Country Report December 2002

Iraq Iraq at a glance: 2003-04

OVERVIEW A military invasion by US and UK forces, leading to the demise of the regime of President Saddam Hussein, is highly likely to begin before the end of 2003, and probably before May. The US’s desire to maintain international support for such an operation, and the time required to be able to move sufficient military assets in theatre, are likely to ensure that the inspection process continues through to next year. However, Iraq’s ability to conceal some weapons of mass destruction (WMD) capability, and given the exacting standards of co-operation required by the latest UN resolution, make it likely that the process will be interrupted. This will probably occur within the first few months of 2003, when the UN, or failing this the US and the UK, will conclude that Iraq is in material breach of its commitments and that military action is needed. Until the regime is replaced and complete WMD disarmament secured, sanctions will continue to constrain the economy. The UN’s retroactive oil pricing policy and war fears are likely to ensure that oil production, and therefore real GDP, will be down in 2003 compared with 2002. However, by the second half of 2004 the likely end of sanctions and strengthening oil production should lift real GDP growth to around 15%.

Key changes from last month Political outlook • Iraq is likely to make a declaration of its WMD capabilities under UN Security Council Resolution 1441, but is unlikely to fully co-operate with the first UN weapons inspections for four years. Economic policy outlook • Iraq continues to try to maximise its legal oil exports under the UN’s oil-for- food scheme and will continue to oppose the UN’s retrospective pricing scheme, which deters some oil lifters. Iraq’s illicit oil trade continues, despite fluctuations in sales in the Gulf owing to successful maritime interdiction. Economic forecast • The Economist Intelligence Unit has amended its forecast for real GDP growth in 2003, and now expects it to contract by 1.5%, as war fears on the part of lifters and the war itself are likely to reduce production from 2002 levels. By 2004 an end to sanctions and the beginning of renewed invest- ment should see growth recover to around 15%. December 2002

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Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 5 Quarterly indicators

6 Outlook for 2003-04 6 Political outlook 7 Economic policy outlook 8 Economic forecast

11 The political scene

26 Economic policy

28 The domestic economy 28 Economic trends 31 Oil and gas

33 Foreign trade and payments

List of tables 8 International assumptions summary 11 Forecast summary 32 Oil production

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Iraq 3

Summary December 2002

Outlook for 2003-04 There is a strong chance that the regime of President Saddam Hussein will be overthrown in a US-led military campaign by end-2003. Once the regime of Mr Hussein has been removed it is likely that UN sanctions will be lifted quite quickly, and Iraq can look forward to substantial aid and investment once a new regime is installed. However, the military campaign may not happen until the second half of next year, and it will take a number of months for foreign investment to invigorate the economy. Therefore, the Economist Intelligence Unit’s forecast for real GDP in 2003 is a contraction of 1.5%, following the estimated fall of 3% this year. In both instances this reflects falls in expected oil production. However, we expect a substantial recovery in 2004 as reconstruction, foreign investment and aid flows start to revive the economy.

The political scene The passing of UN Security Council Resolution (UNSCR) 1441 has begun both the process of UN weapons inspections in Iraq and, if their work is frustrated, the countdown to war. Iraq is expected to make some declaration of residual weapons of mass destruction (WMD) capabilities to forestall any imminent prospect of invasion by US-led forces. However, the thoroughness of the in- spection process demanded by the UN resolution, and the expected impatience of the US with any prevarication on the part of the Iraqi authorities, is likely to lead to war. Iraq will continue to hope that the discomfort of the US’s Arab allies will complicate the military and political preparations by the US and the UK. However, Iraq has few regional cards left to play, especially now that Syria, the only Arab member of the UN Security Council, has effectively delivered the Arab governments’ acquiescence in war if inspections fail by voting for UNSCR 1441. While wanting to retain some residual WMD capability in the event of war, Iraq will also hope that the maintenance of loyalty among its elite military forces will undermine the US/UK war effort, and that the deception of its elite intelligence agencies will complicate the work of the inspectors without precipitating armed conflict.

Economic policy Iraq’s legal oil earnings continue to fluctuate as the UN’s retroactive pricing policy deters some lifters. The Central Bank has introduced a ID10,000 note. The illegal surcharge previously extracted by the regime from oil lifters has ended.

The domestic economy Despite the recovery in official oil earnings, the oil-for-food escrow account has a US$3bn shortfall to fund key purchases. Significant boosts to oil production are unlikely until at least the second half of 2004 owing to the shortage of spare parts.

Foreign trade and payments Saudi Arabia continues to prevaricate over prospects of strengthening trade with Iraq via a planned trading post, while Iran’s poor trading relations with Iraq have not prevented a showpiece agreement being forged. Editors: Neil Partrick (editor); Hania Farhan (consulting editor) Editorial closing date: November 21st 2002 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Republic of Iraq

Form of state Arab socialist republic based on provisional constitution of 1968

Legislature National Assembly of 250 members, elected from 56 constituencies; last election March 27th 2000

Head of state President, currently Saddam Hussein, elected by the Revolutionary Command Council (RCC), the highest national authority. The vice-president is Taha Yasin Ramadan

Executive Cabinet chosen by the president, who regularly replaces individual ministers. Last reshuffle: April 18th 2001

Main political parties Arab Baath Socialist Party; Democratic Party of Kurdistan; Kurdistan Revolutionary Party. Opposition parties (illegal): Supreme Council for the Islamic Revolution in Iraq (SCIRI), comprising six Shia parties; seven Kurdish parties, including the Kurdish Democratic Party (KDP) and the Patriotic Union of Kurdistan (PUK); Iraqi Communist Party; Democratic Gathering; Iraqi Socialist Party; independent nationals

Prime minister Saddam Hussein Deputy prime ministers Tari q Aziz Mohammed Hamza al-Zubaidi Hikmat al-Azzawi

Ministers Agriculture Abdullah Mohammed Saleh Culture Hamed Yousif Hammadi Defence General Sultan Hashim Ahmed Education Fahad Salim al-Shaqra Finance Hikmat al-Azzawi Foreign affairs Naji Sabri al-Hadithi Health Umid Midhat Mubarak Higher education & scientific research Himam Abdel-Khaliq Abdel-Ghafur Housing & reconstruction Maan Abdullah Sarsam Industry & minerals Adnan Abdel-Majid Jasim Information Mohammed Said Kazem al-Sahhaf Interior Mohammed Zimam Abdel-Razzaq Irrigation Mahmoud Diyab al-Ahmed Justice Munther Ibrahim al-Shawi Labour & social affairs Shabib Lazem al-Malki (acting) Military affairs General Abdel-Jabbar Khalil Shanshal Oil Amir Mohammed Rashid Trade Mohammed Mahdi Saleh Transport & telecommunications Ahmed Murtada Ahmed Khalil

Speaker of the National Assembly Saadoun Hammadi

Central Bank governor Isam Rashid Huwaish

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Economic structure Annual indicators 1998a 1999a 2000a 2001a 2002a GDP (US$ bn) 18.1 23.7 31.8 27.9 25.8 Real GDP growth (%) 35.0 18.0 4.0 -6.0 -3.0 Consumer price inflation (av; %) 90.0 80.0 70.0 60.0 70.0 Population (m) 21.8bc 22.3 22.9 23.6 24.2 Exports of goods fob (US$ m) 7,416.6 12,749.7 20,603.1 15,905.1 12,997.2 Imports of goods fob (US$ m) 3,990.8 6,886.0 11,153.1 11,000.0 7,802.3 Current-account balance (US$ m) 1,168.3 2,017.5 3,269.5 1,031.4 2,254.5 Total external debt (US$ bn) 56.1 58.0 60.1 62.2 63.4 Debt-service ratio, paid (%) 0.0b 0.0b 0.0b 0.0b 0.0 Exchange rate (av) ID:US$ 0.311b 0.311b 0.311b 0.311b 0.311 November 21st 2002 ID2,000:US$1

Main destinations of exports 2001d % of total Main origins of imports 2001d % of total US 60.6 France 19.4 France 8.5 Australia 14.4 Netherlands 7.4 Italy 10.7 Italy 5.8 Germany 9.9 a Economist Intelligence Unit estimates. b Actual. c Iraqi government census. d Derived from partners' trade returns; subject to a wide margin of error.

Quarterly indicators 2000 2001 2002 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Sectoral trends Crude oil production (m barrels/day)a 2.40 2.18 2.23 2.49 2.53 2.38 1.54 1.75 Crude oil spot prices, Kirkuk-37 (US$/barrel) 26.21 22.30 24.05 23.19 17.87 19.10 22.76 25.10 Foreign trade (US$ m)b Exports fob 4,008 2,065 3,300 2,644 3,078 2,210 2,154 n/a Imports fob -1,098 -1,024 -1,246 -1,106 -1,372 -1,132 -1,294 n/a Trade balance 2,910 1,041 2,054 1,538 1,706 1,078 860 n/a Exchange rate ID:US$ (end-period) 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 ID:US$ (av) 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 0.3109 a Estimates. b DOTS estimates. Sources: IEA, Monthly Oil Market Report; Oil Market Intelligence; IMF, International Financial Statistics; IMF, Direction of Trade Statistics.

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Outlook for 2003-04 Political outlook

Domestic politics The Economist Intelligence Unit believes there is a high likelihood that a US-led land-based military assault on Iraq will take place by end-2003, with the campaign most likely to start before May. For all its experience and ruthlessness, the regime would not survive such an attack, and any resistance by Iraq’s elite military units could only delay its collapse for a matter of weeks. In the meantime, Iraq will continue to consolidate its internal security measures around and within: the capital, Baghdad; the regime’s tribal base, the north- western city of Tikrit; and the northern part-Kurdish cities of Mosul and Kirkuk. Further superficial efforts to present itself as open to political reform can also be expected, including the encouragement of exiled groups to play an ostensible role in the political process. However, we expect that such steps will before long become irrelevant as the US remains committed to using military force, including US ground troops, to overthrow the regime of the Iraqi president, Saddam Hussein. The US will seek to build international support for such action by continuing to work with the UN, but will not constrain its military options, a position endorsed by a recent vote of the US House of Representatives. The latest UN Security Council (UNSC) resolution on Iraq (1441) led to the beginning of weapons inspections in late November. If Iraq fails to acknowledge at least the remains of a weapons of mass destruction (WMD) programme by the deadline of December 8th, or frustrates the work of the inspectors (the UN Monitoring Observation Verification and Inspection Commission—UNMOVIC) in a substantial manner, then this will constitute a further material breach of its commitments under this and previous UN resolutions. The US and the UK would then declare that Iraq, under the terms of the new resolution, had been given its “final opportunity” to comply with its obligation to co-operate with the disarmament of its WMD, and there is no alternative but to take military action. Under the terms of this resolution, there would be little basis for other permanent five (P5) members of the UN Security Council to object to military action. France, Russia and China, which along with the US and the UK are members of the P5, are unlikely to veto military action against Iraq at the UN, providing that weapons inspections have been properly attempted. Serious frustration of the inspections, withholding of information, or evidence that WMD are being developed, would lead to further Security Council discussion of Iraq’s prospec- tive “material breach” and possibly another UN resolution specifically authorising military action. With or without a second resolution, the US would lead what would become (unless a member of the P5 vetoed it) UN military action. This would take place with UK and some other Western states’ involvement, as well the provision of military facilities by two or three Gulf Arab states. Some co-operation with UNMOVIC can be expected from Iraq. However, the exacting standards of a greatly empowered UN inspection regime, assisted by external intelligence, or failing this a US conviction that the

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inspectors are being deceived, make it unlikely that military conflict can be prevented. The time taken before UN arms inspectors can comprehensively conduct their work in Iraq, in part related to Iraq’s scheduled declaration of its WMD by December 8th, makes military action before the first few months of 2003 unlikely. Our expectation is that a possible war in 2003 will begin before May. This is based on the assessment that the Iraqi regime will not fully disclose its residual WMD capabilities, nor wholly co-operate with the inspectors, given that it assumes that the US is intent on overthrowing it, regardless of progress in the work of the inspectors who could also provide the US and the UK with key targeting information. However, if there are no problems before UNMOVIC is due to report back to the UNSC by January 27th, then the possible timeline for war may slip. Furthermore, given that the US may decide to expand the current projected build-up of men and materiel, to a potential 250,000 troops and an expanded array of heavy armour and aircraft carriers beyond those due in the Gulf at end-December, then war could be set back to the second half of the year. Either way, the regime is likely to have been overthrown before the end of next year. A military campaign is not without risks for the US. An Iraqi regime with nothing to lose might decide to launch a missile with a chemical or biological warhead at US forces or towards Israel. Furthermore, the aftermath of the over- throw of the Iraqi regime could also see bloodshed along ethnic and religious lines. However, these considerations are unlikely to deflect the US from its goal of regime change in Iraq.

International relations In the face of US determination to be rid of Mr Hussein’s regime, Iraq will continue to try to improve its regional and international position. However, given US efforts to build international support in advance of military action, the US’s regional allies will not oppose outright military action that has UN approval. For example, Saudi Arabia is likely to make its air bases available in the event of a UN resolution “authorising force” against Iraq, despite its own foreboding at the prospect of war. Following the fall of Mr Hussein, Iraq can be expected to enjoy aid and debt relief from the wealthier Gulf Arab states and the international community.

Economic policy outlook

Policy trends While Mr Hussein remains in power, UN sanctions will stay in force. These allow Iraq to export oil (priced retroactively) in return for regulated imports of humanitarian goods (the oil-for-food programme). Within this programme, the regime has little choice but to continue to distribute imported goods in what is a highly centralised command economy. Iraq’s economic policy will remain focused on bypassing UN sanctions and maximising sources of export revenue that flow directly to the regime. The US and the UK are the main proponents of the UN’s retroactive pricing policy for Iraqi oil. This was enforced to counteract an illegal Iraqi surtax, the recent abandonment of which by Iraq has boosted sales. Despite this, Iraqi oil

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sales remain vulnerable to fluctuation, given the impact of the pricing scheme and war fears on lifters. Despite initial UNSC wrangles in late November over an extension of the list of banned items, the latest phase (XIII) of the oil-for-food programme will probably be extended for the next six months. However, Iraq is likely to continue smuggling heavily discounted oil to neighbouring states. It can be expected that any military campaign would stop Iraqi oil production or severely reduce it from its already low levels for the duration of the conflict. Once a military campaign is over, a recovery in oil production and investment in the energy sector should begin. By 2004 we expect UN sanctions on civilian goods to have been lifted. The UN will remain closely involved in Iraq’s economic affairs, however. Its immediate priority, and that of the post-sanctions Iraqi government, will be to remedy humanitarian problems and to accelerate the process of infrastructural recon- struction and the regeneration of the oil sector.

Fiscal policy Direct taxation has never been a preferred means of raising revenue in Iraq, in part because of the difficulty of assessing and raising taxes in an economy dominated by family-owned businesses, and also because the country has been under economic sanctions or at war for more than 20 years. In the absence of a real taxation system, the state’s main source of revenue will remain oil exports. Even in a post-sanctions context, it is unlikely that a new Iraqi government would be able to impose an effective tax administration for several years.

Monetary policy The government has persistently monetised its fiscal deficits for over a decade, thereby fuelling monetary growth. Furthermore, it cannot operate an effective monetary policy since there is little confidence in the banking sector. With little bank lending, interest rate movements, for example, are unable to influence the supply of money to the economy. Public confidence in the banking system will take a while to be restored following the removal of Mr Hussein’s regime, given that there would need to be a lengthy period of recapitalising and rehabilitation of Iraq’s banks.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2001 2002 2003 2004 Real GDP growth World 2.0 2.7 3.3 3.9 US 0.3 2.3 2.3 3.3 EU 1.4 0.9 1.6 2.2 Exchange rates ¥:US$ 121.5 125.5 128.8 130.5 US$:€ 0.896 0.948 1.070 1.053 SDR:US$ 0.785 0.771 0.737 0.744 Financial indicators ¥ 2-month private bill rate 0.17 0.10 0.10 0.35 US$ 3-month commercial paper rate 3.61 1.68 1.26 3.08

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Commodity prices Oil (Brent; US$/b) 24.5 24.9 24.5 19.1 Total non-oil commodities (% change in US$ terms) -5.2 9.2 11.4 3.6 Food, feedstuffs & beverages (% change in US$ terms) -1.9 15.4 14.5 0.2 Industrial raw materials (% change in US$ terms) -9.8 0.2 6.1 9.7 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. As a result of our expectation of extremely weak economic growth in the US in the fourth quarter of this year, we have further amended downwards our forecast for world growth in 2002-03, and now estimate that GDP (at market exchange rates) will this year increase by 1.8% (from our previous estimate in September of 2%). As the upturn is expected to be slow in 2003, global real GDP is expected to rise by 2.4% (down from our previous estimate of 3%). By 2004 the pace of growth should be above trend, increasing by a further 3%. (In purchasing power parity exchange-rate terms, these growth rates translate to 2.7%, 3.3% and 3.9% respectively). The most important element of the international economy for Iraq is the impact on oil demand and prices. There has been a decline in the size of the political risk premium in the oil price owing to the likelihood of UN inspections fore- stalling war. This has led us to adjust our estimate of the price of benchmark dated Brent Blend crude this year slightly downwards, to an average of US$24.9/barrel (from US$25/b in our last quarterly report). Oil production levels should increase in 2003 as the international economic recovery becomes more pronounced in the second half of the year, but with the threat of war keeping oil prices relatively strong, we forecast that the average price of Brent will be US$24.5/b. This is up from the estimate of US$22.9/b in our last report, as war fears are expected to prolong the price premium for the first few months of next year. By 2004 oil production is expected to increase further, with the result that we forecast that the price of dated Brent Blend in 2004 will fall to US$19.1/b.

Economic growth The absence of economic data for much of the past two decades makes it impossible to accurately assess Iraqi GDP. However, with oil accounting for most of Iraq’s output, and oil revenue continuing to determine levels of public and private consumption, it may be assumed that Iraqi real GDP growth will broadly track the changes in the country’s oil production. Iraqi oil production is expected to average around 1.97m barrels/day this year, representing a 16% fall on 2001, principally because of the UN’s retrospective pricing policy. As a result, we estimate that Iraqi real GDP will contract by around 3% in 2002. We have revised our forecast for real GDP in 2003, and now expect that the impact of war fears on Iraqi oil sales, as well as an expected invasion, will see the economy contract by around 1.5%. However, if the war proves relatively short-lived, a post-attack recovery should begin soon thereafter, and in 2004 real GDP growth should be around 15%, in line with an expected increase in oil production.

Inflation The recently revised sanctions regime is releasing contracts, but the backlog of old contracts remains high and the new procedures will ease, not eliminate, current shortages. As a result, price inflation to likely to fall to an average of

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around 60% in 2003, from an estimated 70% in 2002. Even if the military conflict in 2003 is of relatively short duration, it would take months before supply shortages could be permanently ameliorated, and therefore before consumer price inflation would ease more significantly. In 2004 the expected lifting of UN sanctions and sizeable increase in imports will ease domestic shortages, thereby reducing inflation.

Exchange rates For as long as the present regime is in power the official exchange rate will remain at ID0.311:US$1, although at over 5,000 times the current black-market rate of around ID2,000:US$1, it bears no relation to the currency’s true market value. Significant change to the exchange-rate regime is unlikely while sanctions are in place, as the UN restrictions hold Iraq’s legal foreign-currency earnings in an external escrow account. The currency is likely to continue to come under pressure in 2003 as expectations of military conflict cause Iraqis to hold US dollars, rather than dinars, wherever possible. The increasing likelihood of a US- led military campaign should weaken the dinar from an estimated average this year of ID2,000:US$1, to a forecast average of ID2,300:US$1. With the economy expected to begin to recover in 2004, it is likely that the dinar will strengthen. If a new regime is in place the rehabilitation of the banking system should begin, and the exchange rate may be revalued to better reflect market conditions.

External sector The UN oil-for-food scheme deducts 28% of Iraq’s official oil export revenue for compensation and other payments. As a result of this, together with holds and other bottlenecks in the import process, the UN sanctions regime has created a structural trade surplus. Iraq’s illicit trade is substantial, but does not undermine this overall surplus: illicit imports and exports should continue to almost balance each other out. Oil export volumes should show a slight recovery in the second half of next year from the sharp fall seen in 2002. However, in the meantime oil lifters will remain cautious as a result of fears of an imminent war against Iraq. The expected decline in the price of oil next year will see a small fall in the current-account surplus. As a result, we estimate that legal and illicit trade will generate a trade surplus of US$4.5bn in 2003. As long as sanctions remain in place, Iraqi import spending will be restricted, while the balance of export revenues, counted as current transfer debits, will finance payments to the UN Compensation Fund and other UN-related costs. It is worth noting that if a US-led attack on Iraq occurs in the first half of 2003—as looks likely—both exports and imports, and therefore the current-account balance, will be substantially affected. The extent of this effect will depend on the duration of the conflict. The current account is forecast to record a surplus of just under US$2bn in 2003, and if sanctions are lifted in 2004 the trade surplus will decline as the boost in exports will be offset by a jump in both capital and consumer goods imports. With negotiations between Iraq, Kuwait and the UN about the future of the compensation arrangements likely to be protracted in the event of a regime change, we have assumed that the present trend of net current transfers out of Iraq will continue.

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Forecast summary (% unless otherwise indicated) 2001a 2002a 2003b 2004b Real GDP growth -6.0c -3.0 -1.5 15.0 Consumer price inflation (av) 60.0 70.0 60.0 35.0 Oil production ('000 b/d; av) 2,355c 1,973c 1,746 2,625 Exports of goods fob (US$ bn) 15.9 13.0 11.3 13.4 Imports of goods fob (US$ bn) 11.0 7.8 6.8 11.3 Current-account balance (US$ bn) 1.0 2.3 2.0 -0.9 Current-account balance (% of GDP) 3.7 8.7 7.9 -3.1 External debt (year-end; US$ bn)d 62.2 63.4 64.7 66.0 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual. d Estimates of Iraqi debt are extremely dubious. Press reports have indicated figures both higher and lower than Economist Intelligence Unit estimates. The political scene

Threat of US military strike The threat of a US military invasion of Iraq, aimed at removing the regime of continues to dominate President Saddam Hussein, has increased over the past quarter. This threat has continued to inform the regime’s domestic, regional and international manoeuv- rings. At home, the regime has continued to deploy its military forces in line with shifting perceptions of its most obvious military weakspots. However, in a more notable policy shift, the regime has also made a number of political and humanitarian gestures in order to boost the impression, largely for external consumption, of regime popularity and stability. The latter tactic appears aimed at reinforcing domestic loyalty to the regime, while simultaneously demon- strating the regime’s “legitimacy” to the outside world.

An amnesty is announced The government has also been making overtures to the wider population. The most notable gesture came on October 20th when a radio announcement by the information minister, Mohammed Saeed Kazam al-Sahhaf, declared that all prisoners in the country were to be released (excepting murderers and debtors, who would require the express permission from the families of their victims or their creditors in order to be released, and “spies”, a term which can include political prisoners). Mr Sahhaf added that an amnesty was to be extended to all opponents of the regime both inside and outside Iraq. At Iraq’s largest prison, Abu Ghraib, west of Baghdad, there was a stampede of inmates as the gates were finally thrown open. Officials declined to say how many prisoners had been released, but it is estimated that Abu Ghraib alone held 13,000 inmates. In the chaos that marked the amnesty’s announcement, it is possible that a number of political prisoners will have made their escape. This is a marked change of tactic from the government’s previous effort to empty the country’s prisons, which were becoming dangerously overcrowded in 2000. At that time Mr Hussein’s younger son, Qusai, resolved the problem by having thousands of prisoners shot. This impression of a loosening of the structure of control exercised by the Iraqi regime ostensibly allows political opposition to grow in the country once again. Periodically in the last few years it has been suggested by senior officials, including Qusai, that political exiles could return and a flowering of political

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parties, albeit those judged suitably patriotic, could occur. This has been reaffirmed recently in the context of apparently ending the crime of belonging to opposition political parties. This is not the first time that the Iraqi regime has toyed with the idea of presenting a more pluralistic face for both domestic and international consumption, and this has tended to occur at times when the gov- ernment feels under either internal and/or external pressure. Following the end of the first Gulf war (1980-88), despite the spoils of apparent victory, the regime was conscious of the potential damage that could be caused by economic hardship, a relatively assertive military, and tensions among its narrow clan- based power structure. As a result, elections were held to the National Assembly (parliament) in an atmosphere of supposed greater openness, when a number of non-Baath Party members were chosen and elected to the parliament. This proceeded in tandem with more substantive moves toward economic liberal- isation, which were, however, heavily geared toward individuals with close links to the regime.

Presidential referendum has October’s amnesty was ostensibly a “thank you” from Mr Hussein for the traditional feel results of that month’s presidential referendum (although some shop-owners in Baghdad were reported to be less than happy about a gift that saw the release of thousands of convicted felons back on to the streets of the capital). The referendum gave the president, the only candidate, a 100% victory, giving public approval for the principle that his rule should be extended by a further seven years, after a less absolute success in 1995 when he scored 99.6%. This was not an election in the conventional sense, being more like a bey’a, or “affirmation of allegiance to the ruler”, claimed for leaders of more traditional Arab regimes such as Saudi Arabia. According to the Iraqi vice-president, Taha Yassin Ramadan, who was speaking on Iraqi satellite TV, “The people did not declare their allegiance and their support for an election programme that the president had promised to implement if he won.” Mr Ramadan added that the president’s programme had already been tested over 34 years. The turnout in October was also 100%, according to the authorities. While the latter figure is undoubtedly exaggerated, it seems likely that virtually all of those who did vote would have voted for Mr Hussein. In a country where the concept of a “secret” ballot is merely nominal, fear means that few would run the risk of spoiling their ballot paper in protest against his rule.

Both events intended as The amnesty and the absoluteness of the outcome of the referendum were seen message to outside world by the regime’s detractors as attempts to present itself in a better light, and in the process to blunt US and UK criticisms. In fact, the referendum had long been scheduled, as the last poll in 1995 had conferred on Mr Saddam a seven-year approval. The turnout figure, however, stood apart, even in a region noted for manipulation of elections. Both events were presented by the government as demonstrating the connection between the government and the people, and thereby underlining the legitimacy of the former. It was also intended to serve as a warning to would-be invaders that the Iraqi people would fight to defend the regime from outside attack.

Some Iraqis might fight; most The basis of the regime, in common with its predecessors since the foundation will take cover of Iraq in 1921, is a combination of patronage and strong, interdependent—if

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periodically mistrusting—relations with the military. However, having success- fully secured the monopoly of violence, the feature of any stable state, the president’s regime has proven the Iraqi exception in the extent to which it is willing to use violence to preserve control. Any element of Baathist ideological legitimacy has long since been lost. Despite this, some Iraqis may well fight to defend the country. For those who are intimately connected to the regime, this may be the only option. Such potential fighters include: senior and well-known members of the Special Republican Guard; elements of the 18,000-20,000-strong militia, Saddam’s Fedayeen; and the armed sections of key intelligence units, such as Jihaz Amn al-Kusour, which guards Saddam Hussein. In a “post-Saddam Hussein” environment they would be unlikely to escape retribution from Iraqis, or prosecution by the new authorities. Nevertheless, the other option, to flee— possibly over neighbouring borders—may be the more attractive, and realistic option. As for the population at large, many are longing for the end of the regime, but this does not equate to an open embrace of the US. Many Iraqis have bitter memories of the post-Gulf war rebellion in 1991 when the US appeared to encourage open revolt, but then failed to provide any material support. Prior to the 1991 conflict, the regime made gestures of reconciliation towards sections of its population, only to exact brutal revenge against large sections of the mainly Shia Muslim south when the rebellion failed. Consequently, this time around most Iraqis will probably retreat to their homes and wait for the fighting to stop.

Regime focuses on Baghdad According to opposition reports—none of which can be independently confirmed—the regime has deployed some of its elite Republican Guard units to the west of Baghdad in the expectation that a US military assault may be partly directed from Jordan, through the Iraqi western desert area of al-Anbar province and southern Ninevah. According to the Internet news service, Iraq Press, in early October Republican Guard units, including tanks and armoured personnel carriers, were digging in around a major airfield close to Ramadi, the last major city west of Baghdad. Reports in the summer indicated that units of the 15,000-20,000-strong Jihaz al-Amn al-Khass, controlled by Qusai, had put a cordon around Baghdad. This reinforces the impression that the regime has decided to concentrate its resources in protecting the capital and the surrounding so-called central Sunni heartland, which is in fact significantly populated by Shia in the environs of Baghdad. Other reports indicated that the regime was still reinforcing its positions in the north of the country, around Mosul and Kirkuk. In these two cities units of the elite Special Republican Guard were engaging in urban warfare exercises. However, sources speculated that the fact that the exercises involved Special Republican Guard soldiers storming houses, rather than defending them, suggested that the intention was offensive and was aimed principally at intimidating a restless population.

An army purge is reported Further reports from the Damascus office of an Iraqi Shia Arab opposition group, al-Dawa, suggest that the regime is worried about the loyalty of officers in the 10th Armoured Brigade. The 10th Armoured Brigade is in a class apart from the regular armed forces, whose loyalty is normally suspect in the eyes of the regime. The 10th brigade played a key part in the coup that brought the Baath

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Party to power in 1968, when it was led by a senior Tikriti general. Opposition reports in early October suggest that a number of very senior officers, including generals, were purged by members of Jihaz al-Amn al-Khass following reports of defections. In addition, arrests of officers in the 3rd and 10th Divisions were reported in September. While no doubt exaggerated, it may be that some officers were purged. However, given that the nature of Saddam Hussein’s rule is to have a regular “turnover” of personnel, this does not indicate that the regime is, as yet, as brittle as opposition sources would suggest.

Exiled opposition’s military The opposition in exile continues to be divided, despite the seeming ongoing role in doubt willingness of the Pentagon to support the most publicised Iraqi opposition group, the Iraqi National Congress (INC). In October it was announced that, despite long-standing US State Department reservations, up to 10,000 INC volun- teers would receive training as scouts to assist the targeting of US aerial forces in the course of a military campaign. However, this initiative seems to have failed to get off the ground, in part because the Pentagon-commissioned INC intelligence gathering role became public knowledge.

US administration seeks to There has been considerable internal US administration division over the INC unite the opposition and whether the exiled and other recognised opposition forces should play a role, whether military, political or both, in changing the regime and in any post- regime government. The US Department of Defence under the administration of the current US president, George W Bush, gives the INC a far better hearing than it has enjoyed from the State Department. However, it appears that the US administration is finding it politically advantageous for an opposition conference (and for itself) to present a united front. As a result, State Department, Pentagon and National Security Council representatives arrived in London in mid- November to meet with a cross-section of Iraqi opposition representatives and to persuade them to hold a conference in the British capital as soon as possible, provided wrangles over who participates can be resolved. Talks were held with the INC and other opposition groupings, including the Shi’ite opposition organisation, the Supreme Council for Islamic Revolution in Iraq (SCIRI). As we went to press, the conference looked likely to go ahead in the next few weeks, and probably in the UK.

Opposition fractious over SCIRI are part of a loose and rival grouping known colloquially as the “Group united conference of Four” (June 2002, page 13). Divisions between these two blocks had pre- viously led to the opposition conference, which had been scheduled to take place in Belgium from September, to be indefinitely postponed. SCIRI had apparently been demanding that Shia Islamists be given 35% representation among the delegates at an event designed to draw up a pluralistic blueprint for the future of Iraq after Saddam Hussein. Although this is far less than the 60-65% (according to the CIA’s World Facts Book 2002) that Iraqi Shia represent as a proportion of the total population, it would as likely make SCIRI the leading political faction at the conference, when nationally it is unlikely to enjoy anything like that level of support. The leader of the INC, Ahmed Chalabi, has long been opposed by the State Department, who have doubts about his personal probity and credibility, and

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strategically have preferred to back opposition military groupings. The Group of Four includes one such organisation, as well as, from the US perspective, having the presentational benefit of including the two main Kurdish groups and SCIRI. However, the Group of Four also remains internally divided, despite seemingly now uniting against the INC. Kurdish proposals that oil-rich Kirkuk be included in a federally autonomous province of Iraqi Kurdistan have upset SCIRI, which, despite its traditional links with the revolutionary Islamic model prescribed by Iran, is presenting itself as an alternative Iraqi national leadership with appeal to non-Shia as well as relatively secular Iraqis. INC efforts to persuade either the US or the Group of Four to back the idea of an opposition conference uniting behind a declared government-in-exile appear to have floundered, an indication that opposition conferences may be a long way removed from events on the ground in Iraq over the next few months, and of the flexibility that the US wants over how the political process will play out after the end of Saddam Hussein’s regime. The conference would, however, aim to agree principles for the future governing structure of the country, although, given INC opposition to federalism, and Group of Four disputes about what it should mean in practice in Iraq, it may only be possible to agree broad outlines at best.

Future uncertain after the fall In September the US State Department organised an ostensibly confidential of Saddam Hussein discussion on the “Future of Iraq”, in which subjects such as the political order, the legal system, and oil policy were discussed among a carefully selected group of opposition figures, and largely US academics. While reportedly involving interesting exercises in role playing, such discussions do not provide clear indications of the nature or priorities of the next government in Iraq, or how the US may wish to influence it. It is noteworthy that a number of State Department officials have recently been emphasising that political developments after the fall of the regime would be “for Iraqis to decide”, suggesting those in positions of power on the ground after the dust settles. Furthermore, US officials have recently been making clear that the emphasis in Iraq would be ensuring the rule of law, and that elections, which could in theory produce an Islamist govern- ment, would not be the priority.

Regional relations are Until the early November passage of UN Security Council Resolution 1441, Iraq superficially good appeared to be enjoying some modest successes in its regional relations over the past few months. In truth, however, Iraq did not have to do very much; Middle Eastern states are palpably nervous about the possibility of a US-led military assault on Iraq and have generally articulated their misgivings. The day after the New York Times newspaper leaked “plans” by the US to occupy Iraq and install a US military governor, Prince Sultan bin Abdel-Aziz al-Saud, the Saudi deputy prime minister and defence minister, said that the kingdom would not be bound by any resolution on Iraq that jeopardised the country’s national interests. “We don’t have the ability to oppose the resolutions on the Security Council. But we are not obliged to implement what is said”, said Prince Sultan. Yet this appeared to contradict an earlier statement by the foreign affairs minister, Prince Saud al- Faisal bin Abdel-Aziz al-Saud, who said Riyadh would go along with any new resolution mandating the use of force against Iraq if authorised under Chapter VII of the UN charter. This section legitimises action to counter threats to international security and to maintain collective and individual self-defence.

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However, in qualifying this statement, Prince Saud said that Saudi Arabia would not allow the US to use its territory as a launch pad to attack Iraq. Further confusion followed when two days later, in an interview with the New York Times, Prince Saud said the kingdom had not yet decided whether to allow the US to use the Prince Sultan airbase. It is “a sovereign right of Saudi Arabia to decide when the time comes,” he said.

Difficult balancing act for the The Saudi foreign minister’s ambiguity reflects the fact that the kingdom is kingdom trying to avoid stating a definitive position on this critical issue. This is partly because there are genuine differences among senior members of the ruling family on getting involved at all in a possible conflict, a difference which the foreign minister is struggling to bridge. However, it is also because Saudi Arabia would prefer that the UN weapons inspection process is conducted as thor- oughly as possible. Saudi Arabia needs to be seen domestically and regionally as not pre-empting any outcome by signing up to the military campaign and, as far as it is able, to be using the threat of its non-co-operation as a means to encourage the US to stay the course on weapons inspections. Ultimately, it is likely that some semblance of UN “cover” following attempted arms inspections will bring the kingdom’s rulers, at least, on board. Saudi Arabia will argue that if there is clear UN authorisation, it can hardly refuse to co-operate.

Iraq may not threaten Saudi oil However, many Saudis are uncomfortable with the presence of US troops in the interests kingdom and resentful about a prospective US attack on a fellow Arab state. Some of the Arabic-language daily Saudi press have attacked Washington for its alleged arrogance and domineering tendencies. Prince Saud expressed disquiet when he suggested that some in the West wanted to turn the “war on terror” into a form of unilateral hegemony. There have also been some Saudi as well as wider Middle East press suggestions that that the US’s desire is to create a compliant Iraq in energy and political terms. However, the very fact that additional Iraqi oil production is likely to reduce the price of oil, even allowing for potential increased demand internationally, has made Saudi leaders believe that Iraq cannot remain isolated indefinitely. While the long-standing difficulties of OPEC co-operation would be potentially compounded by a revived Iraqi oil sector, loose talk of the next leaders in Baghdad seeking to break OPEC apart as part of a deal with the US does not drive the kingdom’s judgements on whether to help a likely US war effort. Iraq would stand to lose out in any price war with Saudi Arabia.

Qatar’s position is more One country that has fewer qualms about extending support to the US is Qatar. straightforward Although Qatari politicians have also expressed concern about the ramifications of a possible military conflict, they have done this less forcibly than their Saudi Arabian counterparts. Unnerved by the level of popular Saudi hostility to the US, and aware that the kingdom might not allow the use of its territory in a military conflict, Washington has reportedly spent some US$1.4bn on expanding Qatar’s Al-Udeid facility into a major airbase and military staging post. Some 600 members of the US Central Command are expected to move to Qatar this month for exercises that would provide a test of the base as a regional head- quarters. Unlike Saudi Arabia, Qatar has the advantage of having a small national population that is easy to police. Having decided that a US-Iraq conflict

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is probably inevitable, and reflecting a gradual development of its US align- ments since the last Gulf war and the expansion of its enviable gas reserves, Doha has seemingly decided to strengthen the US’s protective embrace.

Kuwait appears ready to Kuwait has continued to keep its diplomatic distance from Iraq. Nevertheless, at support the US the same time it has allowed the gradual build-up of around 12,000 US troops, who operate in a cordoned-off area running up to the Iraqi border that occupies more than a quarter of the country. While expressing the hope that a peaceful solution can be found to the current crisis, Kuwait has not responded particularly positively to Iraq’s apparent willingness to hand over all of Kuwait’s national archives that were looted during the 1990-91 conflict. Of more impor- tance to Kuwait is the fate of more than 600 prisoners of war (POWs), which it says have been held in Iraq for the past decade. Iraq continues to deny all knowledge of the prisoners. Even if Iraq were to give up the POWs, it is doubtful that this would make much difference to Kuwaiti policy. The Kuwaiti foreign affairs minister, Sheikh Sabah al-Ahmed al-Jabr al-Sabah, said on November 4th that “if a [UN Security Council] resolution is issued, the bases will be used,” although he added that Kuwaiti forces would not participate in any military operations. Kuwait concluded in 1990 that an unambiguous alignment with the US was its best long-term security strategy, but its relative public caution about too close an embrace of the US reflects a long-standing response to domestic imperatives.

Turkey has reservations, but is Turkey appears to be thinking along similar lines to Qatar and Kuwait, although likely to support it has been more forceful in its stated opposition to the war. Turkey’s main concern is that one of the two Iraqi Kurdish parties, most probably the stronger Kurdish Democratic Party (KDP), would use the cover of war to seize either of the oil-rich cities of Kirkuk or Mosul, or possibly both. Turkey fears that this oil could serve to underpin a viable Iraqi Kurdish state, which would act as a source of inspiration, and possibly material aid, to Turkey’s own Kurdish minority. In recent months, right-wing Turkish parties have urged the army to launch a pre-emptive occupation of Mosul and Kirkuk, feeding far-right nation- alist aspirations for a national link to the Turkoman-dominated population of Kirkuk. Turkey now has around 5,000 troops in northern Iraq, and there is spec- ulation that it is reinforcing its position with extra units. Certainly the soldiers have unsettled the KDP: its leader, Massoud Barzani, said in mid-October that “we want these troops to go home”. This seems a forlorn hope. Turkish troops are likely to remain in the area at least until the fallout from a US-Iraq military conflict becomes clear; a war could include a repeat of the refugee movements seen in 1991. The general election victory of the Islamic-leaning AKP party in October is unlikely to lead Turkey to end co-operation with the US on Iraq. As the election proved, the main issue that exercises most Turks is the country’s fragile economy. To this end the country’s relationship with the IMF—and by extension the US—remains paramount.

UN resolution boxes Iraq into While Iraq could draw some hope that Saudi Arabia might use its influence to a tight corner avert a conflict, this illusion was shattered on November 8th when the 15 mem- bers of the UN Security Council (UNSC) unanimously passed Resolution 1441.

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This demands that Iraq accept the unconditional return of UN weapons inspectors—its “final opportunity”—or face “serious consequences”. The UN Security Council, in assessing the situation, would be mandated to act under Charter 7 of the UN resolution, which enables member states to act militarily in defence of international security. Weapons inspectors began their work in Iraq on November 27th. By December 8th Iraq must have issued to the Security Council full details of all its weapons of mass destruction (WMD) and related programmes; any false statement or omission is to be reported to the Security Council. Key points of UN Security Council Resolution 1441

The Security Council decides: That Iraq has been and remains in material breach of its obligations under relevant resolutions, including ceasefire Resolution 687 which ended the Gulf war in 1991. To afford Iraq a final opportunity to comply with its disarmament obligations under relevant resolutions of the council. Iraq shall provide to UNMOVIC, the IAEA and the Council, not later than 30 days from this resolution, a currently accurate, full and complete declaration of all aspects of its programmes to develop chemical, biological and nuclear weapons, and ballistic missiles. (That) ... false statements or omissions in the declarations ... and failure by Iraq to comply with, and co-operate fully in the implementation of, this resolution shall constitute a further material breach of Iraq’s obligations and will be reported to the Council for assessment. Iraq shall provide UN inspectors with immediate, unimpeded, unconditional and unrestricted access to all sites and personnel. Inspectors will have immediate, unimpeded, unconditional and unrestricted access to presidential sites in Iraq. Directs the executive chairman of UNMOVIC and the director-general of the IAEA to report to the Council any interference by Iraq with inspection activities, and any failure to comply with its disarmament obligations To convene immediately on receipt of a report ... to consider the situation and the need for full compliance with all the relevant Council resolutions to secure international peace and security. Recalls that the Council has repeatedly warned Iraq it will face serious consequences as a result of its continued violations of its obligations. The resolution is a triumph for The resolution marks a triumph for US diplomacy and is a major blow to Iraq’s the US efforts to keep the UN Security Council divided (and by extension ineffectual), a tactic that had served it well over the past decade. Arab states have also been forced to line up behind the resolution since its passage means it is illegal for Iraq to resist. Although US proposals for armed guards for UN inspectors were dropped in the final resolution, it provides for a tough mandate. In addition, it also includes other uncompromising language, including a declaration that Iraq is presently in “material breach” of existing UN resolutions, and a warning of “serious consequences” should Iraq fail to comply with inspections. On the latter point, the US president was far more blunt. The Iraqi leader had to extend “prompt and unconditional” co-operation with the weapons inspectors or he would face not merely “serious” but “the severest” consequences. There is little doubt that this means a US-led military assault aimed at removing the Iraqi regime from power.

Even Syria supports the In a final humiliation for Iraq, “sisterly” Syria, which is currently on the Security resolution Council, also voted for the resolution. Many believed that Syria, as the only Arab state on the Security Council, would provide some cover for Iraq by at

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least abstaining in the vote. Iraq’s erstwhile Baathist rival has in recent years become closer to Baghdad as the unpopularity of sanctions in the region has strengthened, illegal trade has blossomed, and Syria’s relations with the US have floundered in the context of the stalling of the Israeli-Syrian track of the peace process. Syria takes around 150,000 barrels/day of Iraqi crude at heavily dis- counted prices, and rail links between the two countries have been restored. Syria chose to present the UN resolution, and its support for it, as a means of protecting Iraq. Syria’s former ambassador to the UK, Adnan Omran, told the the UK Independent newspaper that the resolution guarantees the “central role of the UN Security Council” in the crisis. Without the resolution, Syria argues, the US would be more likely to pursue Iraq on its own terms. While it is true that Syria wishes to avert a US-led war with Iraq, an equally likely explanation is that its relations with the US are more important than those with an Iraqi regime which the US is intent on removing.

Russia confident that Iraq could take some solace from the nuances within the resolution. Much of resolution has no “triggers” the behind-the-scenes debate had concerned the removal of phrases that could trigger direct military action against Iraq if it was found to be in non-compliance with any aspect of the resolution. Accordingly, if Iraq fails to disclose its current WMD capabilities and potentially related civil projects—as it must do by December 8th—then the Security Council will convene to consider this breach, but it would not automatically lead to war. The Russian deputy foreign minister, Yuri Fedotov, said he thought the change was important, stating: “In the accepted resolution it is clearly stated that, in the event of problems, the members of the Security Council will gather to look at the situation as it stands and decide on further action”. Moreover, such a meeting would not necessarily provide a mandate for war. If, as one Western diplomat put it, Iraq was found to be “lying, cheating and just plain in the wrong” by hiding weapons that are later un- covered, then the Council would have little choice but to authorise a US military strike. (That statement was given added pertinence by the Iraqi ambassador to the UN’s insistence on the same day that Iraq was “clean” of all WMD.) However, it might not be that simple. If Iraq genuinely forgets to include one or two items in its inventory, which later come to light, then France, Russia and China are unlikely to consider this justification for military action. The resolution presupposes that Iraq does have at least a residual capability and demands that any programmes that Iraq claims only have a civil use should be included in such a declaration. Iraq has recently suggested that it will make a declaration, so it seems unlikely that the issue of whether an outright denial of any military programmes will be debated on the UNSC as a potential casus belli.

President Bush sounds After the resolution had been passed, Mr Bush commented that there could be uncompromising no “unproductive debates” over whether specific instances of non-compliance are serious. “Any Iraqi non-compliance is serious”, he said. This seems to indicate that that the merest suggestion that Iraq is not co-operating will be enough justification for the US to take military action. Speaking before the resolution was passed, the US secretary of state, Colin Powell, said: “any resolution that emerges from this will be a resolution that preserves the authority and the right of the president of the US to act in self defence ... in concert with the inter-

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national community or with like-minded nations, rather than through the UN should it not wish to act.”

Resolution is extremely Those in the US administration who are keen to launch a military strike against intrusive Iraq whatever the findings of the UN Monitoring Observation Verification and Inspection Commission (UNMOVIC)—the defence secretary, Donald Rumsfeld, and the vice-president, Dick Cheney, among them—may hope that Iraq will balk at the intrusiveness of the inspection regime. Not only must Iraq provide unconditional and unrestricted access to any site that UNMOVIC and the International Atomic Energy Agency (IAEA) choose, but the inspectors must be able to interview any official they choose, and outside of Iraq if necessary. In addition, the inspectors have the right to set up “exclusion zones” in which the movement of any Iraqi ground or aerial forces will be prohibited to prevent them moving suspect equipment away from the sites before the inspectors arrive (this was common practice during the previous inspections regime of 1991-98). UNMOVIC and the IAEA shall also have the free and unrestricted use of fixed- and rotary-winged aircraft, including manned and unmanned reconnaissance vehicles during the inspection process. This could see allied aircraft from the disputed no-fly zones being used to police the new exclusion zones, with an enhanced prospect for conflict as a result of either intent or simply miscalculation on either side.

Iraq decides to accept it Despite these dangers, on November 13th Iraq formally and “unconditionally” accepted the resolution. Iraq’s ambassador to the UN, Mohammed al-Douri, told reporters: “We are prepared to receive the inspectors within the assigned time- table. We are eager to see them perform their duties in accordance with international law as soon as possible”. Yet Iraq’s acceptance of the theory of the resolution is a long way from accepting the reality of its implementation. Messrs Rumsfeld and Cheney, along with many neutral observers, believe Resolution 1441 is “unmeetable”. They assume that Iraq’s habits of secrecy and duplicity, particularly where UN weapons inspectors are concerned, are so ingrained that it would be incapable of full co-operation with UNMOVIC as spelled out in the new resolution. Even if Iraq felt compelled to co-operate fully with the inspectors, it may not be able to withstand the myriad blows to its sovereignty that the inspections regime would inflict, and obstruction would be inevitable.

Talk of “regime change” is Conversely, Iraq might decide not to co-operate because it believes that the US is softened intent on pursuing “regime change” regardless of the findings of the inspectors. This is a belief that the US secretary of state was keen to dispel in an interview with the Qatari based al-Jazira television channel in early November. “If the Iraqi regime got rid of these weapons of mass destruction and were fully co- operating with the inspectors, then, in effect, it has changed its policies; it is a changed regime”, Mr Powell said. Indeed, Mr Bush had made a similar state- ment a month earlier. In fact, as recently as mid-May, when asked whether Iraqi co-operation with weapons inspectors would “stay the US hand” regarding regime change, Mr Powell replied that the two issues were “separate and distinct” (June 2002, page 18). If the ongoing US military build-up in the Gulf—initiated well before

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the passage of Resolution 1441—is any guide, then the US either never expects Iraq to comply with any resolution, or it has decided to pursue “regime change” regardless.

A battle plan is said to have In mid-November the New York Times claimed that Mr Bush has now settled on been drawn up a war plan. Quoting “senior administration officials”, the newspaper said the plan features swift ground actions to seize footholds in the country and strikes to cut off the leadership in Baghdad—the “inside out” approach which would leave the bulk of the Iraqi armed forces without strategic direction. Although the military plan calls for massing 200,000 to 250,000 troops for attack by air, land and sea, the offensive would probably begin with a “rolling start” of substantially fewer forces. The plan calls for the quick capture of land within Iraq, which would be used as bridgeheads to funnel American forces deeper into the country. US forces could operate out of such forward bases in northern, western and southern Iraq, building on lessons learned in Afghanistan, where the military seized a similar outpost south of Kandahar. The existence of a war plan is supported by evidence of an ongoing US military build-up in the Gulf region. According to the New York Times, the army is loading tugboats, forklifts and other cargo-handling equipment on to the Te rn, a giant cargo ship in Virginia that is bound for the Gulf to prepare ports for the arrival of tanks and other armoured equipment. Other sources chart a more comprehensive build- u p. The Washington-based Centre for De fence Infor matio n re por ts the followi ng. • The US ships Bob Hope and Fisher deployed in the Gulf in October to ship heavy equipment and armour stockpiled in the US to the Gulf. Meanwhile, the USS Constellation aircraft carrier is bound for the north Arabian Sea, four months earlier than scheduled. • The USS Harry Truman finished exercises early in November in readiness for despatch to the Gulf in December. The USS Carl Vinson is also heading to the Gulf in December, six months earlier than scheduled. Another aircraft carrier, the USS Abraham Lincoln, arrived in the Gulf in September. • In Qatar, the head of US Central Command, General Tommy Franks, is due to arrive at the Al-Udeid base at the end of November, ostensibly for a week- long exercise. • The US Fifth Corps in Germany and the Marines’ First Marine Expeditionary Force headquarters have been ordered to move to Kuwait. • The 2nd Brigade of the 3rd Infantry Division is in transit from its US base at Fort Stewart. The 24th Marine Expeditionary Force is close to arrival in Kuwait; together, these two units will provide 7,300 troops and over 100 tanks. • Two Apache helicopter squadrons with 1,000 troops from the Army Fifth Corps arrived in Kuwait from Germany in November. • B1 bombers with the 405th Air Expeditionary Wing have been moved to Oman. In addition, B2 Stealth bombers are preparing for their first deployment outside of their home base in Missouri. The location remains undisclosed, but most analysts believe they are bound for the UK island of Diego Garcia in the Indian Ocean.

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Military action in no-fly zones Since mid-September the number of clashes, and the extent of the Iraqi military greatly increases hardware and/or sites of military use targeted by US and UK aircraft policing the no-fly zones over the north and south of Iraq (see map), have significantly increased. As of mid-November Pentagon and UK Ministry of Defence spokesmen said that their aircraft had been “painted” (namely locked-on by Iraqi anti-aircraft missiles) a total of 130 times in the previous two months. Three pilotless drones, or UAVs (unmanned aerial vehicle or Predator surveillance plane), have been brought down, the most recent occurring on October 10th. This has encouraged allied aircraft to utilise their increasingly enhanced capabilities, as a second aircraft carrier and assorted material arrived in the region, to target more typical Iraqi military facilities, such as surface-to-air missile (SAM) sites and anti-aircraft artillery. However, US and UK responses to apparent Iraqi provocations have also extended to attacks on Iraq’s command and control facilities that form part of its air defence network, but which would also have use in the overall defence of the country. On November 20th-21st, alleged air defence facilities were hit in the south of the country. In early October US and British planes destroyed an alleged command and control facility located close to the Basra airfield in the south of the country, while in early November the Al-Tallil air defence facility (near the south-eastern city of Al-Amarah in Maysan province) was hit for the second time in a matter of weeks. The Basra airfield attack occurred within days of an alleged short-range anti-ship missile site, also near Basra, being destroyed by allied aircraft. The alleged site near the Basra airfield would have utility to the Iraqis in seeking to upset the over ten-year long operation over the southern no-fly zone.

US and UK strikes serve a However, it is hard to see how attacking an apparent facility aimed at shipping wider military purpose in the Persian Gulf has the same benefits to US and UK war planners. In general the periodic escalation of activity by allied planes serves a further purpose of “softening up” Iraqi air defences. Therefore, the scale of recent activity, even against sites directly related to Iraq’s ability to mount an aerial defence of the country, may well be related to the increasing likelihood of war primarily in- volving US forces against Iraq. Certainly, the arrival of the USS Abraham Lincoln, and the longer flight time of the Super Hornet F18 jet fighters that operate from it, have allowed a more active “policing” of the southern no-fly zone.

No-fly zones might spark war Iraq has in the last few years proven remarkably adept at rebuilding command and control facilities as well as air defence sites that have been struck in periodic air strikes against the country in the course of the last 12 years. This suggests that the present intensification of military action may not be the start of the expected war, as some analysts have suggested. Rather, it is the continuation of a process that has provided (as is the professed policy behind the zones) some security to the Kurdish and Shia populations, whilst actively enforcing containment and minimising the effort needed in the course of a future extensive aerial campaign. For example, recent accusations made against Ukraine by US and British officials point to the former Soviet republic’s contribution to enhancing SAM facilities in the country. It is also believed that the Chinese have provided the Iraqis with fibre-optic cabling to strengthen the efficiency of its air defences. This allegedly followed the partial destruction by allied aircraft of a command and control

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facility just outside of Baghdad in February 2001. However, paragraph eight of the latest UNSC resolution on Iraq (1411) might be seen by the US and UK governments as justifying military action. According to the paragraph, “... Iraq may not take or threaten hostile acts directed against any representative or per- sonnel of the United Nations or International Atomic Energy Agency or of any member state taking action to uphold any Council resolution” (emphasis added).

The legal status of the no-fly zones remains moot; however, the Allies have long claimed that they have UN authorisation to protect the populations of the north and south of the country under UNSC Resolution 688, which calls on Iraq to uphold the human rights of all Iraqis and seeks the “restoration of international peace and security” in the region. Furthermore, UNSC Resolution 1411 requires the Security Council to consider what needs to be done to “secure international peace and security”. Iraq’s ongoing attempts at downing a US or UK plane may not lead the US and UK governments to declare that they have a casus belli. In fact, suggestions by the US secretary of defence that the first Iraqi attempt to down a US pilot in mid-November after the passing of the resolution was a con- travention of its commitments was soft-pedalled, when the British government made clear that the new UN resolution was about disarmament. However, acting in self-defence, as allowed for by Article 51 of the UN Charter, might be invoked by the US if a manned aircraft is eventually shot down. It might be added that once UN inspectors are actively engaged across Iraq, the scale of

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allied overflight activity in the no-fly zones should decline given the potential risks to UN personnel.

Mr Bush maintains that no Although the US president admitted that he has authorised his armed forces to decision has been made consider options for the use of force, he has continued to assert that no decision has yet been taken on whether to use them. Mr Bush recently refashioned his formerly unqualified commitment to regime change, to the argument that the comprehensive disarmament of Iraq’s WMD would constitute the same thing. This is likely to reflect Mr Powell’s requirements for building support at the UN for what became Resolution 1441, and for US interpretations of what may constitute “material breach” of the commitments Iraq has made under it, rather than a definite shift in US objectives.

Regime change likely to Even if inspectors are able to patiently remove all of Iraq’s WMD programmes, remain the priority and there is no earlier trigger for war, it still seems unlikely that this will be acceptable to the Bush administration. The US president has constantly referred to the “necessity” of regime change since the beginning of the year. A failure to remove Mr Hussein from power, even if Iraq is comprehensively disarmed, could be portrayed by Mr Bush’s political opponents, along with sections of the US media, as a political defeat. Moreover, Iraq’s potential disarmament throws up a difficult strategic quandary if Mr Hussein is allowed to remain in power. If Iraq was disarmed, then under the terms of UN resolution 687 (1991), sanctions on all imports could in theory be lifted. This throws up the possibility—if not the likelihood—that Iraq will start importing the components for WMD again.

Iraq sees WMD as key to As it approaches the December 8th deadline, Iraq is unlikely to declare all its regime survival residual WMD programmes and potentially associated civil facilities. The belief is strong among the regime’s leadership that the US is intent on overthrowing it with, if necessary, US ground forces. Iraq showed in over eight years of UN arms inspections that it attaches great importance for its internal and external security, regime legitimacy and cohesion, and potential regional influence to hanging on to a reserve option of WMD. If Iraq was successfully disarmed, it could leave the Iraqi president domestically vulnerable. Fear of attack by chemical or biological weapons has been an important constraint on the domestic opposition; Mr Hussein proved that he is willing to use these weapons in 1988 when he dropped mustard gas on the Kurdish town of Halabja.

Iraq has regional war options While the potential use of WMD brings US counter threats, the regime sees such weaponry as, at minimum, an important part of defence, and potentially deterrence, if sufficient damage could be done to allied forces. The perception that US determination may be susceptible to US public reservations over the human cost of war has affected Iraqi judgements in the past. In order to maximise its defence and deterrence, Iraq let it be known several years ago that regional commanders were authorised to use Iraq’s military capabilities if the regime was under direct threat. Scenarios could include either the use of battlefield chemical weapons in defence of Iraq against invading forces, or the firing of biological or chemical-tipped Scud missiles at allied forces in neigh- bouring countries or, in extremis, at Israel in order to draw it into the conflict and thereby potentially upset US war plans by fracturing an emergent coalition.

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A further Iraqi rationale would be that the ability of loyal troops engaged in street-to-street fighting in Baghdad to upset an invading army’s war plans would be strengthened by the military and political benefits of having a WMD option.

US public opinion continues to Mr Bush can draw succour from a US public opinion poll conducted on support an attack October 30th by the Pew Research centre. Depressingly for the Iraqi Ministry of Information, two-thirds of Americans polled believed that “Saddam Hussein helped the terrorists in the September 11th attacks”. More pertinently, 55% are still in favour of military action, although this is down from the 62-64% who supported that option in the summer. Meanwhile, 34% said they opposed any war, up from 21% in a late August poll. However, the poll was conducted prior to the unanimous passage of UNSCR 1441. The resolution does not address military action per se, pointing only to “serious consequences” should Iraq not comply. Nor, indeed, is there any guarantee that the Security Council will agree to war should there be a lack of compliance. Despite the applicability of Chapter 7 of the UN charter to any decision on “serious consequences”, legal authorisation for member states to go to war still remains technically a matter of UN Security Council agreement. Yet US public support for any war would presumably be much higher if the US could demonstrate that it had at least attempted to gain UN support for the conflict.

UK support will be important Of more concern might be the poll’s disclosure that support for a war dwindles to 27% if US allies do not agree to it. The only strong ally that the US is likely to have—in terms of committing personnel as well as bases and equipment—is the UK, as well as Italy if requested. Some Arab allies are continuing to sound a different political stance from private understandings, either reached or likely to materialise with the US, that some facilities and/or overflight and refuelling rights would be granted given that military force is likely to be conducted under UN authority. However, with the UK the only clear ally, its relationship with the US has taken on added importance over the past few months. In the UK public attitudes towards a potential conflict are more finely balanced than in the US, with a narrow majority opposing the war. Ultimately this should not prevent the UK committing troops to a possible invasion since, despite a vocal band of opponents in the UK parliament, the government should be able to secure parliamentary support given the likely backing of the majority of Labour MPs and the Conservative Party, the main opposition party.

Significant military role likely There is scant detail about UK military plans, although four minesweepers have fo r UK reportedly been sent to the Gulf, and some 1,000 reservists are said to have been issued with call-up papers at the end of October. Other reports, including the New York Times’ account of an emergent war plan, suggest that as many as 15,000 British troops may form part of an eventual military operation led by the US. While additional weeks, and possibly up to three months from the start of a crisis with Iraq, will be required to have all US military assets in theatre, preparations for the use of British heavy armour, by such steps as “desertifying” Challenger II tanks, may take rather longer. This is another reason why a military campaign edging toward spring may be more likely than one beginning within the next few weeks.

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Congress approves an attack More important, in terms of the fate of Iraq, is the fact that Mr Bush has already won the ringing endorsement of the US Congress for any plan to attack Iraq. In mid-October the House of Representatives voted 296-133 to authorise war. A few hours later the Senate, which at that point was controlled by the Democrats, gave its assent by 77 votes to 23. To add further gloss to an already solid domestic position, on November 5th Mr Bush’s Republican Party enjoyed unprecedented success in the mid-term elections, retaking control of the Senate and tightening its hold on the House of Representatives. Buoyed by the reinforcement of his domestic armour, Mr Bush told war veterans on November 11th that if the UN failed in the “urgent task” of disarming Iraq, “I will commit the full force and might of the United States military and we will prevail”.

Economic policy

Iraq drops oil surcharge The main economic policy initiative of the past quarter was Iraq’s decision to drop its oil surcharge. The UN sanctions committee appears to have won the battle with Iraq’s State Oil Marketing Organisation (SOMO) to prevent it deliberately underpricing its crude in order to make room for a surcharge, pay- able by lifters directly to the regime. To counter this, the UN had insisted that prices be set two weeks after contracts are agreed. This has created considerable uncertainty for many lifters, most of whom have decided to concentrate on competitor crudes, such as Urals. The net effect was that liftings of Iraqi crude under the oil-for-food programme dropped to a meagre 370,000 barrels/day (b/d) by the week of August 31st. Despite fierce criticism of the sanctions com- mittee from Iraq’s customers, it was SOMO that “blinked” first as the squeeze on illicit revenue began to impact the regime’s patronage networks at a delicate political time. SOMO is understood to have removed surcharges from all sales of export crude under the oil-for-food programme as of September 1st. Most major international oil companies stopped lifting Iraqi crude after the surcharge was first introduced in late 2000. Iraqi crude still found its way on to the market through a number of “nameplate” trading companies; however, even some of these firms became increasingly reluctant to lift Iraqi crude as the retroactive pricing system—which meant that lifters were forced to sell their crude to refiners without knowing what their profit margin would be—began to bite.

Oil exports pick up but remain SOMO’s decision, which was apparently communicated to the major oil volatile companies a week later, brought a quick dividend. Official oil exports reached 1.9m b/d in the week beginning September 14th, as major international oil firms returned to lift Iraqi crude. However, the UN sanctions committee has decided to keep the retroactive pricing system in place, believing, probably with some justification, that SOMO would simply reinstate the surcharge if retroactive pricing were abandoned. Oil exports grew exponentially to nearly 3.8m b/d in the week beginning October 12th, before slumping to 730,000 b/d the following week. Overall, the end of the Iraqi surcharge has seen Iraqi oil output rise significantly, with the October average of 2.45m b/d (recorded by the International Energy Agency), or about 1.75m b/d in exports, by far the strongest seen since the first quarter, when the surcharge was only beginning to deter lifters. The daily export average in the eight weeks since the end of the surcharge

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in mid-September saw Iraq’s oil exports nearly double, to 1.57m b/d, compared with the preceding eight-week period. However, although average weekly oil exports are considerably higher than they were, residual market uncertainty has meant continued volatility. Furthermore, the improved export levels still remain significantly below the 2.2m b/d target Iraq has set itself. According to the Cyprus-based Middle East Economic Survey, additional factors affecting exports now and over the short to medium term are production problems in the northern production facility of Kirkuk, and the fact that the market for Kirkuk crude in the Mediterranean region is presently quite poor owing to its high sulphur content. At the same time, Basra Light is being negatively affected by the poor market in the US for sour crudes. More positively, the many oil sales contracts already agreed but not implemented, and Iraq’s acceptance of UN Security Council Resolution 1441, were expected to ensure a smoother roll-over to the next phase of the oil-for-food programme on November 21st than has normally occurred. Another reason is that there is not likely to be any attempt to reform the retroactive pricing system, confirming that Iraqi export levels will continue to fluctuate.

2003 budget is discussed With political concerns to the fore, conventional economic policy initiatives have been few in the past quarter. Nevertheless, the cabinet did attend to economic affairs during a meeting in early November. The cabinet is reported to have discussed the 2003 budget at this meeting, although no details of spending or revenue were revealed. The discussion as reported by the official news agency dealt mainly in generalities. The budget would be aimed at “allocating funds to expenses related to the production process, expanding job opportunities, and giving more attention to the areas and governorates that need greater development,” the report said.

Suggestion that public funds The news agency release also hinted at possible financial problems. The cabinet are being siphoned off discussed a report by the Ministry of Finance on “tracking the Treasury’s dues” and “protecting public funds”. The finance ministry’s report indicated that public funds were going missing from state-owned companies and suggested that “it is not sufficient” to take legal proceedings against the perpetrators. In an ominous message for the managers of state-owned enterprises, the cabinet “stressed the need to punish the officials who are responsible for these damages, both as individuals and in their official capacity”.

Central Bank chief explains The Central Bank of Iraq governor, Isam Rashid Huwaish, has been explaining decision for new dinar note the rationale behind his decision to issue a new ID10,000 note (September 2002, page 25). The governor gave his reasons for launching the new currency last month in an interview published on the website of the official Iraqi govern- ment newspaper, al-Rafidayn. Dr Huwaish was adamant that the introduction of the new notes—which is a considerable step up from the ID250 note—would not have a negative impact on the Iraqi economy. However, his justification for the note’s issuance was unconvincing. He said that the note would “help to facilitate larger transactions”. The governor stressed that rather than a recognition that the current denominations could not cope with soaring inflation and a black-market rate of around ID1,900:US$1, the new note was a sign of the Central Bank’s

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confidence in the Iraqi economy. “The Central Bank has proven over the past three years its ability to bolster the currency and protect the stability of its exchange price and purchasing power”, claimed Dr Huwaish. In fact, that is something the Central Bank has singularly failed to do: the black-market rate of around ID2,000:US$1 is an indictment of a monetary system that has a fixed rate of ID0.309:US$1 and heavily negative interest rates. Sensing the lack of logic in the governor’s answers, the interviewer asked Dr Huwaish whether other “major economies” had resorted to such large denominations. The governor suggested that the euro was denominated in large amounts, although a €500 note is some way smaller than the ID10,000 note. The interviewer then asked the governor whether Iraq had enough gold to back up the currency. The governor explained that currencies were no longer supported by gold, but by confidence in the economy concerned.

The domestic economy Economic trends

O i l - fo r-fo o d ea rn i ng s rem ai n Continuing the pattern of volatility witnessed over the past few months, Iraqi volatile oil-for-food programme exports in the week ending November 8th dropped to 7.3m barrels, less than half of the previous week’s high of 19.3m barrels, accor- ding to the UN Office of the Iraq Programme (UNOIP). This meant an average of slightly over 1m barrels/day (b/d). As of early November, this brought the total volume of oil exported under Phase XII of the oil-for-food programme (May 30th-November 25th) to 186m barrels, generating US$4.46bn. With 72% of the total oil revenue allocated to the humanitarian programme, it is clear that Iraq is going to struggle to raise more than US$5bn of the US$7bn needed for the entire phase to meet its humanitarian budgetary target. As noted by the executive director of the UNOIP, Benon Sevan, in his report to the UN Security Council on November 12th (prior to the end of the recent phase of the oil-for- food programme), this US$5bn is likely to be worth about US$3.49bn after 28% of revenues is deducted to meet UN administrative costs and mandated compensation payments. According to the UNOIP, since the beginning of the programme on December 10th 1996 some US$39.6bn worth of contracts have been approved by the Security Council’s sanctions committee and the UNOIP for the purchase of various humanitarian supplies and equipment, including about US$3.6bn worth of oil industry spare parts and equipment. So far, just over US$25bn worth of general humanitarian supplies have been delivered to Iraq, including US$1.5bn worth of oil spare parts and equipment. A further US$10.4bn worth of oil equipment, for which funds have been made available, are in the production and delivery stage, including US$1.8bn worth of oil industry parts.

Over US$3bn of humanitarian A cumulative revenue shortfall since Phase VIII of the programme has left 1,607 contracts are without funds approved humanitarian supply contracts, worth nearly US$3bn, without avail- able funds. The sectors affected by the revenue shortfall are: electricity, which is short of US$550m; agriculture with US$550m; food handling (US$515m); health

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(US$341m); housing (US$323m); water and sanitation (US$325m); education (US$279m); and telecommunications and transportation (US$248m).

Benon Sevan blames pricing In late September Mr Sevan reiterated his concerns about the slump in oil dispute for export weakness revenue and its impact on the oil-for-food programme. According to Mr Sevan, assuming a sustainable rate of export of 2.1m b/d, between June 1st and September 15th (just after Iraq had ended its illegal surcharge) US$3.2bn in revenue was lost as a result of reduced levels of Iraqi exports. This may be an overestimate, however. The Economist Intelligence Unit’s estimates of lost Iraqi oil export revenue are based on the difference between the same potential export output and the volumes reported by the UNOIP, along with the average selling price of Iraqi crudes, producing a figure of under US$2.75bn. By the time of Mr Sevan’s report to the UN Security Council in the run-up to the next phase of the oil-for-food programme, Mr Sevan estimated that total lost Iraqi oil revenue as of October 31st was between US$3.5bn and US$4bn. However, again our estimate is lower, suggesting that, with the relative recovery in Iraqi oil ex- ports from mid-September, the loss in revenue is around US$3.3bn, and is likely to have risen to around US$3.5bn at the end of Phase XII in late November. In a report to the UN Security Council dated November 12th, Mr Sevan said that the situation has been further compounded by the cumulative revenue shortfall from earlier phases of the programme totalling about US$3.1bn. In his “note” to the Security Council published on the same day (reporting on the humanitarian impact of the oil-for-food programme), Mr Sevan blames the revenue shortfall in Phase XII of the oil-for-food programme on the ongoing pricing dispute between the UN and the Iraqi government (see Economic policy), which has led to the former maintaining the retroactive pricing policy. Mr Sevan has repeatedly stressed that this dispute should be resolved for the sake of addressing the shortfall in revenues necessary to fund humanitarian goods. However, the head of the oil-for-food programme has also highlighted that lifters have also been deterred from buying Iraqi oil exports as a result of the Iraqi government’s tendency seen in the earlier phase of the programme (XI) to suspend oil exports without warning. Mr Sevan also commented that Iraqi oil exports have been hit by the decline in the US market for Iraqi crudes (September 2002, page 31) and that there was reticence on the part of buyers owing to “current political developments”, by which he is likely to have meant the increasing expectation of a US-led military conflict. In his September and November reports, Mr Sevan also noted that the govern- ment’s failure to make necessary adjustments to the budgetary allocations contained in its distribution plan, in line with variable oil revenue during the course of each phase, had not helped the effective implementation of the oil-for- food programme. Despite the UNOIP’s repeated recommendations to the gov- ernment to revise downwards the allocations contained within the distribution plans, the government has tended, perversely, to increase allocations, mostly to sectors that are already fully funded.

Goods review list appears to In his previous two reports Mr Sevan also assessed the progress of the goods have helped review list (GRL). This was the key element of UN Security Council Resolution 1409 of May 2002 (June 2002, page 20), which theoretically allows Iraq to

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import civilian goods without obstruction. Any goods that did not appear on the 332-page GRL—comprised of items that have a “dual” civilian and military use—would be approved. Having processed applications from suppliers, the UNOIP would then send the completed forms to the UN Monitoring, Verification and Inspection Commission (UNMOVIC) for review. If action is not taken by the experts within a ten-day period, then the application will be approved by default, although the experts may request additional information from the supplier during that period. Of the total of 1,646 applications fully processed by the UNOIP from the beginning of the new procedure on July 1st until September 19th, 1,466 or 89% were found to be “compliant” and were sub- sequently forwarded to UNMOVIC or the International Atomic Energy Agency (IAEA). By October 31st this had risen to 1,891. However, this now represented only 60% out of a total of 3,392 applications that had been referred to UNMOVIC or the IAEA, given the inclusion of old contracts that were now being processed under the revised procedures. By November 15th the number of applications judged fully compliant had risen to 2,365 (or about US$3bn-worth), with some 65% of the total number and 44% of the total value of applications being processed. Some 33% of the number of applications processed (and nearly 50% of their value) were “GRL non- compliant” and had been sent back to their suppliers for more information. As of October 31st, around 75% of the latter category were from the backlog of old contracts that had been recirculated, and for which UNOIP was still awaiting clarifications. These are clearly distorting the amount of “non-compliant” contracts under the new system. Mr Sevan said that the two most common reasons for non-compliance under the new system are very similar to those under the old—failure by suppliers to provide a fully itemised list of all goods included, or insufficient details about the services to be supplied. As of November 8th, GRL items had been identified in 137 contracts worth US$450m (3.7% of the total number), of which 13 contracts, worth US$3.85m, were approved. Mr Sevan said that the relative number of applications containing GRL items (as a percentage of all applications processed by the UN experts) remained fairly constant, at around 1.2-1.5%.

A “fast track” list has been On October 28th the sanctions committee approved a list of about 6,000 drawn up humanitarian supply items. Contracts for the supply of these items will no longer require a review by UNMOVIC or the sanctions committee, but instead will be “fast-tracked” for approval by UNOIP. The list, developed jointly by UNOIP and UNMOVIC under the new set of procedures of Resolution 1409 (June 2002, page 21), includes all food items, basic medicines and medical supplies, furniture, printing paper, teaching and educational supplies, agri- cultural seeds and fertilisers and basic construction materials. Overall, Mr Sevan professed himself pleased with the new system (notwith- standing his concerns at revenue shortfalls). He outlined four key improvements. • An increased rate of approvals without reference to the sanctions committee. Under the old system many seemingly innocuous applications were scrutinised, and often rejected by the committee, where US and UK members wielded particular influence.

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• The GRL has created transparency by clearly defining “dual-use” criteria. That is, “dual use” is no longer defined by the sanctions committee, which many felt had politicised the scrutinisation process. • Increased number of options available to suppliers and Iraqi buyers on items assessed as “dual use” under the GRL. • Better focus on the humanitarian implications of the non-approval of GRL items, rather than on their “dual-use” nature alone.

Oil and gas

Crude oil prices soften Crude oil prices remain inflated by political concerns, principally the ever- increasing risk of a US-led attack on Iraq, although fundamentals are beginning to have more of an impact on prices. On November 19th the benchmark dated Brent crude was trading at around US$24/barrel, down on the US$27/b prevailing at the time of our last report. With the decline of the Iraq war premium, owing to the prospect of UN weapons inspections being resumed and therefore the prospect of war at least being deferred, the market appears to be responding to excess supply and uncertain demand prospects. The latter is a product of the hesitant economic recovery in the US and Europe, while the excess supply is largely down to excessive “quota-busting“ by OPEC members. According to the latest data by the International Energy Agency (IEA), October production by OPEC (excluding Iraq) was nearly 23% over its January 2002 quotas; the figure for September was 10%. The worst offenders were Saudi Arabia (14% over quota), Libya (16%), Qatar (25%) and Algeria (a staggering 49% over quota). Despite OPEC’s increasing over production, the reported heavy drawdown of oil stocks in the US, and the generally low level of oil stocks, is expected to set limits to future price falls. Prices are likely to ratchet back up as conflict between Iraq and the US seems more imminent in the first few months of 2003. However, once the conflict begins, prices are likely to fall back quite sharply. In the last Gulf war prices began to fall in the fourth quarter of 199o, before the US-led coalition began its attack on Iraqi forces in Kuwait. The attack caused a short-lived spike before the downward price trend was resumed. Much will depend on OPEC’s decisions over the next six months. If it reduces quotas, then this might return some balance to the market. However, Algeria and Nigeria’s request to have their own quotas raised—and OPEC’s vague reply that it would “consider” their requests, probably in February—does not augur well for the organisation’s management of supply.

Iraq’s crude output edges up Figures from the IEA show that Iraq’s own crude oil production reached 2.45m b/d in October, a significant recovery from the 1.89m b/d recorded in September. This itself marked a slight recovery from the 1.54m b/d produced in August, the lowest level since June 2001, which was distorted by a production stoppage for political reasons. August’s nadir was owing to the reticence of international firms to lift Iraqi crude because of the problems caused by the Iraqi government’s surcharge. The surcharge system was scrapped in early September, and this was communicated to major international oil companies (IOCs) in the middle of that month. Consequently, October’s output figure shows the full

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impact of the decision. It slightly exceeds the 2.43m b/d achieved in March 2002 (before the impact of the surcharge and retroactive pricing became critical), but is someway short of the 2.82m b/d recorded around a year ago. However, the UN’s decision to retain its retroactive pricing system (see Economic policy) has meant that market uncertainty has not been completely eliminated. Consequently, output is likely to continue to fluctuate on a week by week basis, with the result that the next three months may once again see reduced export volumes, especially as war fears are likely to increase in the first quarter of 2003.

Oil production (m b/d) 2001 2002 2000 4 Qtr 2001 1 Qtr 2 Qtr 3 Qtr Oct Production 2.52 2.53 2.36 2.38 1.54 1.75 2.45

Source: IEA, Monthly Oil Market Report.

These problems should quickly disappear if, as many expect, a US-led attack on the Iraqi regime is successful and the oil embargo on Iraq is lifted. Depending on the war’s timing, we would expect that this would enable a significant increase in oil production—with output averaging around 2.6m b/d in 2004 as retroactive pricing and the oil embargo are lifted. Within two years of the change of Iraqi regime, oil production could be expected to increase steadily as IOCs would be readmitted to the country. These firms would presumably help to increase production from Iraq’s sagging fields, before moving on to develop Iraq’s vast but untapped southern and western fields.

Debate on oil contracts in post- The question of which IOCs will be participating in this effort remains an open Saddam Hussein Iraq one. A number of Russian, French and Chinese firms currently have agreements to develop these fields in the event that sanctions and the oil embargo are lifted. However, the contracts they have signed are with the Iraqi government, which is unlikely to be in power when sanctions are lifted. Some observers believe that the US has agreed to allow these contracts to be honoured in return for French, Russian and Chinese support at the UN in its efforts to have the Iraqi regime disarmed. Others think that these contracts will be null and void as soon as the regime is removed from power; moreover, as the principal “occupying power” in a post-Saddam Hussein Iraq, the US will be well placed to acquire the choicest contracts for its own firms. While the US may make its best efforts to this effect, Russia and France, or, for that matter, the UK will know that there can be no guarantees, especially as the next Iraqi government may not entirely owe its existence to US military intervention. Senior Iraqi opposition figures have said that all existing contracts would be “reviewed”, but that no future government in Baghdad will allow contracts to be assigned wholesale to US companies. Nevertheless, the US State Department announced that it would be convening a meeting with members of the Iraqi opposition on the future of Iraq’s oil and gas resources in early December. The aim is to form a working group, consisting of ten to 20 members, including some from the US Department of Energy, which would “lay out policy challenges and proposals”. Whatever the results of these deliberations, oil industry observers believe that it will take several years before the legal and regulatory environ-

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ment is stable and transparent enough to provide a solid foundation for massive foreign investment in exploration and development. The group is expected to discuss the validity of contracts already signed and Iraq’s quota within OPEC. These issues are undoubtedly of interest to the US, not least given the potential impact of an Iraq that greatly increases its output, possibly at the expense of OPEC cohesion. However, the planned State Department committee is no indication that the US is intent on trying to direct the outcome of such issues, or that it necessarily believes that the exiled opposition will be in power and receptive to such pressure (see The political scene).

Iraq’s position in OPEC is also The question remains whether, and under what circumstances, Iraq might be up for debate accommodated within OPEC. Iraq remains a member of OPEC, but, given the existence of the oil embargo and the oil-for-food deal, it is not beholden to the organisation’s production constraints. The OPEC secretary-general, Rilwanu Lukman, said in October that “in the past, Iraq and Iran have shared parity in the OPEC quota system. We would initially expect Iraq [on returning to the OPEC system] to share parity with Iran again. There would be a historical basis for such an agreement. Beyond that, we have no idea how things would develop”. Iran’s current OPEC production quota is 3.19m b/d, a little shy of Iraq’s sustainable production capacity. The leader of the Iraqi opposition group, the Iraqi National Congress (INC), said in early November that increases in Iraqi production under a new Iraqi regime would lead to lower global oil prices unless OPEC agreed to reduce member states’ quotas in order to accommodate Iraqi output. This may well be the INC talking up its utility to the West, and the US in particular, by hinting at a threat to the oil cartel. A government that emerged in Baghdad in the aftermath of a military conflict may well be able to secure an understanding with OPEC, as the cartel would be keen to ensure that some production discipline be maintained for fear of the impact of unrestrained production of all its members on the future price of oil.

Foreign trade and payments

Iraq and Saudi Arabia “reopen Iraq and Saudi Arabia reopened their Arar border post in late October, allowing border post” government officials and businessmen to pass through for the first time since August 1990, when the post was closed. According to Iraqi television, the Arar post was officially opened by the Iraqi trade minister, Mohammed Mahdi Saleh, and was attended by over 100 Saudi businessmen who were due to visit the Baghdad international trade fair. Saudi Arabia has exported around US$1bn of goods to Iraq under the oil-for-food programme, but until now the goods have had to be shipped via Jordan.

Saudi Arabia then issues Strangely, however, the director-general of the Saudi Customs Authority, Salih denial al-Barrak, denied that the reopening of the Arar post had taken place. He told a Saudi newspaper, al-Jazirah, on November 2nd that the crossing remained closed and that direct trade with Iraq remained banned. Mr Barrak said that “only the Iraqi side of the crossing had been opened”. Only religious pilgrims would be allowed to cross into the kingdom, he said. Some 23,000 Iraqi pilgrims use the crossing each year on their way to the Islamic holy cities of Mecca and Medina.

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Despite Mr Barrak’s denials, al-Jazirah itself confirmed that the crossing was used by the Saudi business delegation on their way to the Baghdad trade fair. Mr Barrak’s comments may be symptomatic of Saudi Arabia’s current inco- herent policy towards Iraq. Its inability to decide a clear line on the role of Saudi military bases in a US-led military campaign (see The political scene) appears to be replicated at the “micro” level of trade ties with its northern neighbour. Aware that some within the Pentagon believe the strategic alliance between Saudi Arabia and the US is fundamentally flawed, the kingdom is keen to play down any sense that its scepticism about Washington’s Iraq policy is leading to normalisation with Baghdad.

Iran cautiously promotes trade Iran, too, has an ambivalent relationship with Iraq. Mutual antipathy is deep with Iraq following eight years of brutal war between the two neighbours, while both countries play host to each other’s opposition groups. Yet the prospect of a US invasion of Iraq is an unsettling one for Iran, with the likelihood of US military forces being positioned to its west (in Iraq) as well as to its east (in Afghanistan), and to the south (in the Gulf states). Having been included in US President George W Bush’s “axis of evil” formulation, Iran is acutely aware that these forces could conceivably be used as the basis for “regime change” in Iran. For these reasons, and despite its antipathy towards the regime of Saddam Hussein, Iran’s leadership is keen to create at least the illusion of normalcy with its distrusted neighbour, just as some progress has been made on the issue of the mutual release of prisoners from the Iran-Iraq war in the 1980s. Consequently, in early November the Iranian commerce minister, Mohammed Shariatmadari, went to Baghdad to sign a trade pact with his Iraqi counterpart, Mohammed Mahdi Saleh. At the meeting, the two sides signed a number of agreements covering trade, agriculture, health and transport links, with the aim of raising mutual trade to US$500m. In 2001 official trade between the two countries was small enough not to register with the IMF’s Direction of Trade Statistics, although unrecorded trade, involving the smuggling of Iraqi oil in return for a variety of consumer goods, has been large. However, indicative of Iran’s need to ensure it does not antagonise the US, the illicit oil trade has been reduced of late as a result of successful maritime interdiction by Western navies operating under a UN mandate and enjoying renewed co-operation from the Iranian navy.

The cost of rebuilding Iraq Iraq’s most high-profile exiled opposition figure, Ahmed Chalabi, the leader of the Iraqi National Congress (INC), has said that the US has to be prepared to aid Iraq and reschedule its debts if Saddam Hussein is removed from power. Other- wise the risk of instability would greatly increase. “How are we supposed to feed people and develop the country with an oil revenue of US$25bn and have the money left to pay for debt and war reparations?” Mr Chalabi told reporters in London on November 6th. The leader of the INC added that a new regime would need: US$14bn annually to import food and medicine; US$8bn a year to maintain oil production at present levels; US$38bn to raise crude production levels; and several billion a year to pay for reconstruction. Undoubtedly the INC leader was talking up his own potential role as a future leader of Iraq; however, his costings and the importance of debt and relief from war reparations may well be echoed by whomever is in power after the possible conflict is over.

Country Report December 2002 www.eiu.com © The Economist Intelligence Unit Limited 2002