Iraq is seeking to fund post-ISIS reconstruction through private-sector growth and foreign direct investment, but structural challenges and regional geopolitical competition could derail this effort.

Speaking at a July 2017 economic development conference, Iraq’s Foreign Minister Ibrahim al-Jaafari declared that after ISIS’s defeat, “the country now needs a Marshall Plan for reconstruction.” During subsequent months, however, direct international economic, development, and financial assistance has remained well below levels required to implement the estimated 10-year and $100-150 billion Iraqi government reconstruction effort. Meanwhile, significant portions of previously-liberated areas (including Mosul, Ramadi, and Fallujah) remain without essential services, sufficient shelter, and critical safety provisions such as ordnance-clearance. As Baghdad looks to address funding and capacity deficiencies, few international partners have signaled a willingness to translate counter-ISIS military support into post-liberation financing. On February 8, just days ahead of the major reconstruction and humanitarian pledging conference in Kuwait, Reuters reported that the United States planned not to commit any funding for Iraq’s mid-to-long-term development, avoiding what President Donald Trump derided as “the costly business of nation-building.”

This gap between Baghdad’s need and pledged assistance highlights a shift in Washington and the broader international community away from providing direct development funding to encouraging private sector and foreign direct investment. For the Iraqi government, this business-oriented aid delivery approach will shape how it plans and pays for reconstruction, as well as more fundamental changes within Iraq’s economic framework and regional posture. Echoing Washington’s message, Prime Minister Haider al-Abadi has recently emphasized investment, not traditional aid, as a sustainable foundation for Iraqi recovery over a 10 to 15-year period – and a politically-expedient means of demonstrating the current government’s commitment to hitherto toothless waste-and-corruption reforms.

Although a worrying departure from traditional and predictable aid provision, Abadi’s focus on investment in the post-ISIS environment offers a viable, albeit uncertain, means of sustainably harnessing Iraq’s economic capacity. Beyond the former battlefields against ISIS, several key sectors within Iraq – including electricity, telecommunications, manufacturing, and natural gas – demonstrate remarkable growth potential within a Gulf region searching for economic diversification beyond oil. Although Iraq’s reconstruction needs are immense and political challenges to Abadi’s position threaten reform in a contentious election year, focus on market development – coupled to gradual reform of centralized state practices like electrical subsidy provision – may allow the Prime Minister to open new reconstruction funding streams by capitalizing on shifting economic priorities among western partners and wealthy Gulf Arab neighbors. American policymakers can encourage these efforts by facilitating initiatives like the recently-formed Iraq-Saudi Arabia Joint Cooperation Council, as well as by easing restrictions on US business wishing to expand into Iraq’s market.

Iraq’s Investment Potential

 Iraqi leaders are eager to demonstrate the country’s business-oriented environment. In August 2017, the Iraqi Central Bank issued its first bond in over a decade in a bid to raise $1 billion for reconstruction. Six months later, the National Investment Commission (NIC) published a list of 157 critical reconstruction and development projects, for which it is seeking immediate Foreign Direct Investment (FDI) to cover a $100 billion projected cost. Focused primarily on infrastructure restoration and economic diversification efforts, the list includes initiatives for re-opening Mosul’s international airport, constructing a new freight and passenger railway from Mosul to Basra, and opening multi-billion-dollar metro systems in Baghdad (2-line), Basra (5-line), and Karbala (monorail). Sixteen proposals will require at least $500 million, with the most ambitious among them estimated to carry an average $10.1 billion price-tag. Meanwhile, the NIC has planned for the creation of four specialized economic zones in Babylon (heavy industry), Diwaniya (agriculture and agro-phosphates), Ninewa (fine machining), and Baghdad (advanced cyber, information, and renewable energy technologies) – modeled on similar administrative areas in the UAE.

Iraqi growth potential lies in its ability to pursue regional economic integration.

The Kuwait Conference in mid-February will serve as a barometer of foreign interest in such a far-reaching vision. However, the list itself represents an important departure from Iraq’s traditional emphasis on FDI almost exclusively in oil and gas production. Since 2014 the country has secured FDI inflows of approximately $4.8 billion annually to fund hydrocarbon production. Baghdad today plans contracts that will boost downstream petrochemical industries, including refineries to process crude oil into plastics and fertilizers, while providing the foundation for an expanding domestic private sector through gradual privatization of state-owned entities and pro-entrepreneurship incentives. For example, within weeks of liberation in several central neighborhoods across eastern Mosul, Iraqi Kurdish mobile phone provider Korek had opened dozens of retail outlets across the city, providing reliable 3G coverage. High levels of infrastructure damage in areas cleared of ISIS, particularly in the telecommunication and industrial sectors, offer Iraqi and regional companies new market expansion potential, which forms a critical element of Iraq’s strategy for attracting investors at the Kuwait Conference.

Focus on domestic private-sector growth aims to mobilize Iraq’s enormous, well-educated young population, encouraging the emergence of business incubators and collaboration spaces across the country. Approximately 60 percent of Iraqis are younger than 25 years, and the country currently has the 17^th fastest population growth rate globally; with an estimated 16.5 percent national unemployment rate (much higher for the under-25 population), the Iraqi economy has significant room for growth if reforms are sustained – partially demonstrated by a recent 11 percent increase in the country’s stock market as investors anticipate reconstruction opportunities. Regulatory reform proposals, including a non-discrimination principle announced in a February 8 NIC memo that ensures equal consideration of foreign and domestic business grievance, links international capital to Iraqi talent; a new online reconstruction database further reinforces investor confidence by addressing widespread corruption within Iraq’s ministries. While Iraq’s debt-to-GDP ratio – an important indicator of a country’s ability to honor outstanding payments on its existing debt – grew from 31.34 percent in 2014 to over 63 percent by 2016, rising oil prices and increased regional investment interest beyond the petrochemicals sector will likely push this ratio toward healthier levels in 2018-2019 (the US, by contrast, had a 2016 debt-to-GDP ratio of 104.6 percent; a lower figure is generally considered more sustainable).

Shifting Regional Politics

Iraqi growth potential lies in its ability to pursue regional economic integration, capitalizing on a growing appetite among its neighbors for relatively uncultivated markets through which to implement diversification policies. A sharp uptick in Saudi, UAE, Kuwaiti, and Iranian investment interest and proposals over the past six months reflects Baghdad’s regional significance within an environment of shifting Gulf political-economic dynamics.

Saudi leaders in particular have pursued rapprochement with their northern neighbor and OPEC competitor through heightened investment pledging. Riyadh has thus far focused on shrinking Iran’s economic footprint in southern Iraq by leveraging the Kingdom’s petrochemical, industrial, and renewable energy wealth. A series of high-level ministerial visits in Baghdad and Riyadh since August 2017 – including important meetings between Shia cleric Moqtada al-Sadr, Abadi, Iraqi Oil Minister Jabbar al-Luaibi, and Saudi Energy Minister Khalid al-Falih – strengthened cooperation mechanisms between the two countries, including an Iraq-Saudi Arabia Joint Cooperation Council and Iraq-Saudi Chamber of Commerce and Industry by December. During this period, the Saudi government pledged $10 million of aid for reconstruction in Anbar Province, announced plans to re-open the commercially-vital Arar and Jmeimah border crossings, and establish several free trade zones along the Iraq-Saudi border to promote joint oil market development. At the 7^th Basra Oil and Gas Exhibition that month, the Saudi energy minister announced a series of 18 MOUs that will accelerate the Kingdom’s limited late-2017 economic penetration into the Iraqi energy sector. According to a follow-up Iraqi Oil Ministry press release, state-owned petrochemical giant Saudi Basic Industries Corporation and private Industrialization and Energy Services Company plan to open new offices in Basra, while Saudi industrial conglomerate Salik will expand phosphate and fertilizer production in Anbar Province. Meanwhile, Iraq’s Electricity Minister outlined an initiative to link into the Saudi power grid and support several Aramco-funded natural gas capture projects in the southern Rumaila oilfields.

While Saudi investment policies have been the most aggressive among its Gulf peers, the UAE and Kuwait have quietly expanded their own stakes in Iraq’s oil, gas, electricity, and agricultural sectors. In early February, the UAE announced a $1 billion investment to expand Crescent Petroleum’s gas production in Iraq from 80 million to 500 million cubic meters over the next three years and plans to form an Iraq-UAE Joint Cooperation Council. Thus far, Emirati leaders have outlined a framework through the Cooperation Council to boost small-and-medium-enterprise (SME) cooperation between Iraqi and UAE companies through a draft-MOU. Meanwhile, a Kuwaiti delegation visited Basra Governor Asad al-Aidani to negotiate a link between the two countries’ electrical grids, directly following Iraq’s decision to boost natural gas exports to its Gulf neighbor – a project that aims to spark future Gulf Arab network expansion through Iraq into Turkey and Europe.

Gulf Arab investment, however, has sparked concern for policymakers in Tehran, who view Iraq as a strategically vital sphere of influence. The Kuwait Conference attendee list – which includes Saudi Arabia, the UAE, Kuwait, Qatar, and Iran – highlights this competition that is likely to shape regional aid and investment patterns into the 2018-2020 period. Iran-Iraq trade currently stands at nearly $12 billion annually, with a further $10 billion worth of technical and engineering cooperation at Iraqi petrochemical facilities. Public statements from Tehran indicate that the country seeks to increase this exchange to $25 billion by 2020. Three of Iraq’s power plants run on imported Iranian natural gas, of which 7 million cubic meters arrive daily through Diyala Province. Between 2008 and 2016, Iran’s non-oil exports to Iraq nearly tripled from $2.3 billion to $6.7 billion annually, reflecting what Iranian Supreme Leader Ali Khamenei described as the expansion of a “resistance economy.” The advances made by powerful Iran-backed elements within the Popular Mobilization Units (PMU) both against ISIS and in the Baghdad political environment have sent optimistic signals to Iranian contractors that Tehran stands to expand its stake in Iraqi reconstruction planning, facilitated by diversified freight and trade routes through southern border crossings.

Baghdad’s ability to build sustainable economic partnerships could be jeopardized by widespread corruption and political obstacles in a highly-contentious election year.

While Saudi and other Gulf Arab leaders seek to push the Iraqi economy away from Tehran’s orbit, their efforts have been strictly transactional. Following Mosul’s fall in June 2014, many Iraqis blamed Saudi Arabia (and Turkey) for supporting ISIS, and called for a boycott of Saudi imports. By contrast, Iranian contractors, producers, and politicians benefit from local and organic alliances with powerful actors inside Iraq developed since the 1980s, and further strengthened by numerous student exchanges and financial support for important Shia cultural sites. Iranian consumer goods dominate Iraqi markets, especially in southern and central provinces, a near-monopoly enhanced by Tehran’s ability to secure key government and trade contracts with friendly Iraqi ministries. Yet, Iranian encroachment has met protest in recent months, with prominent Iraqi Shia political leaders like Moqtada al-Sadr voicing a more nationalist-focused message ahead of the May elections. One 2017 opinion poll indicated that 61 percent of Iraqis believe it important to maintain good relations with Saudi Arabia, while only 53 percent felt the same about Iran – sharply reversing the ratio from a similar poll conducted in 2013-2014. Sadr’s visit to Riyadh in August 2017, where he met with Saudi Crown Prince Mohammad bin Salman, indicated that Iraq’s Shia political leadership may be willing to work more closely with Saudi Arabia, particularly within the reconstruction and development context as the Kingdom advertises its turn to “moderate Islam.”

Iranian leaders are prepared to challenge significant Saudi market penetration by mobilizing their influence over key government ministries, including the Badr-led Interior Ministry. As Iraq looks to sustainably expand FDI, Baghdad must ensure that it can protect investors from physical damage as well as regulatory and legal challenges presented by potentially hostile ministries and planning committees. Near-term efforts to strengthen the NIC’s ability to advocate for investment within the Iraqi government are a critical element of this process – both in terms of outlining FDI opportunities while realistically representing limits of such engagement to regional and international actors.

Is this Effort Sustainable for Baghdad?

 Although regional appetite for investment in Iraqi infrastructure reconstruction, energy sector development, and market expansion appears healthy, Baghdad’s ultimate ability to build sustainable economic partnerships with the necessarily diverse array of international partners could be jeopardized by widespread corruption and political obstacles in a highly-contentious election year. Harnessing sufficient FDI into a long-term reconstruction and diversification agenda – especially with regards to promoting SME growth and expansion outside the oil and gas sector – will require political leaders to address these deeper structural challenges.

Fundamentally, pursuing a private investment strategy means that entrepreneurs and creditors expect favorable returns on their investment; private investment is not charity. High-level corruption and vague business proposals hamper contract-allocation and investor confidence that new business could turn a profit in the Iraqi market. Within Iraq’s public-sector-dominated business environment, political power rests with those who can provide their ministries with the most lucrative government contracts. As a result, many business owners in Iraq note that it is impossible to operate in Iraq without paying bribes, often to mid-level bureaucrats in charge of facilitating contract and permissions processes. While the large oil and gas firms that currently dominate Iraqi FDI inflow can afford such corruption costs, many smaller private-sector investors will likely be hard-pressed to overcome these financial hurdles to ensure an acceptable profit. Critically, this highly state-centric environment has encouraged mega-development projects that often go un- or half-finished while simultaneously sucking resources from smaller-scale enterprise that provide employment-boosting potential, such as manufacturing or retail. In many cases, state-owned monopolies in the oil, energy, and transportation sectors directly compete with private firms in search of quick revenue streams.

Yet, overcoming these structural challenges will require policymakers in Baghdad to pursue dramatic and unpopular economic reforms, including privatization of key oil and energy sectors. Although Abadi has attempted to implement such an agenda since 2015, his efforts have produced few tangible results in the face of widespread opposition from Parliament. Stalled electricity sector privatization exemplifies the Prime Minister’s challenge. While the Iraqi government earns approximately $5 billion in revenue from crude oil export each month, the vast majority of these funds are spent providing government electricity subsidies at rates between 15 and 94 percent depending on consumer income-level.

Efforts to reduce this public-sector burden by introducing a new fee-structure sparked violent demonstrations across poor southern regions, including in Basra where thousands of protestors threatened infrastructure and provincial officials in January 2018. Tribal leaders in Nasiriyah declared their intention to use “military force” to prevent privatization in their province. Although privatization was successfully tested in 2016-2017 across five Baghdad neighborhoods, reducing electricity waste by 30 percent and resulting in generally cheaper services, Abadi’s opponents have blocked further implementation in Baghdad as a means of gaining political capital and diminishing the Prime Minister’s popularity. For example, one of Abadi’s most vociferous critics, MP Hanan Fatlawi, secured enough votes in early February to bring Electricity Minister Qasim Fahdawi into Parliament for questioning on allegations of corruption. In response, the Prime Minister’s office announced vague “fundamental amendments to privatization” on Facebook, indicating that new electricity pricing structures are under review. Meanwhile, Iraq’s power sector remains unable to meet the 25,000MW demand of users, producing one-third that amount.

Iraqi policymakers must address these structural obstacles if they are to position the country for sustained FDI inflow, while maneuvering domestic economic reform through a tense geopolitical environment. As wealthy Gulf countries seek to diversify away from their traditional oil-dependency, Baghdad finds itself facing the daunting task of reconstruction at a potentially lucrative regional pivot-point. The Iraqi market holds incredible growth potential both in terms of physical investment opportunities and human capital. The country is balanced between two extremes. Wide-ranging and fundamental reforms could fuel significant infrastructure development, domestic private-sector growth, and massive foreign investment; if unaddressed, bureaucratic paralysis, ministerial corruption, proliferating militias, and political score-settling stands to derail reconstruction after the Kuwait Conference. While Iraq’s international partners certainly have a role to play in incentivizing and encouraging necessary alterations to the country’s economic model, it is ultimately up to the Iraqi government to demonstrate capability in governance and seize this critical opportunity.