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"Financial Reconstruction in Iraq"
John B. Taylor
Under Secretary of the Treasury for International Affairs before the Senate
Banking, Housing, and Urban Affairs Committee Subcommittee on International
Trade and Finance
Introduction
Chairman Hagel, Ranking Member Bayh and other members of the Subcommittee, thank
you for inviting me back to testify on the financial reconstruction of Iraq.
There have been many significant, positive developments since I last testified
in September, and I welcome the opportunity to discuss them with you today.
Just this weekend, during the G-7 finance ministers' meeting in Boca Raton, we
had an opportunity to hear from Iraq's Central Bank Governor, Sinan Shabibi, and
Finance Minister, Kamel Gailani, about their reform priorities. Both officials
participated in a session with the G-7 Ministers, and took the opportunity to
underscore their commitment to moving ahead with sound, market-oriented reforms
that will underpin private sector-led growth. They also stressed that their
vision of a new Iraqi economy shares the following key principles: 1) openness
and transparency of Iraq's institutions; 2) the creation of strong incentives
for private sector development; 3) close economic and financial integration with
the international community; 4) implementation of international standards and
best practices; and 5) a social safety net that addresses the needs of all
Iraqis.
These officials are already taking meaningful actions to back up their
statements. For example, Iraq's Central Bank Governor recently announced three
major actions that will have far-reaching consequences for the development of
Iraq's financial sector: 1) the selection of three foreign banks to receive a
license to operate in Iraq; 2) a plan to liberalize interest rates by March 1;
and 3) passage, soon, of a new Central Bank law. Today, I would like to tell you
more about these developments, as well as update you on the progress that has
been made on currency reform, reducing Iraq's international debt burden, and
mobilizing international support to meet Iraq's reconstruction needs.
Currency Reform
I would like to begin by highlighting one of the most important accomplishments
in the financial sector -- the successful introduction of a new currency in
Iraq. When I last spoke before this committee, I laid out our strategy for
replacing the old national currencies -- the Swiss dinar and the Saddam dinar --
with a new, unified national currency. I am happy to report that this plan was
successfully implemented as scheduled between October 15 and January 15.
Printing and delivering this currency on time was an enormous feat --the
equivalent of twenty-seven 747 plane loads of currency were delivered to Iraq
and distributed to the public through approximately 240 exchange sites, mostly
bank branches, under a significant security threat.
By all accounts, the Iraqis have wholeheartedly embraced their new dinars. Not
only are the new notes much more difficult to counterfeit -- a chronic problem
under the old currency regime -- the Iraqis now have six denominations
available, up from only two. And the value of the currency has steadily
increased since its introduction. Now the challenge is to manage this new
currency in such a way as to provide a stable monetary foundation for a healthy
financial system and vigorous reconstruction.
Restoring and Revitalizing the Banking Sector
Another area where meaningful progress has been made is in the banking sector.
In my last testimony, I reported that Treasury advisors were assessing the
conditions of Iraqi's state-owned and private banks. Since then, we have learned
that Rasheed and Rafidain banks --- the two large state-owned banks which
controlled over 85 percent of banking assets -- are at best marginally
capitalized, and have loan portfolios with a high concentration of
non-performing loans. Compounding these problems is the lack of comprehensive,
modern accounting standards and systems. We also discovered that although these
two banks have an extensive network of more than 360 branches throughout the
country, each branch has operated largely as an independent unit. As a result,
Iraq lacks centralized management and an integrated system for making and
clearing payments.
An evaluation of the private banks uncovered significant problems as well. It
turns out the 17 private banks in Iraq served predominantly to take deposits
rather than finance investments, and that the largest of these private banks had
only $1 million in capital. Finally, our evaluation of Iraq's legal regime
showed that Iraq lacked a competent supervisory or effective regulatory
structure to oversee the financial sector. Despite this bleak assessment, the
Iraqi bankers we engaged with from the private and public sectors -- as well as
key finance officials -- shared an eagerness to adopt the reforms necessary to
develop a modern, efficient financial sector. Though they lack technology,
resources and experience, after only a few months, significant progress has
already been made toward this goal.
First, the Iraqis are moving towards the establishment of a modern legal and
regulatory framework for the financial sector. For example, working with experts
from central banks and other governments and the International Monetary Fund, we
helped Iraq to prepare a modern Banking Law and a new Central Bank Law, both
based on international best practices. The Banking Law was enacted in late
September and contains many provisions designed to support the development of a
strong, robust banking sector, including higher minimum capital requirements (10
billion dinars, or more than $6 million), and more rigorous standards for bank
licensing and for bank governance.
We expect the Central Bank Law to be adopted soon by the Iraqi Governing
Council. It will not only confirm the independence of the Central Bank
established by a July 7 CPA [Coalition Provisional Authority] order, but will
also prevent the Central Bank from engaging in inflationary financing of the
government. Indeed, it establishes price stability as the primary macroeconomic
objective of monetary policy.
Second, the Central Bank Governor announced that interest rates on all domestic
financial instruments -- loans, deposits and securities -- will be fully
liberalized by March 1. This measure is an important step in the direction of
creating a modern, efficient financial sector, because it will enable lenders
and borrowers to make their own decisions rather than having them determined by
fiat and top-down directives issued by the Central Bank.
And third, the Iraqis have taken significant steps to reinvigorate private banks
in Iraq. Under Saddam's regime, private banks fared poorly -- they controlled
less than 8 percent of total banking assets, used antiquated technology, and
offered very limited services. Despite their weaknesses, Iraq's private bank
mangers have been eager to develop their capacity to operate as modern,
commercial bankers. As provided under the new Banking Law, these banks can now
provide new services to their clients. Already, ten banks are receiving
international payments and remittances, and issuing letters of credit. With 143
functioning branches, international payments and remittances are now estimated
at more than $5 million per day into Iraq. This influx of funds will play a
major role in financing investment and consumption.
While some of the existing private banks are expected to develop into fully
functioning financial institutions, Iraqi authorities decided that it would be
important for foreign banks to operate in Iraq because of the experience,
technology and resources they can offer. The new bank law permits up to six
foreign banks to enter the Iraqi market over the next four years. This is in
sharp contract to the previous regime, which permitted only Arab banks to enter
Iraq's market.
Following a request for applications issued in November, Iraq received fifteen
applications for a foreign bank license. On January 31, the Central Bank
Governor announced the three finalists for the first set of licenses to be
awarded -- Hong Kong Shanghai Banking Corporation, the National Bank of Kuwait,
and Standard Chartered Bank from the U. K. The Central Bank anticipates that all
three will be granted a license by mid-March. Already, the National Bank of
Kuwait has announced its intent to purchase 8 percent of one of the existing
private banks.
Next on the agenda is reform of the state-owned banks. Substantial and sustained
restructuring of management, organization, personnel and systems is needed to
make these banks competitive. The Iraqi authorities are now working with
Treasury advisors to develop a strategy for dealing with the state-owned banks
so they can operate profitably and provide a wide array of financial services to
the Iraqi economy.
In the meantime, we are working with the Iraqis to ensure that the state-owned
banks can provide basic services, such as taking deposits, clearing checks and
making loans to support business activity. For the quarter ending November 30,
2003, Iraq's two large state-owned commercial banks, Rafidain and Rasheed,
extended loans totaling about $6 million, primarily to small and medium
enterprises. Trade Bank of Iraq Given the limited capacity of the Iraqi banking
system, we also went forward with a plan to open a Trade Bank in order to
facilitate the imports and exports urgently needed to support Iraq's
reconstruction and the transition from the UN's oil for food program. When I
reported on this initiative last September, the CPA had completed a competitive
bidding process for management of the Bank, and negotiations for its
establishment were underway. The Bank opened on December 4, 2003, and is now
fully operational. To date, the Trade Bank of Iraq has issued over 200 Letters
of Credit worth $190 million for most Ministries and several state-owned
enterprises.
In addition, sixteen export credit agencies have signed an agreement with the
CPA and the Trade Bank under which they will provide guarantees and short-term
credit lines valued at $2.4 billion.
Iraq's International Debt
I want to turn now to the issue of Iraq's substantial foreign debt problem. Last
September, the G-7 Finance Ministers committed to making their best efforts to
resolve this issue by the end of 2004. We have made significant progress towards
this goal. As an indication of the priority we place on this issue, the
President asked former Secretary of the Treasury and of State James Baker to
serve as his Special Presidential Envoy to work with the world's governments at
the highest levels in seeking to restructure Iraq's official debt burden. Over
the past two months, Secretary Baker successfully secured commitments from
leaders throughout Western Europe, Asia, and the Gulf States to provide at least
substantial debt reduction for Iraq in 2004. Final agreement on the amount and
terms of this reduction will be negotiated between Iraq and its creditors,
including through the Paris Club.
We are also continuing our efforts to obtain the best possible data on how much
debt Iraq owes. Current estimates put Iraq's external debt burden around $120
billion. Paris Club members are owed roughly $40 billion -- $21 billion in
principal and roughly an equivalent amount in late interest. Non-Paris Club
governments, chiefly the Gulf States, and private creditors hold the rest. To
further the data gathering effort, the Iraqi government recently issued a
request for proposals from accounting firms and financial organizations to
assist in the process of gathering and reconciling data on Iraq's external debt.
With this data in hand, all parties will be better able to reach a resolution on
reducing Iraq's unsustainable debt burden.
Assessment of Reconstruction Costs and International Fundraising Efforts
Before concluding, I would like to update you on our efforts to mobilize
international financial support for the reconstruction and recovery of Iraq. In
October, Secretaries Snow and Powell [Treasury Secretary John Snow and Secretary
of State Colin Powell] led the U.S. delegation to the Iraq donors' conference in
Madrid. Seventy-three countries participated in this conference, which succeeded
in raising over $32 billion, including the $18.4 billion commitment from the
United States.
Donors also called on the World Bank and United Nations to establish a vehicle
to channel their resources and help coordinate assistance for reconstruction and
development activities. Working with key donors, CPA and the Iraqi authorities,
the World Bank and the United Nations established two trust funds within an
International Reconstruction Facility for Iraq (IRFF). We plan to contribute $10
million to the Facility, which will be equally divided between the World Bank
and UNDP [U.N. Development Programme] trust funds. The World Bank has met
several times with Iraqi authorities to identify priority programs and projects
under this Facility, and hopes to begin disbursements by July 2004.
In addition, the World Bank has pledged to provide between $3 and $5 billion of
its own resources over a four-year period. In consultation with Iraqi
authorities, the World Bank will prepare a lending program in support of Iraq's
economic development with particular attention to health, education and the
creation of a strong social safety net.
The World Bank's sister agency, the IFC, has already approved the establishment
of a Small Business Finance Facility in Iraq. This Facility will be funded by
resources from the IFC, as well as bilateral donors, the Overseas Private
Investment Corporation, and private banks, to provide credit to micro and small
businesses on a transparent, commercial and sustainable basis.
We are hopeful that this facility will be operational by mid-year. The
International Monetary Fund (IMF) is also laying the groundwork to provide
financial support for Iraq. At the Madrid donor conference, the IMF announced
that total assistance could range from $2.5 billion to $4.25 billion over a
three-year period. Iraqi finance officials met with Managing Director [Horst]
Kohler in Boca Raton over the weekend before traveling to Washington for
additional meetings with IMF staff. The purpose of these meetings was to
initiate discussions on a policy framework that could become the basis for a
funded program later this year.
Frozen Assets
Finally, I am pleased to report that our efforts to persuade governments to
transfer assets of the former Iraqi regime back to Iraq have yielded results. To
date, more than ten countries have transferred approximately $650 million in
such assets to the Development Fund for Iraq. We are continuing to press other
governments -- especially Iraq's neighbors --- to move quickly to find, freeze,
and transfer Iraqi assets so they can be put to use for the benefit of the Iraqi
people.
Conclusion
In closing, I would like to stress that despite a difficult security situation,
challenging working conditions and limited capacity, the Iraqis are beginning to
overcome the grim legacy of Saddam Hussein's regime. With the strong support of
the international community, Iraq is making tangible progress towards the
establishment of an open, robust market economy that will offer its citizens a
promising and prosperous future.
(end text)
(Distributed by the Bureau of International Information Programs, U.S.
Department of State. Web site:
http://usinfo.state.gov)
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