By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund. This article was originally published by the LSE Middle East Centre.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Iraq’s Power Conundrum: How to Secure Reliable Electricity While Achieving Energy Independence

Iraq remains in a bind regarding how to secure energy independence within its geopolitical constraints – most pertinently the American sanctions on Iran. The US is continuing to maintain pressure on Baghdad by extending ‘final’ waivers on the purchase of Iranian gas for only another 30 days, as part of its new tougher stance.

Iraq, in response, could produce credible plans to eliminate its dependence on Iranian imports, which it accelerated with the approval in January of the fifth round of gas exploration contracts. However, achieving this would not end the need for Iranian imports, nor would it secure any kind of energy independence. More importantly, it will not change the shortages in the provision of electricity, which have served as a lightning rod for public anger over the failings of the post-2003 system.

Appreciating the dependence on Iran for the provision of electricity means delving into the extraordinary mess that is Iraq’s power grid, consisting of the power plants that generate electricity; transmission system that transport this electricity to population centres; and distribution networks which then distribute this electricity to end users. Decades of conflict have damaged most parts of the grid and, coupled with poor maintenance of the parts that escaped damage, this has rendered the grid impotent.

Rebuilding the grid post-2003 was hampered by the rolling dysfunction of successive governments, in which significant capital expenditures were neutralised by mismanagement, lack of coordination between ministries, and the county’s corrosive corruption. The public’s frustration over this impotence extends beyond the inadequate provisioning of electricity throughout the year, as the summer’s intense heat creates a particularly acute need for electricity, exposing the grid’s shortcomings.

These start at the generating stage with the gap between nameplate capacity, i.e. the maximum sustainable power output under ideal conditions, and actual output. While a gap always exists between these two, in 2018 the nameplate capacity was 30.3 gigawatts (GW), while effective capacity through the year was a mere 11.9 GW. A primary reason for this gap is the lack of appropriate fuel supply, in this case gas, which leads to substitutions by fuels such as crude or heavy fuel oil with the result that plants run at less than 60% of capacity – in 2018 only 62% of operating gas-powered plants actually used gas. Other reasons include poor maintenance and lack of cooling in high ambient heat. Moreover, up to 20% nameplate capacity in 2018 was non-operational.

In turn, this increases the gap between demand and supply – in 2018 average demand was 17.7 GW vs. effective generated power of 11.9 GW. But this gap is only part of the story, as the electricity generated to meet demand does not mean that it was actually delivered to end users. The total electricity generated in 2018 was 105.4 terawatt-hours (TWh), but only 43.7 TWh reached end users for a loss of 58.5%. Most of these losses take place at the distribution stage, with technical losses stemming from age, conflict damage, poor maintenance accounting for two thirds, and non-technical losses, mostly electricity theft, accounting for a third. Technical losses are natural, however they occur at an extremely high rate in Iraq, as do non-technical losses. Stolen electricity – still consumed but not billed – is estimated at 17 TWh, and so the electricity delivered would rise to 61 TWh, equating to a loss of 42.2%. This dynamic can be seen below.

Figure 1: Comparison between electricity demand and supply, 2010-18

The increase in losses from 2014 onwards can be attributed to the ISIS conflict, which damaged 20% of the transmission system and 5.0 GW of generating capacity. 2019 saw meaningful improvement as effective capacity increased from 11.9 GW to 14.3 GW, and crucially during the summer months peak generation was 19.3 GW vs. peak demand of 27.5 GW. This gap of 8.2 GW has narrowed from 2018’s 10.0 GW gap when peak supply was 16.5 GW vs. peak demand of 26.5 GW.

Electricity generated from Iranian electricity and gas imports accounted for 20.7% of that generated throughout 2019, and probably a much higher percentage during the peak summer months. These contributions from electricity imports from 2010 and gas imports from 2017 can be seen below.

Figure 2: Iranian contribution to Iraq’s energy requirements between 2010-19

The importance of Iranian electricity imports as a percentage of the total have steadily decreased, even though they increased in absolute levels; nevertheless, the decline in summer of 2018 was large enough to ignite the demonstrations in Basra. Imports in 2019 returned to the trend line and averaged 1.1 GW for the year. Plans for other regional imports include 0.5 GW to be imported from Kuwait by the end of 2020, rising to 1.9 GW over subsequent years, including planned imports from Jordan and Turkey.

Iranian gas imports were 7.0 billion cubic meters (BCM) in 2019, up from 4.1 BCM in 2018, and accounted for 31% of total gas consumed – up from 24% in 2018. Plans for increased domestic production include increasing captured flared gas to 16-19 BCM by end of 2021 from 12 BCM in 2019. Additionally, the fifth round of gas contracts call for replacing Iranian imports in three years, i.e. generating 7.0-10.0 BCM over that period from the current 3.5 BCM.

Assuming that the government executes these plans, in three years’ time this would replace the current electricity produced by Iranian imports. But demand is set to increase by 20% from current levels, meaning that the current the gap between supply and demand would increase by up to 20%. Moreover, planned capacity additions require additional fuel, which under existing plans is earmarked to replace imported gas. However, maintaining Iranian imports would significantly decrease their importance in power generation from the current 20.7%, and in the process Iraq would add meaningful capacity to address demand.

The goal posts are moving much faster than Iraq’s ability to approach them, and as such the US’s insistence on eliminating Iranian imports, far from achieving energy independence for Iraq, would instead exacerbate its energy vulnerabilities. Compounding these vulnerabilities is the massive investment spending needed to expand the grid’s capacity, currently unaddressed in the government’s structurally unbalanced budget, but which is ever more critical following the collapse of oil prices.

Iraq’s pathway out of this predicament, even at much higher oil prices, involves electricity tariff reform and the removal of energy subsidies, both the source of monumental waste and substantial market distortions. However, this requires a popular buy-in and for the increasingly alienated population to renew their belief in the post-2003 system’s legitimacy. It is here where the international community can help Iraq achieve energy independence.

Sources

The figures and charts used in the article are the author’s estimates, and are based on data from the Ministry of Electricity’s annual reports and conference presentations, the IEA, BP, MEES, Oxford Energy, and publicly available news sources. However, all errors and omissions are the author’s own.

The data used in the article exclude electricity demand and generation in the Kurdistan Region of Iraq (KRI). However, figures for locally produced and consumed gas include the KRI, and as such the Iranian-origin percentages of total gas consumed would be somewhat higher than the 31% and 24% used if the KRI was excluded.

Disclaimer: Ahmed Tabaqchali’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

 

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund. This article was originally published by the LSE Middle East Centre.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Between a Rock and a Hard Place: Iraq’s Political Class’ Dilemma between Budget Realties and Protestor Demands

The twin shocks of the effect of coronavirus on the world economy and the current oil price war will stress Iraq’s budget to the limit, and lead to an economic crisis if it continues for an extended period.

While as extraordinary shocks they were unforeseeable, the Iraqi budget’s structural imbalance would have inevitably led to such an economic crisis – the only question being when and not if.

A low oil price environment exposes the structural faultiness of the budget with projected revenues not covering current spending, which is mostly composed of salaries, pensions and welfare spending. These have increased from 50% of current expenditures in 2004 to an estimated 81% in 2019, and likely to more than 85% in 2020.[1] As such the default choice for the government would be to cancel all investment spending, especially non-oil investment spending, and resort to borrowing.

Such measures have allowed the government to continue functioning, but these come at a huge cost to the economy as Table 2 below shows. Global debt markets are not as accommodating as they were in 2014-17 given Iraq’s estranged relationship with the US and the change in the IMF’s stance toward Iraq. As such the government would have to resort to domestic sources, which ultimately means indirect monetary operations by the CBI at the expense of the its foreign reserves as happened in 2014-16.

Moreover, these measures would only postpone and not resolve the crises, needing much higher oil prices to contain or mask it like in 2017-19. Medium-term oil prices would probably (for Brent prices) settle within a range of $50-60/bbl, which should partially relieve the stress on the budget, but not the need to address its imbalance.

Iraq’s 2019 budget, initially proposed by the prior government, submitted with minor changes by the current government and approved by the current parliament, perpetuated the same deficiencies and weaknessess of all Iraq’s budgets since 2003. Crucially, it deepened the structural imbalance between the budget’s current and investment expenditures, in which public sector wages consumed an ever-increasing share of government revenues.

Moreover, it undermined and reversed most of the small, but essential, fiscal reforms agreed with the IMF in the 2016 Stand-By Agreement (SBA) to address this structural imbalance; and which needed considerable follow-up reforms over the years to put the country on a sustainable path to growth  and reduce the economy’s vulnerabilities to the volatile oil market. The extent of these vulnerabilities came to the fore during the collapse in oil prices in 2014, and coupled with the cost of the ISIS conflict, this led to a sharp contraction to the non-oil economy in 2014-17.

Table 1: Real non-oil GDP change 2014-17. Source: Iraq-Business News

Undeterred by these memories, the budget’s planners, buoyed by the bounty of higher oil revenues, from late 2017 embarked on an expansionary budget that magnified these very vulnerabilities. This was achieved by simultaneously reversing the growth of non-oil revenues and by increasing current spending. Non-oil revenues decreased in both absolute terms and as a percentage of total revenues: -18% and -29% respectively in 2019 and 2018.

Additionally, 25% of these non-oil revenues were in fact oil-related in the form of taxes on foreign oil companies and the budget’s share from profits from the state’s oil companies. Current spending increased by 15% with the salary and pensions component growing by 7.5% instead of decreasing continuously.

The budget’s trumpeted increase of 29% in investment spending hides the fact that only 43% of this total spending for 2019 was earmarked for non-oil investment, which would nevertheless increase by 43% in 2019. However, historically this spending is on paper only, with an execution rate of under 65%. The performance in 2019 was much worse than normal with non-oil investment spending at about IQD 3.3 trn as of November 2019 from a planned budget of IQD 14.0 trn, or about a 24% execution rate.

The budget planners’ aims for 2020 were for a continuation of the expansionary budget of 2019, which dismayed the IMF enough for it to issue a critical country report (19/248) – the first since 2004. Adding to the dismay was the fact that the government’s plan for fiscal probity was based on expectations of continued high oil prices, as well as sticking to its historic under-execution of the budget. Essential budget reforms to address the structural imbalance were delegated to an expression of interest for inclusion in medium term fiscal strategy planning.

The IMF then modelled for a 2020 budget with revenues estimated at IQD 113.1 trn based on oil price assumptions of $55.8/bbl. Expenditures were estimated at IQD 123.2 trn, made up of current expenditures at IQD 99.1 trn, while oil investment spending was estimated at IQD 15.5 trn and non-oil investment spending at IQD 8.6 trn. This would have needed debt financing of IQD 10.0 trn to balance the budget. Since it’s almost impossible to cut the bulk of current spending, the government must have been anticipating a better budgetary situation through Iraqi oil prices higher than $55.8/bbl and from under-executing much needed non-oil investment spending and reconstruction.

By October, plans for budget expenditure ballooned by 31% to IQD 162.0 trn, necessitating debt financing of IQD 48.9 trn. While there are no details apart from spending and deficit figures, the political paralysis following the failure of the prime minister-designate to form a government in early March has put a halt to these runaway expenditure plans.

As long as the political class’ existential fear from the five-month long youth-led countrywide demonstrations continues to ebb and flow, this political paralysis is likely to continue. However, the main economic consequences would be the same whether a new government forms under a new prime minister-designate, or if the current caretaker government continues to limp on. The outcome either way will be that no new budget will be passed, with the government continuing to implement the executed parts of 2019’s budget throughout 2020 according to the ‘1/12th rule’.

Essentially, this means the government will continue to spend (per month) 1/12th of the actual spend in 2019 – effectively extending the current spending component for 2019 in addition to the increased spending of IQD 10.5 trn as a result of government measures to appease the demonstrators in October 2019. The government will likewise continue with the investment projects initiated in 2019.

Estimating the effects of the current events on the Iraqi budget is fraught with uncertainty. Current predictions on the extent of the decline in oil prices mirror those made following the 2014 oil price war, which then assumed a continuation of the decline into the future. This in time proved to be overly pessimistic, as will the current ‘worst-case’ prognoses. Moreover, though the effects of the new coronavirus on the world economy will be profound in Q1/2020, the extent and the continuation of these effects for the rest of the year remains uncertain.

However, these negative effects would be compounded for oil prices by a sharply increased supply in an environment of weakened demand. The upshot would be an extended period of lower oil prices. The table below looks at the budget for 2015-19 and estimates for 2020 based on different realised oil prices for 2020 as whole (please see footnote 2 for notes and assumptions used).

Table 2: Iraq’s budget 2015-20. Source: Iraq Ministry of Finance[2]

Past policies of spending oil revenues on expanding the public payroll and welfare spending, in the process depleting the country’s wealth without building its infrastructure, has resulted in an economy dependent on imports of goods and services, a stunted private sector and a labour market skewed towards public employment. This development has been at the root cause of successive countrywide demonstrations. The need to urgently restructure the budget’s structural imbalances will require painful reforms and a long adjustment period, and thus would need a buy-in by the population at large.

This, given the extent of the current anti-political elite protest movement and the scale of the repression of this movement, is unlikely without significant political reform.


[1] The percentage figures are made up of salaries, pensions and transfers. Transfers are mostly composed of welfare spending and transfers to State-Owned Enterprises (SOEs) which in turn are primarily for salary payments and support to SOEs. Source: IMF Iraq country reports 2004-19.

[2] Revenues and expenditures for 2015-19 sourced from Ministry of Finance (MoF). These figures constitute revenues and expenditures actually received/made at the time and not booked. As such they differ, sometimes significantly, from those provided by the IMF. The crucial difference being that they resemble an actual cash flow statement and not an income statement. This can be seen from the difference between the Ministry of Oil’s (MoO) revenue data which show sales made and the MoF’s data which how funds received which can lag actual sales.
Iraqi oil sales and average Iraqi oil price are taken from MoO website, while average Brent prices can be found here. CBI foreign reserves are as of end of 2019 and are found here. 2019 budget numbers are as of November 2019 and projected to continue into end of 2019. Oil revenues are based on MoO data which are available as of the end of December 2019. The 2020 budget numbers assume a continuation of the budget spent for 2019. It is assumed that Iraq would maintain market share through aggressive pricing and thus that the discount to Brent would increase from $3.35 for 2019 to $4.50.

Disclaimer: Ahmed Tabaqchali’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

By February’s end the market, as measured by the Rabee Securities RSISX USD Index (RSISUSD), was down -3.7%.  The month saw a continuation of the heavy foreign selling in January and mostly in the same foreign favoured stocks, i.e. Baghdad Soft Drinks (IBSD), Asiacell (TASC), and Mansour Bank (BMNS). However, not only was this foreign selling comfortably absorbed by local buying, but its effect on the market was much smaller than previous instances of foreign selling as can be seen from the chart below:

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital, daily data)

The most recent instance of such concentrated foreign selling was in January-February 2019, which although much smaller in absolute amounts, led to declines across the board that took the market to multi-year lows. It should be noted that foreigners were buyers too in instances of concentrated foreign selling, but that the selling then soured local sentiment and so was the main driving force behind the weakening prices which lasted even when the selling subsided.

The most promising aspect of the current market’s action is that while overall market turnover expanded meaningfully in both of January 2020 and February 2020 versus the turnover of the last 12 months, it was concentrated in the stocks mentioned earlier. Ordinarily it would have been next to impossible for the usual liquidity in each of these stocks to deal with this volume of selling without significant price declines, however local demand absorbed them relatively comfortably. For January and February: TASC was -6.7% and -12.3%, IBSD was -10.3% and -11.9%, and BMNS was -3.0% and 0.0% respectively. Bank of Baghdad (BBOB), another foreign favoured stock, on the other hand was up +7.1% in February, reflecting foreign buying after experiencing heavy foreign selling in January that saw it down -6.7% then.

(Source: Iraq Stock Exchange, Asia Frontier Capital, monthly data)

The market’s action indicates that it is bottoming and that stock prices have discounted enough negatives that would comfortably include all of the current concerns – especially considering that the action in January and February comes at the end of a brutal multi-year bear market with back to back declines of -1.3% in 2019, of -15.0% in 2018, -11.8% in 2017, -17.3% in 2016, -22.7% in 2015, and -25.4% in 2014.

Foreign sellers would have had a smorgasbord of concerns to choose from: Some could be expectations of instability arising from the current political chaos in Iraq, ramifications of the US-Iran tensions, and the spill over effects of these on the Iraqi economy. Or the speed and extent of the advance of the coronavirus raising fears of a worldwide pandemic, the effects of this spread on the world economy, and the subsequent consequences for oil prices – the major source of Iraq’s earnings.

However, as serious as these concerns are, the latest macro figures show that they had a short-term effect on the Iraqi economy that has subsided – at least this is the message as of end of February. The first of these macro figures is the market price of the exchange rate of the Iraqi Dinar (IQD) versus the USD, which continues to decline and converge to the official price by end of February, after recovering from mid-January onwards as reported here last month. It is now at the lower end of levels that prevailed over the last 20 months since it began diverging in October following the countrywide demonstrations, and spiking following the events at the start of the year as can be seen below:

(Source: Central Bank of Iraq, Iraqi Foreign Exchange Houses, Asia Frontier Capital)

More importantly the premium of the IQD-USD exchange rate for physical USD notes has returned to the lower end of its normal range of 2-4% over the market price of the USD (red line in chart above). This premium widened significantly during the spikes in the market rate for USD earlier in the year but settled down to about an 8% premium by the end of January, and then to under the 2-4% range by the end of February. All of this argues that the FX market is indicating that the disruptions to economic activity over the last few months have subsided considerably. Although the counter argument would be that the decline in the premium is a function of weakening demand in the cash dominated local retail and trade markets. But then the volumes in the Central Bank of Iraq (CBI)’s daily currency auctions, which are a function of bids or orders for USD, have been mostly at the same levels that prevailed over the last 20 months or so and thus it’s difficult to argue that end demand has weakened, but this counter argument cannot be dismissed yet.

The uncertainties, and differing interpretations of the health of the economy, will continue to persist until other macro data for January, February and beyond are released by the CBI over the next few weeks. Whichever interpretation prevails, preliminary data on the deposit component of the monetary base M0 (i.e. commercial bank’s reserve deposits with the CBI) show a meaningful drop in January from the levels of the last few months as can be seen below. A decline in banking reserves held with the CBI would be due to drops in customer (consumer, business and government) deposits held with these banks.

(Source: Central Bank of Iraq, Asia Frontier Capital, data as of end of January 2020)

This drop argues that the significant geopolitical events early in the year had a meaningful negative impact on the economy in January. Although the deposit component of the monetary base M0 by end of January recovered from the larger drop seen in the middle of the month, the preliminary nature of this data precludes any definite answer. Moreover, updated CBI figures would be overall figures which would not broken down into consumers, businesses or government deposits. Moreover, it’s equally difficult to see if this was a phenomenon for January and that February would begin to witness a recovery or if it would be an extension of January.

Until newer data suggests otherwise, the most likely explanation is that the disruptions to economic activity, and in particular to the cash-dominated retail and trade markets, led to a decline in deposit formation as cash was used by companies/corporates to fund operations in an environment of declining sales. Partially supporting this argument, are CBI data as end of November 2019 for private sector deposits and loans, which shows continued growth in deposits and loans, with deposits ahead, as can be seen from the chart below.

(Source: Central Bank of Iraq, Asia Frontier Capital, data as of end of November 2019)

Earnings data from two of the leading banks, National Bank of Iraq (BNOI) and the Commercial Bank of Iraq (BCOI) support the continuation of these trends into end of 2019. BCOI reported a drop of -4% in loans in 2019 over 2018, but deposits increased by +9% in the same period. While, BNOI reported a +120% increase in loans in 2029 over 2018, and deposits increased by 32% in the same period. The difference in performance reflects the different positions of each bank and its growth strategy – which would be seen as other leading banks report over the next few weeks.

Quarterly earnings data, especially for BNOI which has been leading the banking sector in 2019, lend credence to linking the divergence between the market price of the USD from the official price, that began in October of 2019, to the disruptions to economic activity from the start of countrywide demonstrations then. These quarterly data show a sequential slow-down or decline in these metrics by the fourth quarter (Q4). Loans increased by +2% in Q4 over Q3, +22% in Q3 over Q2, and +39% in Q2 over Q1. Deposits on the other hand declined -14% in Q4 over Q3, increased +20% in Q3 over Q2, and +22% in Q2 over Q1 – while Q4 numbers would be affected by year-end requirements for closing the books, which in Iraq are both cumbersome and time consuming. Nevertheless, the decline in deposits in Q4 would argue that the use of cash, through deposit withdrawals, by companies/corporates to fund operations might have started earlier than January as argued in an earlier paragraph.

Overshadowing the economic data is the continued political paralysis and the inability of the political class to deal with the demands of the five-month long youth-led protest movement. In the last few weeks an unsustainable holding pattern has developed in which the nationwide demonstrations persist, in passion if not in the same intensity of earlier months, while the repression apparatus of the state and the sub-actors continues to take its toll in casualties- both in death and injuries. For now, the political class’s existential fear from the demonstrations has subsided enough for it to return to the old political squabbles as can be seen from the difficulties that the prime minister-designate faced in forming a government. These proved too difficult to surmount which eventually forced him to withdraw his nomination. This means a new search began for the illusive candidate that would square the circle- i.e. satisfy the protest movement’s demands for change, while preserving the status quo for the political elite.

The political class’s existential fear from the demonstrations will continue to ebb and flow, and thus these political uncertainties are likely to continue. However, the economic consequences would be the same whether a new government forms under another prime minister-designate, or if the current caretaker government continues to limp on. These consequences would be that no new budget will be passed and thus the government continues to implement the current spending parts of 2019’s expansionary budget. While it is difficult to estimate the medium-term effects of the disruption to the world economy from the coronavirus and thus on oil prices, yet the government has enough fire power to continue this expansionary budget at least for 2020. This firepower is in the form of a likely year 2019 surplus of USD 2-4 bln for a total of a three-year surplus of USD 25-27 bln – more than enough to compensate for any shortfall in oil revenues during 2020.

Drops in oil revenues in 2020 are likely to happen given the severe drop in global oil prices over the last few weeks as seen in February’s export data. Oil exports in February were about USD 5.1 bln down from USD 6.2 bln in January, reflecting a drop in Iraqi oil price from USD 60.14 per barrel in USD 51.37. However, exports increased to 3.887 mln barrels per day (bpd) in February, up from 3.694 mln bpd in January and therefore revenues from oil exports would be about USD 5.5 bln, and not USD 5.1 bln, if February had 31 days and not 29 days making for better month-on-month comparisons.

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

The year for Iraq, and its equity market, started with two momentous events that raised the feared spectre of a US-Iran proxy war fought in the country and all of the instability that would come with it.

In quick succession, the US’s assassination in Baghdad of Iran’s top general was followed by the Iranian missile attacks on Iraqi military bases housing US military units. Initially the market shrugged them off, discounting the possibility of military conflict as unlikely, but by January’s end the market, as measured by the Rabee Securities RSISX USD Index (RSISUSD), was down –4.7%.

However, this decline masks two contradictory trends. The first of which was heavy selling in foreign favoured stocks, such as Baghdad Soft Drinks (IBSD), Asiacell (TASC), Bank of Baghdad (BBOB) and Mansour Bank (BMNS). This was most likely foreign selling, by either Iraq-focused equity funds or most probably by frontier market funds with small weights in Iraq, likely over concerns of potential political instability following the two momentous events.

These stocks were down between – 3% to – 10%. This trend was contrasted by heavy buying in local favoured small cap cyclical stocks that had a stunning rally by early January, but which cooled off by month end as foreign selling in IBSD, TASC, BBOB and BMNS picked up steam. But this was not before posting solid month end gains on the back of strong performances in 2019 as discussed in December 2019. Certain stocks in particular had impressive performances during the month as shown in the table below (figures rounded):

January performance of selected stocks: –

Stock January’s end Early January
IMAP – Al-Mansour Pharmaceuticals Industries +33% +58%
INCP – National Chemical & Plastic +25% +54%
IMIB – Metallic & Bicycles Industries +6% +24%
IKLV – Al-Kindi of Veterinary Vaccines Drugs +1% +21%

(Source: Iraq Stock Exchange, Asia Frontier Capital)

These conflicting trends are in-line with the 2019 themes as discussed in the “2019 Market Review and 2020 Outlook” in which the market’s bottoming action was seen through its improved dynamics throughout 2019. The first improved dynamic was its discriminating nature – in that negative developments in certain stocks were confined to these stocks and did not spread to others in the sector or to the overall market. While, the second improved market dynamic was the broadening of breadth, and in particular, the market’s focus on the hopes of an earnings recovery for some of the industrial stocks even before any signs of such recovery can be detected in their earnings reports during 2019.

The fears that prompted the heavy foreign selling might be justified on the grounds of instability arising from the current political chaos in Iraq and the spill-over effects of these on the Iraqi economy. The countrywide demonstrations continue unabated in the face of unprecedented violent state crackdowns, however, this youth-led protest movement continues to shape events in the country. Since October these ranged from forcing the political elite to implement reforms that would threaten their interests, to its influence on the choice of the current prime minister designate replacing the forced out prime minister. The prime minister designate faces considerable challenges in the short time that will require him to produce changes, satisfying the protest movement’s demands for change, while preserving the status quo for the political elite. In addition to balancing the conflicting demands of the protest movement and the political elite, he would need to navigate any potential re-escalation of tensions between the United States and Iran.

Yet, as these events are being played out, their effects – real and feared – can be seen in the action in the exchange rate of the Iraqi Dinar (IQD) vs the USD. The market price of the USD versus the IQD by month end returned to levels that prevailed over the last 20 months after spiking higher following the events at the start of the year. This is highlighted in the chart below.

(Source: Central Bank of Iraq, Iraqi Foreign Exchange Houses, Asia Frontier Capital)

Such spikes have happened before, during periods of geopolitical crisis in the summer of 2019 which included the tanker hits and the attacks on Saudi oil installations; and during local political crises such as the elections in May 2018, and more recently the nationwide demonstrations that started in October 2019. The current spike was probably a response to sharply increased local demands for physical USD notes as flight to safety prompted this demand. Cash transactions dominate activity in the local retail and trade markets where the IQD-USD exchange rate for physical USD notes trades at a slight premium to the market price (in red) in the above chart. This premium widened during the spikes in the market rate for USD but settled down to about an 8% premium versus the usual 2 – 4% premium. This wider premium likely reflects local traders’ hoarding of physical USD notes in preparation of a possible future, real or imagined, shortage – but these fears have moderated significantly from the start of the year.

While the FX market is suggesting that the disruptions to economic activity have subsided, other data is needed for a full evaluation of their effects. The first of this data would be broad money or M2, as a proxy for economic activity due to its sensitivity to oil revenues (chart below), in which the most recent data from the Central Bank of Iraq (CBI) indicate continued growth.

(Source: Central Bank of Iraq, Iraq’s Ministry of Oil, Asia Frontier Capital)

(Note: M2 as of Oct. with AFC estimates for Nov. & Dec., Oil revenues as of Jan.)

Actual M2 data as of October shows robust growth with a year-over-year increase of +10.7%, while estimates show a moderation of year-over-year growth in December to less than half of that. However, it should be noted that December estimates are based on preliminary data on the deposit component of the monetary base M0 as of mid-January. These in turn show a decline from earlier figures, but there are not enough data to suggest if it’s the start of a declining trend or a normal seasonal decline. Combining the declining deposit component of M0 with the spike in the market exchange rate of the USD might be interpreted as capital flight. Yet the exchange rate as end of January suggests that it was a short-lived phenomenon. A more likely explanation than capital flight is the disruptions to economic activity, and in particular to the cash-dominated retail and trade markets, led to a decline in deposit formation as cash was used to fund operations.

While geopolitical and local political events are playing out, the equity market’s action, in particular its contrasting trends, in January supports the thesis that the stock market is bottoming following a multi-year bear market with back to back declines of –1.3% in 2019, of –15.0% in 2018, –11.8% in 2017, –17.3% in 2016, –22.7% in 2015, and –25.4% in 2014.

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund. This article was originally published by the London School of Economics (LSE).

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Demands for the expulsion of US troops following the killing of Iranian general Qassem Soleimani, have scaled down considerably since the initial strident calls. What started as high theatrics in parliament demanding an end to US presence, ended with a typical Iraqi fudge in that parliament passed a resolution requiring the government to cancel the request for global coalition support made in 2014, and for it to work towards ending the presence of all foreign troops.

These were further rolled back as reports emerged that the government’s vision of implementing the withdrawal of foreign forces was for the withdrawal of combat forces only and did not include those conducting training and logistical support. Threats of US sanctions have undoubtedly played a role in deflating the illusions of power, especially by those in the axis of resistance, and contributed to this climbdown.

Iraq’s economy is not only vulnerable to US sanctions, but to any disengagement from the US dollar-based global financial and economic system. In fact, the US could affect far worse damage to Iraq than it did to Iran without the need to implement sanctions, let alone sanctions that would ‘make Iranian sanctions seem somewhat tame’. This vulnerability stems from the failures of successive Iraqi administrations from 2003 to reconstruct the country following decades of conflict, or to create the foundations for a diversified economy driven by the private sector, and not by the state.

Instead, successive administrations have deepened the country’s dependence on oil, pursued policies that fostered a structural imbalance between the government’s current and investment expenditures, in which the public sector consumed an ever-increasing share of government revenues. The sole dependence on oil income for these revenues, and the dreadful twins of a dominant public sector and stunted private sector, are the primary reasons why the country is vulnerable to external shocks.[1]

The extent of the damage to the Iraqi economy would depend on the three broad categories of a US response to a hostile Iraq. The first category would be the imposition of primary US sanctions, and secondary sanctions on non-US entities that conduct commercial or financial dealings with Iraq. Their effects would be along the lines to those suffered by Iran due to the imposition in 2018 of similar US sanctions.

For Iran, these included a major drop in oil exports, a severe economic contraction, a significant drop in the value of the currency, a substantial rise in inflation, a lowering of living standards, and a rise in unemployment especially among the youth and the most vulnerable segments of society.

However, the consequences for Iraq would be on a much worse scale than those suffered by Iran. Firstly, because oil exports constitute the bulk of the Iraqi budget’s revenues (about 90 percent of the 2019 budget) unlike those for Iran’s budget (about 30 percent of its fiscal 2019–20 budget). The loss of this income for Iraq would severely restrict the government’s ability to pay for salaries and pensions, social security, goods and services, in addition to reducing any funds available for the reconstruction of the country, the development of its oil sector or the development of its power generation.

Secondly, Iraq depends almost completely on imports for its consumption of goods and services, unlike Iran which has a well-diversified economy, and a more developed industrial, agricultural and financial sectors. Iraq’s small industrial and agricultural sectors cannot meet even a small percentage of its domestic demand, while its under-developed financial sector cannot provide the financing for the development of these two sectors.

Thirdly, Iraq’s cash-reliant economy depends on access to physical USD notes for it to function. Such a disruption in the supply of USD notes would raise the price of the USD against the IQD, and with it a rise in the value of imported goods. In 2015 the country felt some of these effects due to a restriction in the supply of USD notes from the US Federal Reserve as a result of the US Treasury’s concerns that sanctioned entities (Iran & Daesh) had access to these notes. Any effects of a sizeable loss of access to USD notes would be significantly worse than in 2015. Making things worse is that Iraq cannot access USD notes from a third country, unlike Iran, whose need for notes is met through Iraq.

The second category of US responses would be the loss of waivers for the purchase of Iranian gas, which presents Iraq with a Sophie’s choice. Continue with the purchase of Iranian gas and suffer the consequences of US secondary sanctions, which would be only marginally less painful than any possible imposition of full sanctions, discussed earlier. Or, discontinue buying Iranian gas, lose about a third of Iraq’s domestic power supply and enrage a population that is already incensed over a chronic inadequate supply of power.

A less discussed point is that these waivers were granted on the conditions that Iraq develops a credible plan to reduce its dependence on Iranian gas, and in the long term end those imports. The US could still grant these waivers, but impose more stringent conditions on plans to reduce dependence and a tougher monitoring regime with associated penalties for failures in making progress.

The third category, and the most likely US reaction, would be to gradually end its treatment of Iraq as a close ally and therefore subject to increased US treasury scrutiny its financial system, which would negatively affect the functioning of the Iraqi Central Bank and the banking system. The most obvious result would be a disruption of Iraq’s cash-heavy economy, which relies on the access of physical USD notes for the conduct of commercial and financial transactions as discussed earlier.

Unlike the fictional Duchy of Grand Fenwick, in Leonard Wibberley’s satirical cold war novel The Mouse That Roared, Iraq cannot expect any sort of victory from a conflict or strained relationship with the US.

[1] An upcoming piece by the author examines the structural imbalances in the economy as a inevitable consequence of successive post-2003 political system, i.e, the “Muhasasa Ta’ifia”. This imbalance was first explored in: https://auis.edu.krd/iris/latest-iris-publications/iraqs-investment-spending-deficit-analysis-chronic-failures and subsequently in a series of tweets: https://twitter.com/AMTabaqchali/status/1181559159453564928?s=20 and https://twitter.com/AMTabaqchali/status/1182253543144771584?s=20

 

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Stop the Press: Just as this article was being readied for publication, the news came of a US strike in Baghdad that targeted a car carrying Iran’s top general and a senior commander of Iraq’s Paramilitarily Units (PMU). The attack raised the often-discussed spectre of a US-Iran proxy war fought in Iraq. While this is a real possibility, and events are extremely fluid, there a few points that should be taken into account amidst the breathless media coverage:

  • Angry rhetoric from Iran promising fire and brimstone is a given, however, irrespective of all the bluster, Iran cannot afford a direct or indirect full confrontation with the US given the severe weakness of its economy.
  • Iran’s false reading of the US’s hesitation to order a full strike a few months ago led it to push the envelope assuming the US would not retaliate. This attack, demonstrating the extreme extent to which the US will go to defend its interests, will force Iran to re-calculate especially given that the US will be in the midst of an election campaign that will likely see the re-election of the current administration.
  • The dilemma for Iran is the need to retaliate to save face, but without crossing the now abundantly clear US red line, or for that matter starting a wider conflict in the region that it can ill-afford to wage.
  • Iraqi politicians, especially some with sympathies to Iran will, after expressing their perquisite outrage over the violations of sovereignty and threats of revenge, realize that being placed in the same position as that of sanctioned Iran is not advantageous to them, to Iraq, or to Iran.
  • The recent decision by the Iraqi parliament regarding foreign military presence supports the argument made here, in that it’s high on theatrics, but low on substance. It was not a decision to end US military presence, but a typical Iraqi fudge. In essence, it’s a resolution asking the government to do five things, of which two are worth noting: (1) Cancel the request for global coalition support made in 2014; and (2) for the government to work towards ending the presence of all foreign troops. Crucially, the request for global coalition support in 2014 was made by the then government, without parliamentary oversight, and as such could have been cancelled directly by the government, yet it chose to pass the buck to parliament using the excuse of being a caretaker government, but parliament then passed it back. The next steps would involve a lot of noise and bluster, but most likely the resolution would be watered down to an aspiration once the uproar subsides.
  • Finally, within Iran, the government finds itself for the first time in a position to conduct a rational foreign policy, unlike the shadowy operations that were Iran’s effective de-facto foreign policy in the region. This will likely manifest through back channel diplomacy once the dust settles over the next few months.
  • However, the next few weeks are to be marked by a lot of noise and come with spurious threats and counter threats that are reminiscent of the fire and fury that marked the exchanges between the US and North Korea a few years ago, but this time taking place in the most volatile region in the world.

While these events are being played out, it’s worthwhile to look at the Iraq investment story purely on its own merit, especially as the stock market was up +1.5% for the year as of Tuesday 7th January and was building on the trends discussed below. Crucially the market price of the US versus the Iraqi Dinar has only moved up by about +2.0% above the levels for most of the last 20 months. After stabilising in early 2018, It has traded briefly at current elevated levels before the elections in May 2018, during the tanker hits during the summer, and finally, the recent attacks on Saudi oil installations.

(Source: Central Bank of Iraq, Iraqi Foreign Exchange Houses, Asia Frontier Capital)

The Iraqi equity market, as measured by the Rabee Securities RSISX USD Index (RSISUSD), ended December up +2.6% and down –1.3% for the year. The outlook for the Iraqi equity market for 2020 will be shaped by the three events that marked 2019:

  • The equity market’s bottoming following a multi-year bear market
  • The increasing signs, at both a macro and company level, of an economic recovery
  • The repercussions of a youth led protest movement that is bringing with it profound changes (mostly positive) to the Iraq story culturally, politically and economically

Protest movement art in Baghdad’s Tahrir Square

(Source: Art by Yota Namir, Ra’ed Modah & Noor Namir, photo by Mohammed Ghani posted on Baghdad Projects’ Facebook page)

2019’s decline of –1.3% by the Rabee Securities RSISX USD Index (RSISUSD) comes on the back of declines of –15.0% in 2018, –11.8% in 2017, –17.3% in 2016, –22.7% in 2015, and –25.4% in 2014. The small scale of the 2019 decline, the improved market dynamics and the bottoming in trading turnover all point to a bottoming market formation after a brutal bear market that saw the index decline by –66.1% from the peak in early 2014 to the end of 2019.

The first of the market’s improved dynamics is its discriminating nature in evidence throughout the bank rally that started in May 2019, which at the time was led by a stunning rise in Iraq’s leading bank, the Bank of Baghdad (BBOB), which was  up +62.5% in May on hopes it would resume dividend payments for the year. These expectations led to other leading banks such as the National Bank of Iraq (BNOI), Mansour Bank (BMNS) and Commercial Bank of Iraq (BCOI) to join the rally. Subsequently, BBOB’s quarterly earnings results confirmed expectations that it is following through with the recovery in its fortunes that began in 2018 as part of the overall conditions in place for the sector’s future revival. Nevertheless, BBOB did not resume dividend payments for 2018’s earnings. However, unlike in prior years, BBOB declined from the May 2019 peak, yet did not lose all the gains– and more importantly while it pulled the other leading banks up with it in May, it did not drag them lower in the following months. By year end all of the leading banks were meaningfully higher than their pre-May rally lows.

Indexed performance: Bank of Baghdad – BBOB (black), Commercial Bank of Iraq – BCOI (purple), Mansour Bank – BMNS (blue), National Bank of Iraq – BNOI (green)

(Source: Bloomberg, data from 30/04/2019 – 31/12/2019)

The second aspect of the improved market dynamics is the broadening of breadth and the market’s focus on the hopes of an earnings recovery for some of the industrial stocks even before any signs of such recovery can be detected in their earnings report during 2019. This dynamic was evident in small industrial companies and in healthcare providers classified under the industrial sector on the Iraq Stock Exchange (ISX), as discussed here in the last few months. The chart below shows the price action of Al-Mansour Pharmaceuticals Industries (IMAP), Al-Kindi of Veterinary Vaccines Drugs (IKLV), National Chemical & Plastic (INCP), and Metallic & Bicycles Industries (IMIB).

Indexed performance: Al-Mansour Pharmaceuticals Industries- IMAP (green), Al-Kindi of Veterinary Vaccines Drugs- IKLV (black), National Chemical & Plastic – INCP (purple), Metallic & Bicycles Industries -IMIB (blue)

(Source: Bloomberg, data from 31/12/2018 – 31/12/2019)

Normally, cyclical stocks outperform defensive or growth stocks at the start of economic recoveries even though their earnings do not support this outperformance – at least initially. It can be argued that similar dynamics are taking place through the action of cyclicals on the ISX in 2019 such as the banks, mentioned earlier, versus those of market stalwart growth stocks – Pepsi bottler Baghdad Soft Drinks (IBSD) which was down –8% for the year, or for mobile telecom operator Asiacell (TASC) which straddles the cyclical and defensive sectors due to the specifics of its earnings drivers since 2014, which was up +12% in 2019. In contrast, in 2018 both were up +34% and +47% respectively, but the banks were down, such as BBOB –52%, BMNS ­–20%, BNOI –28%, BCOI –4%. Even though the analysis of cyclicals versus growth stocks can only go so far on the ISX, given its illiquidity and limited diversification, the logic of an economic recovery driving cyclical earnings is applicable.

This economic recovery was initially driven by the revival in government spending on goods and services and on wages, the evidence of which was seen in: (1) the upturn of the country’s exports and in new vehicle sales as reported here in October, and (2) the continued growth of broad money, or M2, as a proxy for economic activity as reported here in December.

Data from the Central Bank of Iraq (CBI) on private sector deposits and credit to the private sector support the above trends. These show private sector deposit growth of +12% for the year by end of September 2019 after a few years of no change, while credit to the private sector was up +3% for the period but should accelerate as the economy continues to recover.

(Source: Central Bank of Iraq, Asia Frontier Capital)

The above chart is based on aggregate data for the private sector with the banking system as a whole – both for state banks, and commercial sector banks which accounted in 2018 for 36% of total credit to the private sector and 37% of private sector deposits – and thus do not show the performances of specific commercial banks listed on the ISX.

Drilling down to the company level within the commercial banking sector, the earnings profile of the National Bank of Iraq (BNOI) for the first nine months of 2019 (9M/2019) demonstrates the above macro trends. For BNOI private sector deposits were up +54% in 9M/2019, while credit to the private sector was up +116% for the same period. Its pre-tax earnings for 9M/2019 hold promise for strong full year earnings – a long way to go before recovering to pre-crises levels– but supporting management’s bullish expectations for the year. While it’s not possible to extrapolate much from these results, or to generalize for the sector as a whole from them, they support in any case the argument that the conditions are in place for the sector’s recovery in 2020.

The macro and the micro trends discussed so far are affected by the youth protest movement that dominated all events in Iraq from the 25th of October 2019 after the initial wave of protests in early October. The protest movement forced the political elite to implement reforms that would threaten their interests – contrary to earlier expectations of the opposite. Parliament approved electoral reforms that if made into law would be a meaningful departure from the prior ones that largely allowed the political elite to maintain their oversized influence on successive government formations.

If the hoped-for early elections in 2020 are to be conducted under these electoral reforms they will most likely lead to the formation of the next government with a majority in parliament and parliamentary opposition, as opposed to the case since 2003 in which successive governments were composed of all parties in parliament. This was the root cause of the failures of the past to implement the reconstruction of the country, as each party pursued its own program within its own sphere of influence within an all-inclusive government.

These developments have yet to be played out and a lot of uncertainties remain, yet the near-term effect on the economy would be that the current caretaker government, while unable to act on capital spending plans, will follow up with implementing the current spending element of the 2019 expansionary budget. Moreover, it will continue to implement this budget in 2020 through the upcoming months of pre-election manoeuvring, elections, and post-election government formation. The government has plenty of firepower to fund this spending in the form of a 33-month cumulative surplus of about USD 28.9 bln that will increase in a firmer oil price environment. The most important consequence of this is the sustainable continuation of the consumer led economic recovery discussed in earlier paragraphs.

(Source: Iraq’s Ministry of Oil, Rabee Securities, Asia Frontier Capital)

(Data for oil revenues as of December 2019)

The stock market continues to look through the political developments to the upcoming economic recovery, and while it’s in the early process of forming a base it is worthwhile to point out its continued divergence from its past close relationship with oil revenues (a proxy for the forces driving the economy). This divergence is still at the widest it has been for the last few years and it is showing tentative signs of narrowing this divergence as the above chart shows.

For further reading, here are some interesting, relevant news links related to Iraq:

 

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

 

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Market Review: “Fundamentals on the Upswing, Market continues to Bottom”

The demonstrations which resumed in the last week of October persisted into November and seem likely to continue for some time yet. This contrasts with earlier expectations that they would run out of steam due to a combination of carrot, stick and fatigue, none of which, alone or in combination, dented the spirt of an increasingly sceptical youth movement.

The first to fail were the bundle of carrots in the form of successively enlarged government handouts over the course of the last few weeks. The sticks, in the form of an excessive government crackdown, failed too –  even though the cumulative causality list increased considerably to over 450 people dead and nearly 20,000 wounded, the bulk of which were demonstrators.

The expected fatigue turned out instead to be an explosion of art as the protest movement acquired its own symbolic art form expressed through large street murals, public performances, music and in particular the movement’s version of calligraffiti- a hybrid of calligraphy, typography, and graffiti.

Calligraffiti in Baghdad’s Tahrir Square

(Source: Photo by Mohammed Ghani posted on Baghdad Projects’ Facebook page)

The sheer number of casualties among the country’s youth, while not sufficient to shake the political class into action, caused an expression of extreme anger by the leading religious authorities that led to the resignation of the prime minister by month end. Consequently, there is an intense political manoeuvring among the political elite over the choice and form of a new government that would undertake the needed electoral reform, to be followed by early elections in 2020. Complicating matters is the extent of the compromises by the political elite to ensure that these elections would be a meaningful departure from the prior ones that largely allowed them to maintain their oversized influence on successive government formations.

While it is unlikely that the political elite will implement reforms that would threaten their interests, a consensus is emerging for making enough changes that would lead to the formation of future governments with a majority in parliament and parliamentary opposition, as opposed to the case since 2003 in which successive governments were composed of all parties in parliament, with neither a defined government programme nor any real opposition. This was the root cause of the failures of the past to implement the reconstruction of the country, as each party pursued its own program within its own sphere of influence within an all-inclusive government.

These developments have yet to be played out and a lot of uncertainties remain, yet the near-term effect on the economy would be that the current caretaker government, while unable to act on capital spending plans, will follow up with implementing the current spending element of the 2019 expansionary budget. Moreover, it will continue to implement this budget in 2020 through the upcoming months of pre-election manoeuvring, elections, and post-election government formation. The most important consequence of this is the sustainable continuation of the consumer led economic recovery that first manifested itself through the growth of Iraq’s imports, as discussed here in September 2019, to satisfy consumer demands.

The fuel for this consumer spending can be seen through the return of liquidity to the real economy, expressed through the continued growth of broad money, or M2, as a proxy for economic activity due to its sensitivity to oil revenues (chart below). The healing effects of a benign oil pricing environment in which the trailing twelve-month average Brent crude price is about USD 63/bbl, provided the wherewithal for the government to implement its expansionary budget for 2019 and probably into 2020.

(Source: Central Bank of Iraq, Iraq’s Ministry of Oil, Asia Frontier Capital)

(Note: M2 as of Sep. with AFC estimates for Oct.; Oil revenues as of Nov.)

The growth in M2, as reported here earlier in the year, first accelerated in May 2018 with a pick-up in year-over-year change every month as can be seen from the above chart. However, the current figures for M2 are stronger than discussed here earlier as the Central Bank of Iraq (CBI) upwardly revised the figures for M2 for each month for the last few years – as outlined in the summer release of its “Annual Statistical Bulletin for 2018”. The upshot is that M2’s recovery, while slightly less in year-over-year percentage growth, is taking place from a higher base and thus the amount of liquidity in the economy is larger than believed earlier.

Some of the effects of this liquidity were seen in the return of construction activity in Baghdad as reported here in AFC’s Iraq travel report in the summer. While this would be overshadowed by the demonstrations in Baghdad and the south of the country, this construction activity continues at an accelerated pace in the semi-autonomous Kurdistan Region of Iraq (KRI) which has not seen any demonstrations. While a far cry from the pre-crisis boom, the return of such activity is remarkable and promising for the region’s economy. Moreover, it should have positive implications for banks’ non-performing loans (NPL’s) given the size of construction related loans.

The stock market continues to look through the political developments and is probably beginning to take note of the return of this liquidity to the economy as it spent most of the month, as measured by the Rabee Securities RSISX USD Index (RSISUSD), at between –2.0% and –1.0% of the close of the previous month, to end the month down –1.5%, and down –3.8% for the year.

Encouragingly, the stock market’s dynamics followed through with the improvement discussed here over the last few months, as its breadth continued to broaden with a number of small industrial companies experiencing meaningful year-to-date gains. Like the healthcare providers covered in this report last month, small industrial companies experienced the best gains in the last few months in which the overall market began to stabilize. This dynamic can be seen in the performance of National Chemical & Plastic (INCP), Metallic & Bicycles Industries (IMIB) and Modern Sewing (IMOS), up +95.6%, +34.3% and +62.9% respectively for the year by end of November.

Year to date indexed performance: National Chemical & Plastic – INCP (green), Metallic & Bicycles Industries -IMIB (dark brown) and Modern Sewing – IMOS (blue)

(Source: Bloomberg, data as of 30 Nov. 2019)

Moreover, like the healthcare providers, the stock market is focusing on a revival in earnings for these companies even though the earning results for them show no evidence of such an earnings recovery. It should be noted that the stock prices of these companies benefit from their illiquidity, in particular IMIB did not trade between early August 2018 and early March 2019, and the +34.3% YTD change used is based on the last traded price of the stock in 2018.

A broadening market breadth as well as its increasingly discriminating nature, add to signs that it is bottoming after a brutal bear market in which the current YTD decline of –3.8% is on the back of –15.0% decline in 2018, –11.8% in 2017, –17.3% in 2016, –22.7% in 2015, and –25.4% in 2014.

A recovery following this bottom formation could see the market, as measured by the Rabee Securities RSISX USD Index (RSISUSD), claw back some of the −67.0% decline from the peak in early 2014 to November 2019 closing levels.

Extra reading:

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Market Review: “Fundamentals on the Upswing, Market continues to Bottom”

The demonstrations which resumed in the last week of October persisted into November and seem likely to continue for some time yet. This contrasts with earlier expectations that they would run out of steam due to a combination of carrot, stick and fatigue, none of which, alone or in combination, dented the spirt of an increasingly sceptical youth movement.

The first to fail were the bundle of carrots in the form of successively enlarged government handouts over the course of the last few weeks. The sticks, in the form of an excessive government crackdown, failed too –  even though the cumulative causality list increased considerably to over 450 people dead and nearly 20,000 wounded, the bulk of which were demonstrators.

The expected fatigue turned out instead to be an explosion of art as the protest movement acquired its own symbolic art form expressed through large street murals, public performances, music and in particular the movement’s version of calligraffiti- a hybrid of calligraphy, typography, and graffiti.

Calligraffiti in Baghdad’s Tahrir Square

(Source: Photo by Mohammed Ghani posted on Baghdad Projects’ Facebook page)

The sheer number of casualties among the country’s youth, while not sufficient to shake the political class into action, caused an expression of extreme anger by the leading religious authorities that led to the resignation of the prime minister by month end. Consequently, there is an intense political manoeuvring among the political elite over the choice and form of a new government that would undertake the needed electoral reform, to be followed by early elections in 2020. Complicating matters is the extent of the compromises by the political elite to ensure that these elections would be a meaningful departure from the prior ones that largely allowed them to maintain their oversized influence on successive government formations.

While it is unlikely that the political elite will implement reforms that would threaten their interests, a consensus is emerging for making enough changes that would lead to the formation of future governments with a majority in parliament and parliamentary opposition, as opposed to the case since 2003 in which successive governments were composed of all parties in parliament, with neither a defined government programme nor any real opposition. This was the root cause of the failures of the past to implement the reconstruction of the country, as each party pursued its own program within its own sphere of influence within an all-inclusive government.

These developments have yet to be played out and a lot of uncertainties remain, yet the near-term effect on the economy would be that the current caretaker government, while unable to act on capital spending plans, will follow up with implementing the current spending element of the 2019 expansionary budget. Moreover, it will continue to implement this budget in 2020 through the upcoming months of pre-election manoeuvring, elections, and post-election government formation. The most important consequence of this is the sustainable continuation of the consumer led economic recovery that first manifested itself through the growth of Iraq’s imports, as discussed here in September 2019, to satisfy consumer demands.

The fuel for this consumer spending can be seen through the return of liquidity to the real economy, expressed through the continued growth of broad money, or M2, as a proxy for economic activity due to its sensitivity to oil revenues (chart below). The healing effects of a benign oil pricing environment in which the trailing twelve-month average Brent crude price is about USD 63/bbl, provided the wherewithal for the government to implement its expansionary budget for 2019 and probably into 2020.

(Source: Central Bank of Iraq, Iraq’s Ministry of Oil, Asia Frontier Capital)

(Note: M2 as of Sep. with AFC estimates for Oct.; Oil revenues as of Nov.)

The growth in M2, as reported here earlier in the year, first accelerated in May 2018 with a pick-up in year-over-year change every month as can be seen from the above chart. However, the current figures for M2 are stronger than discussed here earlier as the Central Bank of Iraq (CBI) upwardly revised the figures for M2 for each month for the last few years – as outlined in the summer release of its “Annual Statistical Bulletin for 2018”. The upshot is that M2’s recovery, while slightly less in year-over-year percentage growth, is taking place from a higher base and thus the amount of liquidity in the economy is larger than believed earlier.

Some of the effects of this liquidity were seen in the return of construction activity in Baghdad as reported here in AFC’s Iraq travel report in the summer. While this would be overshadowed by the demonstrations in Baghdad and the south of the country, this construction activity continues at an accelerated pace in the semi-autonomous Kurdistan Region of Iraq (KRI) which has not seen any demonstrations. While a far cry from the pre-crisis boom, the return of such activity is remarkable and promising for the region’s economy. Moreover, it should have positive implications for banks’ non-performing loans (NPL’s) given the size of construction related loans.

The stock market continues to look through the political developments and is probably beginning to take note of the return of this liquidity to the economy as it spent most of the month, as measured by the Rabee Securities RSISX USD Index (RSISUSD), at between –2.0% and –1.0% of the close of the previous month, to end the month down –1.5%, and down –3.8% for the year.

Encouragingly, the stock market’s dynamics followed through with the improvement discussed here over the last few months, as its breadth continued to broaden with a number of small industrial companies experiencing meaningful year-to-date gains. Like the healthcare providers covered in this report last month, small industrial companies experienced the best gains in the last few months in which the overall market began to stabilize. This dynamic can be seen in the performance of National Chemical & Plastic (INCP), Metallic & Bicycles Industries (IMIB) and Modern Sewing (IMOS), up +95.6%, +34.3% and +62.9% respectively for the year by end of November.

Year to date indexed performance: National Chemical & Plastic – INCP (green), Metallic & Bicycles Industries -IMIB (dark brown) and Modern Sewing – IMOS (blue)

(Source: Bloomberg, data as of 30 Nov. 2019)

Moreover, like the healthcare providers, the stock market is focusing on a revival in earnings for these companies even though the earning results for them show no evidence of such an earnings recovery. It should be noted that the stock prices of these companies benefit from their illiquidity, in particular IMIB did not trade between early August 2018 and early March 2019, and the +34.3% YTD change used is based on the last traded price of the stock in 2018.

A broadening market breadth as well as its increasingly discriminating nature, add to signs that it is bottoming after a brutal bear market in which the current YTD decline of –3.8% is on the back of –15.0% decline in 2018, –11.8% in 2017, –17.3% in 2016, –22.7% in 2015, and –25.4% in 2014.

A recovery following this bottom formation could see the market, as measured by the Rabee Securities RSISX USD Index (RSISUSD), claw back some of the −67.0% decline from the peak in early 2014 to November 2019 closing levels.

Extra reading:

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

By Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund.

Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Market Review: “Market continues to bottom, while breadth broadens”

Demonstrations resumed during the last week of October, following a two-week lull since they started. While the government has dialled down on its earlier excessive violence in response to these demonstrations, the cumulative causality list increased considerably to over 250 dead and over 10,000 injured.

However, the demonstrations continued to be mostly peaceful and the overall atmosphere has the feel of a carnival, especially in Baghdad’s Tahrir Square. There, Iraqis of all walks of life, social classes, sexes and ages, have taken to the square demanding the provision of services, economic prosperity and an end to corruption, and all the while celebrating their newfound sense of Iraqi nationalism that first emerged with the conclusion of the ISIS conflict.

Baghdad’s Tahrir Square by night

(Source: Karrar Al-Taie’s Facebook page)

The sheer number of people taking part in the protests is finally beginning to have an effect on the political class, which was hoping to wait out and buy the demonstrations through a series of ever-increasing handouts. A political consensus is emerging for the need to undertake serious reforms, address corruption and hold early elections after amending the electoral rules that largely allowed the same elite to maintain their oversized influence on successive government formations.

These changes, while unlikely to see the light of day in their entirety, will hasten the break-up of the ethno-sectarian monolithic blocs that were dominant over the past 16 years and which were at the root of Iraq’s past instability. In the process they will break the political logjam that was behind the failures of the past to implement the reconstruction of the country.

The most important consequence of the emerging consensus is either the resignation of the government, or a serious effort at amending the election rules leading to early elections. Whichever permutation emerges, it will lead to a caretaker government, followed by a return of government paralysis and fears of a replay of the events that held back the economy in 2018 and the first half of 2019 as discussed here over the last few months.

However, there are crucial differences between now and then. The first is that an upcoming caretaker government, while unable to act on capital spending, will follow up with implementing the current spending plans of the 2019 expansionary budget. Moreover, it would continue to implement this budget in 2020 throughout the upcoming months of pre-election manoeuvring, elections, and post-election government formation. The most important consequence of this is the continuation and sustainability of the consumer led economic recovery that first manifested itself through the sharp increase of Iraq’s imports, as discussed here last month, to satisfy growing consumer demands.

The freeze of capital spending is a negative factor, suspending its intended effect of turning an upcoming three to four year consumer-led economic recovery into a multiyear economic boom. However, mitigating this negative is the fact that a future capital spending freeze is undistinguishable from the current lack of such spending. The Ministry of Finance’s (MoF) latest data as of August reveal a total non-oil capital spending of about USD 1.3 bln from a budgeted USD 11.25 bln for the whole year.

The same data shows a continued build-up of the budget surplus of about USD 7.2 bln for 2019 by end of August, or a cumulative 32-month surplus of USD 30.3 bln. This would provide the wherewithal for an upcoming government to embark on a significant capital spending plan that it can use to solidify its position as the government that would meet the people’s expectations. An un-intended consequence of the current government’s paralysis is the elimination of the temptation to spend its way out of the crises by ever increasing handouts at the expense of capital spending.

The market seems to look to the future through these developments, as it spent most of the month, as measured by the Rabee Securities RSISX USD Index (RSISUSD), fluctuating +/− 1% within the close of the prior month, to end October at +1.9%, and down −2.3% for the year. Encouragingly, the market’s dynamics followed through with the improvement discussed here over the last few months as its breadth continued to broaden beyond the banks, which came to the forefront this year, or that of the high-quality leadership of Pepsi bottler Baghdad Soft Drinks (IBSD) and mobile operator AsiaCell (TASC) that outperformed in 2018. This broadening is seen in many sectors that are leveraged to a consumer recovery and/or to an expansionary government budget.

A group that stands to benefit from an expansionary budget, are the healthcare providers, which depend on government health service expenditures to drive their earnings growth. The government curtailed all such outlays following the twin crises of the ISIS conflict and the collapse in oil prices in 2014, with devasting consequences for the companies that depend on such spending. The market began to focus on the sector in the last few months with expectations that such, hoped for, spending would be manifested in the group’s future earnings – even though the earnings results for most of the companies show no evidence of such earnings recovery as of yet. It’s worth noting that  healthcare expenditures would be part of the provision of goods and services in the current budget section, and not from capital investments, and as such should not be affected by a future government paralysis. This dynamic can be seen in the stock price performance of Al-Mansour Pharmaceuticals Industries (IMAP) and AL- Kindi of Veterinary Vaccines Drugs (IKLV), which were up +43.8% and +28.8% respectively year to date, with most of the performance taking place in the last few months during which the overall market began to stabilize, as can be seen from the chart below:

Year to date indexed performance: Al-Mansour Pharmaceuticals Industries

– IMAP (green), AL- Kindi of Veterinary Vaccines Drugs- IKLV (orange)

(Source: Bloomberg, data as end of 31/10/2019)

Whilst the market is in the early process of forming a base it is worthwhile to point out its continued divergence from its past close relationship with oil revenues (a proxy for the forces driving the economy). This divergence is still at the widest it has been for the last few years, and it is showing tentative signs of narrowing this divergence (see below).

(Sources: Iraq’s Ministry of Oil, Rabee Securities, Asia Frontier Capital)

(Note: Oil revenues as of Sep, AFC estimates for Oct)

 

Extra reading:

Coverage of the nature and breadth of the demonstrations in Tahir Square, has been provided by a number of Iraqi photographers on their Facebook pages.

Some of these photographers are:

Ziyad Matti, Mohammed Aladdin, and Karrar Al Taiee

The following links, a photo album, a video, and an article are provided below:

 

Please click here to download Ahmed Tabaqchali’s full report in pdf format.

Mr Tabaqchali (@AMTabaqchali) is the CIO of the AFC Iraq Fund, and is an experienced capital markets professional with over 25 years’ experience in US and MENA markets. He is a non-resident Fellow at the Institute of Regional and International Studies (IRIS) at the American University of Iraq-Sulaimani (AUIS), and an Adjunct Assistant Professor at AUIS. He is a board member of the Credit Bank of Iraq.

His comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any fund or security or to adopt any investment strategy. It does not constitute legal or tax or investment advice. The information provided in this material is compiled from sources that are believed to be reliable, but no guarantee is made of its correctness, is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding Iraq, the region, market or investment.

From Peace to prosperity:

The Conference to find out what’s happening for Iraq business.

The Iraq Britain Business Council (IBBC) Autumn Conference in Dubai on December 8th is set against a backdrop of relative peace and security in Iraq, and the prospect of oil revenues surging through the economy is driving a wider range of business opportunities and a prospective 8% increase in GDP.

Peace is enabling the economy to diversify through the revenues that pay for a range of infrastructure projects. So this Autumn we are focusing on a range of sectors set to benefit from a stable Iraq: namely, Water, Transport and Logistics, Energy and Tech.

The recent protests have also spurred on Government reforms and incentives to drive employment, entrepreneurship and service diversity, and increase the volume of opportunity that lies ahead and the prospects for not just business-to-business but also a burgeoning consumer market.

The Iraqi Electricity Minister will likely be speaking about his reforms to open up the market to SME’s, training and new players. Other ministers including those from Construction and Transport are attending.

The recent announcement of a 10year tax-free period for SMEs in Iraq will also stimulate the Tech entrepreneur market and drive the uptake of engineering skills.

At this conference, we will discuss big-picture economics with Professor Frank Gunter (Lehigh University), Ahmed Tabaqchali (AFC Iraq Fund), and Simon Penny (UK Trade & Investment), who will address the economic backdrop in the Middle East, and the context for Iraq in particular.

The World Bank and Wood Plc will cover the water sector, while Rolls Royce, Basra Gateway Terminal (BGT), and Menzies will look at transport and logistics, and Iraq’s Electricity Minister, GE, Siemens and Enka will focus on energy.

Alongside the conference our Tech Forum brings experts on HealthTech and Educational Tech, including speakers from GE, Siemens Healthcare, KPMG, EY, Google and the British Council, among others.

While key opportunities will be outlined, the real opportunity for business is to meet the people directly involved in contracts and supply-chain opportunities. This is the place to do business, to network and to find out what’s happening in the Middle East’s most potentially dynamic market that is Iraq.

For further information and to find the latest updates on speakers – more are expected – please contact  london@webuildiraq.org or visit the website to register for tickets.

https://iraqbritainbusiness.org/event/autumn-conference-at-the-address-hotel-dubai

The year it’s all on the up…