Improved oil prices and devaluation could help Iraq's financial stability, IIF says

Iraq's economy shrank by 11.2 per cent last year – the country's worst performance since 2003 – as it dealt with the twin shocks of low oil prices and the Covid-19 pandemic, according to the Institute of International Finance.

These two factors, combined with ongoing political instability in the country, led to Iraq's budget deficit swelling to 15.6 per cent of gross domestic product in 2020 and a sharp decline in its official reserves, a report from the institute's chief Mena economist Garbis Iradian said.

However, a modest oil price recovery and the recent devaluation of the Iraqi dinar could put the country finances on a more sustainable footing, it added.

“We expect the fiscal deficit to narrow from 16 per cent of GDP in 2020 to 8 per cent in 2021 if oil prices average $47 per barrel and under 1 per cent if oil prices average $57 per barrel in 2021,” the IIF report said. “The devaluation alone would improve the fiscal balance by 5 per cent of GDP due to much higher oil revenues in Iraqi dinars.”

Iraq, a major oil producer, devalued its currency by about 23 per cent against the US dollar on December 20. The Central Bank of Iraq set the exchange rate at 1,450 dinars per dollar, from a peg of 1,182 dinars, for sales to the finance ministry. The dinar is being sold to the public at 1,470 and to other banks at 1,460.

As the economy improves, spending is also projected to increase 10 per cent in 2021, "driven by the recovery in capital spending, which was cut by half in 2020,” the IIF report said.

More public investment is needed to repair war-damaged infrastructure and enhance the provision of basic public services, including electricity, the institute said.

Current spending also needs to be reoriented to targeted sectors such as health, and less on wages and pensions, which account for 65 per cent of total expenditure, according to the report.

“In the context of prolonged low oil prices, if spending on wages and pensions remains elevated then the fiscal deficit will remain large and the government will not be able to allocate additional needed resources for spending on infrastructure and health,” it said.

Oil revenues play a major role in Iraq’s economy, accounting for 65 per cent of GDP and 95 per cent of total exports. Iraq is Opec's second-largest producer.

Oil prices have recovered in the last few weeks due to production curbs by Opec and its allies. Saudi Arabia also announced a surprise unilateral one million barrels per day production cut in February and March to support oil markets.

The Washington-based institute expects Iraq's real oil GDP to grow at 1.6 per cent in 2021 due to higher oil exports. Non-oil GDP will grow 3.1 per cent on the back of a recovery in public investment, it said.

Iraq’s economy is dominated by the public sector which encompasses more than 160 "inefficient" state-owned enterprises and employs a large portion of the workforce outside the oil industry.

“Widespread corruption, a weak regulatory framework, and a poor business environment continue to inhibit private sector development, job creation, and higher FDI inflows,” it said.

Iraq’s equally unfavourable ranking in the World Bank’s Doing Business report (171st out of 190 countries) is also an issue and reflects "large difficulties for businesses to obtain credit, access electricity, trade, and protect their rights in court," it said.

Streamlining business regulations and affirming investor rights would help to improve its ranking, the institute said.

In 2020, coronavirus cases and deaths in Iraq were among the highest in the Middle East and North Africa region, as authorities were unable to enforce social distancing or the wearing of masks. As of Saturday, Iraq has recorded 12,984 deaths from the pandemic and more than 612,000 cases, according to Worldometer.