A reading in the fiscal and monetary policies of the IMF report – May 2024
Economy News — Baghdad
The report showed important data for the Iraqi economy during the period (2020-2023) actual and the outlook for 2024 and then the forecasts of the economic policy course during the period (2025 – 2029), and according to the data of the main table listed below, the data of SDR, inflation and crude oil production came to some extent stable, but the other data came unstable, and some of them even portend the risk to come for years, especially the fiscal policy, in which the volume of the government’s interventionist economy emerged in terms of large expenditures, specifically the salary and wages and retirement paragraphs, as well as the rise of public debt to the levels of the risk zone of (60%) of GDP.
Although oil output accounts for about 40% of real GDP, non-oil output represents only a fraction of total revenues and exports, making Iraq highly vulnerable to oil price fluctuations. Moreover, the public sector wage bill (under increasing pressure from mandatory recruitment policies) remains the highest in the region.
This challenge is exacerbated by a lack of development in the private sector, which is hampered by factors including the footprint of the large state, corruption, bureaucracy, underdeveloped infrastructure and poor access to credit. Unemployment rates remain high and levels of labor force participation are low, especially among young people and women, and despite improved domestic stability, public reforms are still lagging behind in key areas.
* The red color indicates a danger facing the Iraqi economy, yellow to relative stability, green to economic growth.
First: Economic policy discussions
Current policies significantly increase the dependence of the Iraqi economy to oil prices, and to protect macroeconomic stability and sustainability, a financial reform (adjustment) focused on controlling the wage bill and mobilizing non-oil tax revenues while protecting vital social and investment needs must be complemented by the acceleration of structural reforms to stimulate private sector development, including through labor market reforms, restructuring of state-owned banks (Al-Rasfida and Al-Rasheed in particular) and ongoing anti-corruption efforts.
Second: Financial policy
The fiscal situation is expected to deteriorate in 2024 and beyond, adding to weaknesses, and although IMF employees expect only partial implementation of the investment budget due to capacity constraints, total government spending is expected to continue to continue to increase by 3.8% of GDP in 2024, of which 3.4% is due to higher salaries and pensions (including transfers to the KRG).
Thus, the deficit is expected to rise to about 7.6% of GDP in 2024 due to high government expenditures, and in light of the weakness of non-oil revenues and the continued dependence on oil revenues, the fiscal deficit is expected to deepen further under the assumption that there are no changes in fiscal policy, which forces the government to rely on monetary financing, which means the Central Bank financing the government’s expenditures in exchange for securities (deduction of treasury transfers).
This increases government debt from 44% of GDP at the end of 2023 to more than 86% by 2029, leading to a high-term signal of risk in the medium term.
Fiscal policy reform requires a number of the following measures (mobilizing non-oil revenues and restricting current expenditures, while protecting capital investment and possibly expanding targeted social transfers). Interim yield estimates indicate that the following list of measures can provide sufficient savings:
A. The focus of any adjustment strategy should be to look for savings in the wage bill. Savings can begin by phasing out mandatory employment requirements, and this can be pursued with an attrition-based strategy to adjust the volume of government employment. Given the role of public sector employment in the Iraqi social contract and the large gaps that exist in gender employment, such measures must be gender-balanced and supported by reform in the labor market to expand employment opportunities in the private sector.
B- It must be the mobilization of additional non-oil revenues. By removing tax exemptions on profitable state institutions, reforming salary tax and reviewing customs duties in the near term. Material increases in revenues can be achieved by making salary taxes more progressive, and subjecting public sector allowances to tax, which can be as large as salaries where personal income tax is reserved from the source. A review of the tariff structure, along with the unification of customs regulations with the KRG, the imposition of new duties (e.g., on cigarettes) and sales taxes on luxury goods can also contribute to non-oil revenues. Targeted technical cooperation in tax policy can help enrich and develop the design of measures to mobilize these revenues.
Further improvements in revenue management and customs can also bring in additional revenue. Authorities should build on the remarkable progress made in the experience of the SYCUDA system by expanding its use at other border control points and controlling customs operations in line with the new system. In the medium term, a public sales tax or VAT could boost non-oil revenues.
Third: Monetary policy
The Central Bank of Iraq has resorted to using a strict monetary policy to improve the liquidity management framework, and more liquidity absorption may be needed to support the transition of monetary policy. In response to the sharp increase in excess liquidity, the central bank raised the policy interest rate from 4% to about 7.5% and reduced the funds of subsidized lending initiatives in mid-2023, however, the policy price outflow was weak due to excess liquidity and lack of market incentives in financial intermediaries, especially in government banks. Reserve requirements were also increased from 15% to 18% and the Central Bank of Iraq billing facility was submitted for 14 days.
After these measures by the monetary authority, the liquidity surplus initially decreased, but rose again in August 2023 as a result of the implementation of the general budget, which means that more measures are needed to absorb the liquidity surplus, including better coordination between fiscal and monetary policy towards achieving the goal of price stability. As fiscal policy is expansionary through the huge volume of expenditures offset by a deflationary monetary policy by raising interest to counter the excess liquidity in the economy.
Increased reserve requirements on government deposits could therefore be considered, which will help absorb excess liquidity in government banks without damaging private banks.
Regulating and securing correspondent bank relations is also critical to ensuring an easy transition to the new trade finance system. The authorities must intensify efforts to modernize the banking sector to facilitate the establishment of correspondent banking relationships. Trade finance before 2023 was done in a financial reinforcement manner, but after the introduction of the compliance platform, trade finance changed and the Central Bank of Iraq previously financed dollar accounts abroad for local commercial banks that have correspondent banking relations with Bank Citi Trade Finance. This allowed an increase in the share of cross-border payments settled through commercial banks.
The Central Bank of Iraq plans at the beginning of 2025 to fully transition to a supervisory role in the settlement of cross-border payments (import financing) and to facilitate this transformation, the Central Bank of Iraq has helped private banks in securing correspondence-banking relationships, including providing guidance on the accreditation and evaluation of banks in line with international best practices. As of the writing, (6) banks have established correspondent relations with US banks, and many others have correspondent banking relations with non-US banks. Strengthening these efforts is essential to ensure a successful transition to the new trade finance system.
In addition, monetary policy has made an important breakthrough in expanding the scope of digital payments, as several measures have been taken to promote digital payments, including expanding the use of point-of-sale devices and requiring the use of electronic payment cards in certain transactions such as the purchase of fuel, lifting transaction ceilings at ATMs and bank cards and reducing bank fees. These efforts are welcome and will help reduce Iraq’s dependence on cash and improve financial inclusion, especially for women whose access to financial services may be restricted due to limited movement and other obstacles.
Monetary policy also integrated the banking sector, as the central bank made the decision to increase the minimum bank capital requirements from 250 billion to 400 billion Iraqi dinars. Banks (many of which are small in size) must either pump more capital or submit a merger and acquisition plan by the beginning of 2025, and careful planning and public communication will be critical to achieving the reform goal of improving the efficiency and competitiveness of the private banking sector without creating uncertainty about the viability of banks.
However, the implementation of basic banking systems, the issuance of previous financial statement certificates and the amendment of regulations to strengthen the governance of state banks remain weak, and the slowness in making progress in reforming those government banks is hampered by the effective allocation of credit and the transfer of monetary policy.
Authorities should continue to strengthen the AML/CFTF and its effectiveness including in the banking sector
. These efforts should be guided by the priority actions emanating from the MENA Financial Action Task Force (MENAFATF) Mutual Assessment that will end in the third quarter of 2024, once key areas have been identified for further improvements, seeking further targeted technical assistance could help support these efforts.
No comments:
Post a Comment