• ,-., .. r r No. E-57 CONFIDENTIAL 66964 report is restricted to those members of e staff to whose work it directly relates. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT IRAQ oS CREDITW ORTHINESS July 25,1949 Economic Department Prepared by William G. Welk TABLE OF CONTENTS I. Summary and Conclusions II. The ~ases of Repayment Capacity ••• 1 Introduction • •.•••• ... 1 ~asic Elements in the Economw • • .... 1 Land ••• 1 ~vater ... 1 Oil •• . .. 2 Current Economic Position. ... 5 General Situation. ... 5 Budget 6 Public Debt 7 Foreign Trade and Balance of Payments • •• 8 Foreign Exchange Position • • • ~ . • • •• 9 I. Sm4MARY AND CONCLUSIONS Iraq is, potential~, one of the wealthiest countries in the Middle East: it has more cultivable land than its people can till, more \'Jater than they can effectively use, and royalties from its oil resources "rhich are ex- pected to grow from a pos~flar peak of 2.5 million pounds sterling in 1947 to 20 million pounds in 1954. Although its future is promising, the countryts present economic and financial position is. however, a rather difficult one. The hasty depletion of the large foreign assets obtained during the war, the serious crop failure of 1947. and the current costly hostility toward Israel, "rhich finds expression in the closing of the oil pipeline ~o Haifa at a cost, to the people of Iraq, of $4 million in 1949 and a possible $10 million in 1950. have combined to place the Iraqi economy into a temporarily embarrassed position. Public finances are, at present., seriously strained. foreign trade is unbalanced, the general international payments position is "reak, the volume of general business is declining and., as a consequence, a lack of confidence in the immediate future appears to pervade the countryts business classes. IraqIs longer range prospects, however, are favorable. Because of them, a development loan of moderate size seems possible and advisable at this time. To ensure itssafe~y and greatest effectiveness. such a loan should, ho,",ever. be made only up to the amount to Nhich: 1) Present income from oil royalties assures availability of the local currency required for all projects for which the loan is sought,; and -2) Future oil royalty income assures repayment of the loan itself. Detailed recommendations as to the size and purpose of such a loan are made. in harmoIllf 1!1ith the principles set forth above, in the "0peratiop.al Report on a Possible Loan to Iraqllprepared by the Bank's Loan Department. II. THE BA§Jl1S OF REPAYMENT CAPACITY , • _ _~ _ d _ ) • Introduction In determining Iraq's creditworthiness. t1ftTO groups of factors must be evaluated: the basic elements upon which the long-term development of the countryls economy rests, and the factors which determine its current position. A brief analysis of both is presented be 1011' • Basic Elements in the Economy In Iraq. cultivable land is plentiful and the possibilities for further agricultural production and exports are therefore considerable. Iraq is still. predominantly, an agricultural country. Over 80 per cent of its population of less than 5 million are engaged in t:l,grieulture ...- yet only one-fifth of its total cultivable area Is, at present. under cultivation. The main obstacles to immediate development are lack of irrigation and drain~ge facilities and a threatening shortage of farm labor.lI 'Nater The full development of Iraqf s large agricultural potential depends, primarily. upon irrigation. This in turn is predicated upon the control of the countryts rivers, the Tigris and Euphrates and their tributaries. Al- though vlater is relatively abundant in Iraq, its proper use has barely begun. Destructive floods still recur every few years and irrigation,even in the fertile area betlpTeen the tltrin rivers, is less developed today than it appears to have been centuries ago~ The Iraqi Government estimates that. through its 1I Iraqi s present agricultural population is barely sufficient to "'ork the land now' under cultivation; a material expansion of the eult:lvated area would require the provision of additional farm labor through immigration or the introduction of mechanized farming on a large scale. -2- two main proposed flood control projects alone it could effect a saving of over half a million dinars ($2 million) a year, the sum nO't" spent annually. on the average. for flood control and relief measures. The third major natural resource of Iraq is oil. Since the middle 30 t s, when output increased sharply. Iraq has become a substantial oil pro- ducer. The 0.11 field at K1rkuk 1I!here the bulk of the output is obtained, is said to be the largest in the l.rorld; its current production is lim! ted only by existing transport (pipeline) capacity. At present, t1l TO 12-inch pipelines, each l.rith a capacity of 2 million tons per annum, extend from the Kirkuk field to the Mediterranean; one reaches the sea at Haifa. in Palestine, the other at Tripoli, in the Lebanon. T1Iro additional l6-inch lines. each with an annual capacity of 4 million tons. are being laid along the same routes; their completion is expected before the end of this year. A 30-inch line,l'Tith a maximum capacity of 16 million tons per annum, running from Kirkuk to Banias in Syria, is expected to be available by the end of 1953. i"Ji th these five lines in full operation, pro- duction is expected to increase from 4.7 million tons in 1947 to over 25 million in 1954 and to continue at that rate for at least 40 years before the Kirkuk field is likely to sho"'" signs of exhaustion.lI This rate of production is, moreover, unlikely to be affected by a fall in the price of oil, since production at Kirkuk takes place under very favorable conditions and at comparative~ low cost. 11 Statement to the IBRD Mission by the manager of the Kirkuk 011 fields. In addition to the product~on at Kirkuk f about 2.5 million tons per annum are expected from the IvIosul and Basrah fields; by 1954 the countryls total production should, therefore, exceed 27 million tons a year. - 3 - The production figures just quoted are, of course, based upon the assumption of full and uninterrupted operation of all available pipelines. The refusal, since May 1948, of the Iraqi Government to permit the piping of oil to the port of Haifa beca'Q.se of its un'tlrillingness Itto aid the Israeli economy through Iraqi oil" has resulted in the temporary closing of the 12- inch pipeline to Haifa and in the suspension of work on the l6-inch pipeline, "rhich had. ho"rever, been almost entirely completed. Because of the political difficulties involved, it is impossible to predict with any certainty t.rhen the piping of 011 to Haifa may be resumed; it seems unlikely, ho~,·rever, that the Iraqi Government ",ill continue to maintain its present costly attitude much beyond the coming year. As the follo",ing table sho,",s, even 1,ri th the pipelines to Haifa closed, a considerable annual income flows to the Iraqi Government from oil royalties. i'lith the reopening of Haifa, the availability of ne'l.o' pipeline facilities, and the renegotiation, at materially increased royalty rates, of the concession agreements nO\'T in force, that income is expected to be very considerably increased. Annual oil royalties accruing to the Iraqi government, now paid at the rate of 4 shillings (gold) per ton, are expected to increase (l.-rhen the Haifa line is reopened) from a post",ar peak of 2.5 million pounds sterling in 1947 to over 13 million in 1954. If, as is likely, the present royalty rate is increased from 4 to 6 shillings (gold) per ton. as a result of negotiations currently undenlay. the expected annual income to the Iraqi government \o]ill. in 1954 and the years following, exceed the sum of 20 million pounds sterling per annum. - 4- Income from Oil Royalties Expected to Flow to the Government of Irag (In million pounds sterling) At Rresent ro~a1tz rates Grand Total From Pine1ines to From production From pipelines at Year Tripoli Banias at Mosu1 and Total to Haifa Grand Increased Only (30 in. line) Basrah (if opened) Total Rates 1949 .91/ .8 1.7 .4JJ 2.1 3 •. 2 1950 2.4Y .8 3.2 2. 4Y 5~6 8.4 1951 2.7 .8 3.5 2.7 6.2 9.3 1952 2.7 1.8 4.5 2.7 7. 2 10.8 1953 2.7 2.3 5.0 2.7 7.7 11.6 1954 2.7 5.2 2.8 10.7 2.7 13.4 20.1 Sources: Based on data obtained from the Iraqi Government and checked th the Iraqi Petroleum COnlpalW. liT 1 11 l2-inch pipeline only. For Haifa estimate is from August to end of the year. 6/ 12 and 16 inch lines. -5- Current Economic Position General Situation As in most other countries significant changes ...rere caused by the t"'ar in the condition of the lra~i econo~. Currency and bank deposits increased tenfold, wholesale prices and the cost of living rose to over five times their prewar level.lI large British military expenditures permitted the accumulation of substantial pound balances in London. When the war ended. Iraqi merchants, impatient to fill the backlog of orders "'hlch had accumulated during the "rar, expanded imports rapidly, the increase resulting in a widening gap in the country-fS trade balance and in the rapid depletion of accumulated sterling credits. An unusually bad harvest in 1947 led to an embargo on food exports and to temporary but costly imports of grain. The resulting strain upon the country's finances and balance of pB¥fllents position "-'Tas intensified ,,!hen. in trs spring of 1948, active hostilities against Israel began and the pipeline to Haifa was closed, receipts from oil royalties being, as a result, cut in half. More recently, the beginning of a marked fall in the prices of Iraqi exports and a gradual decline in domestic trade -- said to be. in part. the result of a number of arrests for pro-Zionist activities among members of the Jewish commercial community and a resulting desire for extreme liquidity on the part of most of its members -- contributed to inject into business sentiment a decided note of caution. At the present moment the country is undergoing a recession in business activity. acute credit stringency and a period of gro~ring difficulty for the government to meet its current obligations. ~fuolesale prices reached a p~ak of 657 in April 1948. declining thereafter to 487 in April 1949 (1939 = lOO)~ The cost of living rose to 763 in April 1948 and declined to 559 in ~~ 1949 (1939 = 100). -6- Although certain signs of improvement, such as the excellent harvest predicted for 1949, some relaxation in anti-Jewish feeling following tre Palestine armis- tice, and the recent introduction of import controls, exist, money is still tight, sterling balances are dwindling, and a general lack of confidence is much in evidence in commercial circles. Budget Greatly increased wartime revenues and lo~rer expenditure~ mainly because of the enforced limitations on its capital "Torks program. enabled the Iraqi government to show a series of surpluses in its wartime budgets and to main- tain a balanced post Uon in 1ts accounts during the first t",o post\,rar years. As the follo1rJing table indicates, hot/rever, in the years 1947/49, large emer- gency expenditures occasioned Qy the war in Palestine, the purchase of grain during the food crisis of 1947-48, a substantial increase in cost of living allo1r,ances to government emploYees,and the partial financing of the Iraqi railways' capital "rorks projects, in addition to the loss of revenue caused Qy the closing of the Haifa pipeline, resulted in a series of serious budget deficits and in- a growing difficulty for the government to obtain the funds required for its operations. Budget Position (Balances) of the Iraqi Government (In millions of Iraqi Dinars) Years Ordinary Capital ~iorks Railroad Other Special Total Government Budget Budget Budget 1/ Budgets 2/ Budget 1946/47 f .2 - .7 - .6 -1.1 0.0 1947/48 -1.8 fl.2 -1 .. 5 f .6 -1.5 1948/49 -1.4 -1.0 -2.4 - .7 -5.5 1949/50 0.0 - .6 -2.4 -1 .. 3 -4.3 11 Includes both operating and capital works budget. Y Port of Basrab t T1;.,in Rivers :Bar Dredging Scheme, Iraqi Currency Board. Source; Prepared from data obtained by the IBRD Hission from the Iraqi Ministry of Finance. - 7 - Although an attempt is no'" being made to ease the finaneial strain through an increase in taxation and customs duties, the governmentts financial position is likely to remain diff1eult until sUbstantially increased oil royal- ties will increase its revenues or until a thorough, long overdue reform in the country1s tax system and a judicious pruning of its expenditures are carried out. Under Iraq's rather primitive tax structure no taxes at all are no"" levied on ONners of land, the ~Irealthiest class in the population, and over 40 per cent of the government's current revenues are obtained from customs duties -- ,-"hich are, obviously. bound to fall materially during a period of bUsiness recession and of declining imports. Public Debt Iraqts public debt is comparatively small and its burden on the country's economw not a material one. It consists of several domestic medium and long term 3 and 4% loans floated bet~'reen 1945 and 1949 for a total of 6 million ID and of short-term 2~ Treas~y bills for a total of 5.1 million ID.ll In addition there are: an unfunded non-interest bearing debt of about 2 million pounds sterling o~.red to the :British Government for war surplus material, against ,.rhich, hm.rever. Iraq claims an almost equivalent credit for custom duties on wartime imports and for railroad transport services rendered during the t.rar, outstanding adva..'lces of 4.2 million pouncE sterling against oil royal- ties, repayable at a rate not to exeeed ~ 900,000 per annum, and various debts owed by the Iraqi railroads to suppliers of material for their development program for a total of about 2.2 million ID.6J ID stands for II Iraqi Dinarff. the countryl s currency unit equivalent in value to one pound sterling. As the foregoing enumeration shows. Iraq has no funded external debt represented by bonds quoted on any exchange -- no external measure of its credit represented ~ such bond quotations therefore exists. ... 8- Foreigp. Trade and 13ala.n.ce. of Pa.yme.nts Iraq's foreign trade and balance of payments position during the last three years is sho1t;n by the follo1tJing figUres: Summcg:y of Iraq I. s Balance of ps;:.yments1l (In millions of Iraqi Dinars) 1246 1947 1248 P~ments Receipts P~ments Receipts Payments Receipts Imports 28.4 40.1 45.5 Exports 13.2 14.7 8.5 Net income from: Port dues. etc. 1.1 .8 .8 Emigrants & tourists 1.4 .4 .4 U.K. military expendi- tUres 2.7 2.2 2.5 lIet value of: Oil royal ties 2.2 2.2 1.7 Oil compa~ imports 2.0 4.1 8.4 Local oil comp~ expenditures 2.1 5.5 5.0 Decrease in Iraqi balances abroad 1.9 8.3 13.5 Totals ;,.....--:,. 28 . 4 26.6 - 40.1 38.2 45.9 40.4 Omitted items, adjustments, errors, etc. 1.8 2.0 5.5 28.4 28.4 40.1 40.2 45.9 45.9 11 To achieve clarity in the presentation of essentials. a number of smaller items have been omitted .. Source: Prepared from data furnished the IBRD Mission by the Iraqi government. As these figures indicate, in 1946 and the years follot.dng, a rapidly growing import surplus was financed mainly by British military expenditures in Iraq, receipts from oil royalties, imports and local expenditures by oil - 9- companies and a variety of 'invisib1es' such as port dues. tourist expenditures, etc. During 1947 and 1948, ~rhen the trade deficit had assumed unprecedented proportions, p~ment for the excess of imports was made mainly by drat-rings against the country's accumulated sterling balances abroad. Since these balances are no", quite 101.'1, it is becoming imperative for the Iraqi government to limit the country's imports and to bring the trade deficit back to manageable proportions. An apparently serious attempt to do this is current~ being made. The government's desire to restrict imports to essential commodities in order to reduce the pressure on its foreign exchange resources has resulted in September 1948 in the introduction of a stringent import license system. Since then imports have shown a declining tendency and are expected to be considerably lower throughout 1949. Iraq's leading exports on the other hand - mainly barley, Nheat and dates - are expected to increase materially as a result of the excellent crops expected during 1949. Although the prospect for the coming year thus looks encouraging. it is too early to say just what effect the measures undertaken by the government "rill actually have. Although "rell intentioned, the administrative apparatus of the Iraqi government is, on the 1"rho1e, still l,reak and at the mercy of frequent changes in government personalities and policies. Foreign Exchange Position As the discussion thus far has shown the substantial foreign exchange balances accumulated by Iraq during the t'lar were sharply reduced in post"rar years, mainly to meet the countryts growing trade deficit. Their position, since 1946, is shoilm belo\\T; (in million pounds sterling) - 10 - December 31, December 31, December 31, 1946 1947 1248 Sterling o1!rned by: Currency Board 1/ 43.0 39.0 3309 Private Banks 20.6 18.3 10.4 Government Departments 2.4 1.1 .8 Other foreign currency balances 1.3 .6 .4 Total 67.3 59.0 45.5 Reduction from previous year 8.3 13.5 1/ The Iraqi Currency Board is the agency whiOh was responsible for the issue of Iraqi currency until JUly 1, 1949. Nhen its functions were taken over by the lTationa1 Bank of Iraq. Iraqi Dinars "'ere issued against sterling cover; the backing for the Iraqi currency ,,'as, and still is, therefore, not gold, but sterling, formerly held by the Iraqi Currency Board and now by the National Bank of Iraq. Source: Prepared from data obtained by the IERTI Mission from the Iraqi Governmen t • Since Iraq is a part of the sterling area the use of her sterling balances is subject to agreement with the United Kingdom. As a result of such agreement, the use of a part of the balances shoi'Tn abotTe (about 5 million ~ at the end of 1948) is now free while the rest. still blocked at present, is to be 'unblocked' only gradually. Sterling earned. currently thl-ough exports, oil royalties. etc. may, ho",ever, be disposed of freely by the Iraqi government. As for hard currencies. all Iraqi earnings of hard currency must no,\-, be turned into the sterling area exchange pool: the amount to be placed at Iraq's di~osal by that pool being determined annually by agreement between the British and Iraqi governments. During the past year (1948/49) a larger amount ($22 million) than Iraq herself had earned and, as it turned out, than she was able to use, was made available to her. - 11- It seems reasonable to assume that so long as Iraq remains a part of the sterling area she 'l'Jill be provided "ri th hard currency in amounts at least equal to those obtained thus far, i.e. $22 million per year. If she should lea'V'e the sterling area, steps could be taken by the Iraqi Government to ob- tain from the United Kingdom Government the equivalent of the dollars accruing to the sterling pool from the sale of Iraqi all for dollars, as '\>