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Iraq’s Economic Collapse Could Be Biden’s First Foreign-Policy Headache

By Farhad Alaaldin, Kenneth M. Pollack

A new Iraq crisis is the last thing that U.S. President-elect Joe Biden needs. Unfortunately, it may be the first foreign-policy problem he has to face.

Iraq is headed for a financial collapse, and in its current fragile state, fiscal ruin is likely to bring down its rickety political system, which could then ignite yet another round of civil war.

Over the course of the past two decades, corruption has created a two-headed problem for Iraq. Iraq’s weak, collusive, inclusionary governments have meant that every major political party gets to run one or more ministries. They administer these bureaucracies not for the good of the country but as massive patronage networks—corruption machines that suck oil revenues from the treasury and pass them on to their constituencies in the form of jobs, contracts, and other perks. The rampant graft has effectively smothered what little private sector Iraq once had, meaning there isn’t much of an alternative to public-sector jobs.

As a result, the government is now the largest employer by far and a huge percentage of the populace counts on the state for its livelihood—either directly through salaries and pensions, or indirectly via contracts or the provision of goods and services to those on the government payroll. Even small businesses in Iraq ultimately depend on the government because so many of their customers—especially in the major cities—are themselves paid by the government, one way or another. Moreover, the Iraqi government still provides a monthly “food basket” via the Public Distribution System, which remains an important element in the daily lives of working-class and poor Iraqis.

Not surprisingly, there has been a threefold increase in public workers since 2004, and the government pays 400 percent more in salaries than it did 15 years ago. Thus, the government and its oil revenues have become the principal driver of the Iraqi economy and the provider of the Iraqi people.

The upshot is that Baghdad needs $5 billion every month to pay direct salaries and pensions, as well as another $2 billion to cover essential services and operating costs, much of which constitutes indirect forms of support to the population.

However, since the onset of the COVID-19 pandemic and the collapse of oil prices (which provide some 90 percent of government revenue), Iraq’s monthly income has fluctuated between $2.5 and $3.5 billion. That means Baghdad is running a monthly deficit of $3.5 to $4.5 billion.

Now Iraq is running out of money to sustain that deficit. In October, Iraq’s minister of finance, Ali Allawi, stated in a TV interview that Iraq’s “Central Bank reserves stand at $53 billion.” Since then, the parliament passed a funding deficit law that enabled the government to borrow $10 billion to pay salaries for October, November, and December 2020. That brings Iraq’s total debt to a staggering $80 billion, according to government sources and budget proposals, and has forced the country to allocate more than $12 billion from the yearly budget to interest and principal repayment on these loans—all of which is further exacerbating the government’s capital shortfalls.

By the summer of 2021, Iraq’s hard currency reserves could be dangerously low. Indeed, the government could run out of cash to pay for most of its current, minimal obligations.

According to Iraqi officials, because Iraq’s currency reserves are already drying up, the government is being forced to print money to pay for loans to the government that cover salaries and operation costs, running the risk of unleashing rampant inflation. Because of the dangers of unchecked inflation, Baghdad may soon have to devalue the dinar instead, but this, too, entails major economic and political risks. Devaluation without accompanying economic reforms—which Iraq’s political powers refuse to consider—will cripple imports, undermine savings, and increase hardship.

Moreover, devaluation would probably cause further inflation as well. The evaporation of hard currency means that Iraq soon won’t be able to pay for imports of food and goods. Iraq is a net importer of virtually everything except oil. If money flows run low and the dinar is devalued, goods will become scarce and prices will rise. The dinar could go into free fall within six months should the government continue to draw down the remaining funds in the Central Bank of Iraq once a devaluation starts.

Some Iraqi government officials are simply hoping that a projected increase in oil prices this spring will save them. Yet most projections suggest no more than a 10 to 15 percent price hike, according to multiple oil traders and analysts—far too little to eliminate Iraq’s looming crisis. And even that could vanish if expanded Iraqi, Libyan, and Iranian oil exports cause the Saudis and Russians to follow suit and increase production to protect their market share.

Iraqi Prime Minister Mustafa al-Kadhimi sounded the alarm of a coming financial reckoning in a press conference on Nov. 17, warning, “We will face the problem of paying salaries in January. I am warning you now.”

As a technocrat without a political power base, Kadhimi has been unable to push Iraq’s political parties to address, let alone solve, the problem. The government produced a white paper for reform on Oct. 13; however, it has not started its implementation. Consequently, there has been no effort to reduce salaries, pare back the numbers of government employees, or even to eliminate the hundreds of thousands of so-called ghost employees on Baghdad’s payroll for fear of upsetting important Iraqi political bosses.

When he took power, Kadhimi had widespread support: from average Iraqis and the thousands who had been protesting in the streets, from Iraq’s Shiite religious establishment, from moderate Shiite political parties, from many Sunnis, and even from the Kurds. He was seen as smart, apolitical, effective, and close to the Americans.

However, there is a growing fear across the country that Kadhimi cannot fix Iraq’s broken system. The economic crisis that would result from Iraq running out of money could be the nail in that coffin. Kadhimi would likely be completely discredited. Many of Iraq’s venal political parties would try to make him the scapegoat to avoid the inevitable popular backlash. Meanwhile, the Iranians, who oppose Kadhimi, would try to exploit the chaos to reassert their influence over the Iraqi government.

A financial crisis would almost certainly spark widespread street demonstrations, with Iraqis once again demanding a change of government. It would be challenging for the government to keep order if salaries were not being paid and the prime minister lacked authority. Armed groups and tribes, including the armed militias backed by Iran, would try to fill the vacuum and usurp the role of the primary security forces in Iraq. These same groups would also fight for territory to control. They might try to take control of revenue-generating resources such as oil fields, ports, border crossings, large businesses, agricultural land, and private properties.

In such a situation, armed conflict and land grabs could become commonplace again, except in those areas with robust security, such as the Kurdistan region. However, even the Kurdistan region will not be safe from internal economic troubles unless it can expand its resource base, because it, too, is financially dependent on Baghdad. Perhaps the Kurds’ most apparent target would be Kirkuk and its oil fields, but this would only inflame the conflict between Erbil and Baghdad, not to mention Shiite militias, who would resist such a move.

Turkey would feel threatened by Kurdish gains, particularly if the Kurdistan region retakes Kirkuk. Ankara would feel obligated to defend the Turkmen ethnic group there and prevent the Kurds from reviving their dream of independence. Iran is already working to regain its dominant influence in Baghdad, and Tehran cannot afford to lose Iraqi trade revenues (which stand at around $12 billion), smuggling opportunities, and access to international financial markets.

The Saudis might well respond to any resurgence in Iranian influence by supporting Sunni groups and tribes with funding or weapons to defend themselves, especially since Riyadh cannot count on a large U.S. troop presence to handle the problem, as they could in 2006. Iraq could easily slide back into intercommunal civil war, with regional powers intervening against both the Iraqis and one another.

Given the gravity of the situation and the importance of Iraq to the region and the international oil market, the United States and the international community cannot idly stand by. Of course, during the first six months of his administration and with a pandemic and massive economic crisis at home to deal with, Biden won’t be able to afford to make this his highest priority either—but acting sooner will be cheaper and avoid harder choices later, when Iraq could be in free fall.

Iraq’s coming crisis is a crisis of liquidity. Iraq will need money to prevent the collapse of its financial system, which would be the first domino to fall. If the United States were willing to pledge a significant amount, perhaps $1 billion, it should be possible to put together a larger package of $5 billion to $10 billion for Iraq with other countries chipping in.

The idea of providing $1 billion in emergency budget support to Iraq may seem impossible at this moment. It shouldn’t. It wouldn’t come out of the pockets of ordinary Americans in the form of increased taxes—and the last 12 years should have taught the United States two important lessons about this part of the world.

First, what happens in the Middle East does not stay there. And second, an ounce of prevention is worth a pound of cure—as Washington’s tragic policies toward Iraq, Syria, and Libya have all demonstrated.

Of course, at Iraq’s current burn rate, even $10 billion will barely last three months. That’s why the money must come with strong conditions attached: austerity measures to encourage saving, major cuts in government spending, draconian anti-corruption measures, fully integrating militia personnel into the Iraqi military—as individuals, not as militias, and therefore answerable to the Iraqi government. Subsequent aid packages should be dangled as a further incentive, but only if Iraq makes good on these requirements.

Such an international aid package would have a crucial secondary purpose. In Iraq, the only way to build support for a political agenda—and to build a power base to see it implemented—is with resources. Kadhimi has demonstrated repeatedly that he has the right intentions and ideas, but he lacks the political and military strength to follow through. Putting billions of dollars at his disposal but with strict conditions would give him the resources to build that support and use it to take on Iraq’s political parties, militias, and kleptocrats.

Such measures are what Iraq needs over the long term as well. The more that Kadhimi can blame the international community for forcing Iraq to take these steps, and the more that other Iraqis understand that either they take them or the entire system collapses, the better able he will be to do what he has always hoped to do and what the U.S. government always hoped that he would.

When Biden was U.S. vice president, he won the dubious prize of handling Iraq. Given then-President Barack Obama’s intended course of action, it was arguably the worst assignment of all. When he takes office as president, addressing the problems of Iraq may not be his priority or his desire, but Baghdad’s crisis offers him an opportunity to put the country—and U.S. interests there—on the right path in a way he never could the last time he was responsible for Iraq policy.

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