Islamic State struggles to maintain economic viability

Saadi Abdul-Rahman was recently forced to pull his three children out of school in the Iraqi city of Mosul, where Islamic State (IS, formerly known as ISIS) militants have ruled with an iron fist since June. The cost of living has soared there, and the family is barely able to make ends meet, even after putting the kids to work.

"We are not able to pay for cooking gas, kerosene and food," laments the 56-year-old retired government worker. "The situation in Mosul is miserable."

The economy in the self-styled "caliphate" declared by IS bridging Iraq and Syria is starting to show signs of strain. Prices of most staples have more than doubled as coalition airstrikes make it difficult for products to move in and out of militant strongholds, leading to shortages, price-gouging and the creation of black markets.

Resentment has grown among residents under the rule of the extremists, who initially won support with their ability to deliver services.

In the early days of its rule, IS subsidised food and gas prices through the wealth it accumulated from oil smuggling, extortion and ransom demands. They sold their smuggled oil at a discount - $25 to $60 a barrel for oil that normally cost $100 a barrel or more, according to analysts and government officials.

The situation in Mosul is miserable. - Saadi Abdul-Rahman, Mosul resident

But in recent weeks, prices have soared in militant-held cities. Items like kerosene, used for heating and cooking, are in short supply, while others, such as alcohol and cigarettes, strictly banned by the group, are making a comeback at higher prices on the black market.

Smoking is a punishable offence in militant-held Mosul. But at a warehouse on the outskirts of the city, cigarettes, as well as hard-to-come-by essentials like kerosen, can be found at hugely inflated prices on a black market run by the extremists. There, a pack of cigarettes sells for 30,000 dinars - the equivalent of $26 - more than double the pre-caliphate price, according to residents who spoke on condition of anonymity for fear of reprisals.

The militants "are developing an unsustainable economy," said Paul Sullivan, an expert on Middle East economies at the National Defence University in Washington. "Eventually the costs of keeping the subsidies and price controls going will overpower their smuggling funds, which are also used for offensive and defensive actions."

"They can collect taxes, extort money, and so forth," he said. "But that will likely not be enough in the long run to keep such an unbalanced economic system going."

In the Syrian city of Raqqa, the extremists' so-called capital, the breakdown of security along the border with Iraq in areas under IS control has led to flourishing trade with Mosul. Trucks are also able to access the city from Turkey, allowing for a steady supply of fruit and vegetables, wheat and textiles. However, the cost of living has surged since US-led airstrikes began in September, and power and water cuts grew more frequent, residents said.

In addition, the strict social laws imposed by the group have been very bad for business, said Bari Abdelatif, an activist in the IS-controlled town of al-Bab in Syria's northern Aleppo province. But, he said, foreign fighters were bringing with them lots of hard currency, making up somewhat for the shortfall.

Last month, Abu Bakr al-Baghdadi, the leader of IS, decreed the minting of gold, silver and copper coins for the militants' own currency - the Islamic dinar - to "change the tyrannical monetary system" modelled on Western economies. But trade in most militant-held cities continues to be in Iraqi dinars and US dollars.

The start of winter has led to serious shortages of gasoline and kerosene. The official price for a litre of petrol in government-controlled areas of Iraq is 450 dinars (40 cents) - but in Mosul, it sells for four times that. Two hundred-litre barrels of kerosene are now sold in Mosul for 250,000 dinars ($220), versus the official price of 30,000 dinars.

In the western Iraqi city of Fallujah, under militant control for almost a year, residents have started cutting trees for firewood because kerosene is in such short supply. The city is surrounded by government troops and near-daily shelling often make parts of town too dangerous to visit.

Food and fuel prices have risen sharply as a result - a 50-kilo sack of rice costs 75,000 dinars ($65), up from 10,000 ($9) three months ago. A cylinder of cooking gas goes from 140,000 dinars ($115).

That has put many staples out of reach for Abdul-Rahman and his family in Mosul, even with the additional money brought in by his sons, who left school to drive a taxi and work in a restaurant.

A number of factors are driving the shortages and price hikes, according to residents in Mosul and Fallujah, the group's biggest Iraqi strongholds. The militants have imposed a tax on vehicles entering their territory, leading to a decline in business. Deliveries are also subject to militant theft, and coalition airstrikes and military operations make many roads impassable.

As a result, the trip from the Turkish border to Mosul took four hours prior to the militant takeover. Now, a delivery truck can spend as much as a week traveling the same road, and will pay a tax of as much as $300 for entry into Mosul, residents said.

According to Luay al-Khateeb, director of the Iraqi Energy Institute and a visiting fellow at the Brookings Doha Center, the population of the areas under IS control in Iraq and Syria is 6.5 million to 8 million people.

Our business and means for living are in ruins now. - Mohammed Abdullah, Mosul shopowner

"They need 150,000 barrels (of crude) a day just to meet local consumption," he said. "And that is the bare minimum to meet the demands for transportation, bakeries, power generation."

"That doesn't mean they have access to such supply," he added.

Last month, the militants shut down mobile phone service in Mosul, claiming that residents were tipping off US-led airstrikes to their whereabouts. Mobile phone signals have not been restored, causing the city to come to a virtual standstill. Workshops, factories and markets are closed and bitterness is growing among business owners.

"Most money-transfer operations are done by mobile calls," said Osama Abdul-Aziz, the owner of a money-transfer office in Mosul. "We have the option of using the Internet, but this method is very slow and sometimes the Internet does not work at all, which causes big delays to our work."

At Mohammed Abdullah's shop in Mosul, the pile of mobile phone scratch cards is growing higher by the day. "Our business and means for living are in ruins now," he said.