Press Center

 Reconstruction in Iraq: Economic and Financial Issues John B. Taylor Under Secretary of the Treasury for International Affairs


6/4/2003

FROM THE OFFICE OF PUBLIC AFFAIRS

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Chairman Lugar, Ranking Member Biden, and other members of the Committee, thank you for inviting me to testify on the reconstruction of Iraq.  I will discuss economic and financial issues, focusing on accomplishments since the end of major military operations and on our plans for the future.

The international community and the Iraqi people face an enormous task in the reconstruction of the Iraqi economy.  A quarter century of repression and economic mismanagement under Saddam Hussein cut the size of the economy to only a small fraction of what it was before his regime took over.  In 1979, GDP in Iraq was $128 billion in PPP (purchasing power parity) terms; by 2001, it had declined to about $40 billion.  And income per capita has plummeted, impoverishing the Iraqi people.  While the world economy expanded, the Iraqi economy shrunk.  As a consequence, the Iraqi people fell way behind, from a rank of 76 in 1990 to a rank of 127 in 2001 on the UN Human Development Index. 

While the reconstruction task is significant, the opportunities are great. Simply restoring the economy to what it was before Saddam will be a tremendous improvement in the well being of the Iraq people.  Establishing a market economy based on clear property rights, a sound rule of law, and economic freedom will unleash a long tradition of entrepreneurship and build on the abundant human potential and natural resources of Iraq.  I am confident that if these resources are used effectively, economic growth will soon be above, rather than well below, the world average. 

Though there is much to do, I believe that we have already achieved important successes since the end of the major military operations, especially in the economic and financial areas.  Over 1.5 million workers and pensioners have received salaries and emergency payments.  Our financial experts in Baghdad report that Iraqis and other observers consider this act alone as a turning point in the mood of the city for many.  These payments have enabled Iraqis to return to work to run the railroads, teach school children, or help in the payment of other

There are other successes.  Since March 20, $1.7 billion of Saddam�s assets have been vested; $1.2 billion have been frozen; and $0.9 billion in cash has been found in Iraq.  Working with the international community, we have removed sanctions on the selling of Iraqi oil and we have agreed that the international financial institutions should provide needs assessments and technical assistance.  Later this month in New York we will convene the first meeting of donors.  I will provide more details on these and other accomplishments later in my testimony. 

 We have also achieved successes in avoiding catastrophic events that could have occurred; we were concerned about such events and took actions to prevent them.  Instead of collapsing as many had feared, the Iraqi currency has recovered from its low levels at the start of the war.  Hyperinflation has been avoided.  Oil fields have been saved from destruction. There has been no humanitarian crisis.  And the crippling burden of debt service payments has been lifted through the end of 2004 so that Iraq can focus on reconstruction needs.     

These successes are due to the work of experienced and dedicated people and to the contingency plans laid out months in advance of the war.  We began selecting members for our team of Treasury advisors back in January; the first wave was deployed to Kuwait in March and arrived in Baghdad in April.  We have since sent over a dozen additional advisors with expertise in areas ranging from budgets, to payments systems, to monetary policy.  Peter McPherson�former USAID Administrator and former Deputy Treasury Secretary�now serves as financial coordinator and adviser to Ambassador Bremer on economic and financial issues.  He and his team have responsibility for working with Iraqis to get the Central Bank, the Finance Ministry, commercial banks and other financial institutions up and running.  Their very first task on the ground was to assess conditions and evaluate the basic economic infrastructure, including the payments system.  The work they are doing is similar to some of the tasks that we undertook in Afghanistan; indeed, while Treasury�s work continues in Afghanistan, some of the same people who worked there have brought their experience to Iraq.  I am in nearly constant contact with them through telephone and email, providing support and advice with the help of our Iraq Financial Task Force, Office of Technical Assistance, and others stationed here in Washington. 

A Plan to Pay Workers and Pensioners

 A top reconstruction priority from the start was to make emergency and salary payments to government workers and pensioners.  Starting late last year we developed a contingency plan for such payments.  The plan called for paying workers and pensioners in U.S. dollars on an interim basis.  Making payments in dollars on an interim basis was not an attempt to dollarize the economy.  On the contrary, the plan called for the continued use of dinars as an acceptable means of payment.  Using dollars on an interim basis would create stability immediately after the war, as the dollar is a stable medium of exchange and a good store of value.  By making sure that the spending on salaries was matched by the revenues available, the dollar payment plan also was a way to prevent inflationary financing.

To make this payment plan operational, financial resources were required.  Hence, the first step in the plan was to vest the Iraqi regime assets that were frozen in the United States over a decade ago.  The plan also required some functioning payroll system, so a high priority of our first wave of people on the ground was to assess the state of this system.

This plan is basically on track and has been successful thus far.

On March 20, President Bush vested $1.7 billion of assets and placed them in an account at the New York Fed to be used to support reconstruction.  Treasury representatives, in close cooperation with the New York Fed and the Department of Defense, arranged the delivery of $199 million of these vested assets in three shipments from a storage facility in New Jersey to Andrews Air Force Base, where the currency was loaded on a transport and flown to the region.  A fourth shipment of $358 million will be made shortly. 

A mechanism for making emergency payments was quickly established on the ground, so that payments could commence for dock workers, rail workers, power plant workers, and others.  At the same time, upon arriving in Iraq, our advisors conducted an assessment of the existing payroll system for salaries and pensions and found that adequate, functional procedures already existed.  While this system will have to be updated over time, it provides the basic infrastructure for making salary and pension payments.

Despite tremendous logistical challenges, the system of payments has been a success.  To date, over 1.5 million pensioners, civil servants, and workers crucial to the functioning of essential public services have received payments.  Our advisors have played a key role, working closely with counterparts from the Defense Department and other agencies, in extending this initial financial life-line to the Iraqi people.

Establishing a Stable Currency

 One of the most important objectives in the near-term is to promote the establishment of a stable, unified national currency.  A currency that has the full faith and confidence of the Iraqi people, and which can be used as a store of value, is a prerequisite for establishing a vibrant economy.

The pre-existing currency situation in Iraq makes this a complex and difficult task.  Iraq has not had a stable currency for some time; several currencies circulate widely in Iraq, including the Iraqi (or �Saddam�) dinar in central and southern Iraq, the Old Iraqi (or �Swiss�) dinar in the northern part of the country, and the U.S. dollar.  The Saddam dinar has fallen dramatically in value over the past dozen years due to the policies of the Saddam Hussein regime.  One dollar used to purchase only a third of a Saddam dinar under the official exchange rate; now, it will purchase about 1,200 dinars in the market.

One of our primary concerns was that the conflict and its aftermath would result in a massive depreciation of the Saddam dinar and hyperinflation.  There were concerns about losing control over large warehouses of Saddam dinar notes and currency printing facilities. 

And with the fall of the regime, there was the risk that the currency would cease to serve as an accepted means of exchange.

For these reasons, early action was taken to secure currency stocks and currency-printing facilities and stop the printing of the Saddam dinar.  The military made public announcements that existing currencies in Iraq would continue to be accepted as means of payment.  These measures helped stabilize the Saddam dinar and avert a monetary crisis.  In fact, the Saddam dinar has actually strengthened in recent weeks�from a low of about 5,000 dinars per U.S. dollar during the conflict to approximately 1,200 per dollar today.

This achievement notwithstanding, a stable, unified currency system is essential for Iraq�s long-run economic prospects.  Several options exist for currency reform, including the introduction of a new currency or the replacement of Saddam dinars with Old Iraqi dinars.  We stand ready to assist in the implementation of whichever option the people of Iraq choose through a representative, elected Iraqi government. 

Development of an Iraqi Budget  

Prior to the war, no Iraqi government budget was published.  The lack of transparency and accountability in fiscal operations made it difficult to determine how resources were allocated or how revenues were raised.

Development of an integrated and transparent Iraqi government budget is necessary for ensuring that essential government services and reconstruction needs can be financed without resorting to printing money.  Our advisors are working with personnel within the Ministry of Finance to develop an interim budget and to implement a centralized treasury mechanism for government spending.  In addition, several Treasury advisors with expertise in tax systems will be working with Iraqi officials to revise the tax code and build the capacity of revenue agencies.

Initially, budgetary resources will derive primarily from returned Iraqi assets, oil sales, and donor contributions.

 With the initiation of military action, the United States and its coalition partners acted to secure the Saddam Hussein regime�s assets for the benefit of the Iraqi people.  In addition to the rapid vesting of $1.7 billion of assets in the United States, we have spearheaded bilateral efforts that have led to the identification and freezing of about $1.2 billion of Iraqi assets outside of the United States since the beginning of the war.  We are working with these countries to return them to the Iraqi people, as required by UNSCR 1483.  The United States has deployed financial investigation teams to Iraq and other foreign jurisdictions to identify and recover additional Iraqi assets. 

Efforts have also been made to secure assets inside of Iraq.  Since the end of the conflict, approximately $900 million in currency has been found in various locations, in addition to $350 million of currency and gold discovered in vaults at the Central Bank of Iraq.

All of the vested assets in the United States, as well as the assets found in Iraq, will be used to assist the Iraqi people and support the reconstruction of Iraq.

Proceeds from the sale of Iraqi oil will be another critical source of funds.  The Security Council resolution introduced by the U.S., Spain and the UK and approved unanimously last month provides immunity from attachment for Iraq�s oil and proceeds from its sale through 2007.  Oil revenues will be deposited in the Development Fund for Iraq, an account of the Central Bank of Iraq.  The Coalition Provisional Authority now is working on the development of regulations to ensure transparency and accountability in the use and administration of oil proceeds and other revenues that will be deposited in the Development Fund for Iraq.

An important part of this effort will be the establishment of the International Advisory and Monitoring Board, which will be responsible for approving the auditors of the Development Fund for Iraq and reviewing their findings.  Representatives from four international organizations�the IMF, the World Bank, the United Nations, and the Arab Fund for Social and Economic Development�will participate on this board.  On May 24, Ambassador Bremer sent letters to the four organizations to initiate the process of constituting the board; I will chair a meeting later this month to finalize the terms of reference.

Role of the International Financial Institutions

 Donor contributions will also play an important role in the reconstruction of Iraq.  Active participation by the international financial institutions is important to mobilizing this international support.

I am pleased to report that the international financial institutions are intensifying their support for the process of reconstruction and recovery in Iraq.  IMF and World Bank officials are traveling with the delegation of Sergio Vieira de Mello, the U.N. special representative for Iraq, on his trip to Iraq this week.  In addition, IMF Managing Director Horst K�hler announced last week that he was prepared to send out a team to Baghdad for a fact-finding mission as early as this weekend.  This team will work with the Coalition Provisional Authority and Iraqi officials to identify priority needs related to budget planning and execution, central bank functions, payments systems and banking sector reform, as well as the social safety net.   

 Later this month, the United Nations Development Program and the World Bank will co-host a donor meeting in New York to launch a coordinated, international effort to support Iraq�s reconstruction needs and lay the groundwork for a donor conference in late summer after the World Bank has completed its needs assessment of Iraq. 

Reforming the Banking Sector

 Strengthening and modernizing the banking sector is central to achieving overall economic progress in Iraq.  We are still in the early stages of assessing the banking system.  We know, however, that Iraqi banks were oriented much more toward the fulfillment of Ba�athist political objectives than toward financial intermediation and other economic services that one normally associates with banks.  Essentially, Iraqi banks were vehicles for storing and moving cash around the country, and in some cases outside the country. 

 Our overarching objective in this area is to help Iraq restore its banking sector and ensure that it begins to function in a commercially viable way.   We want Iraq�s banking sector to be a vehicle for sound economic growth, to meet the needs of the Iraqi people, and to reflect regional as well as international best practices.  For example, we endorse the objective of Iraqis having access to financial products and services that are based on Islamic principles. 

Creating a sound supervisory and regulatory regime is a critical step to establishing a sound financial system.  We are working with the Iraqis to help them bring this about.  To this end, we will be working with governments in the region that have strong systems and have offered technical assistance for the banking sector.

Iraq�s Foreign Debt

An issue that has garnered much attention and will clearly have to be addressed is Iraq�s capacity to address the potentially enormous burden of its existing financial obligations.  Estimates of Iraqi external debt range from $60 billion to $130 billion.  Whatever the precise level, Iraq�s external obligations are significant and must be addressed in a comprehensive manner.

In the near-term, we have taken two important steps put to address this situation.  First and foremost, we have worked with our G-8 partners to provide Iraq with some breathing room.  We achieved agreement that given Iraq�s precarious financial situation, creditors should not expect Iraq to make any payments on its debt for at least the next eighteen months.  Secondly, we have put a lot of people to work on what could be described as data forensics.  On the creditor side of the ledger, we proposed at the last meeting of the Paris Club, and creditor governments agreed, to report the amount of debt they are currently owed.  We have also approached the IMF for its assistance in determining the amount of debt owed to non-Paris Club governments.  To address the other side of the ledger, we have placed Treasury advisors in Baghdad to go through Iraqi government debt records. 

In the medium-term, once we have a better estimate of the true level of Iraq�s debt, we can move forward to develop a comprehensive strategy to deal with Iraq�s official debt.  To supplement these efforts, we are providing a Treasury advisor to work with Iraqi officials to develop a notional strategy for external debt treatment.

Conclusion

Achieving our economic objectives in Iraq is central to achieving our ultimate goal of a stable, unified, and prosperous Iraq�one which provides opportunities for all Iraqis to forge a better future for themselves and their children.  The challenges are formidable.  We have a tough job ahead.  Our achievements to date can be attributed to careful planning, vigilance to potential problems, and early action by dedicated and talented professionals to prepare for them.  We will bring the same spirit to our work in the coming months.

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