Investors still fight shy of Iraq

By James Arnold
BBC News Online business reporter

There's a stirring in Iraq's economy, but investors are wary

Is Iraq's economy on the mend? "It's a case of two steps forward, two steps back," sighs one Baghdad business veteran.

"Count your blessings: at least it's not three steps back."

Iraq's battered contingent of foreign business people has grown well used to making the most of small mercies.

Two years after the fall of the Iraqi capital, there are discernible signs of commercial life. But reasons to steer clear grow more compelling by the day.

There is fodder for the optimists.

Economic statistics must be taken with a heavy pinch of salt, but are at least starting to turn positive. The currency is stable enough, and annual inflation is a tolerable 30% or so.

Gross domestic product leapt by 52% last year, the International Monetary Fund (IMF) says, and should increase by another 17% in 2005.

The IMF is pleased with Iraq's progress, and said this week that it should have a new support programme in place by the autumn.

At the same time, the domestic institutions necessary to support economic development are creaking into action.

Just another tax to pay

The Central Bank of Iraq is a year old, and is preparing to expand its scope into banking supervision and money markets.

The Iraq Stock Exchange, launched last June, still only trades twice a week, and turns over an average of less than $1m a session. But according to brokers, the authorities are planning to open up the market to foreign investors for the first time.

And the Trade Bank of Iraq, backed by an international banking consortium to help finances imports and exports, has already issued letters of credit worth $5.3bn since its launch in November 2003.

Impressive progress, perhaps. But investors are underwhelmed.

According to anecdotal evidence, up to one-third of the Western firms that rushed into Iraq after the end of the war have now quit the country.

Part of the reason is financial.

The main source of revenues at this stage is the pockets of Iraq's donors, principally the US Project and Contracting Office (PCO), and contractors grumble that the money is not flowing freely enough. The PCO has so far doled out only $1.9bn of the $18.4bn in available reconstruction funding.

'The most dangerous place in the world'

By far the biggest deterrent, however, is violence. More than 200 foreign contractors have reportedly been killed in the past two years.

Sabotage and mismanagement are hampering the oil sector

According to Simon Treadgold of Olive Security, Iraq is "unquestionably the most dangerous place in the world to operate right now".

Protection can, of course, be bought: ex-armed forces types earn upwards of £300 a day, tax free, by working as security guards.

But when business is less than buoyant, heavy security costs act like a particularly punitive tax.

Without the arrival en masse of foreign investors, Iraq's economy has little medium-term chance of reviving, argues Muhammad-Ali Zainy, an economist at the Centre for Global Energy Studies.

Foreign capital, he says, provides the mechanism by which an otherwise narrow, oil-dependent economy can be broadened out.

In the meantime, oil accounts for upwards of 60% of GDP, and although global prices are certainly extremely high, prospects are mixed.

Iraqi production has not bounced back as robustly as hoped.

The government has been targeting output of 2.9 million barrels per day, roughly in line with the records hit during the Saddam Hussein era. In fact, the country will be fortunate to produce two million barrels per day.

That is partly because of insurgents, who caused damage that knocked a reported $7bn off the country's oil revenues last year.

But it is also the result of decades of mismanagement of oilfields, whose reserves were not husbanded carefully under Saddam.

The Iraqi oil ministry has hired Shell and BP to see whether the massive Kirkuk and Rumaila fields can be nursed back to health, but the work is unlikely to be completed before the end of the year.

"Until then, we are producing blindly," says Dr Zainy. "Perhaps the reserves are being irreparably harmed."

Pipe dreams

And the country's oil infrastructure is in shabby condition.

Iraq cannot export via Turkey because the pipeline from the Kirkuk field has been blown up.

To the south, the country's refineries are in such poor shape - and hampered by frequent power shortages - that Iraq has had to squander hard currency on importing petroleum products, says David Butter of the Economist Intelligence Unit.

These imports cost the country something like $60m a month. And overall, direct and indirect subsidies to the oil sector - to assure affordable supplies of petrol, for example - cost the economy an estimated $8bn a year.

Slow start

Such is the world's thirst for oil, though, that these problems should eventually be resolved.

Trickier, however, is to ensure that Iraq evolves into a diversified economy, avoiding the sort of dependency suffered by oil-rich economies such as Nigeria or Venezuela.

As an indicator of whether that happens, says Mr Butter, take a close look at the performance of the new government, which will have considerable authority to spend, invest or squander the $25bn or more Iraq earns in annual oil exports.

This is the body, remember, that took nine weeks to elect a speaker. A hesitant start - or admirably unhasty, for those counting their blessings.