iles.
There will be positives that will emerge from the substantive spending programme. For one thing, there will be a substantial liquidity boost that will drive economic growth. It will also help insulate the government against protests.
For a country that, in the words of the World Bank, has suffered from a combination of corruption, weak state institutions and patronage – leaving 9 million Iraqis living below the poverty line and unemployment as high as 14 per cent – this spending will come as a soothing balm.
Currency crisis averted
Another plus is that the country’s currency crisis of previous months, which led to a shortage of dollars, appears to have been contained.
“The dollar shortages that we have seen in Iraq since late 2022 reflect governance issues and political risk, rather than any fundamental economic imbalances. The central bank’s foreign reserves are at record high levels,” says Iles.
The constraints on FX supply came from long-standing concerns about the ultimate recipients and uses of FX sold via the central bank’s daily auctions. However, notes Iles, now there are higher volumes again in the central bank’s daily auctions and the premium of the unofficial exchange rate over the official rate has narrowed to some extent, reflecting gradual adaptation to the central bank’s new procedural requirements.
If more robust and transparent procedure bed in and normalise, this will have ultimately been positive.
And yet, if the 2023 budget gets passed and Iraq commits itself to a highly expansionary three-year fiscal cycle, fresh vulnerabilities will be baked into the Iraqi economic system that could store up troubles for later generations of Iraqis to deal with. The clock is ticking.
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Rate outlook
Morin dismissed concerns that the conflict had structurally weakened Dubai’s pricing power, drawing a parallel with the period following Covid-19.
“When we came out of Covid, everybody said those prices would never hold. The question at every analyst call was always the same: your pricing strategy is unsustainable. Guess what? Nothing changed. The prices now, three or four years later, are still the same.”
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Morin also said Dubai has a track record of outpacing expectations after previous disruptions. “The first part of the world, post-Covid, that came back to positive RevPAR was the Middle East – it was Dubai. People forget that. The capacity of this part of the world to rebound, and the capacity of the industry to rebound in general, is always misunderstood.”
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Bahrain is exploring the use of nuclear power for domestic consumption as well as for potential export of surplus, with state energy conglomerate Bapco Energies tasked with studying the prospect of building a modular nuclear power plant.
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Case for nuclear power
Bahrain’s interest in exploring nuclear power has been driven primarily by the limitations of its hydrocarbon endowment. Given its small territorial size – about 786 square kilometres – Bahrain holds relatively modest hydrocarbon reserves compared with its Gulf peers.
The kingdom produces about 200,000 barrels a day (b/d) of oil, of which the Awali Field, also known as the Bahrain Field, contributes approximately 42,400 b/d.
Most of Bahrain’s crude production – about 145,000 b/d – comes from the offshore Abu Safah field, located in Gulf waters between Bahrain and Saudi Arabia and shared between Bapco Energies’ subsidiary Bapco Upstream and Saudi Aramco.
Bapco Energies has long pursued additional resources to boost oil and gas output. However, the discovery of the Khalij Al-Bahrain basin in 2018 – its biggest find in decades – has yet to live up to its promise. Initially estimated to hold 80 billion barrels of oil and 10-20 trillion cubic feet of gas, the find has not translated into production at the anticipated scale. Other, smaller exploration efforts with foreign players have also yet to yield the desired results.
The kingdom therefore remains heavily reliant on its larger neighbour, Saudi Arabia, for oil and gas supplies, importing about 350,000 b/d from Aramco via the AB-4 pipeline.
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Bapco Energies published emissions-reduction targets in July 2023, in one of the most detailed disclosures by any state energy enterprise in the GCC. It has also engaged advisers including Boston Consulting Group to help devise a strategy to meet its environmental goals, and Standard Chartered to support financing requirements.
Using 2017 as a baseline year, Bapco Energies has committed to reducing absolute Scope 3 emissions in Bahrain by 30% by 2035, and to reaching net-zero Scope 3 emissions by 2060.
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