The oil sector is the single main source of income for Iraq. The Iraqi government currently employs over 40% of the population with 90% of Iraqi oil revenues being paid as salaries and pensions for the public sector. This leaves little room for supporting the costs of healthcare, education, defense and security among others and inevitably, long-term investment. This issue is only aggravated even further by the rapid depletion of Iraq’s foreign reserves.
Establishing a sovereign wealth fund (SWF) with sound financial management and strong fiscal discipline will be a tool to support Iraq’s macro fiscal framework, however, it should not be seen as a substitute for fiscal reforms. SWFs are saving mechanisms that represent an innovative attempt to leverage a country’s resources, not a replacement for spending through the budget allocation process, rather a complement to facilitating growth and development in a domestic context.
SWFs are not mechanisms to circumvent weak governance and poor institutions at the local level. If the necessary institutional framework is absent or lacking, the resulting sovereign wealth fund will fail. However, given the right fiscal and institutional prerequisites in place, a SWF can promote transparency, help smooth resource volatility, manage exchange reserves, develop domestic infrastructure, create long-term savings for future generations and most importantly perhaps given the current environment, reduce political corruption and minimize the temptation for misusing Iraq’s wealth.
From a technical point of view, Iraq has a weak public financial management (PFM) system and an unskilled public administration, making it challenging to construct and administer a sound fiscal strategy. From an institutional point of view, Iraq lacks a predictable legal framework and stringent enforcement of the rule of law. And from a political point of view, the fragile governance structures allows for a weak separation of authorities and as a result, hinders the success of any transparency and accountability measures that may exist.
For Iraq to succeed in using its natural resource revenue to improve macro and socio economic landscapes in Iraq, it must embark on a journey of political and institutional reform to ensure long-term fiscal sustainability and foster the necessary prerequisites and functions for facilitating development in an Iraqi context.
Indeed the real challenge for Iraq in the context of any SWF discussions is not the current lack of surpluses for the establishment of a SWF, but rather designing and managing a SWF that can realistically achieve the objectives set out for it by the government.
The last thing Iraq needs is a “blueprint template” of a SWF that does not consider local conditions and the institutional and economic policymaking climate, and use local inputs to model a fund most suitable to Iraq’s current circumstances. To grow the local economy, Iraq must invest in it. In this regard, establishing a development fund with a co-investment SWF framework would address a number of these issues by allowing private and foreign investors to add to the transparency of the process and ultimately the likely success of the initiative. This policy brief attempts to explore this option and offer an operational “roadmap” to policymakers in Iraq.