Iraq needs fiscal discipline and reforms to maintain growth momentum, IMF says

Country’s fiscal expansion plans pose further economic risk and can stoke inflation

An oil refinery on the outskirts of Karbala, Iraq. The IMF says Opec’s second-largest crude producer needs to boost its economic resilience. AFP

Iraq needs fiscal discipline and wide-ranging structural reforms to reduce its economic vulnerabilities as foreign exchange market volatility and a drop in crude production continue to slow its growth momentum, the International Monetary Fund has said.

Opec’s second-largest oil producer needs to boost economic resilience to achieve its inclusive growth targets.

However, its fiscal expansion plans pose risks and could stoke inflation further, the IMF said in a statement at the conclusion of a staff-level discussion with Iraq.

Inflation in the country, which hit 7 per cent in January, is projected to average 5.6 per cent in 2023, said IMF mission chief Tokhir Mirzoev, who met Iraqi officials in the Jordanian capital, Amman, last week.

After recovering to its pre-coronavirus level last year, oil production is expected to contract by 5 per cent in 2023 as Iraq complies with Opec+ production cuts and partly due to the effect of the closure of the Kirkuk-Ceyhan oil pipeline.

Foreign exchange market volatility, in the wake of tighter anti-money laundering controls by the Central Bank of Iraq, has “adversely affected import-dependent non-oil sectors”, the IMF said.

Earlier this month, the Iraqi Interior Ministry banned people from dealing in US dollars in the latest move to control a fluctuating black market exchange rate.

The announcement reflects an attempt to close the gap between the official exchange rate and the black market, which has stoked inflation and caused public outrage.

The First Gulf War in 1991, followed by harsh UN-imposed economic sanctions and the US-led invasion in 2003, caused a substantial devaluation of the Iraqi dinar.

As a result, Iraqis have turned to the US dollar. A wide range of dealings, from wholesale trading to retail purchases, are settled using the greenback.

Iraq, which relies heavily on the sale of hydrocarbons for revenue, has struggled to maintain growth momentum despite favourable oil market conditions last year.

The IMF estimates that its real non-oil economy contracted by 9 per cent on an annual basis in the last quarter of 2022, “negating its growth during the previous three quarters”.

It expects real gross domestic product to expand by 3.7 per cent in 2023.

However, authorities’ fiscal loosening plans laid out in the draft 2023 budget law would widen the non-oil primary fiscal deficit further to 75 per cent of non-oil GDP and bring the overall fiscal balance to a deficit of 6.5 per cent of GDP, Mr Mirzoev said.

Shoppers at a popular market in central Baghdad. Inflation in Iraq could rise with the government's fiscal expansion plans. EPA

The combined effects of increased government spending, the exchange rate revaluation and reduced oil production would bring the fiscal break-even oil price to $96 a barrel.

“In the short run, implementation of the authorities’ fiscal plans could reignite inflation and FX market volatility,” he said.

“Over the medium term, continuation of current policies in the presence of substantial uncertainty about the future path of oil prices poses critical macroeconomic stability risks.”

Barring a large increase in oil prices, the current fiscal stance could lead to “mounting deficits and intensifying financing pressures in the coming years”, the IMF official said.

The IMF mission cautioned against the planned establishment of new extra-budgetary funds, which raise governance and efficiency concerns, and recommended that authorities adhere to on-budget government expenditures.

The fund also urged Iraq to put in place a framework to manage government guarantees, including parliamentary approval, as well as the publication of an annual ceiling and a list of government guarantees as part of the budget law.

“Accelerated efforts to establish a Treasury single account are also needed to strengthen public financial management,” the IMF said.

Creating an enabling environment for the development of the country’s private sector is critical for achieving “durable and more inclusive growth”.

Iraq should also prioritise efforts to boost governance and reduce corruption, as well as restructure large state-owned banks to improve access to financing and reform its labour market to promote private sector job creation, the fund said.