TRANSPARENCY SNAPSHOT

Iraq, a nation of 25 million people, holds the second largest oil reserves in the world, estimated to exceed 300 billion barrels. While Iraq enjoyed a period of relative prosperity and modernization in the 1950s and 1960s, its more recent history of pervasive violence, mismanagement and abuse has denied the people of Iraq any lasting benefits from this wealth. Today, a nation mired in conflict, Iraq suffers severe shortages of fuel and power, despite the fact that it literally "swims on a lake of oil."

The widespread and systematic abuse of the country's vast resources has its causes in decades of authoritarian rule, war and international sanctions. The collapse of the state in the aftermath of the 2003 invasion, and the resulting security and legitimacy deficits, have only exacerbated the problem.

Five years after the U.S.-led invasion in March 2003, which toppled the authoritarian regime of Saddam Hussein, Iraq remains close to the bottom of Transparency International's Corruption Perceptions Index.

Despite a raging conflict, Iraq generated over US$40 billion in oil revenues in 2007. Oil accounted for over 75% of GDP and 95% of government revenues. At the beginning of 2008 output stood at more than 2.5 million bbl/day with exports over 2.2 million bbl/day, near the export levels prior to the 2003 Iraq conflict. The economy is expected to grow by 7% during 2008.

Revenue Transparency

Iraq is almost entirely dependent on oil and gas revenue to support state expenditures. The size and use of oil revenues was a jealously guarded secret during Iraq's years of authoritarian rule. The oil sector was nationalized in the 1960s-1970s. Since then, oil was managed first by the state-owned Iraqi National Oil Company and, after the company's abolition in 1987, by the Ministry of Oil directly.

Oil is exported by the State Oil Marketing Organization (SOMO), a department of the Ministry of Oil. Until 1991, revenues were deposited directly in a special account at the Central Bank of Iraq.

During the years of sanctions after the first Gulf War (1995-2003), Iraq's oil revenues had to be deposited at an escrow account at a designated international bank BNP Paribas, under the supervision of the UN Sanctions Committee. Iraqi oil revenues were subject to extensive abuse during the so-called Memorandum of Understanding years. It is estimated the government of Iraq alone was able to divert over US$20 billion away from the account through a vast network of intermediaries. United Nations staff were also implicated in abuses of Iraqi resources. Since Saddam Hussein's fall, all revenues from the export sales of petroleum, petroleum products and natural gas are deposited into the Development Fund for Iraq (DFI), that was created under United Nations Security Council Resolution 1483, dated 21 May 2003 and continued under UNSCR 1468. The DFI account is held by the Central Bank of Iraq at the Federal Reserve Bank of New York (FRBNY).

In the immediate aftermath of the Saddam Hussein's removal, the DFI was managed by the U.S.-led Coalition Provisional Authority (CPA), until June 28, 2004, when the CPA was disbanded.

The Iraqi government's Ministry of Finance then took formal control of the DFI and allocated funds to other ministries according to the national budget. Each of Iraq's then 31 ministries was assigned an inspector general by the CPA before it shut down, to look into any corruption. An independent Commission on Public Integrity (CPI) was also created with wide-ranging powers to investigate anyone in government. All have hotlines for the public to call, and any findings from these agencies can be referred to the Central Criminal Court of Iraq for prosecution.

The continued media spotlight on Iraq and civil society activism by Revenue Watch and other groups have enforced a degree of transparency for Iraqi oil revenues that is unprecedented in this region.

The arrangements contained in UNSCRs 1483 and 1468, which have been extended through the end of 2008, allow for relatively accurate tracking of oil revenues coming into the DFI. The DFI provides a focal point for all of these revenues. The DFI is monitored by the International Advisory and Monitoring Board for Iraq (IAMB) which includes among others the chief comptrollers of the World Bank and the IMF. IAMB functions are in the process of being transferred to the Council of Financial Experts (COFE), an Iraqi body that includes the Board of Supreme Audit, which is expected to continue to contract DFI audits to the international audit firm Ernst &Young LLP. Since 2004, DFI audits have been regularly published on the IAMB's website in a timely manner.

The DFI is set to expire in 2008, and the Iraqi government is exploring options to extend the arrangement with the U.S. government. Although draft laws envision a central collection account for oil revenues, there are objections from the Kurdistan Regional Government (KRG) over who would exercise control over the single account and how revenues would flow into it. The Federal Government is wants the account under the control of the Ministry of Finance, which oversees the national budget. The KRG would like the account to be controlled by an independent committee which would give the region a veto over its disposition.

In accounting terms Iraq's unspent revenues are accumulated as Central Bank Reserves, kept in the DFI account at the FRBNY. This is a simple but robust solution which allows not only for proper accounting of accumulating assets but also constrains the government's ability to spend them.

Expenditure Transparency

Iraq signed its second Stand by Arrangement (SbA) with the International Monetary Fund in late 2007. Fulfillment of the first 2005 SbA allowed for the reduction of more than 80% of Iraq's debt to Paris Club lenders, opened the way for similar debt write-downs from other countries and private creditors.

Per the terms of the SbA, Iraq has also reduced large subsidy programs, nearly eliminating fuel subsidies which had cost as much as US$4 Billion a year. Iraq has reduced inflation, which reached an annual rate of 65% in 2006 and is expected to drop and remain below 25% by the end of 2008.

The latest IMF reports gives Iraq good marks on most policies, although it raises concerns over continuing violence and corruption.

All this progress has not prevented abuse, as evidenced by Iraq's "missing billions." It is estimated that while fuel subsidies were in force, an amount equal to the full value of the subsidies themselves would be diverted through smuggling. There are also reports of diversion of crude from pipelines and rogue export terminals. Unverified estimates say crude smuggling amounted to US$3 billion, based on the discrepancy between output and consumption and export figures. But the estimates but could be inaccurate, given the absence meters at either the field or the export terminal during that time. It is assumed that large quantities of fuel and other products are also diverted from refineries.

The nation's budget and public finance rules have formal transparency and public accountability standards which, if implemented properly, could increase transparency on the expenditure side.

In the World Bank's recent draft report on public expenditure and institutional assessment (PEIA), Iraq receives relatively high marks for its Public Finance Management.

Iraq's budget is fully implemented for current expenditures, mainly public sector salaries and subsidies. The execution rate for the investment budget remains very low. In 2006 it was only 20% and stood at 10% by September 2007.

Iraq's financial management law includes provisions for strong parliamentary oversight. However, neither parliament not the ministry of finance have yet demonstrated the capacity to carry them out properly. Parliament has yet to receive an audit of public finances for the past three years. (Revenue Watch is currently providing technical assistance to the Iraqi Parliament in the establishment of a budget office.)

Most waste and abuse takes place within the line ministries, which oversee specific business sectors. Local governments are receiving a growing portion of the investment budget—US$4BN in 2008—and they are ill-equipped to spend their resources in an efficient and accountable way.

The Fight Against Corruption and the Road Ahead

Billions of dollars in Iraqi resources and United States aid continue to be unaccounted for. Mismanagement and lack of accountability have plagued both the U.S.-led coalition and Iraqi authorities that succeeded them. Reports by Revenue Watch and our partners catalogue many of these abuses, as do reports from the Government Accounting Office and the Special Inspector General for Iraq Reconstruction.

Iraq has the potential to overcome these issues. New legislation, including pending petroleum laws call for a high degree or transparency and accountability in the management of oil wealth. Parliament is actively seeking to improve budget oversight. The IMF and the World Bank have commended the government's efforts to tackle waste and abuse of public resources and to combat corruption despite challenging circumstances.

Iraq's government and its public clearly recognize the mismanagement of public finances as an existential threat to the nation; some refer to corruption as "the second insurgency." New efforts have been undertaken to streamline anti-corruption measures. Iraq has joined the UN Convention to Combat Corruption In early 2008, the Iraqi government expressed interest in joining the Extractive Industries Transparency Initiative.

The fight against abuse of public resources is a long-term struggle made all the more difficult by ongoing violence, and the combined crises of legitimacy, legality and confidence.

Working with Iraq's government, parliament, activists and international partners, Revenue Watch continues its efforts to help open up the political process, accelerate reconstruction and development efforts and forge a consensual framework for the management of Iraq's hydrocarbon wealth.