The Iraq Energy Institute (IEI) has published an interview with Dr Ahmed Tabaqchali, CIO of Asia Frontier Capital (AFC) Iraq Fund; it is re-published with permission by Iraq Business News:

In the latest instalment in our series on sustainable job creation in Iraq, we spoke to Ahmed Tabaqchali, visiting fellow at the American University of Sulaimani’s Institute of Regional and International Studies (IRIS). Mr. Tabaqchali is also CIO of Asia Frontier Capital’s Iraq fund and Board Member of the Credit Bank of Iraq. Additionally, he has decades of experience in finance, having also worked with the National Bank of Kuwait’s investment arm.

In our last interview, we spoke with World Economic Forum contributor and distinguished economic historian Ewout Frankema, who discussed the role of the state in job creation.

This month we take a different tack and hear Mr.Tabachali’s views on the role of finance and markets, Iraq’s early efforts mobilizing financial technology (FINTECH) for the unbanked and kickstarting small and medium-sized enterprise (SME) growth.

AT: In terms of strategy, everything the new government will have to do has to go through parliament, including accessing foreign loans and reforming the public sector. When it comes to Iraq it is not a question of how strong the institutions are or how competent individuals are, it is a question of passing this through parliament with all of its political fragmentation, between the different pollical parties and within each party between its leadership and members, all of which makes reaching a consensus to embark on real, and thus difficult, reforms very hard. However, the scale of the crisis, brought by COVID-19 both socially and economically, might act as a catalyst for real change.

What is the current risk with having so much of the hiring in the public sector and what might be done to minimise this problem?

AT: Some things have to be done now that are comparatively easy and have been done in the past. Ad hoc measures such as freezing new hiring, cutting staff through attrition, putting a cap on benefits and letting this cascade through every department. This worked last time to a limited extent. But these changes are small scale, easily reversible and they do not solve the wider problem.

One problem is that you cannot have every ministry manage its own human resource processes, there is a need to have a central human resource structure. One course of action could be to separate benefits from salaries and link them to performance. This may sound horrendously complicated but on the public sector side, there is a little alternative. I don’t subscribe to the idea that this is a crisis that will pass, it is a multi-year crisis, a lot of oil demand will come back, but I cannot see a recovery anywhere near the pre-COVID situation.

Iraq is now not only battling a difficult internal situation but a weakened global economy. We are not just talking about a major disaster in one sector only. Consider such effects on hospitality and tourism; that will affect entire countries dependent on tourism, and then consider the knock-on effect on other sectors: what does that do to worldwide aggregate demand? What does that mean to Iraq? It means that oil prices will recover but they won’t be anything sustainably higher than $50 or $55. This points to the need for a complete change in mentality within the Iraqi governing elite and indeed, society at large.

Within Iraq, the government has very limited space to manoeuvre. If you look at Central Bank data on bank lending to the government and on T-Bill issuance, we survived in 2014-2017 through using reserves, via indirect monetary financing, and government bank lending. But while some of that has been paid off, CBI data as the end of November 2019 show that total domestic debt has increased to the prior crisis’ peak. So, I cannot see that being repeated, not in the same way as then. This time, I struggle to see the state banks’ lending beyond a few billion. The reserves are there but not un-limited and then there are conditionality constraints on any upcoming IMF loans. So, there will be no waiting out this crisis, there has to be decisive reform.

What danger is there to the SME sector, in terms of constrained available credit from banks, given this lending is important for start-ups?

AT: For the private sector banks, if you look at the end of 2018’s data, there is something like a $9 bn deposit base, 70% of which is in current accounts, so they can’t lend more than one-third of this, maximum. So, you can’t look to the private sector for state loans. That leaves the state banks, and they are so undercapitalized, burdened by un-resolved legacies of the prior regime, they function by a miracle or by pushing the accounting rules’ envelope. For example, you have an asset that is no longer a creditworthy asset, but you leave it on the books without making realistic downward adjustments to its value and without taking sufficient provisions. So that room for manoeuvre is very limited. Iraq has the foreign deposits at the Ministry of Finance, there is about $6bn there so there are some available funds here and there to meet immediate needs, but how far will you go with that? The need for the state to access domestic debt will eventually place restrictions on available funds for the SME sector.

Iraq is sliding towards a danger zone, a crunch point with foreign reserves where there is a risk of currency devaluation.

AT: Yes. And one problem here is that the last government, to appease the October demonstrations, hired additional employees and lowered the retirement age, adding at least another $6bn to the salary and pensions outlay which is now baked into the current budget. So, the $44bn in salaries and pensions in 2019, is more like $50bn for 2020. Similarly, the $73 bn spent on current expenditures, which also includes transfers to SOE’s, social security and subsidies for fuel and energy, is now more like $80 bn in current expenditures. How much can you cut from that without real restructuring?

So Iraq is facing an emergency situation to mobilise the private sector and there is a risk state banks may have limited room for lending to SMEs. One thing Iraq can do perhaps is maximise export finance and partnerships with foreign banks for SME lending, such as the recent scheme with Commerzbank. And of course, the Iraqi government has its own fund for this, the One Trillion Dinars initiative.

AT: There is no doubt that these initiatives are vital for new business ventures. The issue is structural impediments that are limiting these schemes. Access to finance is very crucial for start-ups to work, but in order for these organizations to operate you need to remove the stifling regulatory environment. The arbitrary nature of taxes, the expenses involved in just setting up and the many bureaucratic steps required to get started. So at the moment many of these start-ups are informal. The only way for these schemes to work is for them to start in the informal sector.

But they can’t make the transition to formality because the process to attain that status is so complicated and expensive, to start and to maintain. We always talk of mobilizing the private sector, but we are throttling it on a daily basis. Look at the UAE for example, they have the Free Zones, a very low time required for company registration, but with Iraq it is a stifling number of procedures.

The solution as far as the Iraqi government are concerned sadly seems to be another level of bureaucracy. In order to mobilise more start-ups, the government following the October demonstrations allowed for 18-35-year-olds to have fast-track separate set of regulations for start-ups in certain industries. So, the same bureaucracy will handle two parallel categories. You open up the door for even more corruption with more bureaucracy.

Every country, of course, has bureaucracy. But we have absurd requirements on top of the usual. Even just very small things, like paying a bill, can be a nightmare. And this is the legacy of formal socialism.

You are saying that in Iraq, socialism is not simply a term to be used as a political label, it is a word that is formally used in laws that are still on the books from decades ago.

AT: That’s right. So what Iraq needs is a change in the political economy. Look at the informal sector -it is mostly in retail, such as hawking goods, and in hospitality such as restaurants, and not in productive sectors. It’s informal because it is so expensive to start up formally. Change the regulations so it is more like the UAE, give them a year’s amnesty before you implement a much easier, formal registration process. These businesses hide because the only way they can operate is by bribing various officials. An amnesty would free them from harassments and un-necessary expenses during the transition to sensible regulations. The government needs to do something that is drastic, and very different from the past, to mobilise the private sector.

You can’t have a top-heavy, authoritarian socialist bureaucracy creating jobs or opening up the private sector. During the Kuwait conference, Iraq’s National Investment Commission came up with the One-Stop-Shop initiative – more bureaucracy on top of the bureaucracy. Why not follow the Kurdish Region of Iraq’s approach? Just get a visa on arrival for certain nationalities. That is the direction we need to be going in.

There has been a growing relationship between telecoms and banks in Iraq to provide services such as mobile wallets. Some of it is Iraqi initiative, some of it is fostered by development agencies. Perhaps one danger now is that if public sector payments are digitized, the salaries are still in jeopardy. How important have these FINTECH developments been?

AT: This is where we will see a lot of growth and excitement. One barrier to further progress is not technological. We have decent internet so the issue is firstly, we need to increase the number of areas where these innovations can be used. Right now they are quite limited. I am thinking of using a mobile e-wallet but I have to go to an official shop in town and register, supply the required set of documentation, and once you use it, the places you can use it in are rather limited. A part of the potential in this technology is that it will make it difficult to cover up small scale corruption, which is easy with cash. But there is still a chicken and egg situation in terms of outlets where e-wallets can be used.

So we could say in the long run, the public demand for convenience may crowd out the demand for corruption?

AT: Yes, and in the long run, it can have a huge effect on the “unbanked” and that will have huge potential for job creation. I have some relatives in government who started receiving their salaries through their banks, and their usage followed the same patterns seen by those in the private sector who were provided with Bank cards as I learned from speaking to bankers. At the beginning where there was an ATM when salaries were dispersed the ATM would just empty as people used it as a cash-out outlet. But in time they started leaving money in the bank and starting using the cards for making purchases. So, the cards have been extremely useful in the transition away from cash.

Similarly, for the government’s initiative when the card/ e-wallets were linked to a Mastercard, people started keeping some funds on the card. In the process they were creating deposits, giving the bank the ability to lend as these deposits grow and become sticky. So, there is convenience and value there, and that could spark wider financial development. But there needs to be a bigger deposit insurance scheme in banks, more than the very small $25,000-dollar limit recently introduced. But in the long term, this is extremely exciting. And these are the reforms that need to be pushed, and they should be COVID-inspired reforms because this is how Iraq gets out of its nightmare.

Would you say then, this is not about what the government needs to do but in some ways, about what the government should not do?

AT: I agree although of course there is a vital role for the government in general. The government should ensure there are law and order. Without that, a business cannot run, they need reliable mechanisms of exchange, debt and credit, and the enforcement of contracts. That is only done through law and order. It doesn’t have to copy a Western model either, but what is needed is the monopoly of violence by the state, and its monopoly to enforce the law, i.e. when rules of the game are predictable, enforceable, and applicable to all. Other competencies of the government are in infrastructure. Roads and electricity are enablers, as well as education and healthcare. Healthcare is a great equalizer, at least with decent healthcare you are helping the most vulnerable, and in the process building the state’s legitimacy. And if the government focuses on these and opens up the private sector, it will flourish.

(Source: IEI)

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: “Lockdown Iraq & the month of Sundays”

Iraq, like other countries, went into full lockdown on March 16th that was only partially lifted just before the fasting month of Ramadan – in which activity is normally subdued. Unlike many countries, Iraq went a step further in that its lockdown included its whole financial sector.

In particular, the Central Bank of Iraq (CBI) and the banks that it regulates suspended most activities during the lockdown. In turn, this negatively affected the availability and circulation of the USD in the country’s cash dominated economy – where about 85% of the currency in circulation is outside the banking system.

The CBI conducts five daily USD auctions every week to facilitate foreign trade transactions (transfers or green bars in the chart below) and to satisfy the need for physical USD for Iraqis travelling abroad (cash or red bars in the chart below). The closure of this facility over the lockdown period, and its much-reduced frequency following that, have naturally resulted in an unmet need for USD and hence a rise in its price in the market versus its official price.

Typically, the market price of the USD is at a premium to official prices, but spikes higher during periods of uncertainty or crises – the last of which were the momentous events at the start of the year that raised the feared spectre of a US-Iran proxy war fought in the country. This premium began to spike, and stayed at elevated levels, as the lockdown came into full effect as can be seen from the chart below.

(Source: Central Bank of Iraq (CBI), Asia Frontier Capital. The CBI did not provide market prices on March 16th-April 21st, so the chart assumes gradual increases in prices in this period)

Consequently, this affected the market price of the physical USD which normally trades at a further premium of 2-4% over the premium discussed above (i.e. the gold/brown line in the above chart). This extra premium widened, as it does during spikes, and is now about 8-10% and remained at these elevated levels by the CBI’s ceasing of its offering of physical USD in its currency auctions from mid-March (above chart). In a country in which the dissemination of economic updates is poor and trust in the government is very low, rumours come to the fore and drive perceptions and subsequently fears.

One such rumour that dominated perceptions was that sharply falling oil prices were resulting in major USD shortages at the government level and it was thus conserving its reserves by stopping the flow of physical USD. This line of thinking has some merit as it takes its cue from a similar pattern during 2014-2017’s twin crises of the ISIS conflict and the collapse in oil prices. However, then the CBI restricted the supply of the USD during its auctions but didn’t stop either transfers or cash offerings. As it turned out, the physical USD offerings were halted as no foreign travel was taking place, given that they are meant to satisfy the needs of individuals’ foreign travels.

Rumours of a USD shortage aside, the weakening of demand in the economy is evident as seen from the smaller volumes of transfers in the currency auctions during late April, and from the “Community Mobility Reports” provided by Google. These are based on data from mobile phone users who have opted-in for “Location History” on their Google accounts. These users provide a reasonable population sample given the high levels of mobile penetration in Iraq (chart below) – more so given the high combined Samsung/Huawei market share, a proxy for Google’s Android system, which is about 75% in mobiles – and thus should provide a reasonable picture of economic activity during the lockdown.

(Source: Statista)

While every sector of the economy has felt the effects of the lockdown, the informal sector – dominated by retail trade, transport and hospitality, and which accounts for the bulk of private-sector economic activity in Iraq – has been particularly hard hit as can be seen from the chart below, which shows changes in activities compared to the baseline January 3rd-February 6th.

(Baseline is the median, for the corresponding day of the week, on January 3rd-February 6th,

Source: Google, data as of April 30th)

However, the decline in activities are likely to have been more precipitous than shown in the above chart as activities in the retail, transport and hospitality sectors were subdued during the baseline period given the chilling effects of the dramatic events at beginning of the year. More so, these events came on the back of a slowdown induced by the continued countrywide demonstrations from October 2019.

The Iraq Stock Exchange (ISX) resumed trading on April 26th, after closing on March 16th, and in-line with government guidance of reduced commercial activity, it reduced trading days to three days per week from five. However, the board of governors of the ISX, in a misguided attempt to calm market fears, lowered the daily stock price limit downs to 5% from 10%, but kept the upside limit at 10%. Inevitably it did the exact opposite of its intended purpose, as the same low trust in authorities fuelled rumours that the market authorities were hiding some major negative news. The new limit-down limits served as magnets for sellers during the remaining three trading days of the month with prices obligingly closing down 5% on each of these days. As often happens in frontier markets, buyers disappear for several days as sellers chase down small bids and drive prices to very attractive levels. While prices tend to recover as buyers return to pick up bargains, which seems to be taking place in early May.

For the three days that made the trading month of April, the Rabee Securities RSISX USD Index (RSISUSD) was down 12.7%. The argument made here last month that ” Iraq’s equity market was discounting neither an economic nor a corporate earnings recovery, it’s difficult to see why it should decline as other markets have elsewhere“, is stronger now, especially given that the market by end of April is now down 75% from the 2014 peak.

The closing argument of the Asia Frontier Capital team in the March newsletter, is an appropriate end here.

“The recent stock market correction, though painful, is now providing an excellent entry point to investors as valuations across our universe are at 10-year lows – stock picking has never been easier. Though we believe global markets could remain volatile in the near term as the number of infections rise and poor economic numbers come through, a sustained rally could be seen once there is an indication of infections peaking especially in Europe and the U.S.

“Asian frontier markets have bounced back very strongly after previous episodes of market dislocation such as in 2008-09 with markets like Pakistan and Vietnam generating much higher returns than major indices. Though it is very easy to get distracted with the negative consequences of the pandemic, Asian frontier markets are at present and will over the next few months provide an opportunity to invest in these markets last seen a decade ago.”

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 John Lee.

The Iranian parliament, the Majlis, has approved a government bill to redenominate its currency, dropping four zeros.

According to Tehran Times, the proposal came from the Central Bank of Iran (CBI), and will result in a new currency, the “toman”, which will equal 10,000 rials.

Reuters reports that the bill must now be approved by the clerical body that vets legislation before it takes effect.

The rial has lost more than 60 percent of its value since US President Donald Trump abandoned the 2015 nuclear deal (JCPOA) and reimposed sanctions.

(Sources: Tehran Times, Reuters)