Comprising 93% of fiscal budgetary revenues, 60% of GDP and 99% of exports, oil is indisputably the lifeblood of Iraq’s economy. The gravity of this dependence was harshly exposed during the double shock of 2014-2017; austerity due to the oil price collapse and the rise of the Islamic State. With the price of oil tumbling by almost $14 or 30% on Monday, Baghdad seems to be going back to square one, this time while experiencing a crisis of governance.
With the global health emergency of COVID-19, financial markets have registered losses reminiscent of those sustained post the economic crisis of 2008. In its Interim Economic Assessment published on March 2nd, the Organisation of Economic Cooperation and Development (OECD) highlighted negative economic growth prospects, noting how the virus has already resulted in “significant economic disruption” from a decline in production, spending, supply chain disruptions, in addition to an overall fall in various economic sectors; tourism, electronics, automobile manufacturing and many others.
Chiefly, lower economic growth is seen in China, the epicentre of the COVID-19 outbreak, where automobile sales have lowered by 80%, passenger traffic is down 85%, while the official Purchasing Managers’ Index (PMI) has reached a low of 35.7 in February from a high of 50.2 last year. A centre of supply and demand contributing 17% of global GDP, 40% of overall demand for commodities and making up 11% of world trade, the slowdown in Beijing has effectively started a domino-effect for an upcoming global contraction.
In February, Iraq’s federal oil exports, not including Kurdistan, reached an average of 3.304 million barrels per day (mbpd), up 3% from the previous month of January and at an average price of $51.374 per barrel as published by Iraq’s State Oil Marketing Organisation (SOMO). According to the International Energy Agency, China and India were Iraq’s highest buyers of crude oil, at an average of 1 mbpd in 2019. In Europe, around 900 thousand barrels per day (tbpd) of medium sour crudes are imported, including from Iraqi Kurdistan. Practically, China buys around 26% of Iraq’s exports (see Figure 1), leaving the country’s revenues at risk of any domestic demand deterioration there. In February Iraq’s revenues dipped by $1.1 billion on the back of lesser demand due to COVID-19. At around $5 billion, Iraq’s proceeds are $2.276 billion below 2019’s highpoint in May (see Figure 2).
Last week’s failure of OPEC+ to reach consensus on a proposed additional adjustment of 1.5 mbpd to the end of 2020, has exacerbated a price war between oil producers. This comes after the OPEC+ alliance had leaned towards the limit of ‘acceptable’ cuts in December when the Saudis pushed for an additional 600 tbpd of reductions. Moscow was only convinced to join the decision when Russian condensates were exempted from the overall liquid production target (OPEC+ is led by Saudi Arabia but includes Russia as a principal exporter outside the group). With their open disagreement last week, both Riyadh and Moscow have launched a price discount war and pledged to add 2.5 mbpd and 500 tbpd of additional oil to the market.
It seems that the Saudis dearly require the price of oil to float above $60 to fund their budgetary obligations and ambitious Vision 2030 plans, while the Russians seem to care more about ousting American shale producers and indirectly retaliating to sanctions imposed by the United States against the Russian gas giant, Rosneft. The Kingdom enjoys a 2.32 mbpd of spare capacity, as assessed by the IEA in January, and a sovereign wealth fund that has been refuelled by the high oil prices of 2019 while Moscow’s oil and gas industry is served by efficient domestic supply chains, paid in Rubles, with almost a monopoly over gas exports to Europe. A source of important revenue for Russia.
For Iraq, it is a completely different story. While Baghdad has pledged to add 350 tbpd, the country has neither the readily available spare capacity nor the high cash reserves to sustain a long period of low oil prices.
One advantage that Baghdad might be able to utilize in the coming months is the recently signed oil-for-infrastructure financial framework agreement with China. Iraq may employ this mechanism to ensure sustaining a significant market share. Both beneficiaries from the crude oil sales agreement, SinoChem and ZhenHua oil, enjoy a substantial refining capacity in China. In return, Iraq may well be able to maintain a steady flow of revenues for both fiscal budgetary needs and infrastructure development.
In 2019, Iraq’s budget suffered an actual deficit of $22.6 billion or 20% of the overall spending of $106.01 billion. This deficit was plugged with a circulated surplus from 2018 of $14.3 billion in addition to increased oil revenues from favourable oil prices in 2019. The federal budget of 2019 was based on an estimation of $56 per barrel, while the average price of sold Iraqi oil was at $64 per barrel.
In 2020, oil market conditions are undoubtedly grimmer. Initially, the 2020 federal budget was set at oil revenues stemming from $53 per barrel leading to a fiscal income of around $116.7 billion with an approximate deficit of $60.43 billion, or almost 52%, according to lawmakers. This led the Ministry of Finance and the Parliamentary Financial Committee to take several steps to reduce the deficit and as a result, the expected price of oil was amended higher to $56. This marked the anticipated deficit down to 30% or approximately $42 billion. This is still 10% higher than in 2019 (see Figure 3).
Public spending makes up 45% of Iraq’s GDP according to senior government economic advisors. In 2018, the public payroll made up 57% of fiscal spending while in 2020 it is expected to increase by 10% with the addition of 500,000 new employees to the existing expanded public employment system. Each year, Iraq is expected to add at least 400,000 entrants to the workforce (some estimates put this figure far higher) while the Ministry of Planning expects its National Youth Programme (NYP), supported by the World Bank, Central Bank of Iraq, National Investment Commission, and some others, to help absorb 100,000 workers into the public sector when fully implemented this year. Iraq’s private sector still suffers from key structural issues including an underdeveloped banking sector, challenges accessing capital and thickets of regulations for new businesses.
Amid this discouraging picture, the current Iraqi cabinet has become a caretaker since its resignation three months earlier as a result of nationwide protests that erupted throughout central and southern parts of the country. While Iraq might be facing one of its gravest economic crises, the executive branch of government is effectively dormant. Political discussions in Baghdad have not produced the selection of a new candidate for the premiership after the failure of Mohammed Tawfiq Allawi to pass his proposed cabinet by parliament. The Shia political house is still not unified. At the same time, the current government has not been clearly mandated by Parliament to steer the country, with full responsibility and executive powers, towards elections by the end of the year, as proposed by outgoing Prime Minister Adil Abdul Mahdi.
If these political affairs continue, the country will be driven towards at best, a passive financial situation, being able to barely cover the public payroll. While sustaining previously financed infrastructure projects, the government will not be capable of expanding or launching a new one. Although it is still too early to enter panic mode, capital expenditures need to be passed through the current budgetary draft legislation in order to secure finances for oilfield development by international oil companies. This is greatly needed for maintaining and possibly expanding Iraq’s oil production in the event of intensifying market competition between oil producers in the upcoming few months.
This is in addition to planned power generation, transmission and distribution projects substantially needed for the upcoming summer. Also, to augment progress achieved last year in the development of the Grand Faw Port project in Basra, long-awaited employment and economic diversification driver.
While these are strategic necessities for Iraq, what is more, immediate and vital is ensuring emergency spending for combating the COVID-19 outbreak nationally, especially if it continues in severity beyond summer, as well as supporting reconstruction efforts in liberated areas of western and northern Iraq. The latter is crucial to ensure long term security and stability in those areas and to prevent the return of the Islamic State.
This is the first article in our coverage of the impacts of the global Coronavirus (COVID-19) outbreak on Iraq’s economy this year. If interested in contributing, please review our submission guidelines.