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Cablegate: 2009 Budget: Falling Oil Prices Mean Cuts, Deficit, Dfi

DE RUEHGB #3698/01 3281633
P 231633Z NOV 08




REF: Baghdad 449


1. (SBU) Summary: Despite pressures from key members of the
Maliki Government for fiscal largesse, Finance Minister Bayan Jabr
cut the proposed 2009 budget while it was under consideration by the
Council of Ministers (CoM), where it secured approval before moving
on to the Council of Representatives. This clears a key hurdle with
the IMF, but leaves political difficulties to be overcome before
passage. Even with the GoI's uneven record at budget execution, a
deficit of this amount will likely entail drawn-down of the GoI's
accumulated fiscal surplus in Development Fund for Iraq (DFI). The
2009 budget is constructed with the Kurds taking 17 percent share,
however sentiment in the CoR is growing against the size of the
Kurdish take.

--------------------------------------------- -
Oil Price Drop Forces Cuts in Proposed 2009 Budget
--------------------------------------------- -
2. (SBU) The original 2009 budget submitted to the Council of
Ministers (CoM) was based on a forecast 2 million barrel per day
export sales rate at USD 80 per barrel. Oil exports make up 90 - 95
percent of Iraq's budget revenues, so this allowed the budget to be
formulated with USD 58.4 billion of oil revenues. However, oil
prices have dropped sharply since Finance Minister Jabr agreed to
this estimate with the IMF at the Bank/Fund meetings in October.
While the budget was under consideration by the CoM in early
November, Jabr was forced to make significant budget reductions to
adjust to dramatically lower estimates of 2009 oil revenues.

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3. (SBU) This process started with meetings between Iraqi
government officials and the IMF mission in Amman, Jordan the week
of October 27. Based on these conversations, the broad form of a
new budget package emerged. Most notably, the agreement with the
IMF included cutting the oil price forecast to USD 62.50 per barrel,
and reducing the total budget envelope from USD 78 billion to 67
billion, while still preserving a USD 14 billion capital program
(reduced from 19 billion USD). The resulting 15 billion USD deficit
is roughly equal to that forecast in the initial budget submission.

Revenue forecast remains aggressive
4. (SBU) The revised revenue forecast is based on 2 million barrels
per day of exports sold at USD 62.50 per barrel, which equates to
USD 45.6 billion, a 22 percent decline. Partially offsetting this,
other revenue is forecast to increase from USD 4.0 billion, to 6.0
billion. The combination creates a total revenue forecast of USD
51.6 billion.

5. (SBU) COMMENT: Despite the 17 percent decline in forecast
revenue, several aspects of the GoI projection are optimistic.
There seems little justification for the USD 2.0 billion increase in
other revenue. The only time Iraq had this amount of non-oil
revenue was in 2008, when they realized USD 7.0 billion of revenue
from the auction of cell phone licenses. There is no obvious source
of any such windfall, nor are there plans to implement tax regimes
capable of accruing that amount of revenue. Moreover, the oil
revenue forecast itself may prove optimistic. Iraq has exported at
a 1.85 million barrel per day rate this year, and domestic demands
are growing, so it will be difficult for Iraq to export at a 2.0
million barrel per day rate, even barring further deterioration in
production levels. Moreover, the oil price continues to fall.
Minister Jabr noted that recent shiploads have been sold as low as
USD 45 per barrel, a price 26 percent below the reduced estimate.
QUSD 45 per barrel, a price 26 percent below the reduced estimate.
End Comment.

--------------------------------------------- --
Expenditures will be curtailed, but a sizeable
capital budget will be preserved
--------------------------------------------- --
6. (SBU) Under the agreement with the IMF, Jabr agreed to cut the
overall budget envelope from the USD 78.4 billion originally
submitted to the Council of Ministers to USD 67.0 billion, a 14
percent cut. With the Maliki government refusing to pare
recently-granted wage increases for government employees, Jabr had
little flexibility in reducing operating expenses, which were cut
from USD 59.2 billion to 52.6 billion, an 11 percent decrease.
According to Jabr, operating expense cuts included reducing the
allocation for the Public Distribution System (PDS) from USD 5.8
billion to USD 5.3 billion on the basis of lower world agricultural
prices. In addition, planned wage increases for state-owned
enterprises were reduced, deferred, or cut altogether. This does
not reduce wage costs, but it does reduce SOE subsidy levels.
Finally, while funds budgeted for importing electricity (USD 480
million) and fuel for power plants (USD 500 million) were increased
in 2009, the total budget outlay does not appear out of line with
the relative austerity of the budget construct.

BAGHDAD 00003698 002 OF 004

7. (SBU) From a technical standpoint, the MoF made a number of
changes in the 2009 budget. These will increase transparency of SOE
finances, and hopefully will lead to better management. Direct
budget subsidies to the SOEs were formerly budgeted in the MoF
Subsidies chapter. Now, the cost of subsidies has been moved to the
Ministry responsible for the relevant SOE. In the 2009 budget plan,
no Ministry of Oil (MoO) SOE will receive any subsidy, but several
units of the Ministry of Electricity (MoE) will continue to receive
transfers from the GoI budget. At the same time, both the MoO and
MoE will receive large increases in their Goods and Services
accounts, with the MoE increasing from USD 30 million in 2008 to USD
1 billion in 2009. MoE Goods and Services will increase from USD 90
million to USD 940 million. Moving these amounts to the parent
ministry from the SOE will provide a better understanding of how
these ministries operate from a financial perspective.

8. (SBU) With operating expenses relatively inflexible, Jabr did
well to preserve a capital budget of USD 14.3 billion, a cut of 25
percent from the USD 19.2 billion capital budget originally
developed. However, there are some changes in individual budget
lines that merit additional comment. For example, the Ministry of
Oil capital budget remains untouched at USD 2.6 billion. The
Ministry of Electricity budget was cut from USD 2.4 billion to 1.3
billion. There is a full project list against this budget, so it
leaves the question of where funding for the multi-billion dollar GE
turbine procurement will be sourced. Also, despite being
politically popular, for the first time provincial allotments have
been reduced - essentially being halved from USD 5.1 billion to USD
2.5 billion. (COMMENT: Planning Minister Baban had earlier
expressed his concerns at the level of capital budget cuts fearing
they would hamper efforts to diversify Iraq's economy. A separate
report will be written on his reaction to the final bill. End

--------------------------------------------- -
Budget deficit forecast. Drawdown of DFI
reserves seems inevitable
--------------------------------------------- -
9. (SBU) The forecast budget deficit for 2007 and the 2008 base
budget ranged around USD 7.5 billion. The initial 2009 budget
effectively doubled the forecast deficit to USD 15.9 billion. The
revised forecast cuts the deficit slightly, to USD 15.3 billion, but
it remains almost 23 percent of total budget. This approaches the
outer bounds of what the IMF will agree. Fund Staff told TREASATT
they want to see a budget deficit below 10 percent, but they will
develop independent cash projections based on the official GoI
forecast. However, the GoI has good success spending its operating
budget, and with nearly 80 percent of all expenses in the 2009
budget coming from the operating budget, under spending may not be
as pronounced as in previous years.

10. (SBU) The MoF forecast budget deficits in each of the last five
years. However, each year has concluded with a surplus, as actual
spending has underperformed programmed levels. As a result, the MoF
has an accumulated fiscal surplus, which includes USD 21.2 billion
in the DFI and an additional 4.3 billion U.S. Dollar balance at the
Central Bank. Both Minister Jabr and the IMF are prepared to see
these balances fall this year, as accumulated reserves fund any
budget deficit. However, neither is prepared to countenance a
precipitous drop, nor are they prepared to see these reserves
committed in bulk to a single capital investment program, no matter
Qcommitted in bulk to a single capital investment program, no matter
how dire the need in Iraq.

No Roll-over of 2008 Funds
11. (SBU) Previously, the MoF allowed provinces to carry over
unspent balances from the current year for use in the following
year. This was done to give the provinces, which had received
separate capital funding allocations only since 2005, more time to
work their capital programs through the MoPDC and MoF. The 2008
budget law allowed both ministries and provinces to carry over
unspent capital funds (the 2007 budget law permitted only the
provinces to carry-over), as the GOI wanted to improve rates of
expenditure and utilization of funds. This was popular with
spending units, but it played havoc with a cash-based accounting
system based on an annual cycle.

12. (SBU) The initial 2009 budget submission contained a provision
that would allow both ministries and provinces to carry-forward
unspent balances in their capital budgets, as was done in 2008.
This was seen as necessary, as the USD 22 billion supplemental
budget was only enacted in September, leaving little time to expend
it in compliance with unwieldy GOI procedures before year-end.
However, as part of his agreement with the IMF, and to conserve
cash, Jabr removed the 2009 carry-over provision. Without such a
provision, the MoF effectively will freeze budget execution on
December 31. Any programs not contractually committed at that time
will need to be converted to 2009 funding. As such, withdrawing the

BAGHDAD 00003698 003 OF 004

carry-forward provision is a backhand way to curtail spending
programs. At the same time, it reduces the amount of cash flowing
out of the DFI to fund 2008 capital expenditures, so it increases
the cash buffer available to fund deficit spending in 2009 and

Disgruntlement Growing Over Kurdish Share
13. (SBU) Both the initial submission of the 2009 budget and the
revised version call for the Kurds to receive 17 percent of the
budget after deduction of "sovereign expenses." According to Jabr,
this is a rational apportionment that goes back to the time of Ali
al-Alawi, Jabr's predecessor as Finance Minister. Jabr is prepared
to change this percentage, but only based on an objective measure.
The 2008 budget called for a census to fix a percentage share for
the Kurdish regions based on population, but the census has been
postponed to late 2009, and Jabr feels compelled to stay with the 17
percent. Jabr added that while the Kurdish share of the budget
remained controversial, the question of funding for the Peshmerga,
which was one of the issues behind the delayed passage of the 2008
budget, had fallen into the background. The GoI is now unified
around the position that the Peshmerga would only be funded by the
central government budget when it fell under Iraqi Army command, a
position which the Kurds find unacceptable. With no way to resolve
this impasse, debate has moved to other issues.

14. (SBU) Minister Jabr expressed optimism that a census would be
conducted in 2009, as it is long overdue and a wide range of GoI
programs (i.e., PDS) would benefit from an accurate population
count. Jabr noted that a new provision on this score was inserted
into the 2009 budget legislation to allow adjustment of the KRG
share should the census conclude that the Kurdish share of the
budget was unrepresentative of actual population distribution. Jabr
believes this will mollify certain Shia and Sunni groups who believe
the Kurds are getting an unfair share of the national budget, but
Kurdish elements can be expected to react adversely.

15. (SBU) Jabr has also indicated that pressure was building with
regard to the Kurdish share of the GoI budget. "A number of CoR
members were furious at Kurdish maneuverings in regard to this
year's Supplemental Budget, which substantially increased the
funding they received," Jabr told TREASATT. Another thing he
pointed out was that when a budget is initially distributed, the
Kurds take their 17 percent in full. However, if funds bound for
non-Kurdish spending units are not used, they typically are returned
to the budget and re-allocated. This gives the Kurds a second 17
percent. And the more times GoI funds are cycled through the
budget, the more times the Kurds receive their share. Jabr remarked
that many economically savvy CoR members were becoming upset over
this issue, particularly when combined with Kurdish intransigence on
other issues.

Special Provision for FMS Included in 2009
Budget Law

16. (SBU) The PFMAG, working with the MoD, MoI, MoF, Board of
Supreme Audit, and the Finance Committee of the Council of
Representatives, sought a solution to the issue of reconciling
actual deliveries of weapons and other items procured under the
Foreign Military Sales (FMS) program with amounts previously
budgeted. This inter-agency work led to a decision to allow unspent
allocations for weapons and military supplies within the 2006, 2007,
Qallocations for weapons and military supplies within the 2006, 2007,
and 2008 budgets to be rolled-over into the 2009 financial year.
This allows the MoF to record the expense related to millions of
dollars of deliveries under the FMS program over these three years.
Article 27 of the revised draft budget law puts this approach to
resolving past FMS issues into law, eliminating an important
impediment to this method of military goods procurement.

--------------------------------------------- --
CoR Finance Committee will cooperate to secure
prompt budget passage
--------------------------------------------- -

17. (SBU) After the meeting with Minister Jabr, TRESATT and
Econoff met with Ayad al-Samarai, Chairman of the Iraq Council of
Representatives (CoR) Finance Committee to discuss the 2009 budget
(septel). Noting the "softness" in oil revenues, al-Samarai is
concerned about the level of operating expenses, and will look for
additional cuts. With no carry-forward provision, al-Samarai agreed
with TREASATT that it is critical to pass the 2009 budget on a
timely basis, as capital spending will stall without funds available
for expenditure. To expedite passage, al-Samarai told us that the
CoR received the budget November 16, and it was go to an immediate
first reading, as well as simultaneous beginning of the comment
period. (Note: COR consideration of the SOFA has apparently side
tracked the budget reading. End note.) Al-Samarai wants to have a
second reading after the end of the Haj recess in mid-December, and

BAGHDAD 00003698 004 OF 004

he is hopeful that debate and final passage can be completed before
year-end. Al-Samarai agreed with Minister Jabr that the Kurdish
share of the budget was controversial politically, but he is hopeful
that the provision to "adjust" shares in response to census results
may placate opposition in the CoR. (COMMENT: The developing close
cooperation between Finance Minister Jabr and Chairman Samarai bodes
well for implementation of the GoI fiscal agenda, as well as
demonstrating how Shia and Sunni leaders can work together for the
benefit of Iraq. End Comment).

Uncertain Future Calls for Restraint

18. (SBU) COMMENT: The reductions forecast in the revised budget
approved by the CoM and moved on to the CoR embody the fiscal
restraint needed as oil prices fall from the heights they reached
just a few months ago. Removal of the provision allowing carry-over
of the "rich" 2008 capital budget into 2009 aligns the capital
budget with a realistic rate of spending. Nevertheless, it seems
inevitable that Iraq will need to tap into its accumulated fiscal
surplus during 2009. However, this is not a permanent source of
funding, and as a result, 2009 may represent something of a
watershed year for Iraq. If oil prices do not recover, or if they
decline further, the GOI may have to force a true fiscal austerity
budget through the CoR beginning with the 2010 budget and prepare
the reforms needed to make Iraq an attractive market for
international capital. End comment.

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