IRAN-IRAQ: THE ECONOMIC BALANCE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000302500001-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 7
• Document Creation Date: December 22, 2016
• Document Release Date: January 27, 2011
• Sequence Number: 1
• Publication Date: June 6, 1986
• Content Type: REPORT

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SUBJECT: Iran-Iraq: The Economic Balance
NESA M 86-20082
Distribution:
Orig - Marion V. Creekmore, Jr., State
1 - Dennis Ross, NSC
1 - Sandra Charles, DoD/ISA
1 - David Tar DOD
1 - , DIA/NE
1 - enn s Murphy, State w
1 - Peter Burleigh, State
1 - James Kelly, Commerce
1 - Charles Boykin, Energy
1 - Roger Pajak, Treasury
1 - DIR/DCI/DDCI Exec Staff
1 - DDI
1 - VC/NIC
1 - NIO/NESA
1 - DDO/C/NE
1 - DDO/NE
1 - DDO/NE,
1 - C/PES
1 - C/CSG
1 - C/NID
1 - C/PDB
1 - C/OGI/SRD
6 - CPAS/IMD/CB
1 - D/NESA
1 - DD/MESA
2 - C/PPS/NESA
1 - C/MESA/AI
1 - C/MESA/IA
1 - C/NESA/SO
6 - NESA/PG
DDI/NESA/PG/I (3Jun86)
DATE CQ /o FI Cg-
DOC NO N c 4 M S~o- -Ago 9 -L_
OCR 3
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
6 June 1986
Iran-Iraq: The Economic Balance
Summary
Iran and Iraq face severe economic hardships in the
months ahead. The prospects for the two countries were
gloomy even before the recent fall in oil prices and the
shrinking value of the dollar cut their real earnings nearly
in half. Sustained economic pressure will increase the
danger of Saddam Husayn's ouster in Iraq and strengthen
opposition to the war in Iran. Absent more aggressive Iraqi
attacks on Iranian economic targets, we believe the oil price
decline poses a relatively greater political danger for
Baghdad than Tehran. In addition to Iraq's greater
dependence on oil-financed imports, Baghdad, unlike Tehran,
is saddled with large foreign debts and is unable to
significantly increase oil exports. Although discontent in
both countries will increase over the coming months, the
Iraqi leadership is more vulnerable because of its greater
reliance on domestic spending to maintain support. Financial
This paper was prepared byl the Persian
Gulf Division, Office of Near Eastern and South Asian Analysis. Comments
and queries are welcome and may be directed to the Chief, Persian Gulf
Division, MESA
MESA M 86-20082
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constraints alone, however, will not prevent either side from
continuing the war in the short term.
The recent collapse in oil prices and the depreciation of the dollar
are staggering blows to an already weak Iranian economy. Assuming Tehran
maintains last year's average oil export level of about 1.6 million b/d,
the price of oil is $13 per barrel, and the value of the dollar does not
rise significantly, we estimate Iran faces a 50-55 percent drop in real
foreign exchange earnings this year. We believe Iran intends to increase
oil exports to between 2 and 2.8 million b/d--exports for the first four
months of 1986 averaged 1.5 million b/d. Tehran will have trouble
sustaining higher production and exports because of shortages of skilled
personnel and the deterioration of oil facilities.
Oil revenues are critical to Iran's economy, constituting over 90
percent of foreign exchange earnings. Oil-funded imports provide 20-25
percent of Iran's food requirements, the vast bulk of its war materiel, and
essential supplies for industry, transportation and construction. To
maintain recent import levels of food and military goods, Iran would have
to use almost three-fourths of the $8.5 billion in foreign exchange
revenues that we estimate it will earn in 1986. This would leave little
room for anything else. In particular, it will be virtually impossible to
raise military outlays significantly to help offset Iraq's superiority in
weapons.
We expect Iran to secure some foreign loans from Japan and West
European trading partners despite its strong aversion to borrowing, but
Tehran will need to slash imports by one-third this year. This would
represent about a 50 percent decline in imports since 1984. Tehran
probably will avoid drawing down its limited foreign exchange assets, which
amount to about three months of imports and serve as a cushion in case of a
complete cut-off of oil exports.
Import cuts will be a harsh blow to Iran's hobbled civilian industrial
sector. A lack of imported raw materials and spare parts has already
caused industry to operate far below capacity.
additional factories will have to be closed in the coming months. Even the
oil sector has not been spared. Cancellation of development projects and
stretched-out maintenance will further reduce Iran's oil production
capacity and cause irreversible damage to some fields.
There has been a steady deterioration in the standard of living in
Iran and conditions will worsen
over the next several months. Even imports of high priority items such as
food and medicine reportedly have been delayed or cancelled. Lower imports
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and reduced domestic production will aggravate inflation and
shortages--consumers will turn increasingly to the high-priced black market
to satisfy basic needs. Cancelled development projects leave no hope of
alleviating housing short411 es in major cities or improving public services.
daily power outages in Tehran and other
cities.-]
Unemployment is becoming a serious problem despite the war.
factory closings have caused layoffs even at
government-owned factories. Official estimates place unemployment at 15
percent or about 2 million. The former head of the Planning and Budget
Ministry complained in April that "false employment"--government make-work
projects--and unemployment account for 39 percent of Iran's 12.3 million
labor force, according to press reports.
Economic problems probably will not translate into active opposition to
the regime in the immediate future.
The regime can still find enthusiastic volunteers willing to
martyr themselves at the front. Subsidies for food and other necessities
will limit the impact upon the poor who form the backbone of support for
the Islamic Republic. Many;of the poor are not much worse off than they
were under the Shah and believe the regime attempts to act in their best
interest. Moreover, there-is no effectively organized opposition within
Iran to rally the people.
If oil prices remain depressed over the next two years, however, Iran
will face tougher choices and could decide to scale down its war effort.
Economic problems will encourage dissatisfaction with the government's war
policy, especially if Iran is unable to make significant military gains
against Iraq. Iran's leaders might become more concerned about
guaranteeing a tolerable level of long-run economic development.
Nevertheless, the regime is likely to end the war only if its continuation
threatens the survival of the Islamic Republic.
Iraqi Economic Outlook
Iraq has accumulated large foreign debts over the past four years while
trying to insulate its population from the economic effects of war. This
has complicated Baghdad's efforts to deal with the sharp decline in oil
prices. We estimate Iraqi foreign exchange earnings will fall to $7.4
billion this year from $11.7 billion in 1985. Moreover, the lower value of
the US dollar will make the real impact even greater since oil is priced in
dollars while most Iraqi imports and debts are valued in other currencies.
We believe Baghdad will need to cut imports by 30-35 percent. In the
unlikely event Saudi Arabia and Kuwait do not provide additional cash
assistance this year, cuts will be even deeper. Baghdad cannot raise
revenues appreciably since oil exports, which represent 98 percent of
foreign exchange earnings, are already near capacity.
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Baghdad's crumbling financial position probably will necessitate even
larger import cuts because foreign banks are restricting trade credit to
Iraq and the number of foreign suppliers willing to do business with the
country is dwindling. Baghdad's failure to 25X1
honor up to $1 billion in letters of credit (L/Cs)--the principal manner of
conducting trade--has caused many banks to refuse to handle Iraqi L/Cs.
The US Embassy in Baghdad reports that Iraq failed for the first time to
make a $120 million payment to France--Baghdad's major creditor and an
important arms supplier. We believe that Paris has suspended short- and
medium-term credit as a result of the missed payment. In addition, Iraq
has missed payments to Germany, Japan, Turkey, Italy, and several smaller
creditors.
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Iraq reportedly is seeking to reschedule at least $3 billion in debt
payments due this year. Creditors have little choice but to accept
rescheduling, but Baghdad is unlikely to find desperately needed additional
credit, especially from commercial banks. Even a bank in Bahrain, partly
owned by Iraq, is unwilling to increase its lending limit.
Baghdad has little recourse but to reduce spending and the Iraqi people
will suffer a significant decline in living standards over the next 12
months. Defense expenditures will not be cut, in our view, especially
given the heightened level of fighting this year. To maintain recent
import levels of military goods and food, Iraq would have to use almost 90
percent of its estimated 1986 foreign exchange revenues. The full weight
of lower spending will fall on remaining development projects, goods for
domestic industry, and consumer items. We believe Iraq has banned imports
of luxury goods and also will reduce imports of semi-finished products.
Many goods are already in short supply and inflation is rising rapidly, yet
the full effect of the austerity measures will not be felt for a few more
months.
Iraq is also likely to cut government wages, benefits to families of
war dead, and subsidies for food and other necessities. We believe a
comprehensive rationing of selected food items will be implemented for the
first time. the government will raise taxes and
issue long-term state bonds to offset plummeting government revenues. In
addition, the regime is trying to reduce the number of foreign workers in
Iraq, about 1.2 million in 1985, despite a war-intensified labor shortage.
Iraq's economic crisis poses potentially serious risks for the regime.
According to the US Embassy, the leadership in Baghdad is more concerned
with falling oil prices than with Iraq's military position. Much of the
dissatisfaction with the new austerity will focus on Saddam Husayn's
leadership. Efforts to blame foreign powers or several Iraqi officials for
the country's economic problems will not shift blame from Saddam for
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starting the war that has brought economic and human hardships. The loss
of perquisites could encourage military officers--already upset by
mismanagement of the war--as well as government officials to become even
more unhappy with Saddam's leadership. Potential dissidents from within
the establishment, however, will be restrained by fear that radical change
could hurt Iraq's war-effort and play into Iran's hands.
Effect on Military Options and Balance
Financial constraints alone will not prevent either side from
continuing the war in the short-term. Iran is conducting a
"labor-intensive" war effort and Arab aid to Iraq should ensure that it
does not find itself critically short of military supplies in the next
several months. Over the longer term, however, Iran will probably find it
difficult to increase the scale of its military operations. Iraq will need
to cancel most of its ambitious plans to modernize its forces in favor of
replacing lost equipment and used munitions.
The economic problems confronting both countries, moreover, are forcing
them to adopt more aggressive policies. Recently, Iraq has increased its
attacks on Iran's infrastructure--hitting oil refineries, pumping stations,
and bridges--in an effort to aggravate Iran's economic woes and force
Tehran to the bargaining table. Although Iraq has the capability to bring
much of Iran's economy to a standstill by destroying its electrical system
and oil refineries, it has not shown the determination to sustain an
effective campaign. This lack of resolve has been evident in Baghdad's
sporadic attacks on tankers in the Gulf and on the Khark Island oil
terminal that have been little more than an expensive annoyance for Iran.
Falling oil prices have clearly pushed Tehran to assume a more
bellicose position toward its Gulf neighbors. Iran has warned Saudi Arabia
and Kuwait to restrain oil production in order to bolster prices and to
discontinue their massive economic support for Iraq. To underscore the
warning, Iran in early May attacked three Saudi tankers in the Gulf and
probably will resume such attacks if Riyadh does not cut its oil
production.
Over the next 12 months, we believe continued low oil prices will be
more harmful to Iraq than to Iran. Therefore, sustained Saudi and Kuwaiti
aid will be crucial if Iraq is to offset Iran's greater economic resilience
and better financial position. Since the beginning of the year, however,
Arab financial support for Baghdad has fallen short of the 1985 level,
rather than risen. Moreover, although discontent in both nations will
increase, we believe the Iranian populace is probably more willing to make
sacrifices than the Iraqis.
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We also believe Iraq will suffer relatively greater economic problems
in the coming months. Iraq has less flexibility to raise export revenues.
Tehran's larger foreign exchange assets and access to loans give it more
options than Baghdad in dealing with falling oil prices. Moreover, the
Iranian economy is less dependent on imports and thus less vulnerable to
fluctuations in the oil market.
-- Tehran has about $3 billion in readily accessible foreign exchange
assets; Baghdad has almost none.
-- Iraq owes $9-10 billion to non-Arab debtors and has virtually no
access to further credit. Iran has negligible foreign debts and
could probably find lenders willing to provide substantial credit.
Japan, West Germany, Italy, and others are likely to be willing to
extend at least as much credit to Iran as they have to Iraq--several
billion dollars--to maintain their position in the larger Iranian
market.
-- Iraqi oil exports are near capacity, with no prospects for
significant increase until a new pipeline through Turkey is completed
in May 1987. On the other hand Iran might be able to raise oil
exports by several hundred thousand b/d within a few months by
devoting sufficient resources to its oil sector. Recent price
concessions probably indicate Tehran hopes to increase exports in the
coming months.
-- The Iraqi economy is more dependent on oil-financed imports.
-- Two-thirds of domestic output in Iraq is directly linked to oil while
the oil sector contributes only about one-third in Iran.
-- The large "black economy" and less rigid government direction of the
economy in Iran allows for greater efficiency and private provision
of many goods.
About $25 billion in financial support from Saudi Arabia and Kuwait
since the beginning of the war has helped maintain Iraqi living standards,
but current aid levels will probably fall far short of Baghdad's growing
needs. Total aid this year is unlikely to offset the $4.3 billion decline
in oil revenues unless substantial additional cash payments are made.
Without such payments, financial assistance from Saudi Arabia and Kuwait
for 1986 will probably be even less than last year's $2.0-2.5 billion. At
current prices, aid in the form of oil sales on Iraq's behalf will be worth
less than half what it was last year. Moreover, the 300,000 b/d oil aid
figure announced by Baghdad may be high because of low production in the
Neutral Zone, which accounts for 80 percent of such oil aid. Saudi Arabia
has also restricted the flow of Iraqi crude through the Iraq-Saudi pipeline
to about 150,000 b/d below its 500,000 b/d capacity, depriving Baghdad of
several hundred million dollars in revenues since last November.
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