Iraq's budget: Growth or fiscal vulnerabilities ahead?

After months of political negotiations and four days of voting, Iraq's parliament finally endorsed the largest budget in the country's history. The draft budget law for 2023 was initially approved by the cabinet in March and was given the green light on June 12, 2023, by the legislative body.

The approved budget amounts to a staggering 198.91 trillion Iraqi dinars, equivalent to $153 billion. However, it does come with a deficit of 64.36 trillion dinars. The projected revenue from oil is estimated at 117.25 trillion dinars, while non-oil revenues account for approximately 17.3 trillion dinars. It's important to note that the budget is based on an assumed oil price of 70 US dollars per barrel and anticipates daily oil exports of 3.5 million barrels, including 400,000 from the Kurdistan Regional Government (KRG). Additionally, there is a plan to set the dinar to dollar exchange rate at 1,300.

Proponents of the budget argue that it will have a positive impact on Iraq's social safety net, including state food rations, and will allocate significant funds for critical infrastructure projects. Moreover, the budget's implementation is expected to lead to the addition of 600,000 to 1 million new public employees.

This proposed budget not only represents a significant milestone for Iraq but also signals the government's intent to maintain a similar level of expenditure in the coming years. Prime Minister Mohammed Shia' al-Sudani's administration plans to replicate this budgetary approach in 2024 and 2025, emphasizing their commitment to progress by avoiding budget debates in the next two fiscal years.

With the approval of this record-high budget, Iraq aims to address pressing social needs, enhance infrastructure development, and foster economic progress. After the adoption of the budget, the advisor to the Iraqi prime minister, Hisham al-Rikabi, said that Iraq will be going through exceptional days of development with the complete implementation of the government's program. Despite this approach, the increase in public expenditures emerges as a risk factor for Iraq.

Baghdad-Erbil relations
In April, an agreement was reached between the governments of Baghdad and Erbil granting Iraq's state-run oil marketing company, SOMO, the authority to market and export crude oil produced from fields under the control of the KRG. This agreement marked a significant turning point after the Iraqi Supreme Court's decision on nullifying the KRG's oil law, which had enabled Erbil to develop its oil sector independently.

With the acceptance of the budget articles, it has now been confirmed that the KRG will receive a share of 12.67 percent from the budget. The 13th article of the budget addresses various crucial issues, including the rate of oil exports from the KRG and the submission of non-oil revenues to the state treasury in accordance with the KRG Financial Management Law. Furthermore, the budget stipulates that sales of the KRG's oil in the domestic market will be handled by SOMO, and it prohibits the KRG from extracting oil in Kirkuk and Nineveh. Additionally, it establishes a provision for collecting all revenues from the sales of KRG oil in a designated bank account, which will be overseen by the prime minister of the KRG with monitoring by the federal government.

Under Article 14, the Iraqi prime minister has been granted a practical role in administering the KRG. This enables the prime minister to directly provide funding for salaries or address the needs of any governorate within the KRG that may be expressing concerns or engaging in protests. Beyond the financial implications of the budget, this provision signifies a broader effort by Baghdad to establish direct communication channels with officials in Sulaimani and, in return, address security concerns and negotiation of a border agreement. Thus, the budget not only reflects the official economic dimension but also facilitates a comprehensive dialogue between the two entities.

The agreement reached on oil marketing and the allocation of budget shares demonstrates a significant milestone in the relationship between Baghdad and Erbil. However, in addition to this, a new balance is expected on  the Baghdad-Sulaimani and Erbil-Sulaimani axes.

What to expect?
Prime Minister Mohammed Shia' al-Sudani's government is set to repeat the budgetary approach next year and in 2025, allowing for parliamentary voting on potential amendments. However, careful consideration is required to ensure the sustainability of Iraq's financial structure, particularly in light of increasing public spending. In this context, the financial advisor to the Iraqi prime minister, Mazhar Muhammed Salih, stresses that renewing the budget for the following fiscal years will save Iraq from a financial vacuum. However, in a scenario in which oil prices drop, Iraq may face serious implications because of the increasing budget deficit.

The new budget law introduces significant changes, including the imposition of tax registration certificate obligations on all businesses, including small enterprises, and stricter audit measures. Furthermore, new taxes have been implemented in various sectors, including electronic devices such as mobile phones. While these measures may have implications for the purchasing power of Iraqi citizens, the budget also incorporates provisions that aim to support the real economy via financial tools. For instance, debtors, including farmers with debts up to 200 million dinars, will benefit from a three-year postponement period without interest.

As public spending on salaries continues to rise, Iraq's financial structure becomes more vulnerable. The country's heavy reliance on oil revenues further compounds the challenge, as higher oil prices are necessary to sustain spending. This situation increases the risk of accumulating more debt, which can have long-term consequences for the economy. Adding to these concerns is Iraq's rapidly growing population, projected to increase from 43 million to approximately 75 million by 2050, exacerbating the strain on resources and public services.

To address these challenges and ensure a sustainable financial future, it is crucial for the Iraqi government to adopt comprehensive strategies. This may involve diversifying the economy, reducing dependence on oil revenues, and exploring alternative sources of income such as the Development Road and the al-Faw port projects. Additionally, implementing effective fiscal policies, promoting investment in non-oil sectors, and fostering entrepreneurship can help stimulate economic growth and alleviate the burden on public spending, as already 37 percent of the Iraqi labor force is enrolled in the public sector on top of an additional 3.5 million Iraqis receiving pensions.

While the current budget presents both opportunities and challenges, it serves as a reminder of the need for prudent financial management and forward-thinking economic planning. By addressing these issues head-on, Iraq can pave the way for a more resilient and prosperous future capable of meeting the needs of its growing population while fostering sustainable development.

This article was published on Rudaw on June 16, 2023, with the title  “Iraq's budget: Growth or fiscal vulnerabilities ahead?”