Country Report

Iraq

Iraq at a glance: 2006-07

OVERVIEW The new Iraqi government will struggle to make much impact on the sectarian conflict being waged for political and territorial advantage by Iraqi militias. The coalition presence is increasingly irrelevant to the struggle of these forces for control on the ground. Furthermore, the interest of provinces in retaining control over oil-related decision-making and in ensuring direct access to oil revenue will make substantive constitutional compromise difficult, although the need to clarify political and revenue arrangements may allow some room for negotiation. Although some points of agreement exist between parts of the Shia coalition and the Sunni Arab and Kurdish politicians represented in parliament, sectarian considerations are likely to prevent any major political realignment. A clear prospect of negotiated compromise will be needed if foreign Sunni insurgents are to be separated from their “host” community and more pragmatic Iraqi Sunnis from the outright rejectionists. On the assumption that some of the factors driving Sunni Arab and wider Iraqi alienation can be addressed, the level of violence should start to decline by the end of the forecast period. Oil production growth will be constrained by security problems and long-standing under-investment, but modest increases in output in 2007 will support real GDP growth.

Key changes from last month Political outlook • The Economist Intelligence Unit continues to believe that it will be difficult for either the political process or coalition withdrawals to affect the struggle for control on the ground. Economic policy outlook • We forecast that Iraq will record a fiscal deficit in 2007, as average oil prices ease, although they will remain exceptionally strong. Economic forecast • Our economic forecast is largely unchanged.

June 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 26 Red Lion Square The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road WC1R 4HQ New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7576 8000 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7576 8500 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2006 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author’s and the publisher’s ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-5502

Symbols for tables “n/a” means not available; “–” means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

Iraq 1

Contents

Iraq

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 5 Quarterly indicators

6 Outlook for 2006-07 6 Political outlook 9 Economic policy outlook 11 Economic forecast

13 The political scene

25 Economic policy

29 The domestic economy 29 Economic trends 31 Oil and gas 34 Infrastructure 34 Financial indicators

35 Foreign trade and payments

List of tables 11 International assumptions summary 12 Forecast summary 28 Status of congressional appropriation (Iraq Relief and Reconstruction Fund) 30 Consumer price inflation 32 Iraqi crude oil production and exports, 2006 36 National stock levels: refined petroleum products, 2006

List of figures 13 Gross domestic product 13 Consumer price inflation

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Iraq 3

Iraq June 2006 Summary

Outlook for 2006-07 The Iraqi government will struggle to control the sectarian conflict being waged for political and territorial advantage by Iraqi militias. The interest of provinces in retaining control over oil-related decision-making and in ensuring direct access to oil revenue will make substantive constitutional compromise difficult. The coalition presence is increasingly irrelevant to the struggle of Iraqi militias for control on the ground. However, the prospect of attaining political goals through negotiation could enable foreign Sunni insurgents to be separated from their “host” community and more pragmatic Iraqi Sunni Arab fighters from outright rejectionists. On the assumption that some of the factors driving Sunni Arab and wider Iraqi alienation can be addressed, violence should start to decline by end-2007. Oil production growth will be constrained by security problems and long-standing under-investment, but modest increases in output will support real GDP growth in 2006-07.

The political scene Iraq has formed a new government under Nouri al-Maliki. Although Mr Maliki is committed to a number of policy steps that could help to end violence in Iraq and promote support for the political process, the strength of competing interests, even within his own political coalition, will probably limit progress. A new and less partisan figure has been appointed interior minister, and the faction of Moqtada al-Sadr, a radical Shia cleric, holds five important cabinet posts. Tensions persist in Basra, where Shia factions are vying for political authority and control over smuggling interests, and tensions have increased in Kirkuk ahead of political changes expected next year.

Economic policy Specific legislation on foreign investment and pensions is being drawn up. Specific steps toward social security provision have been taken and further fuel price subsidy cuts have been considered.

The domestic economy Nominal GDP growth approached 30% in 2005, according to US estimates. A new oil minister has been appointed and faces a number of political, infra- structural and personnel challenges. A decision on the mobile-phone licences continues to be stalled. Despite increased electricity projections, supply is likely to fall short of summer demand.

Foreign trade and payments Further bilateral debt deals on Paris Club terms have been agreed, and some former Eastern bloc countries have been asked to accept the same arrangements. Editors: Neil Partrick (editor); Hania Farhan (consulting editor) Editorial closing date: June 12th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 4 Iraq

Political structure

The current cabinet was appointed in May 2006, following elections for the Council of Representatives (national assembly) in December 2005. The prime minister and cabinet have executive authority, whereas the positions of president and two vice-presidents, who make up the presidential council, are largely ceremonial

Main political parties and The main Shia Arab-led parties are the Supreme Council for the Islamic Revolution in Iraq armed factions (SCIRI); Islamic Dawa; Islamic Dawa-Iraq Organisation; Movement of the Islamic Dawa Party (Martyr Izz al-Din Salim wing); Islamic al-Fadeela (virtue) Party; and (Iraqi) Hizbullah. Moqtada al-Sadr has a loose-knit faction entitled Jamiaat Sadr al-Thani. Kurdish “secular” parties include the Kurdistan Democratic Party (KDP) and the Patriotic Union of Kurdistan (PUK), and there is also a Kurdistan Islamic Union. Among the Sunni Arab Islamist groupings are Tawafuq (the Concordance Front), including the Iraqi Islamic Party (part of the Muslim Brotherhood); Hewar (the National Dialogue Front); and the Iraqi United National Movement. The Sunni clerical bodies, the General Conference (Endowment) and the Association of Muslim Scholars, have a national political function too. Among the representatives of other minorities are the Iraqi Turkman Front and Assyrian Democratic Movement. Parties with a less sectarian identification include the Iraqi National Congress; the Iraqi National Accord; Free Officers; the Iraqi Communist Party; Iraqi Independent Democrats; and the Baath Party. In addition to these more coherent parties, Sunni Arab insurgent groups include the Islamic Army; Jaish Mohammed; Saddam’s Fedayeen; and al-Awdah. Kurdish Islamist militias include Ansar al-Islam and Ansar al-Sunnah. Among the identifiably foreign Islamist groups present are al-Qaida in Iraq and the Tawhid and Jihad organisation President Jalal Talabani Vice-presidents Adel-Abdul Mahdi Tareq al-Hashimi Prime minister Nouri al-Maliki Deputy prime ministers Barham Saleh Salam al-Zuba’i

Key ministers Agriculture Yarub al-Abudi Communications Mohammed Allawi Defence Abdul-Qader al-Mifraji Education Khudair al-Khuza’i Electricity Karim Wahid Finance Bayan Jabr Foreign affairs Hoshyar Zebari Health Ali al-Shimari Higher education Abd Dhiab Industry & minerals Fawzi al-Hariri Interior Jawad Polani Justice Hashim al-Shibli Labour & social affairs Mohammed al-Radi Municipalities & public works Riad Gharib Oil Hussein Sharistani Planning & development co-operation Ali Baban Trade Abdul Fatah al-Sudani

Central Bank governor Sinan al-Shabibi

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 5

Economic structure

Annual indicators 2001a 2002a 2003 a 2004 a 2005a GDP (US$ bn) 18.9 19.0 12.7 25.5 30.6 Real GDP growth (%) -8.2 -14.2 -35.3 46.5 -3.0 Consumer price inflation (av; %) 16.4 26.3 36.3 31.7 33.0 Population (m) 25.8 26.6 27.3 28.1 28.8 Exports of goods fob (US$ m) 16,457.0 12,218.8b 9,711.1 b 16,863.0 b 24,027.2 Imports of goods fob (US$ m) 11,152.0 9,817.3b 9,933.5 b 21,302.3 b 23,432.5 Current-account balance (US$ m) 1,786.1 -807.8b -934.5 b -12,218.3 b -6,505.3 Total external debt (US$ bn) 111.8 112.5 111.1 102.2 92.3c Debt-service ratio, paid (%) 0.0b 0.0b 0.0 b 1.1 0.0 Exchange rate (av) NID:US$ 1,928.750b 1,956.500b 1,936.000 b 1,452.833 b 1,468.583 a Economist Intelligence Unit estimates. b Actual. c Economist Intelligence Unit forecasts.

Main destinations of exports 2005a % of total Main origins of imports 2005a % of total US 49.4 Jordan 12.0 Canada 13.5 Vietnam 5.1 Italy 12.6 USA 20.9 Jordan 19.7 Turkey 22.3 a Derived from partners’ trade returns; subject to a wide margin of error.

Quarterly indicators

2004 2005 2006 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Sectoral trends Crude oil production (m barrels/day)a 2.07 1.82 1.90 1.80 1.82 1.96 1.68 1.72 Crude oil spot prices, Kirkuk-37 (US$/barrel) 31.49 36.47 35.69 40.83 45.02 54.96 50.34 54.83 Crude oil spot prices, Brent (US$/barrel) 35.32 41.54 43.85 47.62 51.63 61.63 56.87 61.79 Foreign trade (US$ m)b Exports fob 4,235 3,807 4,484 3,513 4,419 5,033 5,039 n/a Imports fob -2,929 -2,638 -2,446 -2,803 -3,536 -3,405 -3,141 n/a Trade balance 1,306 1,169 2,038 710 883 1,627 1,898 n/a Exchange ratec NID:US$ (av) 1,457 1,464 1,460 1,460 1,460 1,475 1,473 1,478 NID:US$ (end-period) 1,463 1,463 1,460 1,460 1,460 1,475 1,475 1,476 a Estimates. b DOTS estimates c Central Bank of Iraq. Sources: International Energy Agency, Monthly Oil Market Report; Oil Market Intelligence; IMF, Direction of Trade Statistics; Central Bank of Iraq.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 6 Iraq

Outlook for 2006-07

Political outlook

Domestic politics The Economist Intelligence Unit expects Iraq to remain fundamentally unstable throughout the forecast period, although there should be sufficient common interest to prevent the formal break-up of the country or a full-blown civil war. A political process centred on Baghdad will remain important to the political representatives of the Shia, the Kurds and the Sunni Arabs, despite the weakness of the Iraqi state and the de facto power of local factional, clerical and tribal leaderships on the ground, often underpinned by their respective militias rather than the Iraqi army. Political violence is increasingly being seen as instrumental in furthering sectarian interests, and attacks on coalition forces carry wide support in both the Shia and the Sunni Arab communities. The political process centred on Baghdad will struggle to agree on issues crucial to a reining in of violence, such as oil policy, government revenue distribution and the future political structure of the country. Militia violence, both Shia and Sunni, is increasingly pervasive, although Iraq’s Sunni Arabs continue to present the greatest challenge to any attempt to constrain the insurgency. At present, this community’s more representative political trends are outside the formal process. If, however, the formal structures of power and the redistribution of government revenue could more effectively accommodate their interests, this could begin to change, although not without compromising the demands of at least some representatives of the majority Shia Arabs. It may, though, already be too late for a reduction in the number of coalition troops to have an impact on the legitimacy of the political process. Although coalition forces are especially loathed by Sunni Arabs, who feel politically “dispossessed”, their primary security role is increasingly irrelevant to the militia-based conflict between Shia and Sunni Arab groups. The timetable recently outlined by the new prime minister, Nouri al-Maliki, for the with- drawal of foreign troops, if adhered to, would help local leaders isolate foreign jihadis in Sunni areas and could increase political stability in some Shia areas too. However, with sectarian militias in effect fighting for advantage in advance of coalition troop withdrawals, regular Iraqi armed forces and police units are likely to continue to be dominated by the sectarian militia units that prevail locally, regardless of the professed objectives of Mr Maliki. Although the newly formed government is relatively broad-based, the Shia majority, and in particular the Shia Islamist coalition, the United Iraqi Alliance (UIA), retains the main levers of power. This is partly because of residual tensions from the sectarian rule of the former regime and the polarisation of interests since it was overthrown in 2003, but it also reflects the competition among sectarian-based factions to “defend” their respective communities. Although the formal political process will reflect these interests, at the same time a brutal assertion of political power in a violent struggle for control on the

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 7

ground is likely to continue as a way of settling political scores or advancing political agendas. The Kurds, like Sunni Arab political representatives, are wary of the political and social agendas of the Shia Islamists. However, support among some trends within the UIA for a relatively centralised political model that could place oil- rich Kirkuk off-limits to the Kurds and challenge the regionalist ambitions of some southern Shia politicians is also shared by Sunni Arab leaders. The lack of a clear basis for an alternative to the current UIA-dominated government, though, means that, despite their differences, the parties within the UIA are, ultimately, likely to defend Shia interests and not align with other sectarian- based groupings. For its part, the US will try to encourage compromises that will remove the more provocative aspects of the government, especially in the eyes of Sunni Arabs. However, the US’s extensive role in the deliberations that produced last year’s provisional constitution, and the attachment that some Shia as well as the Kurdish leadership have to its federalist provisions, mean that a dramatic shift towards a more centralised system, even one contained within “Arab” Iraq, as favoured by Sunni Arabs as well as some Shia representatives, is unlikely. The other key area of dispute, the de-Baathification process, will continue to be viewed by Sunni Arabs as a means to punish their community. In practice, though, the constitution’s federalist clauses have yet to be properly clarified, especially as they apply to oil policy and revenue streams. This could provide room for a compromise that would appeal to both Sunni Arabs and the more centralist trends within the UIA, including the Dawa party of Mr Maliki and the powerful, armed faction run by Moqtada al-Sadr, a radical Shia cleric. At the same time, Mr Maliki has suggested that he will soften the relatively punitive form of de-Baathification that has been applied thus far. However, in the Shia and Kurdish areas, where provincial governments already exercise considerable influence, it will be hard for the government in Baghdad to centralise control of the oil sector, and in practice Shia opposition could make any major reining in of the de-Baathification process difficult. Compounding the political problem of agreeing constitutional changes that would in effect re-centralise power are the key political dynamics being played out on the ground in the face of a weak state and of militia authority, reinforced by violence. As a result, even if Sunni Arab political representatives were able to secure policies favoured by their community, their ability to weaken insurgent violence would probably be limited. Further steps to isolate foreign insurgents are possible, but if Iraqi Sunni Arabs are to make decisive moves against sectarian violence, whether by foreigners or Iraqis, they will need to be convinced that they can achieve their political goals via a political process dominated by the Shia. Problematically, Iraq’s Sunni Arab militants are diffuse and grouped locally. They frequently have ex-regime connections and often espouse highly sectarian and militant Islamist beliefs. Sunni Arab political representatives are not the insurgents’ “political wing”, even though some have connections to them.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 8 Iraq

Although any rapid coalition moves to leave Iraq would be highly risky, a clear series of steps, including a withdrawal from urban areas and a reduction of troop numbers, would have the benefit of separating currently co-operative insurgent trends. Iraq’s Sunni Arab insurgents, who currently use the presence of coalition forces as a “recruiting sergeant”, would otherwise struggle to find common ground among themselves. More difficult for the US is the fact that such an approach would also require firmly ruling out long-term ambitions to maintain control of Iraqi military bases. Periodic clashes between coalition troops and Shia militias also emphasise the potential for the presence of these troops to become more of an issue for “mainstream” Shia leaders, something that Mr Maliki has articulated in his timetable for coalition departure. However, the political “prize” for Sunni and Shia Arab militants of a reduced coalition presence will not encourage them to come to terms with Shia and Kurdish factions perceived as having “collaborated” with the US. Instead, it will probably be presented as a victory for the armed option and could even encourage some Iraqi insurgent groups to believe that they could seize power in Baghdad. In reality Iraq’s nascent armed forces and political structures are proving to be little more than vehicles for sectarian and often violent interests. For those who are prepared to compromise politically, however, a timetable for coalition withdrawal would give more credence to the political process based in Baghdad. For those who are using militias to advance factional competition or financial objectives, a coalition troop drawdown may not materially change the scale of conflict and political tension. Furthermore, political compromises in the Green Zone and US-led troop withdrawals will not address many of the features of a weak state during the forecast period, and they run the risk of compounding the problem. Militia politics are likely to continue to dominate events within many provinces. Any formal agreements in Baghdad defining both the authority and the territorial and political limits of the “federated regions” would be constrained in practice by the power of forces on the ground. These will curb the writ of the state! whether centralised or ostensibly federally devolved!for some time to come. With local, and frequently contested, authority structures, the insecurity created by criminal as well as politically motivated violence will remain a feature both in the predominantly Sunni Arab parts and, to a degree, in the mostly Shia areas. In flashpoints such as the contested cities of Mosul and Kurdish-claimed Kirkuk, this will probably continue to cause periodic conflict. In the case of Kirkuk, the recently reinforced commitment to resolve its territorial status over the next year or so will continue to threaten further political fallout in Baghdad and violence in Kirkuk itself. The role of Iran in aiding anti- as well as pro- government Shia factions, and the unwillingness of Syria and Saudi Arabia to do more to prevent the entry into Iraq of foreign Sunni insurgents, is unlikely to change significantly during the forecast period, given the internal and strategic factors motivating these countries’ approach to Iraq. Although we believe that by end-2007 violence will continue to be a characteristic feature of daily life in most parts of the country, its scale is expected to begin to ease as political compromises over oil issues start to

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 9

assuage Sunni Arab anger and disunity among Sunni Arab insurgents increases as coalition troops depart. Efforts to reach a more durable political accom- modation, however, will remain subject to constant challenge by a variety of local interests, whether related to the insurgency or to assertions of authority on the ground, often in contested cities or traditionally disadvantaged provinces. Should the political process fail to engender sufficient compromise to enable the nascent institutions to begin to acquire legitimacy, then sectarian violence will grow even stronger, and the de facto separation of large parts of the country from the centre will deepen the independence of local fiefdoms in which neighbouring countries have a greater influence and presence than they do at present. In such a situation the coalition role would become untenable, and the threat of instability spreading to Iraq’s neighbours in the region would grow enormously.

International relations There is little that the Iraqi government can do to encourage greater co-operation from other countries in policing their side of the border. All neigh- bouring Arab governments feel under threat from the shift to majority Shia authority in Iraq. Syria and Iran view developments on the ground as a potential political lever to offset US threats to them, and the former continues to be viewed by the Iraqi government as instrumental in the funding and backing of Sunni insurgents in Iraq. However, attempts by the Iraqi government at political engagement with its majority Sunni Arab neighbours will continue. At the same time, a Shia-led government in Baghdad, despite long-standing national disputes and the potential, seen in mid-January, for localised border tensions, will remain close to majority Shia Iran. Grand bargains that address the diffuse interests of Iraq’s neighbours, including Iran and Syria, and provide rewards for practical concessions that benefit Iraqi stability, will be almost impossible without direct US involvement, a prospect that remains remote, save for the most limited bilateral discussions.

Economic policy outlook

Policy trends Iraq’s primary economic objective will be to increase oil output on a sus- tainable basis from the 2005 average of around 1.8m barrels/day (b/d) to the claimed capacity level of 2.5m b/d. This target is looking increasingly unrealistic. Output in May 2006 was 1.9m b/d, and exports are estimated to have been around 1.4m b/d. Although output has improved compared with the first quarter, when average production was 1.7m b/d, it is constantly subject to sabotage and practical problems, not least capacity constraints. Achieving the formal target, and more, will be crucial if the government is to generate the funds necessary to achieve the politically vital goal of ensuring the stable provision and expansion of basic services. Oil production should gradually increase over the forecast period, although the pick-up is likely to be much slower than the government hopes, given ongoing security problems. Continued instability will also deter the capital spending necessary to boost productive capacity over the longer term. The liquidation of some loss-making state-owned (non-oil) enterprises and the full privatisation of profitable

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 10 Iraq

companies, together with a comprehensive reduction of price subsidies, are unlikely until 2007 at the earliest.

Fiscal policy We forecast that fiscal revenue (including grants) will rise by over 45% in 2006. Although oil production is expected to be virtually flat, we project that average oil prices will jump by 28% this year. However, revenue is forecast to fall by 4% in 2007, as oil output rises only modestly and average oil prices decline by around 6%. We remain sceptical about government figures that imply that total expenditure fell by around 40% in 2005, and have assumed a smaller decline despite the limited absorptive capacity of the economy. However, notwith- standing the economy’s ongoing absorption problems, we expect government spending growth over the forecast period to be driven up by the pressure to reduce political and social tensions by expanding public-sector employment and other spending. As a result, we project that expenditure will rise by around 10% a year in 2006-07. The upward pressure on spending will be sustained largely by the maintenance of subsidies, which, given political sensitivities, are unlikely to be cut substantially in the near future, despite government commit- ments to do so. Overall, we forecast that this will leave the government with a surplus of around US$1.4bn (4% of GDP) in 2006. We assume that this will be mostly absorbed through additional expenditure in 2007. A budget deficit approaching US$3bn is expected in 2007, largely because of the decline in oil prices. It is assumed that financing of the deficit will be provided by foreign assets transferred to the Development Fund for Iraq held in New York, where Iraq’s oil revenue is held. Should political circumstances improve more markedly than currently appears likely, a much larger deficit would occur (under current oil price and output assumptions), as spending could increase more strongly.

Monetary policy The parlous state of the Iraqi banking sector, and of the economy in general, renders the pursuit of an effective monetary policy very difficult. However, the Central Bank of Iraq (CBI) has sought to manage liquidity in the economy more effectively through the introduction of an interbank market, a basic lending (or “policy”) rate, minimum reserve requirements, a daily currency auction and a government securities market. The CBI continues to see stability of the New Iraqi dinar against the US dollar as a major policy objective, and hopes that this will also play its part in maintaining domestic price stability. Recent pressure on the currency has led to a rise in interest rates, and the CBI may have to increase rates further (primarily using the dinar deposit facility) to stem pressure on the currency. The efficacy of monetary policy is further compromised by the high rate of dollarisation in the economy, exacerbated by the US (and, to a lesser extent, other donors) paying contractors and employees in US dollars.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 11

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.6 4.9 4.9 4.3 US 4.2 3.5 3.1 2.4 EU25 2.4 1.7 2.3 2.1 Exchange rates ¥:US$ 108.1 110.1 109.2 98.5 US$:€ 1.244 1.245 1.296 1.390 SDR:US$ 0.675 0.677 0.665 0.635 Financial indicators ¥ 2-month private bill rate 0.00 0.00 0.25 0.58 US$ 3-month commercial paper rate 1.48 3.49 5.24 4.88 Commodity prices Oil (Brent; US$/b) 38.5 54.7 70.0 66.0 Total non-oil commodities (% change in US$ terms) 13.5 4.2 11.2 -10.9 Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.5 4.0 -4.2 Industrial raw materials (% change in US$ terms) 21.0 10.5 20.0 -17.9 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. World GDP growth (measured using purchasing power parity exchange rates) is expected to slow from 4.9% in 2005 to an average of around 4.6% over the forecast period. These projections are based on a return to trend levels of growth within the OECD, following the US boom in 2004. We expect inter- national oil prices to rise sharply in 2006, and have raised our forecast for the average price of the benchmark dated Brent Blend to US$70/barrel, reflecting the tightness of the international market and continued geopolitical concerns, particularly regarding Iran’s nuclear ambitions. We expect these circumstances to ease only modestly in 2007, when we forecast that oil prices will fall only slightly, to US$66/b.

Economic growth Given ongoing security problems in 2006, we expect that oil output will rise only marginally, that revenue will be significantly absorbed by security costs and corruption, and that the non-oil sector will continue to be constrained by insecurity and the slow pace of reconstruction and fund disbursement. As a result, we forecast that real GDP growth in 2006 will be little more than 1%. This will pick up to around 4% in 2007 as oil output, on average, rises more firmly. If the security situation deteriorates further, then even the modest projected increases in oil output will not be possible, and the non-oil sector will also suffer.

Inflation We forecast that the average rate of inflation will be almost 30% in 2006-07, close to estimates for 2005. The modest easing since 2004 largely reflects the improved availability of traded goods and the relative sluggishness of private consumption growth, given high levels of unemployment. We also expect the government to maintain much of its system of subsidies over the forecast period, despite the possibility of some partial reductions (which would lead to

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 12 Iraq

greater inflationary pressures). The weak US dollar will also boost the local- currency price of some imported goods, although this will be partly offset by the expected decline in non-oil commodity prices.

Exchange rates The CBI is committed to maintaining what has become a de facto peg to the US dollar. With the apparent resort to foreign-exchange “rationing” (under other guises) in some instances in the CBI’s daily currency auctions, the average official rate has not fluctuated much below NID1,475:US$1 since the third quarter of 2005. The Central Bank however appears reluctant to use its large accumulated gross foreign-exchange reserves (of an estimated US$9.1bn at end- 2005) to satisfy dollar demand, and, although it is prepared to raise local- currency interest rates to stem the pressure on the dinar, there are likely to be limitations on its willingness and ability to use this as a monetary policy tool. Given the present security situation, we expect pressure on the currency to remain high, although CBI intervention should help to maintain a relatively stable rate of around NID1,475:US$1 in 2006-07.

External sector In 2006 oil revenue will increase in line with the rise in average prices. We forecast a 38% increase in total export revenue to about US$33bn, from about US$24bn in 2005. Export earnings will fall by about 3% in 2007, to around US$32bn, however, as a 4% rise in oil output is offset by a 6% drop in oil prices. Import spending will continue to expand in line with reconstruction needs and slowly strengthening domestic consumption, but the pace of growth is expected to ease to an annual average of around 3% in 2006-07. Security and institutional constraints will also act as a curb on the rate of growth, although the total import bill will still rise to around US$24bn in 2006 and US$25bn in 2007. The trade surplus will therefore widen to US$9bn in 2006, before contracting to around US$7.3bn in 2007. The services deficit will widen largely in line with import growth and other services related to reconstruction. The income deficit (including interest accrued, deferred and capitalised) will contract only slightly, from US$5.1bn in 2005 to US$4.9bn in 2007, partly reflecting a decline in oil-related foreign company profit repatriation. At the same time increases in transfers inflows should mostly offset the rise in income debits. (Non-merchandise flows will continue to be subject to the impact of the unstable security situation on oil profit repatriation and aid disbursement.) Overall, the current account should record a surplus of around US$2.5bn (7% of GDP) in 2006, which will narrow to around US$1bn (3% of GDP) in 2007. These movements in the country’s external account are highly dependent on trends in oil output and prices, as oil earnings account for over 98% of total export receipts.

Forecast summary (% unless otherwise indicated) 2004 a 2005 a 2006b 2007b Real GDP growth 46.5 -3.0 1.3 4.1 Consumer price inflation (av) 31.7 33.0 30.0 25.0 Oil production (‘000 b/d; av) 1,974 c 1,816 1,878 1,953 Exports of goods fob (US$ bn) 16.9 c 24.0 33.2 32.2 Imports of goods fob (US$ bn) 21.3 c 23.4 24.1 25.0

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 13

Forecast summary (% unless otherwise indicated) 2004 a 2005 a 2006b 2007b Current-account balance (US$ bn) -12.2 c -6.5 2.5 1.0 Current-account balance (% of GDP) -47.8 -21.2 6.8 2.8 Exchange rate (av) NID:US$ 1,453 1,469 1,477 1,470 External debt (year-end; US$ bn) 102.2 b 92.3 b 91.6 70.4 a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Iraq Middle East & North Africa Iraq Middle East & North Africa 50 40 40 35 30 30 20 25 10 20 0 15 -10 -20 10 -30 5 -40 0 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

The political scene

New premier appointment The appointment of Nouri al-Maliki as prime minister in late April finally

breaks political logjam ended the political stalemate that had prevented the formation of a new government. A new, albeit incomplete, Iraqi government was put in place in late May, more than five months after elections were held to the national assembly. Mr Maliki is a senior figure in the Shia Islamist party, Dawa, drawn from the same wing as his predecessor as prime minister, Ibrahim Jaafari. Discontent with Mr Jaafari among Kurdish as well as Sunni Arab MPs had created stalemate, as the disparate elements of the largely Shia Islamist coalition, the United Iraqi Alliance (UIA), maintained their support for the incumbent on the basis that no other candidate was agreeable to all of them. However, eventually Mr Maliki emerged, along with Ali al-Deeb, a long time aide of Mr Jaafari, as the main candidates in UIA deliberations to find an alternative prime minister who would be acceptable to all the main political groupings. Although the strength of the two wings of Dawa, together with the MPs loyal to Moqtada al-Sadr, an Islamist radical, were sufficient to ensure that a Dawa member would be chosen as prime minister, the ability of its main rival, the Supreme Council for the Islamic Revolution in Iraq (SCIRI), to ally with the large number of independents in the UIA meant that the new Dawa prime minister had to also secure the backing of SCIRI. As a result his political room for manoeuvre will be more or less as constrained as his predecessor. More positively, Mr Maliki attracted support on the basis that his personal style, judged more managerial than the intellectual preoccupations of Mr Jaafari and

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 14 Iraq

proven in constitutional negotiations in which he even won the admiration of political adversaries, could be more conducive to political progress than that of his Dawa rival.

Security ministers appointed Although what eventually became a 40-person cabinet did not initially include definitive appointments to the key posts of interior and defence minister, and the additional post of minister of state for national security, these positions were agreed two weeks later. According to local sources, the deal involved considerable brinkmanship over the interior ministry slot. The position of defence minister was awarded to a senior military figure, General Abdel-Qader al-Mifarji, a Sunni Arab who had occupied a mid-ranking position in the Iraqi army prior to being imprisoned in the 1990s, and then took over the fledgling New Iraqi Army founded in 2003. Like his predecessor, Saadoun Duleimi, General Mifarji is non-aligned in political terms. His appointment reflected the understanding that the increased strength of Sunni Arab representatives in the parliament necessitated that, in addition to holding one of now only two deputy prime minister posts, they should retain the defence portfolio. Having a Sunni Arab occupant of the position has reflected hopes that this could encourage Sunni Arab insurgents who were military officers in the former regime to be drawn into supporting the new government. In contrast, ever since the formation of the interim government a year earlier, the Ministry of the Interior had functioned as a controversial fiefdom of SCIRI’s Bayan Jabr al-Solagh. He is seen by the US, as well as by Sunni Arabs, as having overseen its transformation from a body that the former prime minister, Ayad Allawi, had used to incorporate members of the former regime’s intelligence service, to one that functioned as a means for SCIRI’s Badr Brigade to use, through the official guise of its national police units, as a vehicle for sectarian attacks. Thus it was expected that, for presentational purposes, a non-aligned Shia would have to be appointed in Mr Solagh’s stead. In the event, the post was given to Jawad Polani, a figure widely seen in Iraq as being more a political opportunist than ideologically aligned, and who, having sided with the former deputy prime minister, and one-time key US ally, Ahmed Chalabi, had manoeuvred himself close to the prime minister, Mr Maliki.

Interior ministry reform Mr Polani’s appointment, delivered, reportedly, as an ultimatum by the prime

proposed, but unlikely minister to the SCIRI leader, Abdel-Aziz al-Hakim, in the form of a threat to resign if the latter vetoed it, is not likely to herald immediate changes at the controversial interior ministry. Mr Polani lacks a political base, other than a connection to the premier and his supporters in the Dawa party. This both made him an acceptable appointment and seemingly makes him unlikely to be able to conduct deep-seated reforms to the ministry. The issue therefore becomes a matter of what the UIA might agree within its ranks, and it appears unlikely that SCIRI would agree to any prospective decision by the prime minister to move against the Badr Brigade. The latter penetrate the ministry’s organisation, populate many of its forces and are seen by ordinary Shia as a self-defence mechanism against the Sunni Arab-led insurgency. As such, there is a view that, although some of the Badr Brigade’s activities have been gruesome, the call for the Shia community to protect itself has been sanctioned by no less

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 15

an authority than the most senior Shia cleric, Grand Ayatollah Ali Sistani, and that in the current environment there is little alternative. Similarly, the Kurds have never been prepared to disarm their peshmerga forces, who maintain a distinct organisation within the Iraqi army and are exclusively responsible for defending Iraqi Kurdistan. Although this argument disregards the wider consequences of militia organisation!and of the politically partisan interests that SCIRI, for example, has in being in the frontline of Shia defence!it emphasises the obstacles at stake in any major reform of the ministry and the wider militia system, for all that Mr Maliki has stated his intention to do so.

Iraqi interior ministry a As well as the fact that the prime minister needed the support of the UIA and

frontline in Iran-US tensions the Kurds for his nomination, there are wider factors constraining any clampdown on militias, and in particular the organisation of the interior ministry. The close political, financial and military relationship between the Badr Brigade and Iran, and the US’s willingness, albeit lukewarm, to conduct a dialogue with Iran on Iraq (and its more recent preparedness to join international talks with Iran over its nuclear programme) have emphasised the international interests at stake in any move to reform the interior ministry. Iran is perceived by a number of Shia (in addition to Sunnis) as viewing the interior ministry in Iraq as, in effect, its own organisation. Thus Mr Maliki, whose own Dawa party is reportedly partly funded, like all the main Shia organisations, by Iran, may well consider that he is powerless to reform it for regional, as well as domestic reasons. The other appointment agreed at the same time was that of another Shia, Shirwan al-Waily, to the post of minister of state for national security. This position is at present, however, only theoretically important. When, and if, Iraq’s National Security Council (NSC), an 18-man body of top political representatives that includes Mr Waily, takes on a more meaningful role, this may change. At present the national security advisor to the prime minister, Muwafaq al-Rubaie, has rather more clout. If the NSC is able to co-ordinate its positions in a meaningful fashion, it may be that the ministerial post, intended as the formal link to the cabinet, will be of more substance. At present it functions like the other nine minister of state cabinet positions do, lacking a ministerial base and offering the reward of a title to political factions who need to be accommodated. In this case the position of minister for national security has been identified as “belonging” to the other, smaller, wing of the Dawa party, the so-called Iraq branch. In terms of the overall composition of the 40-member cabinet, the UIA unsurprisingly dominates, holding a total of 19 posts, which is arithmetically consistent with the strength of the Shia alliance in the national assembly. Although SCIRI captured nearly a quarter of UIA seats, they only hold the finance portfolio, which went to Bayan Jabr, out of the 32 full ministerial posts in the cabinet (in addition to one of the two vice-presidential slots). A similar pattern is evident with Dawa, which aside from the all-important position of prime minister, does not hold a full ministerial position. Mr Sadr’s faction, with whom Dawa have aligned, have taken five full ministerial positions, up from the two held in the previous government, including the important posts of health and education.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 16 Iraq

Political positions carved up Following the pattern of the interim government, the three main on sectarian lines ethnic/sectarian groups in Iraq!Shia Arabs, Sunni Arabs and Kurds!have ensured that the positions of prime minister and the two deputy prime ministers are distributed between them, as they have with the presidency and the two vice-president positions. The political agreement on the nomination of Mr Maliki as prime minister enabled the formal procedure to be followed in late April whereby the president invites the agreed prime minister to form his government. This invitation first required that the president and his two deputies be appointed. To little surprise, the presidency once again fell to the Kurdish leader, Jalal Talabani. The obligation on SCIRI to accept that it could not have its nominee as prime minister ensured that Adel-Abdul Mahdi was re-nominated as a vice-president, with a Sunni Arab representative, Tareq al-Hashimi, given the other vice-presidential slot. The latter appointment reflected the strength of political representation secured by Tawafuq, the leading Sunni Arab group in the assembly (March 2006, The political scene). This ensured that Mr Hashimi, the leader of the Muslim Brotherhood, a dominant trend within Tawafuq, took the slot from Ghazi al-Yawer, a tribal leader. Similarly, Salam Zubayi, another Tawafuq official, was made one of the two deputy prime ministers. This sectarian dividing up of titles was to once again be repeated in the appointments of speaker and two deputy speakers of the national assembly. In keeping with the constitutionally-prescribed formula this, by a few hours at least, preceded the appointment of the presidential positions, and saw the choice of another Tawafuq figure, Mahmoud Mashadani, as speaker, replacing a former Brotherhood member, Hajim al-Hassani. Sheikh Khalid Abu-Dharr al-Attiyah, a Shia Arab, was given the position of first deputy speaker, and Arif Tayfur, a Kurd, was appointed second deputy speaker.

Speaker may become a The position of national assembly speaker is patently the least significant of the Sunni Arab slot formal senior titles, although Mr Mashadani seems intent on maximising its weight. Upon his appointment he announced his intention that, after agreeing its regulations, the assembly will focus on reviewing the constitution, as had been previously discussed in order to accommodate Sunni Arab opinion, in particular. Despite actually accruing more seats in the assembly than Kurdish representatives, Sunni Arabs may be settling for a slot that is identifiably third in the formal Iraqi pecking order. The presidency is currently occupied by a Kurdish leader, and the majority Shia Arabs seem set to retain the position of prime minister for the foreseeable future. There is patently more than an echo of Lebanese institutionalised confessionalism about the evolving Iraqi leadership structure, with some additional similarity in terms of the seniority of positions occupied by ethnicity/sect not being matched by actual population size. However, the Iraqi distribution of the “spoils” is not written into the constitution. Furthermore, the current division of power to the disadvantage of the Sunni Arabs may last no longer than the ongoing alliance between the Shia and the Kurds, which has enabled the latter to secure the presidency for at least the next four years. Another factor in the formal distribution of posts in Iraq has been the withdrawal of support from the government by the other Sunni Arab political

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 17

trend represented in parliament, Hewar, or the National Dialogue Front, a more identifiably secular Iraqi nationalist body led by Salah al-Mutlak. The backing of Tawafuq, the dominant Sunni Arab bloc, helped ensure an overwhelming majority for the new government, however, which in formal terms only required approval by a two-thirds majority. Although it was originally expected that Hewar would be awarded three, albeit minor, posts, Mr Mutlak greeted the announcement of the new government in late May by leading a walkout of 15 MPs, on the basis that the three security-related posts in the cabinet had not been decided upon. As a result the Hewar faction has been excluded from the cabinet and their allocation has largely been redistributed among Tawafuq, giving them six seats in all. Sunni Arab representatives have only secured one of the major portfolios, defence, although the planning and culture ministries could develop more importance when the political and security environment stabilises in Iraq.

Death of Mr Zarqawi could The death of Abu Musab al-Zarqawi, the leader of the self-styled al-Qaida in

create political momentum Iraq (AQI) group, in early June, apparently as a result of a US air strike, has resulted in intense speculation about what the impact may be on the insurgency. The US-led coalition apparently saw Mr Zarqawi as its primary target in Iraq and viewed his organisation as the most damaging. It continued to hold AQI responsible for virtually all suicide attacks in the country and regarded him as a prime mover in efforts to stoke up a sectarian conflict in Iraq. Although a new head, Abu-Hamza Muhajir, who is also assumed to be a foreign Arab, has been appointed in his stead, there is the possibility that the tactical approach of the organisation will begin to change. Last year, Mr Zarqawi was criticised by Iraqi insurgents from other organisations for his commitment to attacks on Iraqi Shia, with Iraqi Islamists condemning his willingness to attack fellow Iraqis whether they had a direct connection to the “occupation” or not (December 2005, The political scene). As some of those who criticised his tactics included both Iraqi and foreign jihadis, not least the second most senior figure in al-Qaida internationally, Ayman al-Zawahiri, then it can be assumed that there are those within AQI itself who may be prepared to take this opportunity to change tactics. On the other hand a loose body consisting of an amalgam of cells is, by definition, unable to enforce a rigorous top-down decision-making structure, and so sectarian killings by those connected to the AQI are likely to continue. However, there is a perceptible difference between targeting the military or police and the random killing of Shia out of ideological and tactical conviction.

Zarqawi group seen as block The US Defence Department issued its latest quarterly report, entitled

to negotiations “Measuring Stability and Security in Iraq”, to the US Congress in late May. The report sees AQI as pivotal in the creation of an atmosphere where the Sunni Arab insurgency is effectively held captive by a group dominated by foreign insurgents whose violence has political objectives outside of Iraq. These include challenging the US and Middle East regimes, but such a group appears to have little interest in advancing Sunni Arab interests per se inside the country. The report says that the violence conducted by the AQI was constraining the possibility of bringing Iraqi Sunni Arab insurgents into a negotiating process, identifying the attacks on politicians and their families who have sought to do

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 18 Iraq

so. However, this ignores the large number of Iraqi jihadis not involved with AQI who are also prepared to kill Sunni Arab politicians for co-operating in the political process. In April two members of the family of Mr Hashemi, the leader of Iraq’s Muslim Brotherhood party, and one of the two Iraqi vice-presidents, were killed, in what appeared to be attempts to intimidate him out of promoting dialogue; such attacks are not the exclusive preserve of AQI. However, it is notable that there are voices among both Shia and Sunni Arabs who view the death of Mr Zarqawi as encouraging a shift in the strategy of those dubbed Iraqi Sunni Arab “rejectionists”, given the community’s discontent with his tactics and his blatant disregard for criticism from fellow insurgents. Whether this occurs or not will partly depend on whether the new Iraqi government sees any indication of greater willingness among Iraqi jihadis, either in or outside AQI, to give space for fresh attempts at dialogue, or any signs of increased tensions between Iraqi insurgents, of which there have been periodic reports. The latter can occur among ideological disputants, whose theoretical differences can overlap with political strategy, as seen in reports of clashes at a Muslim shrine in Fallujah in early June between salafi (hardline puritanical Sunni Islamists) and non-salafi Iraqi jihadis.

Iraqis resent foreign insurgents Foreign insurgents cannot operate in Iraq without local “hosts”. Yet AQI has attracted considerable opprobrium. Earlier this year hostility to the AQI in effect served the government and the coalition’s purpose by encouraging co-operation by tribal figures with official forces in removing AQI fighters from Ramadi. In general, Sunni Arab leaders, including those willing to take up national or regional political office, are unwilling to work with coalition forces and view them with enormous mistrust owing to a mixture of personal and political motives. However, there is widespread hostility among Iraqis, Sunni Arabs included, towards attacks on regular Iraqi police and army units, which is com- pounding the frustration with the tactics of many insurgents, Iraqis or foreigners. It was notable that Mr Zarqawi was killed near the town of Baqubah in the mixed province of Diyala to the north and east of Baghdad, after having been obliged to depart the virtually exclusively Sunni Arab province of Anbar, where much of the insurgency has been conducted and which has proven the most resistant to the political transition in Iraq. Furthermore, he appears to have been intercepted as the result of intelligence provided by local Iraqis, including, by a number of accounts, a source from within his own circle, suggesting that removing him from the insurgency, rather than ending it, may have been the intent. Although not confirmed by the US or Iraqi authorities, it also appears that Jordanian intelligence played a role in pinpointing Mr Zarqawi’s whereabouts, drawing on their own contacts among Iraqi Sunnis, in Anbar and beyond.

Sunni Arab ministers could Time will tell whether some of the Sunni Arab figures incorporated in the new

connect with insurgents government can serve as a conduit for efforts to engage with the insurgency. At present there are elements within Tawafuq who have links to some insurgent groups, and the mainstream Muslim Brotherhood trend supports the right of resistance against the coalition’s “occupation”. More problematically, the influential Association of Muslim Scholars (AMS), which stands outside of the formal political process, has what one Iraqi source described to the Economist

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 19

Intelligence Unit as “influence” with the insurgency. However, this Sunni clerical body has retained a firm stance in support of attacks on coalition troops and has thus had problematic relations with the US. As such it has not been meaningfully engaged with by the US, who have arrested some of its members. In contrast the Iraqi president, Mr Talabani, and US forces have held dialogue with Iraqi insurgent groups, using the Brotherhood as a conduit. Furthermore, the new Iraqi prime minister, Mr Maliki, has made it clear that he is prepared to issue an amnesty, including for those who have killed US forces, in an effort to build on the political opportunity of the formation of the new government. This is envisaged as taking place before the next round of the Iraqi national dialogue conference scheduled to take place in Cairo at the end of June. The AMS has taken part in these conferences in the past and, in contrast to the nihilistic politics of some of Iraq’s jihadis, has seen the involvement of the Sunni Arab dominated Arab League and in particular Egypt as important in the “defence” of its community’s interests. The new Iraqi government is reportedly considering including some Iraqi insurgent groups that foreign Arab governments may suggest would be worth talking to. There will plainly be a problem for the Iraqi government in agreeing to even such a selective approach, let alone being willing to meet insurgents’ demands for a concrete and unambiguous withdrawal of coalition troops. In addition, the largely Islamist- orientated Iraqi Sunni insurgents would want promises of fixed, and no doubt disproportionate, representation for their community in the defence, security and intelligence infrastructure, which would prove difficult to effect.

Government takes steps to However, in order to promote a reduction in opposition from Sunni Arabs, the reduce Sunni Arab opposition prime minister has already announced the release of 2,500 overwhelmingly Sunni Arab prisoners from among the estimated 28,500 detainees in the country, albeit excluding those defined as “terrorists”!by which is meant those who killed fellow Iraqis as opposed to coalition troops. The first two batches of 200-odd prisoners were released in mid-June in ceremonies overseen by Mr Hashimi, the Muslim Brotherhood leader and Iraqi vice-president. Although they were previously vetoed by the US during the Coalition Provisional Authority period, and resisted during the first post-Saddam “sovereign” Iraqi government under Mr Allawi, amnesties are now reportedly being encouraged by the US ambassador, Zalmay Khalilzhad. He continues to cause resentment among a number of Shia for demands that a majority Shia government give concessions to those often viewed as terrorists. Under Mr Maliki, the government is pursuing a line, as did Mr Allawi, of in effect acknowledging a right of resistance to foreign troops, but rejecting any pardon for attacks on Iraqis. In doing so the new prime minister will be mindful that opposition to the presence of foreign troops is pronounced among Shia as well as Sunni Arabs, despite the fact that around three-quarters of the Iraqi public reject violence as a form of political expression, according to a recent poll. The difficulties in playing on an essentially nationalist sentiment rarely shared by Iraqi Kurds, and talking up the relatively quick departure of coalition troops, as the new prime minister has done, are evident but not addressed. In reality, Mr Maliki knows that a parallel political process sees Shia, Sunni and Kurdish militias fighting for territorial control or political influence

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 20 Iraq

almost regardless of the formal political process that he says he wants to give more meaning to!a sectarian fight that the coalition presence is helping to reduce the excesses of.

Prime minister lays out a Publicly, Mr Maliki began his period in office asserting the objective of

withdrawal timetable transferring control to the Iraqi military in the four southern provinces currently run by the British by the end of the year, and the remaining Iraqi provinces by the end of 2007. The government programme he announced in outline to the national assembly omitted to give timelines, however, and emphasised the more practical need to make it commensurate with when the Iraqi security forces can take up their full responsibility. Considerable scepticism remains among Sunni Arabs about whether Mr Maliki’s commitment to the relatively prompt departure of foreign troops is real, with this issue being pivotal for this community and for the ability of its leaders to accrue credibility. The US Defence Department stated in late May that the New Iraqi Army and national police force have increased their numbers by more than 36,000 since February, and claimed that the combined tally of those in the army and national police who have been trained and equipped is some 263,400. With the police component in this definition being made up of those organised on a national basis under the aegis of the interior ministry and performing duties often, but not exclusively, related to national security, such as public order, then these numbers look strong. Capability issues continue to be more vague, however, with the number of operations led by Iraqi forces (as defined by the US) in April put at 25% of the overall total of 1,797. Not mentioned is the fact that there continues to be concern at the numbers retained by the security forces, how effective the training and equipping actually is, and, as mentioned, how national, as opposed to sectarian, these forces really are.

New government could fill It remains debatable whether the new government seriously believes or desires

political vacuum that Sunni Arab insurgents should be politically incorporated, given opposition from many sections of the dominant UIA alliance. The hope remains, however, that, despite the fact that the smaller Sunni Arab trend represented in parliament has put itself outside of the government, the formation of a broadly inclusive government will occupy the political vacuum created by the time lag since the January election. After all, insurgent violence was constrained in the periods immediately before and during the constitutional referendum in October last year and the national assembly election in January 2006, reflecting the desire of insurgents to test the political water. Despite the anger the new constitution created among Sunni Arabs, the January election was seen as having a potential utility by Iraqi insurgents. The failure to form a new government for the following three months may have further encouraged those Sunni Arabs bent on violence to pursue this path, without clear benefits for pursuing a more political strategy. For the time being, however, the Sunni-Arab insurgency and militia violence among Iraqis appears unabated. The latest figures provided by the MNF-I, the multinational force in Iraq, show that in the three months following the confirmation of the January election results in mid-February, the average number of weekly attacks in Iraq exceeded 620, compared with around 550 a

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 21

week on average in the period between September 2005 and mid- February 2006, and 400 a week in mid-2004. The upward pattern of attacks can be most clearly traced to the attack on the mosque in Sammara on February 22nd (March 2006, The Political scene), which unleashed an upsurge in sectarian violence. This is reflected in the daily tally of casualties, which between mid-February and mid-May this year was approaching 80, up from around 55 in the preceding five and a half months. Civilian attacks made up a still relatively small 13% of all attacks in March, up from 10% in February, with attacks on the military or police targets still by far the greatest number, even if an increasing proportion are being intercepted. There has also been some success in intercepting attacks on infrastructure, which in the three months up to mid-May had halved to just two a week compared with the period from September to mid-February, and contrasting with an average of 13 a week in the same period of 2003-04.

Signs of growing conflict The economic interests and territorial aspirations of the Kurdish Regional

over Kirkuk Government (KRG) of Iraq are increasingly causing contention within sections of the national government as well as on the ground. This is especially the case in the contested oil-rich northern city of Kirkuk, where a co-ordinated series of five bombs killed at least 20 people on June 13th. Such attacks are usually thought to be the work of Sunni Arab jihadis, as has previously been the case. The status of the city is, according to the constitution, due to be resolved by the end of 2007. This has been given additional impetus by Mr Maliki, whose speech outlining the government’s programme in May suggested that the Kurds had made their support for him against his troubled predecessor, Mr Jaafari, conditional on a clear commitment to resolving the city’s disputed status in a way that is almost certain to benefit Kurdish aspirations. The new prime minister committed his government to not only conducting a referendum over the future of the city in the allotted time span, but also ensuring that the districts and sub-districts that “originally belonged to Kirkuk” will be returned to it by March 29th 2007, with the census then conducted at the end of July. According to US estimates, some 300,000 Kurds were displaced from Kirkuk under Saddam Hussein’s “Arabisation” programme, which simultaneously brought in large number of Arabs, in particular Shia from the south of the country. In a reversal of this process, around the same number of Kurds have, since the change of regime, returned to Kirkuk, with a number of Arabs either having been displaced or reportedly feeling under pressure to leave the city. As a result it is assumed that the majority of the Kirkuk population are currently Kurdish, a factor assisted by the Kurdish Alliance’s control of the wider governorate of Tamim since elections in October last year. The prime minister is committed to, in effect, returning Kirkuk to the province status it held prior to administrative changes made under the previous regime, thereby replacing the province of Tamim. It can be assumed that the Kurds will be assured of a majority for uniting a restored Kirkuk province with the KRG. The Transitional Administrative Law, which preceded the constitution approved last year, included the commitment to redrawing boundaries in accordance with the will of the populace living there. However, the latest commitment by Mr Maliki suggests that this will simply be done by fiat.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 22 Iraq

Kurds complain of slow From the Kurds’ point of view the return of their community to Kirkuk has not

progress on property claims been conducted as had originally been assumed. The “Committee for the Restitution of Property” was established as part of the understandings reached between the Kurdish political leadership and other parts of the then Governing Council in order to resolve property claims nationwide, but with a large number envisaged as applying to Kirkuk. As of May this year, about 44,000 claims had been registered in Kirkuk out of around 137,o00 nationwide, but only 2,500 of the Kirkuk claims had been processed. Furthermore, Kurds expressed anger over the adoption by the committee in March of a new ruling that claimants can be offered cash payments as an alternative to property “restitution”. Another body, the “National Understanding and Solution Commission” has sought to process the claims of Arabs who may wish to depart the city but seek assistance with doing so. According to reports in the Kurdish press, 68,000 Iraqi Arabs!some 7,000 families!are willing to leave the city. The process is, however, far from smooth on either side, with large numbers of Kurds having entered Kirkuk and residing in what are effectively squatter camps on the fringes of the city, often on land controlled by the regional governorate. Kurdish aspirations over Kirkuk seem likely to aggravate further tension in the run up to the redrawing of its boundaries and the planned plebiscite in 2007. In April there were reports that members of Mr Sadr’s Jaish al-Mahdi militia have travelled there, in addition to members of SCIRI’s Badr Brigade militia, both of whom claim to be “protecting” the estimated 5% of the population of the city who are Shia. Given Mr Sadr’s assertive commitment to a relatively centralised decision-making model (even though he recently made clear that he is not opposed to federalism in principle), then the lead-up to a plebiscite whose result threatened to subsume Kirkuk into the KRG could create further tensions. Talks were held in May between the Kurds and representatives of Mr Sadr in an attempt to reach an accommodation. The basis of such an agreement remains elusive, however.

Turkoman present alternative At the same time, the significant Turkoman minority in the city are, through the Kirkuk plan Iraqi Turkoman Front (ITF), forging direct links with the smaller of the two Sunni Arab parties represented in the national assembly, and continue to co-operate with Arab representatives in opposition to the Kurds. There have been reports of Arab militias controlling some access roads to Kirkuk, further emphasising how tensions could spiral into the kind of militia violence seen in Baghdad and in neighbouring towns. Turkoman opposition to Kurdish plans saw the presenting of a rival proposal for Kirkuk’s future in early May with the ITF advocating that it become a separate federally autonomous province, not joined to the three existing Kurdish provinces that make up the KRG. This idea has been angrily rebutted by Kurdish politicians.

Turkey steps up military Kurdish aspirations also aggravate the concerns of Iraq’s regional neighbours

presence in Iraqi Kurdistan and in particular Turkey, with whom the ITF is politically close. The ITF once again met Turkish representatives in May, seeking support for the stalling of the issue. Turkey has also stepped up its troop presence, both on the border with Iraqi Kurdistan and inside the country, with an additional 2,000 troops entering

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 23

the north in April. The principle concern of Turkey’s military build-up is the ongoing presence of the Turkish Kurdish guerrilla group, the PKK, operating against Turkish targets, but they also emphasise that Turkey expects its wider interests in Iraq to be respected. At a meeting between the Turkish prime minister, Recep Tayyip Erdogan, and the Iraqi deputy prime minister and Kurdish leader, Barham Saleh, in early June, Mr Saleh pledged that Kurdish troops would take action against the PKK presence. It remains to be seen whether this will actually occur, although at times in the past the Iraqi Kurdish leadership have been prepared to act against the PKK. It was not clear how much of a meeting of minds there was between the two men, given that Mr Saleh reiterated that Kirkuk was “at the heart of Kurdistan”, whereas Mr Erdogan urged “special arrangements” for the contested city, a stance in line with the ITF that found little sympathy with the Iraqi Kurds. Furthermore, Kurdish ambitions do not end at Kirkuk; irredentist claims have been made to other territories outside the KRG area, including to the south of the KRG. These include Tuz Khurmato in neighbouring Salehedin province and Kifri in Diyala province. Claims are sometimes made regarding Tal Afar, to the west of Mosul, which would be seen by Syria as challenging its territorial viability by potentially linking an Iraqi Kurdistan to Kurdish areas inside Syria. Kurdish aspirations over territories proximate to the existing three provinces of the KRG, at least, are well-established and emphasise the fault lines that will potentially continue to be aggravated if and when the size and extent of Kurdish autonomy increases.

Kurds attack Halabja In an indication of the popular pressures that the KRG has to be mindful of in monument its assertion of its community’s “rights”, a riot took place in mid-March at Halabja, on the same day as the commemoration of the gassing of Kurds there by the Saddam Hussein regime in 1988. After shots were fired over their heads, demonstrators wilfully destroyed a shrine erected three years earlier to commemorate killings that are universally deplored in the Kurdish community and internationally. However, the Kurdish youth were more concerned about alleged corruption, which for some Kurds the shrine has become a symbol of. The Patriotic Union of Kurdistan administration based in nearby Suleimaniyah has been accused of manipulating the monument for financial advantage.

Kurds’ oil discovery raises Another key development affecting Kurdish interests was the discovery in early

constitutional tensions June of an estimated 100m barrels of oil in Zakho, close to the Turkish border within the KRG area, by the Norwegian company DNO, who the Kurdish leadership had granted 40% of any ensuing profits to in a deal signed in 2004. The discovery was announced by the KRG’s natural resources minister. This ministry is a recent innovation, and is resented by the Ministry of Oil in Baghdad. The Iraqi constitution appears to underwrite the ability of the KRG to sign such a deal, in that policy affecting “current fields” is referred to as needing, somehow, to be determined between the federal and regional governments. Controversially, the constitution also states that any matter that has not been defined as the exclusive preserve of central government shall ultimately be determined by the regional government, and that in the event of a dispute, authority shall lie with the latter. Arguably, in direct contravention of this,

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 24 Iraq

however, is the clause that stipulates that some form of joint responsibility is required for oil policy in general, and for the distribution of oil revenue. The Kurds interpret the constitution as underwriting the idea that decision- making over “future fields” within the KRG area, such as that at Zakho, are the preserve of the KRG. In May, as DNO appeared to be moving closer to confirming its discovery, this interpretation was rebutted by the head of the National Oil Committee, Ahmed Chalabi. Furthermore, the new oil minister, Hussein Sharistani (see The domestic economy: Oil and gas), an independent member of the UIA, has created the impression that the anticipated new foreign investment law will determine what the terms of any deals with foreign oil companies would be in any part of Iraq (see Economic policy). An even vaguer part of the Iraqi constitution refers to oil being developed for the benefit of all Iraqis, and as such is being used to underscore more nationally orientated claims over management of oil policy. In practice, it appears unlikely that the central government will encroach on Kurdish decision-making within the KRG area. However, conflict appears almost inevitable over policy in the far more productive southern oilfields, which similarly go to the heart of the future structure, or even viability of Iraq. A centralising of decision-making in at least “Arab Iraq” could mollify Sunni Arab discontent. However, scepticism abounds over whether powers already being exercised on a de facto basis in the south can be reclaimed by Baghdad.

Basra events emphasise Pressures for a federally autonomous regional entity among the almost

competing Shia visions exclusively Shia southernmost provinces is being reflected in negotiations between the Basra provincial council, the state-owned Southern Oil Company (SOC) and foreign oil companies. Such discussions, reportedly held in March, are seen by the oil ministry in Baghdad as encroaching on its authority, exemplifying the same constitutional ambiguities that apply to decision-making in the Kurdish area. Pressure from the Iraqi government apparently led to some negotiations with British representatives, even as the faction that the Basra governor belongs to, al-Fadeela, has been seen as challenging British security forces in the southern port city. However, these were superseded by talks with Russian companies, previously the source of much frustration from the oil ministry, which resulted in a major contract being withdrawn under Saddam Hussein. In Basra it appears that the local political leadership, not least the controversial governor, Mohammed al-Waily, is asserting its autonomy, including towards the oil ministry. This is despite the fact that until recently this was represented by a member of the same faction, and it has since been taken other by a fellow Shia Islamist member of the UIA, Mr Sharistani. The al-Fadeela faction supports a regional federal entity embracing the provinces of Basra, Maysan and Dhiqar, where much of Iraq’s oil production is located. As such, al-Fadeela’s ambitions place it at odds with both the nationalism of the Dawa party of the new prime minister, Mr Maliki, and of Mr Sadr, and also with SCIRI, who support!at least as a fallback option!the idea of a so-called “Shiastan” encompassing the nine Shia dominated provinces of the entire south of Iraq. The bottom line of the competing political visions of the Shia parties appears to be whatever suits their political strength, with SCIRI relatively evenly

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 25

distributed in terms of support throughout the south, but weaker in Baghdad than Mr Sadr’s faction and Dawa, who lack significant support in the oil-rich southernmost provinces where al-Fadeela are well-represented. These differing interests can give rise to direct contests between some of the factions, along with much smaller bodies. In Basra these factions have increasingly been vying for control, with criminal networks related to the smuggling of oil providing the strongest incentive for their recently intensifying struggle. Ideology is sometimes used to whip up a more plausible moral justification for the assertions of strength by the differing armed militias, however, with the presence of British troops functioning as the most effective driver. With the downing of a British helicopter in early May, attributed to Jaish al-Mahdi forces by the UK, it appeared as if their competition was overlapping with an intensification of anti-British feeling, as violent demonstrations were subsequently whipped up against the foreign troop presence.

Iran plays role in Basra fallout Iran continues to be accused of playing a role in stoking the armed assaults on the British troops, although much of the armoury used is easy to come by inside the country. However, local sources suggest that al-Fadeela, in common with all the above factions, is a recipient of very generous Iranian funding, in addition, it is alleged, to revenue from illicit oil trading. The central government’s patience appears to be running out with the activities of al-Fadeela and other, much smaller factions in Basra, however. In late May a month-long curfew was declared by the prime minister, Mr Maliki, especially angered by al-Fadeela utilising its influence over the SOC to turn off exports for a day, seemingly in opposition to their man being denied the position of oil minister. However, with the government not able to draw on army or national police contingents that would be seen as neutral in any bid to restore order, then an uneasy stand off is more likely to continue, principally between British troops and local militias, including those represented in the governorate and the national government.

Economic policy

New government sets out its With the formation of a “permanent” Iraqi government, that is one with a four-

economic vision year term, as opposed to the variety of interim administrations that have taken power since 2003, there are hopes that policy will be pursued with less attention to short-term ramifications and more concern about the longer-term impact. There is some evidence that foreign investors have regarded the previous governments, despite being defined as “sovereign”, as not able to authoritatively take executive decisions, and have felt that any agreement with them would not have carried sufficient legitimacy. Thus the new government’s formation could encourage greater interest from investors, although, as ever, the issue of security will also continue to be dominant. Although emphasising that a more detailed programme would be put before parliament and be subject to its deliberation in another month’s time, the new government signalled its intention to embody the hopes invested in its “permanent” stature by issuing a number of ambitious pledges, some of which would directly affect the economy. The prime minister, Nouri al-Maliki, committed the government to

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 26 Iraq

producing what he called a comprehensive plan for “reconstruction and development”, which would focus on particularly underdeveloped regions. He also put emphasis on measures to revitalise the electricity sector and on paying what he called “extreme attention” to the agricultural and industrial sectors. He addressed the planned new hydrocarbons law, and the controversial issue of the role of the governorates in determining policy on energy questions within their region, by stating simply that the “reorganisation of the hydrocarbons sector” will “ensure the rights of the regions and governorates upon their formation, as stipulated in the constitution.” He added that the government would also “encourage investment and attract national and foreign capital” to aid reconstruction.

Welfare safety net begins to be One area in which the government can point to recent progress on the

put in place economy is reform of the social welfare system. Funds from a revamped system began to be disbursed by the middle of March. However this had a head start: the Social Protection Network (SPN) was established by the Iraqi government following its stand-by arrangement with the IMF in December 2005 (March 2006, Economic policy). That provided NID500bn (US$340m) from the 2006 budget to beef up Iraq’s existing social welfare system, expanding its coverage from war widows and the disabled to the unemployed, the poor and married students. It also increased the financial support for those who are eligible. These additional measures were meant to offset the price increases that have accompanied previous petrol subsidy cuts. Registration with the Ministry of Labour and Social Affairs (MOLSA) for eligibility began in January this year. By mid-May, it was reported that five million Iraqis had been included in the programme, consistent with the one million households that were predicted in December (March 2006, Economic policy). Despite the progress that MOLSA has plainly made, its resources are clearly stretched. In mid-April, a ministry-run advisory council in the southern city of Diwaniyah announced that it had twice as many applicants as its quota allowed. It subsequently announced that it had only paid half of them. In Amarah in the south-eastern province of Maysan, unemployed Iraqis demonstrated in April in an attempt to be included in the SPN. The ministry’s administrative capacity is also struggling to keep pace with demand. For example, in Mosul, a multi-ethnic and tense city in north-western Iraq, the ministry is barely meeting the demands of the 86,000 eligible families, with press reports indicating that as of April only 1,620 families were being paid. The same report indicated that of the 241,000 families registered in Baghdad, only a few thousand had been paid.

Expectation grows over One of the first major pieces of legislation to be considered by the new

new FDI law parliament, once it gets down to business, is likely to be a law governing foreign direct investment (FDI). One was passed by the US-led Coalition Provisional Authority in December 2003, purporting to supersede all previous Iraqi legislation. However, major security problems as well as political and legal ambiguities limited the impact of the legislation. In the meantime, draft legislation has been prepared pending approval by a new parliament. In early April, an Iraqi newspaper, Al Mashriq, reported that the then industry minister,

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 27

Usama al-Najafi, claimed that the legislation was finalised, and that it ruled out foreign investment in the electricity and oil sectors. In the middle of May, Hashem al-Hashimi, the outgoing oil minister from the al-Fadeela faction, would only confirm to Al Mashriq that discussions about drafting were under way. The following month, Mr Najafi again floated the possibility that new legislation, this time on privatisation and banking sector reform, would shortly be publicly presented. Earlier, in March, Taha Ahmed Abdul Salem, the head of the Iraq Stock Exchange, estimated that 500-700 state-owned enterprises (SOEs) could be listed on the exchange within five years. In the meantime, however, the SOEs are pressing ahead with new plans, opening men’s clothing factories in Najaf, installing new production lines in cotton factories and building new grain mills. Other legislation that is also quietly being prepared in the background includes a new pensions law, which it was claimed would take effect at the beginning of June. However, there is little likelihood of significant legislative changes in any areas until the government is firmly in place and feels it has sufficient confidence to tackle issues with major fiscal consequences. A report in a pro-government newspaper, Al Sabah, suggests that, when the pension legislation appears, it will raise pensions up to a maximum of 80% of final salaries, as well as streamlining administrative procedures by integrating pensions with other social insurance provisions.

Further fuel subsidy With the government putting in place steps to create something of a social

cuts planned security safety net, its target of reducing overall subsidies by 25% and, specifically, price subsidies by some 13% may see further action as the new finance minister takes up his responsibilities. The lack of agreement over the formation of the new government had seen specific price increases for diesel and petrol scheduled for March postponed until the end of June. Although the new minister, Bayan Jabr, is untested, so was his predecessor, Adel-Abdul Mahdi, when he took the job in 2004. Given the formal commitment to cutting fuel subsidies as part of the IMF stand-by agreement, it is expected that further moves in this direction will be made, albeit cautiously and mindful of the political repercussions. As the new cabinet was being announced, an Iraqi newspaper, Al Ittijah Al Akhar, reported oil ministry sources as asserting that the increases scheduled for 30th June would go ahead.

Kurds claim Baghdad is “short- In March, Rashid Tahir, the director-general of Iraqi Kurdistan’s Ministry of

changing” them on budget Finance, told a UK-based newspaper, Al Hayat, that the 2006 federal budget allocated fewer funds for the three Kurdish provinces than the 17% called for by the 2005 budget law (March 2006, Economic policy). Thus, he explained, rather than receiving US$5.8bn from a budget of US$34bn, only US$4.1bn had been allocated, of which US$1.2bn would be paid in kind. According to the Middle East Economic Survey (MEES), Mr Tahir has written to the finance ministry in Baghdad complaining about the shortfall.

Drying-up of US aid The November 2003 US congressional allocation of US$18.4bn is expected to emphasises current waste run out by the end of 2006. This has only emphasised the difficulty in ensuring that disbursal meets existing needs and the problems in expanding the amount of donor support from other countries. Most tellingly, funds originally intended for aid continue to be redirected towards project security. According to the most

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 28 Iraq

recent figures related to the US$12.2bn of US aid money that has been disbursed (see table below), expenditure under the security and law enforcement budget is responsible for over a third of the total. In early June the newly appointed minister for planning, Ali Baban, gave an estimate that between 40% and 50% of all foreign aid ended up being spent outside Iraq, of which it is assumed a large proportion goes on security-related contracts with foreign companies.

Status of congressional appropriation (Iraq Relief and Reconstruction Fund) (US$ m) Apportioned Committed Obligated Disbursed Security & law enforcement 5,036.0 4,935.2 4,911.7 4,502.2 Electricity 4,220.0 4,021.5 3,526.2 2,174.7 Oil infrastructure 1,735.6 1,678.0 1,604.1 948.3 Justice, public safety & civil society 1,316.0 1,254.5 1,215.9 844.6 Democracy 1,033.9 984.0 983.9 722.9 Education, refugees, human rights & governance 410.0 354.7 353.7 271.1 Roads, bridges & construction 333.7 317.9 313.3 180.9 Healthcare 739.0 719.8 663.3 482.6 Transportation & communications 465.5 444.7 421.3 279.8 Water resources & sanitation 2,131.1 1,850.2 1,594.2 1,082.0 Private-sector development 805.3 788.9 782.4 637.7 Administrative expenses 213.0 212.4 212.4 101.2 Total 18,439.0 17,561.7 16,582.4 12,228.0

Source: US State Department, Iraq Weekly Status Report, May 24th 2006.

Health facilities contract runs The US-appointed Special Inspector-General for Iraq Reconstruction (SIGIR),

into problems Stuart Bowen, issued his latest quarterly report at the beginning of April. Mr Bowen provided examples of additional allocations to security expenditure. He noted that a further US$353m intended for electricity and health care programmes had recently been moved into “non-construction” programmes. In addition to security absorbing a large proportion of project outlay, the SIGIR report drew specific attention to the problems encountered by a large-scale health contract given to US contractors, Parsons Group (PG). In a project initiated in March 2004 with a maximum ceiling of US$500m, PG was commissioned to build 150 primary healthcare clinics (PHCs). Iraq had 1,200 PHCs nationwide before the 2003 US invasion, but these had been poorly maintained. The US reconstruction authority decided after the war that rejuvenated PHCs, able to serve the needs of their locality, were the right focus for health spending. In addition, however, some 21 hospitals (20 rehabilitated and one built from new) were intended to form part of a hospital stock that, pre-war, numbered some 250. Mr Bowen’s latest report notes that, with more than 90% of the total health allocation having been made, and 56% spent, Parsons had only completed six PHCs from the original contract for 150, which had been reduced through “descoping” to 141. As of late March 2006, SIGIR reported that of the 141 PHCs Parsons was committed to undertaking, 121 clinics were in various stages of completion. The SIGIR inspection team examined work on some five PHCs and found them to be “incomplete and poorly constructed”.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 29

The SIGIR report states that the 121 incomplete PHCs have now been “terminated” as work to be completed by Parsons, but will be finished through “alternative funding means” or by Iraqis “at a later date”. Parsons plans to complete a further 14. This outcome contrasts with the work conducted under the first phase of US-funded reconstruction of PHCs, in which the US Agency for International Development (USAID) facilitated the rehabilitation of some 110 PHCs, equipped a total of 600, and built and equipped six small new PHCs. SIGIR added, however, that, although the USAID-funded work was conducted in areas in need of urgent services, these were also areas of “less risk”. In a further sign of frustration with PG’s progress, however, in May the US Army Corps of Engineers (USACE) was reported as having cancelled the work remaining on the contract to repair 20 of Iraq’s hospitals. Parsons had failed to complete work on eight of them by the contracted deadline. The USACE plans to complete the contract with Parsons’ own Iraqi sub-contractors.

Reconstruction projects An additional problem with the reconstruction effort is that when projects are often lie idle completed, they often lie idle or are underused. Typically there are no funds to train Iraqis to use the new, unfamiliar facilities, thereby increasing maintenance costs. Furthermore, Iraqis have been unable to secure many of the facilities, whose staff have often been threatened or killed. As a result, the US Government Accountability Office estimated that one-quarter of the US$200m US-funded water and sanitation projects in Iraq were, by June 2005 “either " not operating or were operating at lower capacity”. Another critical issue identified by Mr Bowen in his report is the limited distribution of international donors’ committed support. As of the end of March, international donors (excluding the US) had pledged US$14.7bn, of which, he said, only US$3.5bn had been spent.

EU announces further In May, the European Commission announced its readiness to release a further

aid tranche #200m (around US$257m). Of this, #100m will be allocated to education and health care and will be channelled through the International Reconstruction Fund Facility for Iraq, administered by the World Bank and the UN Development Programme. A further #40m has been allocated to democratisation projects, including support for a constitutional review and local governance. Another #40m is committed to capacity-building in key ministries. The balance of #10m is intended as a reserve. In a further sign that international donors are keen to extend their activity in Iraq, in mid-May the World Bank announced that it would be opening an Iraq office; it has not had staff in Iraq since the August 2003 bombing of the UN headquarters.

The domestic economy

Economic trends

Nominal GDP growth In early April the US State Department has presented its first “presidential

estimated at 30% in 2005 report” to the US Congress, outlining political, economic and security developments in Iraq. Among its assertions was the claim that “Iraq’s economy grew from US$18.9bn in 2002 to US$33.1bn in 2005”. The report only implies

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 30 Iraq

that the IMF is the source for these figures, but both are in line with data in the IMF’s Request for a Stand-by Agreement report, published in early December 2005. According to the Fund, nominal GDP was US$25.7bn in 2004 (an actual) and US$33.2bn in 2005 (an estimate). Taking the IMF’s latest GDP figure for 2004, it appears from the State Department report that growth last year was 28.8% in nominal terms. Much of this nominal growth will have been a reflection of domestic inflation, which the IMF suggests was around 20%, which means that real growth will have been much lower. Although the IMF has provided no detailed information for real GDP growth in 2005, the State Department report says that the Fund assumes that the economy expanded by 2.6% last year, an increase that is likely to be optimistic given that oil output contracted by 8%; we estimate that real GDP contracted, albeit by a relatively modest 3%. The IMF is reported by the State Department to be projecting a 10.4% rise in real GDP in 2006, a figure that appears to assume relatively firm oil output and relatively robust activity in the non-oil sector. Interestingly, the nominal GDP figures are far lower than inferred from the previous Iraqi nominal GDP data series published by the IMF in its August 2005 Statistical Abstract. Based on previous data it would have been closer to US$45bn. The IMF has not explained why the data series should be so different.

Poverty and health Iraq’s economic growth appears to be having little if any alleviating affect on

trends worsen worsening poverty and ill-health, however. In March, according to local press sources, the Ministry of Planning put the incidence of what it referred to as abject poverty at 20%. In May the planning ministry released an interagency report!backed by Unicef!on child malnutrition. This surveyed 22,000 house- holds throughout the country, and found that one-quarter of children were be chronically malnourished, rising to one in three in isolated rural areas. Furthermore, the planning ministry report indicated that the incidence of acute malnutrition had jumped from 4% in 2002 to 9%. Child health measures are particularly sensitive to household income. Anecdotally, the Institute of War and Peace Reporting, in a report released in April, attributed some of the contraction in Baghdad’s car market to “declining average incomes”. Iraqi news- papers have also carried stories on the growing number of beggars in Iraq.

Consumer price inflation (% change, year on year) 2005 2006 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr 41 55 34 38 34 37 33 42 36 34 33 32 22 42 53 48

Source: Central Bank of Iraq, Key Financial Indicators.

Inflation remains very high The latest data from the Central Bank of Iraq (CBI) shows Iraqi inflation picking up again after reaching a low of 22% (per annum) in January, down from last February’s high of 55%. As these series are not seasonally adjusted, the increases in early 2006 are less significant than they appear when compared with previous months. Indeed, year-on-year inflation only started to climb again from March 2006. The US State Department projects that low or negative rates will occur throughout the summer.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 31

Oil and gas

New oil minister welcomed The appointment of Hussein Sharistani, an independent, but well-connected,

but faces uphill battle member of the United Iraqi Alliance (UIA) as the new oil minister has been broadly welcomed both in Iraq and internationally. Mr Sharistani is seen as having integrity and as possessed of a determination to crack down on corruption, both within the Ministry of Oil and within related companies for which it is responsible. His unaligned status (in factional terms) means that he is viewed as a welcome replacement for the al-Fadeela oil minister, Hajim Hashimi, who has been accused of playing politics with oil production and of allowing the diversion of revenue from the re-export of refined products (see The political scene). What Mr Sharistani lacks, like Mr Hashimi before him, is specific oil industry experience, which stands in contrast to the candidate who was reportedly favoured by the US, Thamir Ghadbhan, an oil ministry official during the Saddam Hussein era whose Sunni Arab and solid ministry credentials suggested that he might be a firmer defender of the right of central government to determine oil policy. In the event Mr Sharistani stressed soon after his appointment that he believed that oil revenue should be managed by the central government and that the new foreign investment law would promote the involvement of foreign oil companies, seemingly as an act of national policy, not an issue, he implied, that would be determined locally. However, Mr Sharistani will have to accommodate the realities of political power, not least in the UIA (which nominated him), a number of key components of which have been seeking to monopolise the illicit export of petroleum products out of Basra. On the question of Kurdish oil, it seems unlikely that the new oil minister will be able to challenge deals affecting Kurdish Regional Government (KRG) territory. The more problematic issue will be if, and when, the KRG decides that it wants to have a direct say in how Kirkuk’s oil facilities are managed and funded. Preliminary negotiations with international oil companies (IOCs) have been conducted by the oil ministry since last year. However, the unsettled political structure of Iraq, let alone the lack of a definitive model of partnership with an IOC, has made these efforts difficult, although there may be understandings on policy direction that the new oil minister will try and uphold.

Oil exports struggle to reach The most fundamental and immediate problem Mr Sharistani faces, however, is

pre-war levels that production and exports remain below pre-invasion levels, and have only recently improved on their lowest levels since the change of regime. Since January, production and exports have climbed out of the slump that began last October. April’s production figures of almost 2.1m barrels/day (b/d) are the highest since late 2004, although the latest data from the US State Department suggest that export level dipped again in May. According to the latest data released by the International Energy Agency in its June edition of the Monthly Oil Market Report, Iraq’s production declined in May to an average of 1.91m b/d, down from 2.1m b/d in April. Ongoing sabotage has ensured that almost all of Iraq’s oil has come from its southern fields. However, after four months in which the export pipeline from Kirkuk to Ceyhan in Turkey had been virtually dry, it reopened again in mid-June and after just three days some 600,000 b/d of oil that had passed through the pipeline had been exported, based on

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 32 Iraq

average production levels of 150,000-250,000 b/d, and a further 2.5m barrels had been stored in the Ceyhan reservoir ready for export.

Iraqi crude oil production and exports, 2006 Jan Feb Mar Apr May Production (m b/d) 1.58a 1.9 a 1.85 a 2.08a 1.91b Exports (m b/d) 1.05a 1.47 a 1.32 a 1.6a 1.4b Revenue (US$ bn) 1.84a 2.16 a 2.25 a 3.02a 2.79c a US State Department actuals. b International Energy Agency actuals. c US State Department estimates. Sources: US State Department, Iraq Weekly Status Report, May 24th 2006; International Energy Agency, Monthly Oil Market Report.

Although the Iraqi authorities have persisted in setting ambitious targets, including an export figure of 2m b/d by the end of 2006, according to an oil ministry spokesman in April, Iraqis outside of government but who are familiar with the oil sector tend to be rather less sanguine. In May a former oil minister, Issam al-Chalabi, told the Cyprus-based Middle East Economic Survey that in the best-case scenario Iraq could produce only an additional 150,000 b/d by 2008, by which time the northern Khormala and Himrin fields and the southern Subba/Lubais fields may have been be upgraded. Over the coming two years Mr Chalabi forecasts that production will be around 2m b/d and that exports will be below 1.5m b/d.

Staffing fallout bedevils Another key challenge for the new oil minister is personnel issues. Although

oil ministry there is speculation that attempts by the new government to reach out to disaffected Sunni Arabs may see some loosening of the de-Baathification programme, there has been significant frustration among oil ministry employees at its implementation thus far. An Iraqi daily, Al Bayyinah, reported in early May that directors in the oil ministry had threatened to resign en masse if de-Baathification continued. There has been turnover at senior levels of the ministry since the US invasion in 2003, with no-one in position long enough to impose a clear sense of order. There has also been a burgeoning of appointments made on political rather than technical grounds. In March Reuters reported that the number of staff within the State Oil Marketing Organisation (SOMO) had trebled. In keeping with his projection of technocratic priorities for the ministry, Mr Sharistani has called for a commitment to professionalism over party political or sectarian considerations. However, the political backdrop to his appointment raises questions over whether he can escape the pattern partisan appointments seen in the oil ministry and elsewhere.

Official says oil corruption is This partisanship has seemingly helped drive alleged corruption throughout the

the biggest economic threat ministry, where the paying off of supporters and allies has been as important as acts of individual greed. In late April the inspector-general of the oil ministry Ali al-Alak, published a report into smuggling, identifying it as “the most important and prominent” economic threat facing Iraq. It estimated that “about 20% of the oil products that Iraq imported last year, worth US$4.2bn, were smuggled to neighbouring countries”. Mr Alak commented that matters were getting worse, claiming that he had sent three or four reports to “the highest authorities” without seeing any changes. In addition, a significant portion of imported fuel products are assumed to be traded on the black market in Iraq. In

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 33

April comptroller-general of the US Government Accountability Office, David Walker, stated that the local black market took about 10% of all of Iraq’s refined fuels. He also put the amount of smuggling of imported fuels as high as 30%. Other reports have suggested that the export of imported fuel is directly funding the activities of militias, political parties and insurgent groups.

Refining shortfall is also a The demand for additional refined products is resulting in an imported refined

budget burden fuel products bill of around US$500m a month. Given the tightness of the budget for imported fuels, which is less than half of the cost, this only emphasises the need for expanding refining capacity as quickly as possible. Although efforts in this respect continue, no contracts have been awarded for new refineries, despite the issuance of a number of tenders. A number of prospective contracts should be agreed in the months ahead. However, Mr Chalabi assumes that even if these contracts are signed there will be no new refining capacity before 2009.

Metering the export of oil may One difficulty in making definitive judgements about exactly how much oil is

not stop the illicit trade leaving Iraq’s oil terminals is the lack of metering. In early April the oil ministry announced the formation of a supreme committee to purchase oil meters. The director-general of SOMO, Falah al-Amiri, said at the time that installing the meters would raise southern export rates significantly. Ibrahim Bahr al-Uloum, who was oil minister until this January, complained that the ministry had been trying to install meters for some time, and Isam al-Chalabi commented that his sources within the ministry indicated that this would not happen for many months. However, although Mr Sharistani is keen to make progress on the issue, he has stressed that this will make no difference to the management of oil smuggling, which he argues is only being conducted in refined products that are often re-exported, hence the difficulty of definitive figures for the amount of refined oil being distributed in the country. Mr Sharistani says that smuggling is worse than “acts of sabotage” and appears to have his own ministry in his sights. He also emphasises that the pipelines carrying refined products lack security, and in May urged that a dedicated unit from the Iraqi army of some 5,000 personnel, which has been a long-standing government commitment, should be put in place as soon as possible. His statement emphasises the limitations of the existing Strategic Infrastructure Battalions (which defend key infrastructure sites), of which there are currently a total of seven for the whole country, out of a total of 111 battalions in the entire Iraqi army. Although both SOMO and oil ministry officials, including Mr Hashimi, who believes that the accusations of corruption are politically motivated, have strenuously denied taking kickbacks, there is no doubt that the still heavily subsidised price of refined oil creates an incentive to sell it on at a large profit. One example of the ease with which refined products can be moved down or across the Gulf is the fact that Basra’s fishing vessels are entitled to between five and 30 tonnes of petrol a month at about 1% of the price of imported petrol. The shipping routes replicate those used under sanctions; the difference is that now anyone with a fishing boat can register for the discount, leading to the registration of many battered old vessels.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 34 Iraq

Infrastructure

Lack of progress over Since the request in February for expressions of interest in up to four 15-year

mobile contracts national mobile-phone licences, no further public information has been made available (March 2006, The domestic economy: Infrastructure). In early June, a spokesman for PriceWaterhouseCoopers, financial advisors to the Iraqi National Communications and Media Commission (NCMC), told the Economist Intelligence Unit that they were still in the process of reviewing applications. The existing three licences are due to expire at the end of June. Although the February request mentioned “up to four” licences, thereby raising the prospect that either one of the existing providers could lose out, or at least that a new provider might be added to the existing three, the US State Department’s April 26th weekly status report only mentions three licences as being under consideration.

Confusion over wireless The licensing of wireless local loop (WLL) contracts!connecting wireless

loop licences applications, including voice and internet access, to the existing public telephone network!seems equally confused. In late March the Iraqi press reported that five companies had been awarded licences. These presumably included the two national licences and three regional ones, as advertised. However, in mid-April the US State Department weekly status report announced that the two national licences would be auctioned in May and that the NCMC was “re-competing” the three regional licenses. Apparently the Telephone and Post Company surprised the NCMC last year by granting, without authorisation, WLL licences to two companies to operate in Baghdad and Najaf. The NCMC is therefore requiring the two, unnamed, companies to re-compete for the licences, despite the fact that they have already begun to install their networks.

Financial indicators

ISX performance falters The Iraqi Stock Exchange (ISX) index has trended downwards over the past year, from 74 in March 2005 to 26.5 at the end of May 2006. However, reports suggest that there has also been an increase in the number of shares being issued, partly owing to the rise in the number of traded companies to 94 from 88 a year earlier. Market capitalisation has risen comparatively modestly over the year from March 2005, from NID2.26trn (US$1.5bn) to NID2.49trn, but recently witnessed a downturn. A US-based website, isx-data.com, publishes a market capitalisation weighted index, which shows that Iraq’s score halved in the same period.

Banks continue to Iraqi banks, however, have continued to be the most actively traded shares on

attract interest the Iraqi Stock Exchange, making up just over half the trading volume, and seven of the ten most actively traded shares, as of late May. However, in early April Iraqi newspapers were reporting that banks were moving their operations abroad for security reasons. This seems to reflect an ongoing process of capital leaving the country. Iraqis, for example, continue to actively purchase property in Jordan. In early May an Iraqi newspaper, Al Mashriq, reported that “looting”

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Iraq 35

of private banks reduced Iraqis’ willingness to trust their savings to the banks. Later that month, Al Zaman, an Iraqi daily, reported that 15 of Iraq’s private banks had moved their headquarters and assets abroad. Since April suggestions have been floated in the Iraqi press that the Ministry of Finance plans to close branches of the state-owned Al Rasheed and Al Rafidain banks.

Emergent banking Despite better economic conditions in Iraqi Kurdistan, private banking is not yet

enthusiasm in Kurdistan that developed there, with many financial transactions across the KRG area conducted on a cash basis. Within Erbil and Dohuk provinces, controlled by the Kurdistan Democratic Party, three private banks are registered, one as recently as last year. In addition, the Trade Bank of Iraq, founded shortly after the change of regime as an international venture to provide finance and co-ordinate export credit support for trade with Iraq, is proposing to open a branch in Iraqi Kurdistan. There are also reports of interest from two Turkish banks in operating branches in the KRG area, and some Iraqi banks headquartered in Baghdad are interested in opening branches for the first time. In March, the Al Iraqiyah television station reported that the Commercial Bank of Kuwait planned to open branches in the KRG area. This development, should it occur, would be in line with the Kuwaitis’ development of relatively deep business connections in Iraqi Kurdistan, including in the airline, mobile telephony and real estate sectors.

CBI raises interest rates In April the Central Bank of Iraq (CBI) increased its policy interest rate to 8% from 7%. An advisor to the CBI commented that the Bank may be “experimenting” to see whether a higher interest rate can control Iraq’s inflation rates, which have risen since February. The CBI now auctions securities with four separate maturities. To the 91-day bills that it has auctioned for the finance ministry since 2004, it added 63-day and 28-day bills in January and February, respectively. On its own behalf, it began 1-year bill auctions in March. In April and May, the finance ministry cancelled a number of its auctions. The public explanation was that their deficit financing needs are less than expected; officials may also have hesitated to issue debt with rising interest rates in the absence of ministerial support before the formation of the new government.

Foreign trade and payments

More bilateral debt The Ministry of Finance has continued to sign bilateral agreements with Iraq’s

deals agreed sovereign creditors under the terms of the November 2004 Paris Club agreement. In the past quarter, the Paris Club terms, envisaging a three-phased 80% write-off by 2007 pending Iraq’s adherence to its stand-by agreement terms with the IMF, have been implemented bilaterally with Sweden and Korea (in early March), and Australia (in mid-May). Of the 18 Paris Club sovereign creditors, only Russia and the UK have yet to finalise bilateral agreements with Iraq. An Iraqi finance ministry spokesman indicated that agreement in principal with the UK has been reached; once reconciliation of claims has been completed, the agreement should be finalised. The Russian case is slightly more complicated, as it has a different agreement with the Paris Club. In March, the Paris Club Secretariat wrote to seven of Iraq’s non-Paris Club sovereign creditors, encouraging them to agree to comparable terms. By May agreements

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 36 Iraq

had been reached with Hungary and the Czech Republic. Discussions with Iraq’s Gulf Arab creditors, to which Iraq is estimated to owe around US$35bn as of 1990, remain secretive. As yet, no agreements have been announced.

Turkish oil products finally Ensuring the supply of refined petroleum imports from Turkey continues to

arrive as debt issue resolved demand high level political attention (March 2006, Foreign trade and payments). Recent efforts finally resulted in Turkish trucks reaching Iraq in early May, following around three months in which Turkish exports had been stalled after disputes continued over unpaid bills for fuel supplied in 2005. In early March, Iraq’s deputy finance minister, Karim Humud Faraj, announced that the ministry had paid Turkey US$637m owed for oil imports in 2005. That same month Ahmed Chalabi, the chairman of Iraq’s Energy Council, claimed upon returning from a trip to Turkey that Ankara had promised to reschedule Iraq’s US$1.4bn debt!contrasting with the US$1bn cited by Turkey in mid-January despite no fuel having been supplied in the meantime (March 2006, Foreign trade and payments). According to Mr Chalabi, the agreement would allow Iraq monthly imports of 100m litres of fuel. (In early March, an Iraqi newspaper, Al- Zaman, reported that payment problems had also halted supplies from Saudi Arabia and Kuwait.) By end-March, Mr Chalabi announced that Iraq had settled its debts in full and thus Turkish fuel was expected to re-enter Iraq again. He added that Kuwait had also agreed to export fuel to Iraq. Still, Turkish fuel supplies did not arrive until early May, when 1,000 Turkish trucks crossed the border with Turkey at Zakho.

National fuel stocks improve According to US data, national stocks have improved somewhat, but still

but are below target remain well below the official 15-day target. Liquefied petroleum gas stocks have been run particularly low, shutting down restaurants in some cities and leading the Ministry of Oil to cut families’ monthly ration from two cylinders to one. A suggestion in late March by an oil ministry spokesman, Assem Jihad, that private companies could be allowed to import refined products might improve matters, if implemented.

National stock levels: refined petroleum products, 2006 (days) Jan Feb Mar Apr May Diesel 3 3 3 5 6 Kerosene 7 6 5 5 10 Petrol 4 2 2 4 4 Liquefied petroleum gas 15 14 5 4 4

Source: US State Department, Iraq Weekly Status Report, 24th May 2006.

TruckersIraq face takes delays further at Turkish steps Iraq has taken further steps to advance its case for membership in the World

towardsborder trade crossing deals Trade Organisation (WTO). In March it announced that it had opened a representation office at the WTO and set up a negotiating team. Iraq has enjoyed observer status in the WTO since February 2004. In March the EU agreed to begin negotiations on a trade and co-operation agreement once Iraq’s new government was in place. In April officials at the Ministry of Trade said that Iraq planned to sign a free-trade agreement with the US, but were later reported as denying such statements.

Country Report June 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006