A man counts US dollar banknotes at al-Kifah stock market in Baghdad

A man counts US dollar banknotes at al-Kifah stock market in Baghdad on December 27, 2022 as the value of Iraqi dinar against US dollar drops further.

(Photo by AHMAD AL-RUBAYE / AFP) (Photo by AHMAD AL-RUBAYE/AFP via Getty Images)

Rebuilding the Iraqi Economy 20 Years After US Invasion

Twenty years after the start of the military operation that led to the fall of Saddam Hussein’s regime, Iraq is still trying to reclaim its status as a major regional economic player.

Research from Brown University’s Watson Institute estimates the cost of the Iraq war at approximately $2.9 trillion. Although it is harder to estimate the cost to the Iraqi economy—the approximately 300,000 dead civilians and combatants and 3 million internally displaced refugees was a trauma that is difficult to recover from—it is easy to see how much it has been set back by the conflict.

It seems a long time ago now, but back in the 1980s, Iraq was seen as one of the most advanced Arab economies, with some of the best infrastructure and the highest per capita income in the region. With the country so sorely dependent on oil revenues, which still represent around 87% of the government’s budget, the 1980s oil crash hit the Iraqi economy hard; the Iran-Iraq war also cost billions of dollars and hundreds of thousands of lives, and the international sanctions that followed Saddam Hussein’s 1990 invasion of Kuwait sounded the death knell for this period of relative prosperity.

Then, following the 2003 U.S.-led invasion of Iraq, the economy contracted by up to 50% by some measures, due notably to the widely criticized destruction of the Iraqi state apparatus; as flawed and morally bankrupt as it may have been, the Baathist regime provided a measure of stability that no longer existed after the fall of Saddam Hussein, and the chaos of internecine fighting that followed enabled the rise of the Islamic state.

Massive Resources for a Slow Reconstruction

The U.S. invested significantly in the country in the following years, but much of that was in security—with a need to replace the disbanded Baathist security forces—and the rest of the spending in infrastructure was highly inefficient due to corruption and a fractured social order. As a result of all this, per-capita GDP is roughly the same now as it was in 2003. A once-leading regional power had become a basket case.

Given the hardship that the Iraqi population has undergone over the last few decades, one can only be relieved that the authorities are making efforts to modernize the economy, but the road to economic recovery is long and littered with potholes.

Although it is true that Iraq seems finally to be on the mend, its economy remains extremely fragile and largely dependent on oil revenues. Indeed, a recent IMF mission concluded that a drop in oil prices could severely jeopardize the country’s macroeconomic stability and capacity to implement the reforms it needs. As such, it is concerning that OPEC is forcing Iraq to cut its oil production in 2023, which will amputate oil revenue.

The IMF estimates that growth was stagnant in 2022, although real GDP is expected to expand by 3.7% in 2023, but as Moody’s Investors Service said in its latest report on Iraq’s credit fundamentals, “Iraq is heavily exposed to significant carbon transition risks because of its economic, fiscal and external reliance on the hydrocarbon sector.”

The problem is that Iraq also still requires major investment. The new 3-year budget voted this spring allows for some of this; it was certainly crucial to allow the government to continue operating following several years of gridlock with the parliament unable to agree on a budget, and according to Prime Minister Mohammed Al Sudani the budget will enable the government “to start the implementation of the infrastructure projects and turn Iraq into one of the biggest workshops in the region.”

Al Sudani also believes that the budget “prioritizes the essential needs of Iraqi citizens and families, aiming to meet their expectations for government services, construction and infrastructure projects.” But critics disagree: “there is no real investment spending in the budget,” says Sajad Jiyad, an analyst and fellow at the Century Foundation, “it just focuses on expanding what was in previous budgets and leaves very little—a few billion—on investment.”

At any rate, as IMF mission chief Tokhir Mirzoev says, Iraq’s structural imbalances mean that even the government spending that is in the budget, such as it is, “could reignite inflation and foreign exchange market volatility.” Inflation is a chronic issue for Iraq, not helped by the fact that the country has a massive trade deficit: “Iraqi society buys everything from abroad, from agricultural materials to food and medicines, and industrial goods,” said Iraqi Foreign Minister Fuad Hussein in a recent interview with VOA’s Kurdish Service. “If you look at Iraq's trade or its trade balance with other countries, you will see that everything comes from abroad,” he added.

This is one of the subjects that Hussein discussed on his recent visit to Washington. Since the dinar collapsed after the 2003 invasion, many Iraqis chose to use the dollar for their everyday purchases, but the Iraqi Interior Ministry has banned trade in U.S. dollars to prevent runaway inflation. The recent sharp decline of the Iraqi dinar against the dollar is further causing foreign exchange volatility which, according to the IMF, has “adversely affected import-dependent non-oil sectors.” One of the ways that the Iraqi government is trying to fight this is a system for monitoring American dollars that enter the Iraqi economy and tracking when they leave the country, which has the added benefit of preventing the financing of terrorism.

The Central Bank of Iraq in Action

The Central Bank of Iraq’s (CBI) actions seem to be bearing fruit in this respect, with the foreign exchange market stabilizing, helped by the growth of real non-oil GDP, which is expected to reach 3.7% in 2023. Inflation, which peaked at 7% in January 2023, has begun to fall and is forecast to average 5.6% this year.

Meanwhile, in May 2023, the Governor of the CBI, Ali Mohsen al-Allaq, unveiled a new state-owned financial institution, the Social Development Bank (SDB), which aims to promote inclusive economic progress in Iraq. The SDB will "diversify the non-oil economy by fostering small and micro-scale projects, thereby stimulating the private sector and reducing unemployment and poverty rates," said al-Alaq. "The bank will be the first in Iraq to cater to low-income individuals, offering facilitated loans and simple guarantees to support vulnerable groups," he added. The CBI also plans to open a Centre for Finance and Business, which according to al-Alaq, “will host the securities market, the business sector, and financial institutions."

The CBI has also signed an agreement with British banknote manufacturer De La Rue for the production of polymer notes. This decision seems somewhat at odds with the other recent positive initiatives by the Iraqi government to modernize their economy. Indeed, polymer banknotes are far from having proved themselves as a prudent fiduciary choice, and certain countries which had previously rolled out polymer banknotes because they were thought to be more robust, have backtracked because the notes started to show signs of wear and tear much more rapidly than originally thought. With a shorter-than-expected lifespan, it becomes harder to amortize the extra initial cost of polymer banknotes and the anticipated savings are not forthcoming.

Many of the central banks around the world who have made the transition to polymer banknotes also cite their greater security, but again, polymer banknotes add little in this respect; modern printing techniques mean that paper banknotes, like the Euro notes, which are made of cotton fiber, boast numerous cutting-edge security features like raised ink, security threads, and holograms. In fact, because some of these security features are woven into the actual fabric of the paper, modern paper banknotes may even be harder to counterfeit than polymer banknotes, on which security features are simply added to the substrate. It is easier for counterfeiters to obtain polymer material and try to imitate the security features that are printed on the surface of banknotes than to accurately reproduce the embedded threads, for example, that are used in banknotes like the new Euro series. According to the European Central Bank, the number of counterfeit Euro banknotes withdrawn from circulation reached a record low in 2021, and indeed, one of the largest counterfeiting operations shut down in recent memory was for polymer banknotes in Romania. Likewise, it is worth noting that the U.S. dollar—the world's principal reserve currency and the most widely used currency in the world—is still printed on paper. The U.S. dollar is subject to a high degree of regulation and oversight, so if the Federal Reserve is not considering switching to polymer banknotes, the consensus must be that paper provides strong enough protection against counterfeiting.

Given the hardship that the Iraqi population has undergone over the last few decades, one can only be relieved that the authorities are making efforts to modernize the economy, but the road to economic recovery is long and littered with potholes; to maintain credibility in Iraq’s fiscal policy, the government should continue to focus on more productive measures, rather than falling prey to fads that do nothing to promote actual economic stability.

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