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Cablegate: Babil's Industry: Private Sector Guardedly Optimistic, Soe

VZCZCXRO0343
RR RUEHBC RUEHDA RUEHDE RUEHKUK
DE RUEHIHL #0096/01 3421326
ZNR UUUUU ZZH
R 071326Z DEC 08
FM REO HILLAH
TO RUEHC/SECSTATE WASHDC 1128
INFO RUCNRAQ/IRAQ COLLECTIVE
RUEHIHL/REO HILLAH 1201

UNCLAS SECTION 01 OF 03 HILLAH 000096

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EIND ELAB IZ
SUBJECT: BABIL'S INDUSTRY: PRIVATE SECTOR GUARDEDLY OPTIMISTIC, SOE
FUTURE UNCERTAIN

REF: HILLAH 92

HILLAH 00000096 001.2 OF 003


1. (U) Summary: Babil's private sector manufacturers struggle
with access to reliable power and credit, but say their sector
is improving, especially for companies making construction
materials. SOEs employ over 30,000 workers in the province, but
most only show up to collect paychecks. SOEs have focused on
creating jobs, not profits, and face an uncertain future.

A Questionable Future
---------------------
2. (U) Babil's manufacturing industry presents a patchwork of
small struggling private sector factories with about 10,000
workers and large non-functional State-Owned Enterprises (SOEs)
with over 30,000 employees. According to official statistics
industry generates 14 percent of provincial GDP. Salah Hassan
Bahaya, Director of the Babil Center for Business Community
Development thinks the figure might be a few points higher since
the recent building boom (reftel) has generated an increased
need for locally-produced construction materials. Still, in
conversations with dozens of public and private sector business
actors all unanimously expressed concern about the future of
Babil's industry.

Private Sector Optimistic Despite Infrastructure Credit Concerns
--------------------------------------------- -------------------
3. (U) According to Bahaya there are about 200 medium and large
private sector factories in Babil concentrated in
food-processing and manufacturing construction supplies. The
average plant has 10-20 workers but some employ hundreds. In
addition, there are close 5,000-7,000 craftsmen working in small
1-3 person shops mainly producing metal and wood products.
Productivity and quality are generally low, and competition with
imports is a problem. Nonetheless, in a recent survey of
Babil's private sector manufacturers the majority said the
sector was improving. Companies supplying the construction
industry with bricks, cement, and wood-products are doing
particularly well.

4. (U) The survey pointed to two significant problems: lack of
reliable electricity and difficulty in obtaining credit.
Electricity has been gradually improving over the past year, and
the Provincial Council Energy Committee member Hassan Hamza has
predicted that the installation of new generating units and
transformers will lead to significant improvements in
electricity by mid-2009.

5. (SBU) The root of the credit problem is that fact that banks
make more depositing money with the Central Bank than by making
business loans, according to Layla Adnan Yehia, regional manager
for the Bank of Baghdad. Yehia told Econoff that her bank makes
a small number of business loans, usually at rates between 10-12
percent, but only when it believes the borrower, or their family
and associates, will ultimately deposit more money than they
borrow: money that the bank can then put in the Central Bank.

6. (SBU) Improved regulatory regimes can create new private
sector niches. Al-Wind Pharmaceutical, a major South-Central
medicine importer-distributor for 40 years, wants to develop a
manufacturing plant in Al-Hillah. CEO Murthda Bahya explained
to Econoff that as the GOI began regulating the quality of
imported medicine, which constitutes 90 percent of medicine sold
in Iraq, the price skyrocketed -- in some cases tripling. The
PRT worked with Bahya to develop a business plan and find a
foreign pharmaceutical company for a license agreement to
manufacture medicine. Al-Wind has now begun a USD 3.5 million
project to produce intravenous solution and distilled water --
using its own funds -- that will employ close to a hundred
skilled workers. Still, plans to build a drug manufacturing
plant are on hold while the company tries to obtain a USD 4.5
million loan.

The SOE Production Problem
--------------------------
7. (SBU) Babil's 20 SOEs are intended to create jobs -- not
profits -- and were never competitive, according to Dr. Mejbel
Rafia Merjan, Dean of the Economic Department of the University
of Babil. They produce cement, bricks, textiles, automobiles,
machinery and chemicals under the auspices of the Ministries of
Industry, Trade, and Agriculture. Provincial SOEs range from a
few hundred employees to almost 6,000 employees on huge
facilities covering dozens of acres. Still, on any given day
less than 10-20 percent of employees can actually be found
working.

8. (SBU) Because the GOI funds SOEs they do not need to make a
profit. This means the input cost of SOE-produced goods often
outweighs the price they are sold for. Jabar Lool,
Director-General of Al-Furat Chemical SOE, gave EconOff an
example: woven plastic bags cost Al-Furat over 1,000 ID to
produce, but can only be sold for 500-600 ID. Increased
production is therefore not a metric of industrial success, and

HILLAH 00000096 002.2 OF 003


can actually mean an SOE is losing more money.

All Warp But No Weft
--------------------
9. (SBU) Lack of market incentive means SOEs have little reason
to plan. When asked why Al-Furat's dozens of weaving machines
lay inactive, Lool explained that while they had materials to
weave warp lines, they had been out of materials for weft lines
for the past six months. An executive at the Al-Hillah textile
factory said the general practice was to wait until they ran out
of raw materials before trying to find the resources to purchase
more. Delays in obtaining supplies can be compounded by the
fact that many raw materials come from other SOEs: so there may
be a long wait even once money for a purchase has been located.

10. (SBU) SOEs have a reduced incentive to sell products. A
nearby garment SOE spent USD 1.5 million buying materials to
make 12,000 business suits more than a year ago. Yet a visit to
the factory reveals over 90 percent of finished suits stored in
a warehouse: management would not lower prices to a market
competitive level because they said it did not matter when they
sold them. Even if SOEs do sell their product, market issues
may be largely irrelevant as the GOI or another SOE is often the
customer. Lool does not have to worry too much about being
competitive in the market because he knows that, at least for
now, he sells most of his plastic bags to other SOEs.

SOEs: A Looming Social Catastrophe ?
-------------------------------------
11. (SBU) Even though the majority of SOE employees rarely show
up for work they still expect to get paid: earlier this year
when the GOI temporarily froze salary raises that SOE employees
had been promised, they demonstrated in the streets for days
until being assured that they would receive their raises at the
beginning of the year. Provincial Council Planning Committee
Chairman Quesay Nadi Ali Hummadi called SOEs a looming social
catastrophe. He told Econoff that SOEs showed that Iraq's
economic evolution had not kept pace with its democratic
transformation. He worried that if the GOI phases-out SOEs,
either by shutting them down or privatizing them, without
adequate plans for workers, then it could lead to significant
social disruption.

12. (SBU) Sabah Al-Khafaji, Director-General of a 5,800 person
SOE and chairman of the local Nahia council in Iskandria,
discussed the possibility of an SOE phase-out. He told us that
when he wears his DG hat he does worry about a phase-out, but
when he puts on his politician hat, and reflects on the
political problems a phase-out could create particularly with
upcoming elections, then he thinks it is highly unlikely that
the GOI will phase-out SOEs in the foreseeable future. Still,
Al-Khafaji said he plans to focus USD 30 million the GOI
recently promised his SOE to improve profitability and
sustainable employment.


Helping Stand-Up SOEs: A Litmus Test
------------------------------------
13. (SBU) SOE management recognizes that their companies are not
currently economically sustainable and require continued
government subsidies. They have told us they understand their
SOEs need to become more competitive by: breaking monolithic
SOEs into separate independent units with their own management
and fiscal control, creating products that meet market demand,
increasing manufacturing efficiency with technology upgrades,
and enhancing worker productivity through training and
incentives. The PRT has worked with five local SOEs that
collectively employ 20,000 workers.

14. (U) Creation of an independent 425-person Velvet Production
unit within the 3,800 strong Al-Hillah Textile SOE represents a
litmus test. The PRT has worked Al-Hillah Textile management to
try to develop a profitable factory-within-a-factory.
Management chose to make velvet because it builds on existing
fabric design and production expertise and because there is
strong local demand for velvet for upholstery, drapes and
women's clothing.

15. (U) The new unit purchased state-of-the-art Belgium velvet
weaving machines and sent teams to Belgium for training sessions
using USD 3.6 million from the GOI (including a USD 1.8 million
bank loan against a MIM guarantee) and USD 3 million from the
task force to improve Business and Stability Operations (BSO).
The PRT organized a three-day class for management covering
basic management principles. If the unit, scheduled to begin
production in January 2009, turns a profit, then workers will
receive bonuses. Management hopes that if the unit turns a
profit it will set an example that other units in the SOE will
emulate, particularly once unit workers begin receiving bonuses.

HILLAH 00000096 003.2 OF 003

16. (SBU) Comment: While the power outlook is improving, access
to credit remains a problem. We plan to work with the Tijara
USAID programs for small-medium business credit and microcredit
to develop innovative ways to facilitate loans, possibly by
helping cover the interest spread between what borrowers can pay
and what banks will accept -- an idea Yehia is eager to
explore. Still, SOEs remain the figurative elephant in the
room, and unless some way to make them sustainable is found,
they may soon face extinction. The future of the Velvet
Production unit represents a test case: if the combined efforts
of the GOI, USG, plant management and PRT are not able to make
it economically viable, then it is difficult to figure out how
most SOEs will ever turn a profit.
HILLAS

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