Ahmed Tabaqchali


Market Review: Telecoms dial up Recovery

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.

Average daily turnover in November continued to improve, increasing 24% on the back of October’s 24% month-on-month growth. However, the recovery is coming from an incredibly low base and still shows the average daily turnover in-line with the dismal levels of September, which were among the lowest for some time (chart below).

With the gradual recovery in turnover, the market, as measured by the RSISUSD Index, moderated its month-on-month declines, down -1.7% for the month- continuing to test the major bottom of May 2016.

However, the end the Arbaeen, summer, and the government formation are yet to mark the end of the period of, probably, the lowest daily trading volumes on the Iraq Stock Exchange (ISX) since it first witnessed an expansion in volumes in 2010. The anomaly and un-sustainability of these low levels was discussed last month, and logic continues to argue for a reversion to the mean.

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital)

It was also argued last month that an uptick in M2 (broad money and a proxy for economic activity) could imply that liquidity, brought on by a two-year recovery in government finances, has finally begun to filter down into the economy – which should accelerate as the new government begins to act on its spending programme.

A nascent recovery in telecoms adds support to this line of reasoning. The two major mobile operators out of three national operators, reported Q3/2018 earnings that display the markers of recovery in earnings, margins and profits. Of the two, AsiaCell (TASC) has been listed since 2013 and as such its reported earnings span the period 2012-2018, and thus reflects the operating environment before, during and just after the ISIS conflict.

(Sources: Rabee Securities, ISX, Company reports, Asia Frontier Capital)

TASC’s earning’s profile marked by rapidly increasing revenues – driven by the country’s adoption of mobile phones – peaked in 2013. The turn for the worst started in late 2013 with the increasing violence before the May 2014 elections, which accelerated by mid-2014 with the ISIS invasion and the loss of over a third of the country, and with that a significant loss in TASC’s subscriber base.

The roll out of 3G in early 2015 brought its own set of problems. The amortization of the fees of $307 million (on top of fees of $1,250 million in 2007 for a 15-year licence) to access the 3G spectrum increased costs meaningfully. While, revenues took a hit as free IP voice telephony soon replaced most expensive regular telephony-especially for international calls, while data fees could not fully replace these lost voice revenues. This was compounded by increased competition among the three mobile operators as they sought to replace both lost consumers and voice revenues through competitive price offerings to lure consumers from each other.

Capping the woes of mobile operators was the severe economic decline brought about by the ISIS conflict and the collapse oil prices as non-oil GDP declined by -3.9%, -9.6% and -8.1% for 2014, 2015 and 2016, respectively.  Finally, the resultant weaknesses in both consumer and business demand was made much worse with the introduction of 20% VAT on phone cards in the summer of 2016.

For TASC, the revenue decline, while cost increases crushed its profits (as the chart above shows), however this decline in profits was moderated by very strict cost controls and decreasing capital expenditures reflecting an earlier heavy investment in infrastructure.

The bottoming in revenues over the last few years came to end in late 2017 with the liberation of Mosul and the gradual return of customers which contributed to the recovery in profitability. The company signalled its confidence in its future outlook with a distribution of a 12% dividend on the back of last year’s 14% dividend – however, in absolute terms the dividend is about one third higher than that of last year. The grandfathering of the transition to 3G, the amortization of the licence and the effects of the VAT introduction, all coupled with the return of customers as well as the expected growth in data usage should lead to a healthy period of resumed earnings growth.

The next few quarters should see a similar recovery for the battered banking sector, with probably the first to recover being the quality of loans. A return of liquidity and an economic pick-up should be followed by a recovery in the quality of bad loans and the reversal of NPL’s (non-preforming loans) with past provisions becoming earnings, thus providing the first boost to earnings recovery. This should be followed by growth in loans and deposits, as should growth in trade finance revenue, and therefore similarly to the case of telecom should lead to a resumption of a period of earnings growth, and with-it better stock price performance. For more details on the banks see “Of Banks and Budget Surpluses”.

Recovery, in frontier markets, is a mirror image of Mark’s Twain’s phrase on going broke, in that recovery happens gradually and then suddenly. If similar experiences in other frontier markets of declining prices while fundamentals point to a start of a gradual recovery, then the trend of the last few months could be followed by a sharp reversal to the upside.

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.

A Review of Iraq’s 2019 Budget Proposal

By Ahmed Tabaqchali, for 1001 Iraqi Thoughts.

The proposed budget law, prepared by the prior government and adopted by the current one (with some minor revisions), resembles the ongoing negotiations on completing the formation of the government.

Just as the participants in these negotiations had left behind the pretence of responding to popular demands and are engaged in a replay of the prior squabbles over the spoils of war.

This budget too is a replay of the prior budgets and a continuation of the old rentier state practices and socialist policies.

For both cases, the old Iraqi saying “رجعت حليمة لعادتها القديمة” or “Halima has gone back to her old ways” is an apt depiction.

Click here to read the full article.

The Economic Perils of Youth Nostalgia for Authoritarianism

By Ahmed Tabaqchali, for 1001 Iraqi Thoughts.

The Economic Perils of Iraqi Youth’s Nostalgia for the Return of Authoritarianism

Although Iraqi youth’s nostalgia for authoritarianism in the form of a powerful presidential system as a cure to their country’s ills is understandable, the economic costs of Turkey’s increasing move toward such a system over the last few years argue otherwise, as this paper asserts.

The Turkish experience, nevertheless, provides valuable lessons for Iraq — to avoid the failures and to mirror the successes — as it reconstructs its own post-ISIS economy.

Click here to read the full article.

Market Review: Volumes and Reversion to the Mean

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.

The end of the month brought with it the end of the multi-month paralysis in government as the designated prime minister was confirmed by parliament through the approval of his proposed cabinet on October 25th. Although, parliament has not approved all of his ministerial choices- a function of the fragmented politics of the new parliament and a possible marker of risk for the government’s future stability.

Nevertheless, the new government is in a position to implement its policies, as articulated by the prime minister in presenting his government, which are focused on the provision of security, services, and investment in much needed infrastructure. The implementation of these policies is made possible by the accumulated budget surplus for 2018, which was about USD 14.5bn at the end of August- and on course for a two-year accumulated surplus of USD 24.5bn by the end of 2018.

Coinciding with this has been the end of the 40-day Arbaeen pilgrimage that brought the country to a standstill as millions of pilgrims took part in “the largest annual gathering of people anywhere on earth.”, including almost two million Iranian pilgrims.

The end of the Arbaeen, summer, and the government formation should be followed by the end of the period of, probably, the lowest daily trading volumes on the Iraq Stock Exchange (ISX) since it first witnessed an expansion in volumes in 2010. Average daily turnover in October, while higher in percentage terms than the dismal levels of September, was among the lowest for some time (chart below). In tandem the market, as measured by the RSISUSD Index, declined ending down -5.3% for the month, continuing to test the major bottom of May 2016.

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital)

While, the anomaly of these low levels can be seen in the chart above, they come into sharp focus when viewed statistically in the form of a frequency distribution. The two charts below drill down into actual daily turnover for two periods: (1) January 2013-April 2014-representing the bull-market phase of rising prices and high turnover; (2) January 2016-October 2018- representing the bear -market phase of declining prices and low turnover. The frequency refers to the number of trading days corresponding to ranges for the daily turnover index on the LHS of the above chart. The contrast between the two periods is extreme from both the level of the average daily turnover, the concentration of daily turnover around the average (standard deviation) and the full range of turnover.

(Source: Iraq Stock Exchange, Asia Frontier Capital)

Almost 63% of the lowest turnover days, for January 2016-October 2018, were in the last two months, while the other 37% was spread out as odd days throughout the whole period. As such, it seems that with the end of the political paralysis and summer slowdown that turnover should revert to the mean. While neither this nor the direction of the market are assured, a clue can be obtained from the initial recovery in M2 (see chart below) which has ticked up over the last few months, following months of sharply increasing oil revenues. While the October M2 figure is an estimate, it is based on actual M0 figures for the month and the recent M2/M0 multiplier figures. As such, this could mean that liquidity has finally begun to filter down into the economy – which should accelerate as the new government begins to act on its investment programme.

(Source: Central Bank of Iraq, Iraq’s Ministry of Oil, Asia Frontier Capital)
(Note: M2 as of Sep. with AFC est.’s for Oct, Oil revenues as of Oct)

The strong improvement in the finances of the country following years of conflict lie behind the reason for the continued expectations, expressed here over the last few months, that the market would be correcting and then bottoming. However, these expectations continued to be tested as the market sustained its dismal performance, and its divergence from its past close relationship with oil revenues is currently at the widest it has been for the last few years (see below).

(Source: Iraq’s Ministry of Oil, Rabee Securities, Asia Frontier Capital)
(Note: Oil revenues as of Oct)

The end of the political paralysis, the sharply improving government finances and tentative signs of liquidity reaching the wider economy could act as the catalyst to change the direction of the market to the upside. If similar experiences in other frontier markets were to be repeated here (a big if) then the anomaly of the current low trading volumes coupled with the market’s sharp divergence from its historic association with oil revenues would suggest that the next move could be a sharp reversal of the recent trend.

The irony for the market (having risen sharply this time of the year in each of the last the two years only to lose almost all gains within a few months) is that its real recovery would be greeted with the same scepticism that met the “boy who cried wolf”

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.

A Thriving Entrepreneurial Culture takes root in Iraq

By Ahmed Tabaqchali and Emily Burlinghaus. Originally published by bite.tech; re-published by Iraq Business News with permission of the author. Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Most of the coverage and analysis of Iraq post-2003—by international, regional, and local journalists and analysts—has focused on the dysfunctional state and warring political elites whose failures to provide basic services to an already alienated population has come in sharp focus during the recent Basra demonstrations.

However, despite the vital nature of this coverage, it has missed a new entrepreneurial Iraq—represented by its youth—that has emerged and flourished in the new cultural openness and interconnectedness of post-2003 Iraq.

Since 2003, Iraqis’ and Westerners’ sentiments of blame and guilt in response to the 2003 invasion—as legitimate as they are—overlook the silver lining that accompanied it. For all its ills, Iraq experiences freedom from state censorship, unfettered access to the world, and life that is mostly free from state interference.

It is this openness that has provided youth with an opportunity to create exciting new businesses. They inhabit a parallel Iraq—one that is undiscovered by both the outside world and many Iraqis whose spirits have been crushed by the trauma of conflict and daily grind of living in a country largely defined by corruption and mismanagement.

The opening of “The Station,” the first purpose-built co-working space for young entrepreneurs in Baghdad, in early 2018 brought much neededyet fleeting, attention to this parallel Iraq. The Station, however, is just a small taste of the vibrant entrepreneurial space operating in Baghdad and elsewhere in Iraq.

A recent trip to Baghdad by members of the AUIS Entrepreneurship Initiative (AEI) provided a brief opportunity to explore the scene at The Station, Al-Faisaliya Restaurant & Café, and IQPeace—three different manifestations of the co-working space in the Baghdad. Each location—along with the startups it supports—has a story worth telling.

Over the past several years, a rich culture of entrepreneurship has developed in Baghdad upon which these new co-working spaces and their supported startups have flourished. Some of the most well-known of these success stories include Miswag and Mishwar, online and app-based delivery platforms, and the first “Escape the Room” game in Iraq.

Recently-founded startups such as Hilli, Bilweekend, Daraj, Tech4Peace, and Ikfal Nakhla have taken inspiration from these initial success stories and expanded the need and market for co-working spaces, mentorship, and training programs. They have joined the ranks of others such as Brsima, Indigo Canvas, The Book Cafe, and Mirsha Media, as well as training organizations such as re:coded, Tech Hub, and Five One Labs based in Sulaimani and Erbil. These, in turn, are part of a broader network that extends all the way from northern Iraq down to Najaf and Basra.

 (below is an overview of three Baghdad-based co-working spaces and a major virtual support network, a list of some unique established and emerging start-ups in Baghdad, and an overview of some additional startups operating at various stages in the Kurdistan Region of Iraq.)

The visons, business models, and growth challenges of Iraq’s start-ups are no different than start-ups elsewhere in the world; however, they face additional Iraq-specific challenges as detailed in a 2017 report by IRIS “Obstacles and Opportunities for Entrepreneurship in Iraq and the Kurdistan Region.” These broadly fall into three main categories.

Bureaucracy

The first category, bureaucracy, involves an extensive network of public sector requirements to incorporate and maintain companies. Such lengthy procedures place huge financial, time, and operational demands on these start-ups. As a result, most of them opt to operate in the shadow economy—a decision that stunts their growth prospects and hinders their abilities to develop into sustainable growth companies that would expand the private sector.

Infrastructure

The second category, infrastructure challenges, is defined by a number of problems, the most notable of which is the under-developed banking sector and its very slow adoption of mobile banking and payment systems despite the wide adoption of mobile phones. Almost all transactions with suppliers, trade counter-parties, and customers are performed in cash, which strains working capital and affects start-ups’ cash flows and operating flexibility, security, and transaction paper trail, and increases the costs of handling cash. Other infrastructure challenges include a cumbersome legal structure and poor enforcement of existing regulations, both of which affect trade and payment disputes and weaken intellectual property and copy rights.

Access to Capital

The third and the most crucial category is the very limited access to capital. The main sources of growth capital in Iraq come from savings, family, and friends. Entrepreneurs face extremely limited access to or availability of bank lending and local investors. In the rare cases that either of these options are available—i.e.  banks and investors—they demand high collateral and immediate high returns in the form of interest payments or dividends. These limit investments and business options to those that generate quick returns rather than encourage ongoing investments in the form of reinvested earnings that generate sustainable businesses.

The solutions provided by these co-working spaces and AUIS’s upcoming Entrepreneurship Initiative go a long way in providing a nurturing environment essential to encouraging and sustaining the entrepreneurial culture. However, long-term and patient investment capital is crucial for these efforts to be translated into a thriving start-up scene in which existing start-ups can evolve into larger sustainable companies.

Iraq’s challenging environment means that the sustainability of start-ups is fraught with uncertainty. Therefore, only long-term and patient investment capital can accept the high risks and the long wait time for financial returns – which is what is necessary for these start-ups to transform into successful companies. 

In more developed economies, this long-term capital is provided through an ecosystem of angel investors, venture capital firms, and private equity funds. However, the development of these mechanisms in Iraq requires considerable time and the introduction of new laws, regulations, and policies. The dilemma for Iraq is that the need for such long-term capital is immediate, and therefore the need to find solutions to bridge this gap is urgent.

A viable solution is the creation of an investment fund that combines the attributes of angel investment, venture capital, and private equity funds to provide the growth and expansion capital for commercially promising start-ups. However, the risk profile of the underlying investments means that initial funding will come from neither the traditionally risk-averse and short-term focused private sector nor the Iraqi public sector given the enormous demands placed upon it and its strained resources. Therefore, initial investment capital must come from Iraq’s international stakeholders as part of their support and development aid. Private sector capital will, in time, be attracted to the fund once the risk-profile is lowered by evidence of its success and higher possibilities of financial returns.

The fund’s success will, to a large extent, be dependent on the existing entrepreneurial culture that has succeeded despite all odds and prevailing pessimism, and therefore would build upon an existing success story. Its establishment would fuel the enthusiasm and achievement of these young, bright start-ups by providing them with the essential capital required to build upon and sustain their achievements. Their success will invite others to join, and therefore herald the emergence of an independent private sector in Iraq.

Baghdad offers a variety of spaces that provide support in the form of mentorship, and networking, and skills development. These range from a state-of-the-art coworking space to a startup-hosting cafe and community center designated to creativity and innovation.

Al-Faisaliya Restaurant & Cafe

  • Founded in March 2017 in Karrada
  • Cafe and restaurant with live music and local bands like Project 904
  • Features local startups Hili, Daraj, Tech 4 Peace, Razouna, and Jakaroo
  • Hosts game nights, films, speakers, and literary sessions

IQPeace

  • Founded in 2011 in Karrada
  • Center that offers daily support for young innovators and a space for music and art production
  • Develops programming in 5 categories: music production, entrepreneurship, photography, computer programming, and peacebuilding and conflict resolution
  • Helps individuals and groups establish and build membership in specialized clubs on a variety of topics, including music, jazz, chess, and nutrition
  • Uses recyclable and sustainable material in building structures, including a solar-powered phone charging station
  • Organizes the annual Baghdad City of Peace Carnival, which at its most recent celebration in September 2018, attracted approximately 30,000 visitors

The Station

  • Founded in February 2018 in Karrada
  • State-of-the-art co-working space and maker space that offers events, workshops, and talks for innovators and entrepreneurs at different levels of membership for a fee
  • Helps tech, cultural, and social entrepreneurs such as Bilweekend, Baghdad Toastmasters, World Merit Iraq, Daraj, Zuqaq13, Ariika and Ikfal Nakhla by providing physical space, mentorship, and training to develop and expand their businesses

Zain Innovation Campus

  • Support hub for entrepreneurs, currently with a physical space in Amman, Jordan, but with virtual support for entrepreneurs in Iraq in the form of resources, activities, and workshops. Zain augmented this with its youth empowerment platform, ZY, aimed at unlocking opportunities for the youth
The following is just a small list of successful and emerging startups in Baghdad, both independently and with the support of startup spaces such as those listed above:

Miswag: First internet-based startup e-commerce platform in Iraq founded in 2014; delivery service operating out of two main branches in Baghdad and Erbil. Upwards of 700,000 Iraqi users can buy more than 250 brands from over 200 local and international merchants through the online service

Mishwar: Online and mobile-app based home grocery delivery service founded in 2015

Hilli: Founded in December 2016 as a physical and online store based in Baghdad and Erbil to sell handicrafts inspired by Mesopotamian culture; promotes domestic production and empowerment of women IDPs by providing them with employment opportunities

Escape the Room Iraq: First escape room game in Baghdad founded in 2017 for group activities and team-building events

Bilweekend: Travel and tourism startup with the goal of promoting cultural heritage as a factor of country development; organizes group camping trips, museum visits, and adventures to natural sites such as Dukan Lake in Sulaimani and the marshes of southern Iraq

Zuqaq13: Baghdad-based and inspired streetwear brand that designs t-shirts and other souvenirs influenced by pop culture and Iraqi heritage

Ariika: Distributor of beanbags and other alternative furniture, based virtually and at The Station Baghdad

Tech4Peace: Online platform with physical location at Faisaliyya cafe dedicated to exposing the credibility of public statements and social media postings in Iraq and the region. Its mission is to “expose lies, spread truth, and protect individual privacy”

Daraj Library: Book-selling and renting vendor for Arabic and English-language texts and novels with three locations in Baghdad and one in Mosul

Ikfal Nakhla (Palm Tree Subscription): Youth-powered project initiated by a group of entrepreneurs aiming to retain the numbers and productivity of the Iraqi palm tree by providing a date palm tree maintenance service on subscription. The project–whose goal is to encourage the growth and use of domestic palms and dates–remains sustainable by selling a portion of the dates from the trees they maintain on the domestic market. Annual subscriptions vary on the basis of the percentage of dates customers retain in their homes.

Project 904: Youth band that remixes old Iraq songs with modern rock and roll and performs in local venues such as Al-Faisaliya Cafe

Supernova: Computer coding and programming school with online and in-person learning options and Arabic-language content; supported by re:coded

The vibrant start-up ecosystem is not unique to Baghdad; support networks, training organizations, and young creative businesses are emerging all across Iraq. Here are just a few:

Five One Labs: An Erbil and Sulaimani-based start-up incubator that provides entrepreneurs with training, mentorship, and a network of innovators from across the region

re:coded: An Erbil-based organization that supports start-ups through coding bootcamps and a tech start-up academy

The Book Cafe: An Erbil-based café, bookstore, and creative co-working space that hosts speakers, events, film nights, and language learning groups

Brsima: An app-based food delivery service based in Sulaimani and Erbil that connects local restaurants with customers and delivers food to their doors

Peyk Bookstore: Sulaimani-based independent online bookstore that delivers books from all over the world after customers place orders via Facebook and Instagram

Mirsha Media: Erbil-based digital media consultancy that provides virtual reality and augmented reality content, 360° video, and social media marketing and management

Indigo: Sulaimani-based advertising agency that curates and develops brands for companies by using media, buses and taxis, and billboards

Ekaratay: An online real estate platform developed by an Erbil-based team to connect potential home-buyers with sellers; supported by re:coded

Dakakenna: A Mosul-based shopping delivery service that offers nearly 2,000 items to buy via an iPhone app and shipped directly to customers; the service has already sold over 9 million IQD ($7,578 USD) worth of products and contracted 14 suppliers since inception in July 2018

Girfan Bazaar: Online and app-based platform connecting shoppers to stores in the Erbil bazaar to streamline the shopping experience and connect buyers and sellers with exactly what they are looking for

Erbil Delivery: Online and app-based grocery delivery service that operates its own warehouses in Erbil

Opportunity: Online and app-based platform that connects job seekers with potential employers, volunteer options, and skills development opportunities

Mowja: A Najaf-based self-financing NGO and miniature library and bookstore whose physical space relies on recycled materials

Science Camp: collaborative laboratory and maker space in which innovators can design and create tech and engineering-focused projects

Ahmed Tabaqchali’s 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. 

Market Review: “Feast or Famine”

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.

The uncertainty that has prevailed over all economic activity during the last few months is finally coming to an end in a typical Iraqi fashion- extremes of either feast or famine. The parliamentary elections in May, having yielded no clear winner, led to a multi-month paralysis during which the election results were contested in court, subsequently leading to a partial recount of the votes.

Increasing the election anxiety were massive demonstrations in Basra and the southern governorates, where citizens demanded reform and investment into basic services, and the proverbial shaking of the political class by raising fears that they would spread throughout the country. Thoughts on the protest movement and its implications are further discussed in, (The Protest Movement, the Politicians and the Elections).

The end of the uncertainty came in early October with the appointment of a president, and a prime minister in quick succession. This was done at a speed almost unheard of in post-2003 Iraq. While the individuals are two of Iraq’s most accomplished politicians with a lot of promise, the important takeaway is that the process of selecting them broke the mould and ended the political gridlock that bedevilled the country since 2003.

This was a continuation of the effects of the same 2015 protest movement that had such a profound effect on how the elections were fought and their subsequent results. The most visible effect was the fragmentation of the prior ethno-sectarian monolithic blocs that dominated over the past 14 years, the root cause of Iraq’s political and social instability since 2003. It is the end of this gridlock that holds the promise for change in Iraq and with it begins the unlocking of the massive reconstruction drive that lies at the heart of the Iraq investment opportunity.

This is made significantly easier for the upcoming new government as the windfall from higher oil prices (based on the year-to-date average Iraqi oil price of USD 65/bbl) could imply that Iraq would have a two-year cumulative surplus of USD 24.5bn, or the equivalent of a 19% stimulus for non-oil GDP by the end of 2018. Conservative assumptions for Iraqi oil prices for 2019 of USD 59/bbl would imply a further surplus of USD 9.3bn by end of 2019, but if Iraqi oil prices were to remain at the current average price then the 2019 surplus could easily double to USD 18.6bn.

The implications of a three-year cumulative surplus of USD 33.8 – 43.1bn by end 2019 are enormous for Iraq’s ability to plan the funding of the reconstruction and to address the country’s structural imbalances. The assumptions above don’t assume that the current rally in oil prices is sustainable, but that Brent would stabilize at about USD 65-70/bbl from the current USD 84+/bbl (Iraqi oil tends to sell at a discount of USD 5/bbl).

However, this is at least a few months away as the new government is unlikely to be formed before the middle of November and as such would not be able to take any action before year end. Given that, the county is in the mildest of the 40-day Arbaeen pilgrimage, the timing of the new government’s spending programme would coincide with the return of activity following the Arbaeen pilgrimage -hence the earlier reference to the extremes of feast or famine for Iraq’s economy.

The market followed through with its longer-term bottoming process as the July interim bottom continued to be tested this month, in-line with the same trend seen in August and will likely continue for some time. The market, as measured by the Rabee Securities RSISUSD Index was down -4.8% for the month and -10.5% for the year. Average daily turnover declined significantly for the month to the lowest levels (by a wide margin) for a number of years as can be seen from the chart below.

Average daily turnover Index (green) vs RSISUSD Index (red)

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital)

The poor market action over the summer months should be seen in the perspective of the low turnover coupled with the continuation of the demonstrations that began in July, the prolonged uncertainty over the governments formation and finally the 40-day Arbaeen pilgrimage that brings the country to a standstill as millions of pilgrims take part in “the largest annual gathering of people anywhere on earth.

However, the low activity was not without fireworks as a sell-off by a foreign investor in Mansour Bank (BMNS) set off a frenzy of trading activity in a replay of the sell-off in the Bank of Baghdad (BBOB), as reported in July’s update “Of Frenzies & Market Bottoms”. At the worst point BMNS, was down -40% for the month and its market capitalization was equal to about 0.5x Book Value, 17% of assets and 22% of cash (based on trailing 12-month numbers). In an exact replay of the events with BBOB, once the position was liquidated locals and some other foreigners bought the stock which sent it up +27% to end the month down -24%, and -10% for the year.

However, the financial position of BMNS during the past few difficult years is almost the mirror opposite of BBOB. BBOB suffered from the same forces that crushed the sector’s earnings, as reviewed in (Of Banks and Budget Surpluses), in addition to its share of company specific issues and structural weaknesses that were exposed by the pains of 2014-2017, including the recent pressure on FX margins. BMNS on the other hand, weathered the storm mostly unscathed as seen below, and in particular it’s in a strong position to reap the rewards of a recovery given its strong deposit growth, low loan/deposit ratio, and low ratio of non-performing loans (NPL’s) to deposits.

As explained “Of Banks and Budget Surpluses”, the banks’ leverage to the economy crushed their earnings. In particular, the double whammy of the ISIS conflict and the collapse in oil prices squeezed government finances as expenses soared while revenues plummeted. The government resorted to dramatic cuts to expenditures by cancelling capital spending and investments which, due to the centrality of its role in the economy, led to year-year declines in non-oil GDP of -3.9%, -9.6% and -8.1% for 2014, 2015 and 2016, respectively. Ultimately, the government had a cumulative deficit of around USD 41bn during this period and accumulated significant arrears to the private sector in the process.

The same leverage should work in reverse as the potential budget surpluses of USD 33.8 – 43.1bn for 2017-2019 should have a simulative effects on economic activity which ultimately should translate to stronger future earnings for the banks. These were discussed in further details in: “Forget the Donations, Stupid.”

BMNS’ financial performance during the years of conflict can be seen through the three charts below that look at loans/non-performing loans (NPL’s), deposits and trade finance and their association with budget surpluses/deficits. BMNS’ loan and NPL data as supplied by the research team at Rabee Securities is gratefully acknowledged, while other data was taken from the Central Bank of Iraq. Data from 2010-2014 are based on Iraqi accounting standards, while data from 2015-2017 are based on IFRS, and all calculations uses the official USD/IQD exchange rate.

BMNS’ loan book growth peaked in 2015 at the same time that NPL’s peaked. Unlike many other banks in the sector, its loan book was almost flat during 2015-2017 and NPL’s as a percentage of loans declined by almost 50%. At the same time BMNS increased its provisions significantly at almost twice the NPL’s in 2017.

Mansour Bank: Loans & NPL’s 2011-2017

(Source: Central Bank of Iraq (CBI), Rabee Research, Asia Frontier Capital (AFC))

Unlike, almost all other banks in the sector, BMNS experienced deposit growth throughout the crisis with growth accelerating during the relative stability in 2017. A flat loan book and sharply increasing deposits resulted in a very low loan/deposit ratio allowing BMNS the opportunity to grow its loans book. Moreover, most of these loans are collateralized by property as most banks’ loans are in Iraq where the norm is for collateral value at 2x the loan.

Mansour Bank: Deposits and Loan/Deposit ratio 2011-2017

(Source: Central Bank of Iraq (CBI), Rabee Research, Asia Frontier Capital (AFC))

BMNS’ trade finance declined, however, at much lower rates than those experienced by the sector, while the damage to BMNS’ earnings was mitigated by the relatively small size of the business.

Mansour Bank: Trade Finance 2011-2017

(Source: Central Bank of Iraq (CBI), Asia Frontier Capital (AFC))

It’s logical to conclude that the sea change which has taken place in the government’s financial health would reverse the trends that affected the banking sector’s earnings as the significant stimulus to non-oil GDP should lead to sustainable economic activity which should provide the sector with room to recover. Given BMNS’ strong position relative to other banks, it should have an opportunity to grow much faster than the sector as a whole.

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.

Budget Surplus Soars, but Markets continue to Bottom

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.

The market followed through with its longer-term bottoming process as the July interim bottom was tested this month. After having rallied 14.5% in July from an important technical level, August saw a retest with the index retracing to 6-8% above it. The market ended the month down -5.9% and -6.0% for the year.

Trading volumes have been low (see chart below) with August being the hottest month of the year and the peak of the summer holidays. This year it coincided with the Eid holidays, the continuation of the demonstration that began in July and the prolonged uncertainty over the government formation – all of which put the market’s action in perspective.

Monthly Turnover Index (green) vs RSISUSD Index (red)

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital)

From a longer perspective, the current test of the July bottom is part of a much larger bottoming process, in which the index is testing the major multi-year low made in May 2016. Given the significantly improving macro picture for Iraq, the most likely outcome is for a continuation of the bottoming process, with the uptrend’s timing highly dependent on the return of liquidity into the broader economy.

The thesis of the return of liquidity is supported by the latest budget data from the Ministry of Finance showing a budget surplus of about USD 12.5bn for January-June 2018, which argues for a year-end surplus higher than the USD 18.8bn that was argued for here a few months ago. The variance is driven by higher oil prices and exports than assumed earlier. Based on data showing an average price of about USD 65.5/bbl for January-August 2018, and the direction of oil prices, it would be reasonable to assume that the average Iraqi oil price in 2018 could be higher still by USD 3-5/bbl.  Coupled with higher oil exports, they would imply a year-end budget surplus of potentially USD 24.5bn – equal to about a 19% stimulus for the non-oil GDP vs. the earlier estimated 14.5%.

Supporting this line of thinking is the gradual appreciation of the market price of the USD vs. the IQD over the last few weeks. This premium has been range bound between about 1.5% to over 2% over the few weeks, after hitting lows of around 1.2% in June. This is likely to be a function of a recovery of government spending and a tentative recovery in consumer spending with the resultant increase in demand for imports – it should build on the first signs of this recovery as seen by the 13% year-over-year increase in imports in 2017 as the chart below shows.

Iraq’s Imports 2003-2017

(Source: https://tradingeconomics.com/iraq/imports)

The link between the market price of the USD versus the IQD and recovery in consumer spending is a result of the dollarization of the economy, in that that the strength or weakness of the IQD is a function of the demand-supply balance for USD, and not a specific USD weakness or strength. While, this could be due to the re-imposition of the sanction on Iran and the likely higher demand of USD, as argued in “Iran, Sanctions and Iraq: The Bigger Picture” this is unlikely given that Iran’s access to the USD was severely restricted following the signing of the JCPOA.  As such, there is no reason to expect that the re-imposition of sanctions would change thigs much, and thus the most likely explanation is increased demand for imports due to a tentative recovery in consumer spending.

The implications for this line of thinking can be substantial for the oversold banking sector given its leverage to the recovery in imports. It was shown in “Of Banks and Budget Surpluses” that trade finance revenues – a major source of revenue growth – suffered severely during the years of conflict and low oil prices, which contributed to the decline in their earnings, and subsequent dismal price performance in 2018.

Further recovery in consumer confidence, once liquidity returns, should lead to higher imports, which in turn should lead to an increase in the premium of the market price of the USD over the official rate to a range of 2-4%, if not higher. For commercial banks’ earnings, this means a recovery in trade finance revenues and increased FX margins, which with improvements in deposit growth and quality of loans, should imply a resumption of earnings growth.

However, this improving outlook is yet to be discounted by the market. While all stock markets are a discounting mechanism, they need data to discount. Local trading on the Iraq Stock Exchange (ISX) is dominated by speculators, who tend to appreciate the true values of local assets especially at extreme valuations. However, their discounting mechanism is mostly a rear-view mirror extrapolation of the prior negative trends into the future and thus would not have taken into account this potential change in fortunes for the banking sector.

Trade Finance vs Imports 2010-2017

(Source: Central Bank of Iraq (CBI), Asia Frontier Capital (AFC))

The chart above shows the trends over the last few years in commercial banks’ trade finance revenues, Iraq’s imports and the link to government budget surplus/deficit – given the centrality of the government’s role in the economy. As can be seen from the chart, the improved imports have yet to translate to a recovery in trade finance earnings for the banks. This continues to underscore the opportunity to acquire assets that have yet to discount a full economic recovery.

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.

Budget Surplus Soars, but Markets continue to Bottom

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.

The market followed through with its longer-term bottoming process as the July interim bottom was tested this month. After having rallied 14.5% in July from an important technical level, August saw a retest with the index retracing to 6-8% above it. The market ended the month down -5.9% and -6.0% for the year.

Trading volumes have been low (see chart below) with August being the hottest month of the year and the peak of the summer holidays. This year it coincided with the Eid holidays, the continuation of the demonstration that began in July and the prolonged uncertainty over the government formation – all of which put the market’s action in perspective.

Monthly Turnover Index (green) vs RSISUSD Index (red)

(Source: Iraq Stock Exchange, Rabee Securities, Asia Frontier Capital)

From a longer perspective, the current test of the July bottom is part of a much larger bottoming process, in which the index is testing the major multi-year low made in May 2016. Given the significantly improving macro picture for Iraq, the most likely outcome is for a continuation of the bottoming process, with the uptrend’s timing highly dependent on the return of liquidity into the broader economy.

The thesis of the return of liquidity is supported by the latest budget data from the Ministry of Finance showing a budget surplus of about USD 12.5bn for January-June 2018, which argues for a year-end surplus higher than the USD 18.8bn that was argued for here a few months ago. The variance is driven by higher oil prices and exports than assumed earlier. Based on data showing an average price of about USD 65.5/bbl for January-August 2018, and the direction of oil prices, it would be reasonable to assume that the average Iraqi oil price in 2018 could be higher still by USD 3-5/bbl.  Coupled with higher oil exports, they would imply a year-end budget surplus of potentially USD 24.5bn – equal to about a 19% stimulus for the non-oil GDP vs. the earlier estimated 14.5%.

Supporting this line of thinking is the gradual appreciation of the market price of the USD vs. the IQD over the last few weeks. This premium has been range bound between about 1.5% to over 2% over the few weeks, after hitting lows of around 1.2% in June. This is likely to be a function of a recovery of government spending and a tentative recovery in consumer spending with the resultant increase in demand for imports – it should build on the first signs of this recovery as seen by the 13% year-over-year increase in imports in 2017 as the chart below shows.

Iraq’s Imports 2003-2017

(Source: https://tradingeconomics.com/iraq/imports)

The link between the market price of the USD versus the IQD and recovery in consumer spending is a result of the dollarization of the economy, in that that the strength or weakness of the IQD is a function of the demand-supply balance for USD, and not a specific USD weakness or strength. While, this could be due to the re-imposition of the sanction on Iran and the likely higher demand of USD, as argued in “Iran, Sanctions and Iraq: The Bigger Picture” this is unlikely given that Iran’s access to the USD was severely restricted following the signing of the JCPOA.  As such, there is no reason to expect that the re-imposition of sanctions would change thigs much, and thus the most likely explanation is increased demand for imports due to a tentative recovery in consumer spending.

The implications for this line of thinking can be substantial for the oversold banking sector given its leverage to the recovery in imports. It was shown in “Of Banks and Budget Surpluses” that trade finance revenues – a major source of revenue growth – suffered severely during the years of conflict and low oil prices, which contributed to the decline in their earnings, and subsequent dismal price performance in 2018.

Further recovery in consumer confidence, once liquidity returns, should lead to higher imports, which in turn should lead to an increase in the premium of the market price of the USD over the official rate to a range of 2-4%, if not higher. For commercial banks’ earnings, this means a recovery in trade finance revenues and increased FX margins, which with improvements in deposit growth and quality of loans, should imply a resumption of earnings growth.

However, this improving outlook is yet to be discounted by the market. While all stock markets are a discounting mechanism, they need data to discount. Local trading on the Iraq Stock Exchange (ISX) is dominated by speculators, who tend to appreciate the true values of local assets especially at extreme valuations. However, their discounting mechanism is mostly a rear-view mirror extrapolation of the prior negative trends into the future and thus would not have taken into account this potential change in fortunes for the banking sector.

Trade Finance vs Imports 2010-2017

(Source: Central Bank of Iraq (CBI), Asia Frontier Capital (AFC))

The chart above shows the trends over the last few years in commercial banks’ trade finance revenues, Iraq’s imports and the link to government budget surplus/deficit – given the centrality of the government’s role in the economy. As can be seen from the chart, the improved imports have yet to translate to a recovery in trade finance earnings for the banks. This continues to underscore the opportunity to acquire assets that have yet to discount a full economic recovery.

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.

Iran, Sanctions and Iraq: The Bigger Picture

By Ahmed Tabaqchali. Originally published by Iraq in Context; re-published by Iraq Business News with permission. Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

Current analysis of renewed Iran sanctions often overlooks the wider context of Iraq’s regional trading relations. 

The extent of Iraq’s compliance with US sanctions on Iran has raised concerns regarding the loss of Iranian exports to its economy. However, Iraq’s trade with Iran, when looked at in the context of the wider region, shows these concerns in a different light.

It is arguably smaller than is widely perceived, especially given the long border between the two nations and the supposedly strong influence of Iran in Iraq, something which is contested.

There are many variables, following the imposition of sanctions, that will influence Iraq’s economy and trading relationships, making it difficult to examine any change in Iraq-Iran trade in isolation. Some of these variables are China’s response to these sanctions – its continued or increased purchase of Iranian oil or to impose tariffs on US crude- in light of its escalating trade war with the US.

Add to this the effects on oil demand from a change in world growth prospects as a result of an intensifying US-China trade war. Balancing or complicating events is the success of Saudi Arabia in sustaining increased oil production, or Iraq’s ability to increase its oil production. Finally, the state of the Turkish economy and the declining value of the Turkish Lira (TL[i]), in light of recent events, will play essential roles given Turkey’s substantial trading relationship with Iraq.

Much of the recent coverage of Iran’s trading relationship with Iraq refers to the significant annual exports of USD 12bn- which while significant, should be taken in the framework of Iraq’s overall imports and the trend of these imports from 2003-2017 (chart below). Additionally, Iran’s trade like, all other neighbouring nations’ trade with Iraq, is one-sided to its benefit. Iranian exports to Iraq are made up of goods and services, with the goods element at about USD 6bn for the 12 months ending March 2018[ii], which corresponds to about 15% of Iraq’s imports for 2017.

Iraq’s imports exploded six-fold from 2003 until 2013 to satisfy the population’s demand for goods after the isolation of the years under the sanctions. All of Iraq’s neighbours: Turkey, Iran and Jordan saw massive growth of exports to Iraq during this period for all types of goods, from fresh foods to finished products, given the near destruction of Iraq’ capacity to produce during the 14 years of sanctions and the ensuing civil war.

Iraqi Imports 2003-2017

 

(Source: https://tradingeconomics.com/iraq/imports)

Iraq imports peaked in 2013, after which the twin shocks of the ISIS war and the collapse in oil prices crushed the economy and with-it Iraq’s demand for goods. The effects of the ensuing ISIS conflict on overland trade routes affected the relative performance in the following years of each country’s exports.

The transit routes and volumes for 2014 (before the full effects of conflict and economic contraction) show the relative importance for each route, not only for the trade with a particular country, but that country’s additional role as a source of re-exports (chart below). In particular, Turaybill for Jordanian exports and re-exports coming from Aqaba, Kuwait’s Safwan, and Basra as a route for world exports as well as for UAE exports and re-exports from Jebil Ali. By 2014 exports from Syria ceased with the exception of the Al Waleed crossing, until it too ended when it fell under ISIS control in May 2015[iii]. Trade with Saudi Arabia ended with the invasion of Kuwait in 1990.

Iraq: Trade transit routes & volumes 2014

 (Source: Chart taken from a World Bank Report[iv])

Iranian exports peaked in absolute terms in 2013, declining by about 6% by 2017, while Iraq’s imports declined by 36%, with the result that Iran increased its market share from 11% in 2013 to 15% in 2017. However, this has more to do with the trade routes than any special relationship that Iraq might have with Iran or Iran’s competitiveness. The ISIS occupation closed Iraq’s trade route with Jordan, Syria and degraded the value of the routes with Turkey given ISIS’s occupation of Mosul and surrounding areas.

The growth in Iran’s exports from 2004 is shown in the chart below (data are based on the Iranian calendar up to the year 1395, ending in March 2017). Latest reports indicate that the figure was almost unchanged for the year ending in March 2018. Yet, Iraq’s overall imports recovered by 13% in 2017 vs 2016, and its imports from Jordan and Turkey increased by 8% and 19% respectively. All of which put the relative value of trade with Iran in context.

Given Iran’s natural geographical advantages from the long border and its supposed hegemony over Iraq, it can be argued that it should have accounted for much more of Iraq’s imports or at least cemented its conflict enhanced position when Iraq’s imports recovered. Instead it lost market share from 2016 to 2017, implying that it would continue to lose market share without the imposition of sanctions, and as such the sanctions would only accelerate this trend.

Iranian exports to Iraq 2004 – 2016

 

(Source: http://www.iraqbase.com/trade_with_iraq/iraq_tradition.aspx#c_31)

While Turkey’s exports of around USD 12bn in 2013 were twice Iran’s levels, most of these exports were destined for the Kurdistan Region of Iraq (KRI) in which Turkish goods and companies played a significant role in the economic boom the region witnessed until 2014.  The KRI, in 2017, accounted for 67% of all Turkey’s exports to Iraq up from 50% in 2007[v].

Turkish exports to Iraq suffered significantly due to the triple shock to the KRI’s economy – the loss of federal budget transfers, the ISIS conflict and the oil price collapse – as well as from the contraction of the Iraqi economy. Turkish exports declined 36% in 2013-2016 vs a decline of 43% in Iraq’s total imports, increasing its market share from 20% to 22%. The effective gain in market share is more significant than that, as most of these exports were for Iraq overall as opposed to being concentrated in the KRI. Turkish exports’ 18% recovery in 2017 and total imports’ 13% increase vs flat Iranian exports emphasises the competitiveness of Turkey’s exports whether due to quality or currency competitiveness vs the Iranian Rial.

Finally, the value of Turkish exports actually increased by about 25% in TL terms[vi], as the TL exchange rate against the USD decreased from TL 2.15 by end of 2013 to TL 3.79 by the end of 2017. All of which underlines the importance to Turkey of its exports to Iraq, especially in light of the 40% decline in the TL vs the USD so far in 2018. The significance of these exports might very well increase Iraq’s bargaining power with Turkey over many issues, particularly the water flow of the Tigris and Euphrates. Iraq’s relative bargaining power is further enhanced by the fees -converted to TL- collected for the oil that is shipped through Turkey to its port of Cihan, especially if Iraq resumes the Kirkuk oil exports of 250,000-300,000 barrels per day (bbl/d) that were cut after it reasserted feral authority over these fields in October 2017[vii].

Turkish exports to Iraq 2004 – 2017

 

(Source: https://tradingeconomics.com/turkey/exports/iraq)

Jordan’s exports and re-exports to Iraq suffered a great deal due to the closure of the land routes as a result of the ISIS occupation and subsequent conflict. The chart below shows a decline of 64% from 2013 to 2016 in Jordan’s exports, and probably a similar decline for re-exports. The mild recovery of 8% by 2017 from 2016’s low levels should be seen in the context that the trade route only reopened in October 2017, which argues well for meaningful growth in 2018[viii]. While Jordan’s economy is too small to fully replace Iran’s exports, its fresh foods[ix] would fill some of the gap and its much larger re-exports through Aqaba will make a difference.

Jordan’s exports to Iraq 2003-2016

 

(Source: https://tradingeconomics.com/jordan/exports/iraq)

Kuwait’s exports to Iraq recovered meaningfully in 2017 after a decline in 2013-2016, yet overall volumes are small. Most of these are re-exports through Safwan as Kuwait’s ports complement Basra.

Kuwait’s exports to Iraq 2003-2017

 

(Source: https://tradingeconomics.com/kuwait/exports/iraq)

The biggest potential beneficiaries from the sanctions would be Saudi Arabia and the UAE. Developing their relationship and influence in Iraq through trade and investments is magnified without competition from Iranian goods. Their economies would benefit from both the opportunity to replace Iranian products and from a sizeable recovering market. Even though 2016[x] was a low point for UAE’s total exports to Iraq, exports accounted for 53% of the mix making Iraq the seventh largest export market, while re-exports accounted for 47% of the mix, with Iraq as the fourth largest re-export market.  All of which highlights Iraq’s importance to both the UAE’s economy and its vital re-export business.

UAE’s exports to Iraq 2003-2016

 

(Source: https://tradingeconomics.com/united-arab-emirates/exports/iraq)

Trading with Saudi Arabia ended with the occupation of Kuwait, and while it saw a recovery since 2003, it remained tiny compared to the sizes of the two economies. The re-opening of the Arar border crossing in late 2017, coupled with the re-setting of the relationship, will change this significantly with Saudi expectations that trading values would approach those of Iran in ten years’ time[xi].

Saudi Arabia’s exports to Iraq 2003-2016

 

(Source: https://tradingeconomics.com/saudi-arabia/exports/iraq)

However, there is more to Iraq’s trade with Iran other than its exports of goods, as the relationship includes the export of electricity and gas, as well religious tourism in the form of at least three million religious tourists a year, especially during the annual Arbaeen pilgrimage.

Iran’s recent exports of electricity have been about 1.0 gigawatts[xii] (GW) increasing available domestic supply to 18.91 GW[xiii] by end of 2016. However, the supply has been frequently interrupted since 2015 as Iraq has failed to make the required contractual payments to Iran[xiv]. The supply cut in July 2018 being the latest case – which was a combination of over-due bills of about USD 1bn[xv] and Iran’s increased domestic needs for electricity. The argument over the importance of this supply has been made moot as Iran would not be able to resume exports in the near future, due to its own domestic needs[xvi]. Short-term solutions to replace this lost supply from Kuwait and Saudi Arabia have the potential to become long-term solutions that will further cement the relationship.

For instance, Kuwait supplying fuel for some of the inactive power stations would go some way for Iraq to increase the utilization of its available but unutilized generating capacity due to lack of fuel. This relationship could be developed to one of mutual benefits with Kuwait supplying electricity in return for Iraq supplying gas[xvii], which while mutually beneficial would help the rebuilding of trust. Similarly, discussions with Saudi Arabia for the supply of electricity, possibly under much more advantageous commercial terms[xviii] than those with Iran, would further develop this relationship.

Much more troublesome and very difficult to replace would be the supply of Iranian gas to power stations in Baghdad and Basra – these were based on deals signed in 2013 to supply 9.1 Billion Cubic Meter (BCM) a year to each city. Exports to Baghdad started in June 2017 and totalled 1.2 BCM by November 2017[xix], while exports to Basra were supposed to start after May 2018[xx].  Both sides have been silent on this recently, as media reports have only covered Iraq’s implementation of the sanctions in the form of banking transactions and closing access to Iranian goods. While details could be delayed until the November implementation of the oil sanctions or Iraq would seek waivers. Either way, there are no easy or short-term solutions for the replacement of this vital supply apart from increased focus and spending on capturing flared gas. However, this gas has been only available recently, and in relatively small quantities, while its eventual replacement, i.e. gas recovered from flaring, is substantially cheaper as the Iraqi government pays the Basra Gas Company (BGC) about USD 2.50 per MMBtu vs for Iranian USD 6.6 – 7.2 per MMBtu[xxi] (data as of early 2018).

Religious tourism is an important sector, employing about 160,000 people directly, extending to 447,000 beneficiaries (2014 data[xxii]). While, Iranian pilgrims and visitors are an essential component in religious tourism, yet a significant percentage of pilgrims or visitors are Iraqis. Moreover, the importance to Iraq’s economy from the spending of Iran’s pilgrims is somewhat misunderstood or overstated. For instance, during the Arbaeen, Iraqis provide hospitality through offering accommodation in their homes and providing free food as part of their religious duties towards the pilgrims[xxiii]. As such, the extra consumer spending during the most prominent religious event comes from Iraqis. The spending by regular Iranian religious visitors, throughout the year, will not be so easily replaced- although it is mitigated by the fact that almost all those visitors use Iranian airlines and employ Iranian tour operators.

Finally, the effects, of the loss of USD access for Iran, on Iraq would take a long time to assess. In 2012, the governor of the Central Bank of Iraq[xxiv] suggested that there were increased demands of 40-50% for the USD following the imposition of sanctions on Syria and Iran, which led to an increase in the market price of the USD vs the Iraqi Dinar (IQD) as can be seen from the chart below.

Iraqi Dinar (IQD) exchange rate versus the USD Jan 2011 – August 2018

 

(Source: Central Bank of Iraq, Iraqi currency exchange houses, Asia Frontier Capital)

(Note: The sharp pikes in 2012, 2013 & 2015 were due to CBI policies that restricted the sale of USD, but abandoned after causing a rise in market rates)

The convergence of the market price of the USD and the official exchange rate vs the IQD came to an end in 2011 and diverged in 2012 due to the increased demand for the USD. Apart from the spikes due to policies to limit the official supply of the USD, the normal range was 2-4% premium of the market price over the official rate. This increased up to a 10% premium during the worst of the crisis as oil revenues were substantially below expenditures and exports were less than imports. This divergence came to an end with the recovery in oil prices and the declining cost of war until it stabilized at around 1.5% premium to the official exchange rate.

It’s difficult to make the same argument today about the increased demand, or at least a sharp increase, from the current round of sanctions given that the re-integration of Iran with the world economy following the signing of the JCPOA (The Joint Comprehensive Plan of Action) still suffered from the reluctance[xxv] of most banks to deal with Iran. In particular, Iran’s access to the USD continued to be severely limited. All of which might explain that the signing of the JCPOA had not affected the market price of the USD vs the IQD.

However, it is worth noting that after a stabilization over the last few months, the premium of the market price over the official rate increased in early August from about 1.5% to over 2%. This might be related to the sanctions effect or to the signs of recovery of the local economy from increased consumer spending and the resultant increase in demand for imports. A full recovery in consumer demand for imported products would likely take the premium to a range of 2-4%.

It can be argued, that while Iraq genuinely disapproves of the Iranian sanctions given its own bitter 14 years’ experience with them, yet it stands to benefit from their imposition as they will fast-track a number of positive trends that are already taking place.

Iraq’s new-found ability to self-fund its reconstruction, estimated at about USD 18.8bn by end of 2018[xxvi], will accelerate its economic recovery through a liquidity injection of 14.5% into the non-oil economy once reconstruction projects are underway. In the process making the country extremely attractive for its neighbours’ economies, both as a goods export destination and for re-construction businesses. The opportunity to replace Iranian goods increases the benefit for these exporters. Ultimately, this will cement the USD 30bn pledged for the reconstruction of Iraq at the Kuwait Conference[xxvii] from promises into actual spending that will benefit the economies of the providers as much as Iraq’s economy. The deeper implication is a change in their relationship from that of benefactors into partners which will ensure its sustainability- in the process speeding Iraq’s re-integration in the region and ensure a balanced relationship with its neighbours.

The re-opening of the Iraq-Saudi Arabia border crossing and the Iraq-Jordan border crossings will accelerate the rehabilitation of Anbar (arguably disenfranchised after 2003 and a seat of resentment for the post-2003 political order), and the southern governorates (neglected by both the current and the prior regimes). The resumption of trade-links with their associated economic activities would provide a huge boost to the local economies, which while contributing meaningfully to the healing process, will build upon and magnify the economic revival until it becomes self-sustaining with the boost from reconstruction.

Meanwhile, the relationship with Iran might mature if the Iranians look beyond their frustration at Iraq’s compliance with the sanctions and listen closely the anti-government sentiment within Iran following the December 2017 demonstrations. What is vital here, and something that would increase stability within Iraq, is a complete rethinking the relationship to that of a state to state basis from the current relationship involving sub-state actors. This would subsequently benefit Iran by making another Iraqi security crisis less likely, and ensuring the relationship is based on national sentiment, rather than non state actors.

Disclaimer

Ahmed Tabaqchali’s 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.

[i] The code for Turkish Lira is TYR, but TL is used widely. https://en.wikipedia.org/wiki/Turkish_lira

[ii] The 12 months ending in March 2018 correspond to the Iranian year 1396. Iranian data are provided using this calendar.

 https://financialtribune.com/articles/economy-business-and-markets/81287/iran-third-biggest-trading-partner-of-iraq-with-16-share

[iii] Al Waleed crossing was freed by Iraqi forces in June 2017. https://www.reuters.com/article/us-mideast-crisis-iraq-syria/iraqi-forces-remove-islamic-state-fighters-from-vicinity-of-u-s-base-in-syria-idUSKBN19807Y

[iv] http://documents.worldbank.org/curated/en/672671468196766598/pdf/106132-v2-main-report-P159972-PUBLIC-KRG-Economic-Reform-Roadmap-post-Decision-Review-05-30-16.pdf

[v] https://www.washingtoninstitute.org/policy-analysis/view/turkey-and-the-krg-signs-of-booming-economic-ties-infographic

[vi] Arrived at by diving the value of exports by the year end value of the TL.

[vii] Iraq’s bargaining power is further enhanced if it links this with plans to double Kirkuk’s output over the next few yeaes

 The Kurdistan Regional Government (KRG) exported an average of 550,000 bbl/d in 2017 until October 2017. After which they ranged between about 240,000-370,000 bb/d for an average of 311,000.

http://auis.edu.krd/iris/sites/default/files/Statehood in KRI through an Economic Lens_ FINAL.pdf pages 6 & 7, page 7 footnote 15.

[viii] http://www.jordantimes.com/news/local/industrial-exports-iraq-resume-after-border-reopening

[ix] Although most of Jordan’s exports are currently value-add products. In 2016, Pharmaceutical Products accounted for 16% of total exports, Electrical & Electronic Equipment for 13%; Fertilizers for 12%; plastics for 11%. While Vegetable, Fruits & Nut food preparation accounted for only 2.3%, and Edible Vegetables, certain roots and Tubers accounted for 2.2% for a total under 5%.

[x] http://iraqieconomists.net/en/2017/09/19/uae-iraq-trade-touches-7-billion-2016/

[xi] https://www.thenational.ae/world/mena/saudi-iraqi-trade-to-reach-23-billion-saudi-riyals-within-10-years-1.706487

[xii] https://en.mehrnews.com/news/122562/Iran-to-resume-electricity-exports-to-Iraq-within-weeks

[xiii] Table 3, page 79 ““A New Hope: Iraq Oil’s Way Forward” http://www.bayancenter.org/en/2018/02/1435/

   Figures from the Ministry of Electricity show that available capacity, was 16.0 GW by end of July 2018, which does not include the lost Iranian supply. https://moelc.gov.iq/index.php?name=News&file=article&sid=4212

[xiv] This article explains the nature of the relationship and the history of the under-payments https://www.washingtoninstitute.org/policy-analysis/view/the-irgc-may-try-to-divert-iraqs-electricity-payments

[xv] https://theiranproject.com/blog/2018/07/08/iran-cuts-electricity-supplies-to-iraq-over-unpaid-bills/

[xvi] https://theiranproject.com/blog/2018/07/17/govt-spox-iran-not-to-resume-electricity-supplies-to-iraq-in-near-future/

[xvii] https://www.middleeastmonitor.com/20170202-kuwait-considers-export-of-electricity-to-iraq/

[xviii] https://www.bloomberg.com/news/articles/2018-07-29/iraq-says-saudis-to-sell-it-power-at-a-fraction-of-iran-s-price

[xix] Page 82 “A New Hope: Iraq Oil’s Way Forward” http://www.bayancenter.org/en/2018/02/1435/

[xx] http://www.irna.ir/en/News/82906994

[xxi] Page 82 “A New Hope: Iraq Oil’s Way Forward” http://www.bayancenter.org/en/2018/02/1435/

[xxii] http://documents.worldbank.org/curated/en/255111529495871846/pdf/Jobs-in-Iraq-a-primer-on-job-creation-in-the-short-term.pdf

[xxiii] http://www.bbc.com/travel/gallery/20171220-the-iraq-city-that-opens-its-doors

[xxiv] https://www.alarabiya.net/articles/2012/04/12/207233.html

[xxv] https://www.reuters.com/article/us-iran-banks-kerry-idUSKCN0Y30OJ

[xxvi] A recent report by the author covers this in further detail.http://www.iraq-businessnews.com/2018/06/15/forget-the-donations-stupid-new-dynamics-in-funding-reconstruction/

[xxvii] https://uk.reuters.com/article/mideast-crisis-iraq-reconstruction/factbox-pledges-made-for-iraqs-reconstruction-in-kuwait-idUKL8N1Q55RY

Market Review: “Frenzies and Market Bottoms”

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.

The market, as measured by the RSISUSD index, marked an important bottom in July as part of a likely bottoming process. The multi-month bank selling shifted into high gear. This intensified into a frenzy, climaxing by the middle of the month with the liquidation of a large foreign position in the Bank of Baghdad (BBOB) – one of the top banks on the Iraq Stock Exchange (ISX). At the worst point in July, BBOB and the index were down -24% and -12% respectively for the month, after which both reclaimed these losses to end up +2.4% and +0.5%.

The selling in the banking sector over the last few months, driven by concerns over declining FX margins (as explained here in the past), was paced by consistent foreign selling in BBOB. The size of the selling exaggerated the stock’s declines which had a knock-on effect on other banks which declined in-tandem and dragged the market with them given the sector’s dominance of trading on the ISX.

Local retail trading is dominated by speculators, yet locals tend to appreciate the true values of local assets especially at extreme valuations. At the worst point, BBOB’s market capitalization was equal to about 0.3x Book Value, 8.5% of assets and 15% of cash (based on the trailing 12 months) which would suggest that the stock was discounting some sort of end of the world type event. The locals, aware that such a catastrophe was not around the corner and that the decline was a function of a portfolio liquidation, raised funds from family, friends and banks in order to buy BBOB. Joined by a few foreign investors, undoubtedly aware of the same valuations, the combination absorbed all the significant selling, after which the stock began to climb.

Irrespective of BBOB’s strong position among local banks, it too suffered from the same forces that crushed the sector’s earnings, as discussed in last month review of banks (Of Banks and Budget Surpluses). Furthermore, it had its share of company specific issues and structural weaknesses that were exposed by the pains of 2014-2017, including the recent pressure on FX margins. The bank’s focus on addressing these weaknesses at the expense of revenue growth is hindering near term growth. However, given the quality of its management, strong position with high quality customers (in particular foreign companies) and the strength of its franchise, it should emerge in a position to resume growth in the recovering economy.

As explained last month, the banks’ leverage to the economy crushed their earnings. In particular, the double whammy of the ISIS conflict and the collapse in oil prices squeezed government finances as expenses soared while revenues plummeted. The government resorted to dramatic cuts to expenditures by cancelling capital spending and investments which, due to the centrality of its role in the economy, led to year-year declines in non-oil GDP of -3.9%, -9.6% and -8.1% for 2014, 2015 and 2016 respectively. Ultimately, the government had a cumulative deficit of around USD 41bn during this period and accumulated significant arrears to the private sector in the process.

The same leverage should work in reverse as the expected budget surpluses of USD 28.5bn for 2017-2019 should have simulative effects on economic activity which ultimately should translate to stronger future earnings for the banks. These were discussed in further details at: “Forget the Donations, Stupid.”

For BBOB, the changes for the worse during the years of conflict can be seen through the three charts below that look at loans/non-performing loans (NPL’s), deposits and trade finance and their association with budget surpluses/deficits. BBOB Data as supplied by the research team at Rabee Securities is gratefully acknowledged. Data from 2010-2014 are based on Iraqi accounting standards, while data from 2015-2017 are based on IFRS.

BBOB’s loan book growth peaked in 2015, while NPL’s grew at the height of the crisis in 2016. The sharp decline in the loan book since then exaggerated the growth of NPL’s as a percentage of loans, as NPL’s declined in absolute terms marginally in 2017 vs. 2016.

Bank of Baghdad: Loans, NPL’s & Loan provisions 2011-2017

(Source: Central Bank of Iraq (CBI), Rabee Research, Asia Frontier Capital (AFC))

Though NPL’s are relatively high, even during the relative boom times, loans as a percentage of deposits have been very low at the mid-20%’s level as can be seen below.  Moreover, most of these loans are collagenized by property as most banks’ loans are in Iraq where the norm is for collateral value at 2x the loan. BBOB’s relatively large NPL’s were a function of the relative size of their loan book which meant a larger exposure to riskier loans taken during the boom years.

Bank of Baghdad: Deposits and Loan/Deposit ratio 2011-2017

(Source: Central Bank of Iraq (CBI), Rabee Research, Asia Frontier Capital (AFC))

The decline in deposits as a function of the economic contraction was made worse by the decline in BBOB’s trade finance business as that meant the loss of funds deposited as partial collateral required for the provisioning of trade finance.

Trade finance, once an engine of growth for the bank suffered as a result of the sharp economic contraction brought about by investment cuts and the slowdown in consumer spending.

Bank of Baghdad: Trade Finance 2011-2017

(Source: Central Bank of Iraq (CBI), Rabee Research, Asia Frontier Capital (AFC))

It’s logical to conclude that the sea change which has taken place in the government’s financial health would reverse the trends that affected the sector’s earnings as the significant stimulus to non-oil GDP should lead to sustainable economic activity which would provide BBOB room to recover, address its weaknesses and grow.

The question- when will these budget surpluses find their way into the economy through government action- has been partly answered by the government’s response to nationwide protests that erupted in early July, demanding the provision of services. The first response was to allocate USD 3bn to the city of Basra to fund long delayed infrastructure projects, a USD 669mn injection into the country’s housing fund to provide about 25,000 housing loans, plus a number of smaller projects in the southern governorates.

The eruption of protests in the city of Basra and their spread across the southern governorates right to Baghdad has, as is the usual case in all Iraqi events, led to two polar views. The first dismisses these as the usual ritual of summer protests ignited by the scorching heat that would soon settle with a few government handouts and the end of summer – echoing perhaps an old Iraqi politician who likened Iraqis’ anger to effervescent salts that erupt with a great fanfare before settling down. The second warns of the emergence of instability given that the Iraqi political establishment is incredibly slow to change its bad old habits, if at all, but that the young angry population is running out of patience.

While both arguments have merit, current protests should be seen from a wider prism in that they are the fourth instalment of a protest movement that began in 2010 and developed in both scope and maturity. The last incarnation in 2015 had a profound effect on how the election was fought and its ensuring results, as it led to the break-up of the ethno-sectarian monolithic blocs that were dominant over the past 15 years and which were at the root of Iraq’s instability. Thoughts supporting this line of thinking appear in (The Protest Movement, the Politicians and the Elections).

The influential religious leadership has supported the protest movement calling for the quick formation of a government focused on meeting the demands of demonstrators. This should hasten the formation of the government ending the current uncertainty. However, irrespective of how it is formed, the government would have the financial wherewithal to start the reconstruction of the country and the provisioning of infrastructure in the form of cumulative two-year budget surplus of USD 18.8bn by end of 2018- equal to a stimulus of 14.5% of non-oil GDP once reconstruction projects are underway. These would be enhanced by potential budget surplus of USD 9.3bn in 2019 or a further 6.8% stimulus to non-oil GDP. (Details available in a recent article).

It worth noting that while Iraq has its share of challenges, none are unsolvable in that the key issue of the last few years has been a sequence of crises that have forced successive governments into short -term solutions without providing overall long-term solutions. For instance, the current demonstrations were started by anger over the lack of electricity coverage beyond a few hours each day. Yet, “of 26 gigawatts installed generation, theoretically enough to meet the current 23 GW of demand, less than 17 GW is operable because of lack of fuel, maintenance and transmission capacity: source.” As such, these are addressable in a reasonable timeframe by a focused government with a clear mandate which could emerge given the current pressures from the electorate supported by the religious authority.

Finally a report on Iraq’s debts addresses a number of misconceptions on its debt profile that would have a huge implication for its ability to fund the needed reconstruction and the provisioning of services is here (Understanding Iraq’s Debt).

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). 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.