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R 201053Z APR 06
FM AMEMBASSY BAGHDAD
TO RUEHC/SECSTATE WASHDC 3992
INFO RUCNRAQ/IRAQ COLLECTIVE
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C O N F I D E N T I A L SECTION 01 OF 04 BAGHDAD 001286 
 
SIPDIS 
RUEHC TO RUEHRC 
SIPDIS 
 
E.O. 12958: DECL: 04/19/2016 
TAGS: EAGR ECON ETRD KCOR KDEM KPRV PGOV IZ
SUBJECT: CAUTIOUS BEGINNINGS TO FOOD SUBSIDY REFORM 
 
REF: A. BAGHDAD 375 
     ¶B. BAGHDAD 241 
 
     ¶C. 2005 BAGHDAD 5079 
     ¶D. 2005 BAGHDAD 4559 
     ¶E. 2005 BAGHDAD 4108 
 
Classified By: Deputy Chief of Mission David Satterfield, reasons 1.4 ( 
b) and (d) 
 
¶1.  (C) Summary:  Evidence on the ground indicates that the 
GOI intends to reform -- and eventually eliminate -- its 
Public Distribution System (PDS), a $3 billion subsidy 
program that fails in its mission of ensuring food security 
for all Iraqis.  The Embassy PDS Reform Team (chaired by 
Embassy Econ) supports this decision as economically 
necessary and will provide advice and assistance to the GOI 
as appropriate.  The PDS, managed by the Ministry of Trade 
(MoT), is reportedly foul with corruption and drains 
government revenues that could be used for essential public 
services.  It hinders agricultural and private-sector 
economic development by setting up the MoT as the dominant 
buyer of high-grade wheat and rice in Iraq and as a no-cost 
provider of other food and living items.  The GOI has said 
that it intends to cut "nonessential" items from the PDS and 
monetize it, establishing government reserves of key PDS 
items to guard against price inflation and market shortages 
and to act as a contingency stock in case of food 
emergencies.  The GOI recently carried out a monetization 
experiment and touted its success as proof that it can 
monetize the PDS effectively.  The GOI has also implemented 
policies -- albeit to a limited extent -- to encourage 
private-sector development in food production, processing, 
distribution, and marketing.  The GOI has stated its 
intention to phase out the PDS over the next four years, 
freeing up a significant portion of its budget, and its 2006 
PDS budget cut is evidence of GOI seriousness.  Throughout 
the PDS reform process, we will encourage the GOI to educate 
the Iraqi public on the necessity and benefits of PDS reform 
and link it to the recently launched Social Safety Net, which 
is intended to protect the poorest Iraqis.  End summary. 
 
------------------------------------ 
A Socialist Hindrance to Development 
------------------------------------ 
 
¶2.  (C) The Public Distribution System (PDS) is a massive 
subsidy program in which all Iraqis are entitled to receive a 
monthly basket of foodstuffs and household items.  The 2006 
PDS budget is $3 billion, or 9% of Iraq's total government 
budget.  Another U.S. agency has estimated that the Iraqi 
Ministry of Trade (MoT), which manages the PDS, spends 
approximately $30 per monthly PDS basket, while the actual 
market value per basket is around $9.  Embassy market surveys 
confirm this.  According to Kareem Abdul Fajer (please 
protect throughout), Director General (DG) of Foodstuffs (the 
MoT state-owned enterprise responsible for procuring most 
items in the PDS basket), transportation costs are $0.54 per 
monthly basket.  This leaves approximately $20 per monthly 
basket that is lost to inefficiencies and corruption. 
 
¶3.  (C) The 2006 PDS budget of $3 billion is a 25% cut from 
¶2005.  In 2005 the MoT managed to spend only about $2 
billion, or 50% of the budget, on actual procurement. 
According to the British Department for International 
Development (DFID) and the Iraqi Ministry of Finance (MoF), 
the main hindrance to spending the entire 2005 budget was 
contracting mismanagement within the MoT.  (Note:  The MoT 
has stated that the problem was unavailability of funds from 
the MoF.  End note.)  According to USAID/Food for Peace, in 
the past the MoT has announced "executed contracts" that led 
many of us to believe the food procurement was a completed 
transaction.  However, we later learned that delays in the 
issuance of Letters of Credit, irregular financing 
arrangements with foreign banks, and amendment requests by 
suppliers often led to delays or cancellations of the 
"executed contracts." 
 
¶4.  (C) Bi-weekly World Food Program (WFP) reports indicate 
an average PDS delivery shortfall of nearly 77% over the last 
six months of 2005.  (Note:  Using the $30 basket cost, the 
amount of food procured by the MoT after spending $2 billion 
roughly correlates to the 77% shortfall observed by the WFP. 
End note.)  U.S. military field reports confirm that most 
Iraqis do not receive their entire allotted ration basket 
each month.  This is particularly damaging in the poorest 
areas of Iraq -- located mainly in the far western regions of 
Anbar and Ninewa provinces and pockets of southeast Iraq - 
where, according to the 2003 UN WFP Baseline Food Security 
Analysis (the most recent available), about a third of the 
population is highly dependent on the PDS for survival. 
 
¶5.  (C) The PDS is reportedly corrupt at every stage of its 
 
BAGHDAD 00001286  002 OF 004 
 
 
operation, from procurement contracting to final distribution 
of items to the Iraqi public.  Deputy Prime Minister 
 
al-Jabburi (strictly protect) has told us that Trade Minister 
Mawlud skims money from sugar contracts.  DG Kareem and MoT 
Chief of Staff Azad Hussein Rasheed have stated that 
PDS-laden trucks regularly disappear enroute to food 
distribution points, and that MoT officials sometimes sell 
PDS food articles to enrich themselves.  A previous Iraq 
Reconstruction Management Office (IRMO) Trade Senior 
Consultant strongly suspected that foreign wheat shipments 
were being resold to fund terrorist operations and indicated 
that the MoT Inspector General office was likely involved in 
corrupt activities.  Recent Iraqi press reports credit the 
MoT with being the most corrupt ministry in the GOI.  Local 
Embassy hires confirm the widespread impression that 
government officials at all levels of the MoT enrich 
themselves through the PDS. 
 
¶6.  (C) The PDS hinders agricultural and private-sector 
development by sapping entrepreneurial initiative and 
encouraging dependence on the government.  Deputy Prime 
Minister Chalabi has told us that he instructed the MoT to 
offer higher prices to Iraqi producers for wheat and rice 
(ref B).  (Note:  We do not have evidence beyond verbal 
assurances from MoT officials that they actually pay higher 
prices to Iraqi producers.  End note.)  However, using 
Ministry of Agriculture production estimates and MoT 
procurement records, we estimate that less than half of Iraqi 
wheat production is considered fit for PDS procurement, and 
the farmers are currently only capable of producing about 12% 
of annual PDS wheat needs.  In addition, as ration recipients 
and corrupt MoT officials reportedly sell PDS items into the 
marketplace, they deflate and distort true market prices, 
making it difficult for Iraqi farmers to recover production 
costs on wheat and rice that they do not sell to the MoT.  In 
effect, the MoT has set itself up as the dominant buyer of 
high-grade wheat and rice in Iraq, providing no incentive to 
private-sector buyers to enter the market and decreasing the 
need for GOI investment in distribution infrastructure that 
would benefit small farmers and private distributors. 
 
---------------------------- 
Cutting "Nonessential" Items 
---------------------------- 
 
¶7.  (C) According to DG Kareem, the most important items of 
the PDS are flour, rice, sugar, and cooking oil, mainly 
because Iraqis most need these items for daily living and 
because Iraqi farmers are currently incapable of producing 
sufficient quantities.  "Nonessential" PDS items, according 
to Kareem, make up 25% of PDS expenditures and include adult 
milk, infant milk, baby food, beans, salt, tea, soap, and 
detergent.  According to Kareem and local sources, Iraqis 
generally view these "nonessential" items as inferior in 
quality and prefer to buy higher-quality replacements in 
local retail markets.  These same sources indicate that the 
Iraqi recipients often sell the "nonessential" items for 
income, though the income they receive is significantly lower 
than what the GOI paid to provide the item initially.  Kareem 
has told us that the MoT plans to discontinue providing 
"nonessential" PDS items in 2006.  (Note:  Though press 
reports state that the MoT has done this, MoT sources 
indicate it has not happened.) 
 
--------------------------- 
Providing Freedom of Choice 
--------------------------- 
 
¶8.  (C) Deputy Prime Minister (DPM) Chalabi recently told us 
that the GOI plans to monetize the PDS, giving Iraqis the 
opportunity to procure what they believe they need and 
spurring private-sector development in areas that the market 
(and not the government) dictates.  Minister of Planning 
Barhim Salih has echoed this position to Embassy officials, 
and MoT Chief of Staff Azad has told us the MoT is conducting 
studies in Dahuk and Muthana provinces to determine whether 
or not Iraqis would embrace monetization.  In any case, we 
believe that PDS monetization would be a long and difficult 
process. 
 
¶9.  (SBU) According to recent Baghdad market prices, the 
annual cost to the GOI to provide every Iraqi with the 
monetary equivalent of a PDS basket would be approximately 
$2.7 billion.  Embassy supports the monetization decision and 
believes that the GOI should monetize gradually, starting in 
a province where private food distribution and marketing 
channels are already fairly strong, and then expanding to 
other provinces over time.  As the monetization program 
spreads, the GOI will likely need to continue providing 
flour, rice, sugar, and cooking oil to the provinces where 
monetization has not yet been implemented. 
 
 
BAGHDAD 00001286  003 OF 004 
 
 
¶10.  (C) The GOI recently completed a "catch-up" voucher 
program, through which they compensated all Iraqi households 
 
for food shortages from January through August 2005.  The GOI 
distributed approximately $450 million through over four 
million vouchers, which Iraqis cashed at the nearest branch 
of the Rafidan or Rashid state-owned bank.  According to 
Embassy, DFID, and GOI officials, the program was successful, 
despite glitches in a few cities.  DPM Chalabi said the 
program demonstrated the GOI's ability to monetize the PDS 
successfully. 
 
¶11.  (C) According to USAID's Agriculture Reconstruction and 
Development Program in Iraq (ARDI), most of Iraq's retail 
markets would likely be capable of providing sufficient 
quantities of most PDS items in the absence of a 
government-operated PDS.  The main exception would possibly 
be flour.  Embassy Econ has collected market surveys that 
monitor price and availability of PDS items across Iraq, and, 
though the December fuel-price increases have caused food 
prices to go up in some areas, most PDS items have been 
readily available during "spot" surveys.  It is uncertain how 
much of the local markets' food comes from PDS items sold 
into the market by undesiring recipients or corrupt MoT 
officials. 
 
¶12.  (C) As the GOI gradually discontinues procuring immense 
amounts of food, initially there may be supply shortages and 
price spikes in certain areas as private markets become fully 
functional.  DPM Chalabi has said that the GOI plans to 
maintain reserves of flour and rice to sell on the open 
market at predetermined price marks (above market prices) to 
help hedge against food-price inflation.  Embassy supports 
this action and believes that the GOI should also maintain 
reserves of cooking oil and sugar because there is no 
domestic production of these key PDS items.  The GOI could 
also distribute the reserves to impoverished areas if food 
shortages occur. 
 
--------------------------------- 
Encouraging Private-Sector Growth 
--------------------------------- 
 
¶13.  (C) DPM Chalabi told us that he has instructed the MoT 
to procure domestically as much of its flour and rice 
reserves as possible, exhausting all Iraqi procurement 
options before turning to foreign suppliers.  MoT Chief of 
Staff Azad confirms that the MoT follows this policy.  Iraq's 
population is projected to grow to 43 million by 2030, and it 
will need to import food supplies for the foreseeable future; 
however, this policy of maximizing domestic procurement will 
encourage Iraqi farmers to produce more wheat and rice, 
traditionally strong agricultural products for Iraq.  It will 
also indirectly encourage private-sector development in 
Iraq's food distribution and marketing channels. 
 
¶14.  (U) Embassy PDS Reform Team will encourage the GOI to 
institute additional policies and programs to encourage 
private-sector development in Iraq's food distribution and 
marketing channels.  One way would be for the GOI to sell its 
imported wheat to Iraq's 120 privately-owned flour mills, and 
for millers to in turn make a market in the flour they 
produce through developing private-sector distribution 
channels.  Currently, the MoT provides wheat and pays the 
mills to produce flour, which the MoT then distributes 
through the PDS.  Another way for the GOI to encourage 
private-sector growth would be to target loan programs to 
entrepreneurs who want to establish small- to medium-sized 
food-processing or distribution companies.  The GOI could 
also use the savings from the declining PDS budget to improve 
infrastructure and support programs that would contribute to 
improved private-sector activity. 
 
------------------- 
Eliminating the PDS 
------------------- 
 
¶15.  (C) The GOI has said it intends to eliminate the PDS 
over a four-year period, gradually drawing down the budget as 
food production, processing, and distribution strengthen and 
freeing up resources for increased public investment. 
Several GOI officials, including Finance Minister Allawi, 
have said the PDS budget should be cut by 25 percent per year 
for four years and then eliminated.  The 25 percent budget 
reduction from 2005 to 2006 supports the seriousness of these 
official statements.  (Note:  The PDS budget was also cut by 
20 percent from 2004 to 2005.  End note.) 
 
¶16.  (U) PDS expenditure is not mandated as an economic 
reform by the International Monetary Fund (IMF).  This is a 
reform that exceeds what the IMF has asked for (reform 
through "enhanced financial monitoring and improved 
procurement procedures") and demonstrates a progressive 
 
BAGHDAD 00001286  004 OF 004 
 
 
attitude by some Iraqi leaders toward subsidy reforms. 
 
 
-------------------------- 
Educating the Iraqi Public 
-------------------------- 
 
¶17.  (U) As the GOI reforms and eventually eliminates the 
multi-billion dollar PDS subsidy, Embassy will encourage the 
GOI to link the recently implemented Social Safety Net to PDS 
reform in the public mind.  This new Safety Net is intended 
to protect the poorest Iraqis as economic reforms are 
implemented, and, according to Iraqi public affairs 
officials, Iraqis will not be supportive of subsidy 
reductions unless they believe the Safety Net works.  We will 
also encourage the GOI to educate average Iraqis on how 
corruption and inefficiency have plagued the PDS system, 
outweighing any benefits. 
 
¶18.  (SBU) Embassy Econ and the MoF co-chair the Economic 
Reform Public Education Working Group, which also includes 
Embassy Public Affairs, Treasury, USAID, DFID, the Iraqi 
Government Communications Directorate (GCD), and 
representatives from most Iraqi ministries.  PDS reform 
public-education messages could be coordinated effectively 
through this working group, which is currently developing and 
delivering public messages to support fuel-subsidy reductions 
and anti-corruption efforts. 
 
-------------------------------------- 
Comment:  Stopping the Cultural Damage 
-------------------------------------- 
 
¶19.  (C) Two of the main impediments to Iraq's development of 
a healthy market-driven economy are massive government 
subsidies and endemic government corruption.  The PDS 
contributes significantly to both of these.  Most critically, 
however, there is no objective measure for how damaging the 
current PDS is (and has been) to Iraq's development into a 
free and democratic society.  As long as the GOI continues to 
pour billions of dollars into the PDS, average Iraqis will be 
faced with a corrupt government bureaucracy that saps 
personal initiative without supplying any real benefit to the 
population.  As MoT Chief of Staff Azad has told us:  "We do 
not want to teach the Iraqi people to be lazy."  To achieve 
the transparency and citizen self-reliance necessary for 
successful democratic government, the GOI should eliminate 
the PDS and continue to strengthen the new Social Safety Net 
that supports Iraq's truly needy. 
 
¶20.  (U) We will do everything in our power to encourage the 
new Iraqi government to continue the PDS reform policies of 
its predecessor, following the established principles of 
cutting "nonessential" items, providing freedom of choice 
through monetization, encouraging private-sector growth, 
gradually eliminating the PDS, and educating the Iraqi 
citizenry. 
KHALILZAD