Business in Iraq: Progress stifled by bureaucracy

17 August 2010

Iraq desperately needs foreign support but regulatory hurdles are deterring investors. Sectarian infighting is compounding the problem

In numbers

3 million: Homes needed to ease Iraq’s chronic housing shortage

90 per cent:Contribution of oil and gas to government revenues

Source: MEED

Companies have been queuing up to get into Iraq since the US-led ‘surge’ in early-2007 turned the tide of the insurgency that had pushed the country to the brink of civil war.

The political limbo since parliamentary elections in March failed to deliver a clear winner and has encouraged a spike in violence this summer, but the number of attacks is still far below their peak in 2005-06. The security situation was the first hurdle to deter foreign businesses from entering the country, but others have quickly sprung up to take its place.

The private sector has really suffered. It’s literally impossible to bring a foreign investor into this country

Mowaffak al-Rubaie, former security adviser

The main obstacle now is the country’s antiquated bureaucracy. Iraq’s government still runs along much the same centralised, socialist lines it followed under its former dictator Saddam Hussein. The public sector is still by far the largest employer and the civil service remains bloated. Decision-making is painfully slow and is not helped by a lack of communication between ministries.

Regulatory hurdles in Iraq

Moreover, Iraq’s legislative and regulatory framework does not inspire confidence among foreign companies that their investments will be secure and their contracts honoured.

“The private sector has really suffered. It’s literally impossible to bring a foreign investor into this country, now, with the current situation,” says Mowaffak al-Rubaie, former national security adviser to the Iraqi government.

“Even for companies with money to invest … it’s hurdle after hurdle that you cannot cross because of the restrictions of the old regime … we’re running a free market economy with the old laws of a centralised economy.”

Following the US-led invasion of 2003, it is understandable that Iraqis should be ambivalent towards the idea of foreign direct investment (FDI). Having regained its sovereignty, the government has been cautious about being seen to give away the nation’s wealth and resources. Only in the past two years has the government begun to overcome this wariness and set out an investment framework that will attract foreign capital. After much wrangling in parliament, an amendment to the Investment Law was passed in 2009, allowing foreign companies to purchase land for pre-approved construction projects. The bill was seen as a crucial step forward. A year on, however, little or no land has actually been sold

Despite government estimates that the country needs some three million new housing units to overcome a chronic shortage, companies are still finding it difficult to get approval for any land purchases.

First, Baghdad has overestimated the cost of the land. Even with a 5 per cent discount that was supposed to entice investors, potential bidders have balked at the asking price. Meanwhile, the Iraqi government has been unwilling to sell at what it feels is a loss.

Businesses that do apply find themselves waiting while the purchase is reviewed by any number of ministries. The Oil Ministry checks there are no hydrocarbon deposits on the plot. Even the Tourism Ministry takes an exploratory probe to confirm that there are no antiquities on the site. The deal must then be signed off by the finance ministry before being passed to the National Investment Commission (NIC). Given the pace of bureaucracy in Baghdad, it is unsurprising that no major deals have gone through.

“Since the law takes away powers from some of ministries, particularly the Finance Ministry, there is resistance. They are trying to identify land, but there has been very little progress. It is a major hold-up for investment,” says a US source in Baghdad.

Push for investment into Iraq

In a further effort to speed up the process, the NIC has established a ‘One-Stop Shop’ for companies keen to invest in Iraq. In an attempt to get around the meandering bureaucracy of the ministries, the NIC offers to take care of all the necessary paperwork, process visa applications for foreign staff and offer a single point of reference for any queries related to a project.

So far, the One-Stop Shop’s time has been largely devoted to assisting the international oil companies (IOCs) that secured field development contracts in the 2009 bid round.

Much of the government’s focus in the past year has been smoothing the entry of the IOCs into the country. Although even this has only been partially successful.

At a July symposium for the IOCs in Baghdad to assess their progress, the UK’s BP and UK/Dutch Shell Group presented papers outlining present and future obstacles to fulfilling the terms of their contracts. These ranged from inadequate infrastructure and security, to Iraq’s lengthy visa and customs procedures. A common complaint was the lack of coordination between the various state entities required to sign on each stage of the contract process.

IOC executives, who did not wish to be named, said that while they were reasonably assured that their investments would be secure, dealing with Baghdad still presented numerous headaches. The difficulty of getting the sheer volume of staff required into the country has been particularly problematic. Given that oil and gas represent some 90 per cent of government revenues and 60 per cent of national gross domestic product (GDP), it was inevitable that Baghdad’s attention would be focused on that sector. But even getting the IOCs into Iraq has taken longer that it should, and in concentrating almost solely on this sector, others have been left behind.

Job creation in Iraq

That the Iraqi economy has great potential is not in doubt. The country has the world’s third largest proven oil reserves and production is far below what it should be. Unlocking this wealth remains the key to Iraq’s plan to rebuild and diversify its shattered economy and infrastructure. But this oil wealth has bred complacency in government. The assumption is that once the oil revenues begin to flow, the rest of the economy will take care of itself.

Despite its huge contribution to national gross domestic product, the oil and gas sector contributes little more than 1 per cent of local employment. To stabilise and diversify the economy, Baghdad needs to attract investment in agriculture, industry, manufacturing and tourism.

Job creation for Iraqis is the country’s key economic and political challenge. Although the IOCs’ contracts stipulate a certain percentage of jobs must go to locals, the vast majority of staff on these projects will be foreigners. Oil production can double or triple without creating many more jobs for Iraqis themselves.

“There is an assumption in government that boosting oil production will solve the country’s economic problems, but that is not the case,” says the US source. “Iraq’s population is growing very rapidly, at 3.5 per cent a year. And the population is very young. The average age is 21, compared with 27-28 in Iran.

“That means thousands of new job seekers on the market each year. The economy has to grow at 5-6 per cent a year just to create jobs for them, much less to get unemployment down to reasonable levels.”

To meet the growing demand for employment, Baghdad must focus on investment in fields outside the hydrocarbons industry, particularly on boosting small and medium enterprises (SMEs) in the private sector. Experts believe the militant insurgency in the country would be largely assuaged if ordinary Iraqis had steady jobs and a brighter future.

The hope is that although other sectors have been left behind or ignored entirely while the IOCs are brought into the market, the framework set up to accommodate them will be left in place for firms investing in other sectors.

“The hope is that the IOCs will be the wedge that drives a lot of these changes. The regulatory structures are keeping people out. You can buy security but it is the hassle and uncertainty that is keeping people out,” says the US source.

In this respect, the next parliamentary term will be critical for Iraq’s development. Firms have already waited a long time to get into the country. If they do not get a clear signal that things are changing in the next four years they may simply walk away and look elsewhere.

While oil companies are prepared to shoulder a degree of uncertainty and risk in their investments given the returns available, businesses in other sectors will not look on Iraq so kindly. The country could miss out on billions of dollars of foreign investment if it cannot move beyond sectarian politics in the short term. As with the land deals under the Investment Law, Baghdad needs to be careful it does not price itself out of the market.

Competing markets in the Middle East

“What the government doesn’t realise is that outside the oil sector it’s competing against a lot of other countries. Iraq is just another country,” says the US source. “Iraq has 30 million people. It will never be a strategic market for any company except for the oil sector. So firms have to balance out the cost of labour, productivity, security and the cost of real estate. Iraq does not compare favourably with a lot of other countries out there right now.”

The long delay in forming the next government also does not bode well. The ongoing political deadlock will not allay the concerns of potential foreign investors that Baghdad is an administration with which it is not easy to do business.

When it eventually takes shape, the new government must move quickly to remove these concerns and ministries must overcome their differences before it is too late.

This requires appointing ministers according to their abilities rather than satisfying the competing claims of each faction in the ruling coalition. Appointments along sectarian lines will mean ministries continue to be run as personal fiefdoms and communication between departments blighted by personal enmity, as happened under previous administrations. 

“Why did it take so long to award oil contracts to the IOCs? It took us four years. What were we doing? Politicking,” says Al-Rubaie.

“Until and unless we depart sectarian politics, we will still be going round in circles. In the next four years, if we appoint ministers according to their political affiliation, we’re doomed.”

A MEED Subscription...

Subscribe or upgrade your current package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications