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Cablegate: Goi Proposed 2010 Budget: Riding the Oil Roller Coaster

VZCZCXRO9919
RR RUEHBC RUEHDA RUEHDE RUEHDH RUEHIHL RUEHKUK
DE RUEHGB #3028/01 3210608
ZNR UUUUU ZZH
R 170608Z NOV 09
FM AMEMBASSY BAGHDAD
TO RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/SECSTATE WASHDC 5471
INFO RUCNRAQ/IRAQ COLLECTIVE

UNCLAS SECTION 01 OF 03 BAGHDAD 003028

SENSITIVE
SIPDIS

E.O.12958: N/A
TAGS: EFIN ECON EAID PGOV PREL IZ
SUBJECT: GOI PROPOSED 2010 BUDGET: RIDING THE OIL ROLLER COASTER

1. (SBU) Summary: The GOI has proposed a 2010 budget to the Council
of Representatives (CoR) that would increase expenditures by 22
percent. While security remains a budget priority, as do the
essential services of oil and electricity, more resources are
proposed for health, education, municipalities, water, and culture.
Investment expenditures, key to long-term economic growth and job
creation, are intended to increase a hefty 55 percent to account for
28 percent of the total budget, up from 22 percent last year.
Higher prices and exports of oil are assumed to support these higher
expenditures, but full budget implementation would still leave a
deficit of 22 percent of GDP. Accumulated balances and domestic
financing would only partially finance the deficit, leaving a gap to
be filled by possible IMF and World Bank loans or, if the market
continues to climb, higher oil prices. The Chair of the CoR Finance
Committee hopes that the budget can be adopted by early December.

2. (SBU) This year's budget was the Minister of Finance's (MoF)
first attempt to develop a medium-term budget framework and link
policies to budget expenditures. The MoF also sought to hold
spending steady, but rising oil prices, the prospect of signing
major oil contracts, and electioneering conspired to raise planned
expenditures. A modest spending plan that realistically could be
implemented would allow for long-term planning and avoid the
disruptive "on-again-off-again" cycle of spending that has
characterized GOI budget implementation in the last two years.
Given the pent-up demand and upcoming national elections, it seems
that the GOI would prefer to push the spending envelope than follow
the staid, practical approach of under promising but over
delivering. They are riding the roller coaster of oil prices. End
Summary.

PROPOSED 2010 BUDGET: EXPENDITURE BASICS

3. (SBU) The Council of Ministers (CoM) sent a proposed budget to
the CoR in mid-October with total expenditures of USD 71.3 billion,
revenues of USD 52.8 billion, and a resulting deficit of USD 18.5
billion. Expenditures are slated to increase 22 percent from 2009's
budgeted levels, and revenues are expected to increase around 31
percent, largely based on an assumed oil price of USD 62.50/barrel
and exports averaging 2.1 million barrels per day (mbpd).

4. (SBU) The proposed 2010 budget would increase the share of
investment expenditures to 28 percent of total expenditures, up from
22 percent in 2009's budget, to total USD 19.7 billion. The GOI,
encouraged by the International Monetary Fund, wanted to channel
more resources to investment, which helps generate employment
through projects and engenders long-term economic growth. About
one-third of the increase in proposed capital expenditures is for
electricity investment.

5. (SBU) Operational expenditures would rise 12 percent, with
employee compensation declining as a share of the overall budget
from 30.5 percent in 2009 to 27.6 percent. Last year, the
government sought to cap employment, concerned that it would become
a refuge for all unemployed. That policy seems to have been
reversed this year with the proposed creation of 148,075 new
positions that will be funded by the budget (45,291 in Ministry of
Interior; 47,549 in Ministry of Defense). The draft budget law
would authorize the Minister of Finance to create positions and
amend the work force to rehire politically dismissed employees,
integrate former militia members, and receive transfers from
self-funded companies. Wages and salaries increased only eight
Qself-funded companies. Wages and salaries increased only eight
percent, however, as 20 percent salary reductions are proposed for
the highest executives (President of the CoR, President of the
Republic, Prime Minister and their deputies) with 10 percent
reductions for other senior officials (CoR members, Ministers, Under
Secretaries and Directors General and equivalent staff).

PROPOSED 2010 BUDGET: REVENUE BASICS

6. (SBU) The story of the proposed 2010 budget revenue stream boils
down to oil. True, oil has always accounted for the lion's share of
revenues. The GOI, however, had previously sought to pump up
non-oil revenues -- but not this year. While the government still
stresses the need to increase non-oil revenues, such estimates for
the 2010 budget are marked down 22 percent from 2009's budget to a
more realistic USD 4.9 billion. Oil is expected to generate USD
47.9 billion or 91 percent of total revenue.

THE DEFICIT AND ITS FINANCING

7. (SBU) The MoF does not provide a precise indication of how the
programmed deficit of USD 18.5 billion is to be financed other than
to say it will use accumulated balances (which depends on 2009's
budget execution and oil prices) and borrowing. However, the
proposed budget authorizes the MoF to borrow USD 4.5 billion from
the IMF and USD 2 billion from the World Bank and to use Iraq's
Special Drawing Rights (USD 1.8 billion) from the IMF to help cover
the deficit. This is a particularly important provision since it
would signal to the IMF that the Parliament approves the IMF program
conditions and the associated borrowing.

BAGHDAD 00003028 002 OF 003

POLICY PRIORITIES

8. (SBU) According the proposed 2010 budget, GOI policy goals are
to: (1) achieve security; (2) meet basic needs of citizens; (3)
increase investment in human capital; (4) rebuild and construct new
infrastructure; and (5) reduce unemployment. These policy
priorities are confirmed by the numbers. Security budgets (MoI and
MoD) account for 15.4 percent of total expenditures, still the
highest single priority area, but down one percentage point from
2009's budgeted number. The oil sector accounts for 3.8 percent,
unchanged from last year, and electricity five percent, up from two
percent in 2009. The reason for the increase is to bring on the
2010 budget the payments already made this year of USD 2.4 billion
to GE and Siemens that were not on 2009's budget. Expenditures on
health, education, water, municipalities, environment, and youth,
together up 38 percent, reflect investment in human capital and
infrastructure that could contribute to job creation.

MEDIUM TERM STRATEGY

9. (SBU) An interesting development in building this year's budget
was the first concerted attempt to create a medium-term budget
strategy that linked expenditures to policy measures. With
assistance from international donors, the MoF delivered a draft
framework to the CoM in early June. The CoM then created a
committee to review details with the Minister of Finance, and
produced a report to guide 2010 budget preparation.

10. (SBU) The CoM committee made several recommendations that have
been included in the proposed budget. These include:
(a) any increases in revenue be channeled to investment rather
than operating expenditures;
(b) no automatic annual salary increases for officials at the DG
level or higher rank;
(c) higher priority to health, education and culture during the
next three years;
(d) Trade Ministry to produce a new plan to target the Public
Distribution System to the truly needy (the budget provides for a
reduction of expenditures for PDS by 16 percent to USD 3 billion);
(e) fees to be collected by the Ministries of Electricity,
Communications, Municipalities and Public Works for services
rendered;
(f) eight companies to be dropped from the budget that are under
the Ministry of Industry and Minerals and urge the Ministry to
create economic partnerships or privatize the companies; and
(f) self-funding companies to fund any deficit spending with
loans from Iraqi banks based on a business plan rather than the
budget.

11. (SBU) Some of these issues emerged in the budget debate after
ministries had discussed them in the context of preparing the Iraqi
Poverty Reduction Strategy (PRS) sponsored by the World Bank. The
PRS covers such issues as health, education, environment, and the
social safety net, including the public distribution system. Many
of these recommendations are in the proposed budget, but some would
require supplementary legislation for implementation. Still, the
effort to link policy to budget expenditures is an important step in
budget preparation and planning.

PROCESS: COR AT WORK

12. (SBU) The Chair of the Finance Committee of the CoR would like
to have the budget passed no later than December 15, by which time
she suspects CoR members will return to their districts to campaign
for the scheduled January national elections. She engineered the
first budget bill reading on November 2 and has begun the serious
work of analysis, building upon the experience in passing the 2009
budget law. The Chair also has established a mutually respectful
Qworking relationship with the MoF, which has provided more
information to the Committee at this stage of the budget process
than in previous years. Organizing a CoR vote is not an easy task,
but last year, many members deferred to the expertise of the Finance
Committee on technical issues and did not engage in an extended
political debate.

OBSERVATION: GOOD INTENTIONS AND THE PRICE OF A DEAL

13. (SBU) The MoF drafters of the 2010 proposed budget started out
with good intentions. The initial medium-term budget strategy
delivered to the CoM in early June was conservative, showing no
increase in spending with revenue based on a USD 58/barrel price and
exports of 2.15 million barrels a day, on average. The CoM expert
group recommended increasing the price assumption to USD 60. When
the MoF sent instructions to Ministries, they indicated that
proposed spending for 2010 should not exceed that of 2009, but did
not impose "hard" budget ceilings.

14. (SBU) Budget numbers starting spinning up in August when
Ministries were negotiating with the MoF. Rather than respect
nominal spending ceilings of the 2009 budget, Ministries stuck to

BAGHDAD 00003028 003 OF 003


their usual practice of opening their request with a negotiating bid
rather than a well-considered realistic request. In the event, the
MoF received requests totaling USD 149 billion, more than twice the
budget finally agreed within the CoM. Rising oil prices, the
prospect of major oil contracts, and the elections also played a
role in escalating expenditures. Oil revenues have increased
steadily from May, when drafting began, to October, when the
proposed budget was finalized. The Prime Minister began to pledge
to pass benefits of higher oil prices to the people to meet basic
needs.

15. (SBU) When the CoM agreed on a budget on October 13, total
expenditures had risen to USD 67.3 billion. This was the level
agreed to with the IMF earlier in the month. Some Ministries,
however, were not pleased with their budgets. The Minister of
Planning proposed reallocations based upon execution rates of the
2009 budget. When the Cabinet met on October 16 to consider the
revised allocations, some members balked. Wanting to get the budget
to the CoR for action this year and reach a final agreement with the
IMF on a Stand By Arrangement, the Finance Minister offered the
Ministries a deal. He offered to increase the budget by
incorporating USD 4 billion of a proposed USD 5.7 billion 2009
supplemental budget and covering part of the increased expenditures
by increasing the oil price assumption to average USD 62.50 and
exports to average 2.1 mbpd. He reportedly told the CoM that if
they didn't agree to the new USD 71.3 billion in expenditures, he
would stick with the USD 67.3 billion budget, as agreed with the
IMF. The Cabinet acquiesced in this "take it or get less" stand.
(Note: Accordingly, the MoF stated that as far it was concerned, the
proposed supplemental budget is no longer on the table.) Thus, the
budget deal was cut, but at an expenditure level nearly 22 percent
higher from where the MoF started in May.

IMF ANGLE

16. (SBU) The IMF believed that the GOI faced a financing gap due to
lower oil prices and therefore pressed the MoF to demonstrate budget
discipline. As oil prices rose towards the end of the year, the
financing gap would narrow if the higher prices held. The final USD
4 billion bump-up of the budget came as a surprise to the Fund.
While the Minister was in Washington for the Business and Investment
Conference, he had intense discussions with the Fund, which wanted
some budget reductions. The Minister's response was that the budget
had already been sent to the CoR, and moreover, reopening the budget
with the Cabinet while oil prices were rising would lead to pressure
for increasing expenditures, not reducing them. The Fund dropped
its demand for budget reductions. The Fund and the MoF recognized
that the oil prices could fall again, and tentatively have agreed
that if the price of oil that Iraq receives is above an average of
USD 73 dollars a barrel (to be calculated according to an IMF
methodology) the SBA would become precautionary in 2010 rather than
disbursing.

MORE OBSERVATIONS

17. (SBU) The MoF deserves credit for beginning a more serious
medium-term budget strategy exercise and working hard to keep the
timing of the budget process on track. The Minister is keen for a
budget to be enacted this year, a view shared by the Chair of the
Finance Committee. Failure to pass a budget before early December
when parliamentarians start drifting away to campaign for the
January national elections would mean no budget until a new
government is formed, possibly as late as mid-year. By then,
Qgovernment is formed, possibly as late as mid-year. By then,
preparations for the 2011 budget will be underway. The GOI would
still be able to allocate 1/12 of 2009's budget for expenditures
each month per ministry, but would lose any benefits of the proposed
increase spending. Moreover, failure to agree to a budget by early
December would mean no agreement with the IMF, which needs to know
budget details and the financing gap to be filled.

18. (SBU) While this year's budget process showed admirable
improvements, it was also a missed opportunity. A more moderate
budget that would be fully implemented would allow ministries to
plan and execute strategically important programs and allow MoF to
build up a reserve fund to buffer expenditures from oil price
swings. Instead, the GOI is riding the roller coaster of oil
prices: high expenditures in good times and low expenditures in bad.
The Minister of Finance demonstrated his ability to rein in budget
allocations in early 2009 when oil prices were well-below budgeted
amounts. However, the "on-again-off-again" cycle of expenditures
undermines the intention of policy makers when set national
priorities through the budget.

HILL

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