Iraqi finances will remain under pressure

Iraqi Prime Minister Mustafa al-Kadhimi closed off what was an extremely challenging year for Iraq by implementing the country’s first currency devaluation since 2003 in December, pegging the dinar at IQD 1,460/USD. This is some 20% weaker than its previous level, a move which will exert downward pressure on household spending power as goods imports will become more expensive. Given that this could potentially lead to renewed unrest of the sort already seen over the past several years – and which arguably brought Kadhimi to power in the first place – its adoption is indicative of the severe pressures the Iraqi economy has been under. It has struggled with both the direct effects of the Covid-19 pandemic, and also the secondary impact of depressed oil prices and associated OPEC+ mandated production curbs. The devaluation will help the government’s fiscal position, but given ongoing pressures and plans to boost spending in 2021, the fiscal balance will remain parlous.

Heavy exposure to oil has cost economy dear in 2020

There are few economies more exposed to fluctuations in the oil markets than Iraq, where the commodity accounts for over 95% of exports, over 90% of government revenues, and some two thirds of GDP. Coupled with the security challenges of recent decades and the resultant infrastructure deficit – in particular there remain significant reconstruction needs following the ISIS civil war – Iraq was especially poorly placed to cope with the fallout of 2020. Oil exports in the second quarter fell 60% y/y as a collapse in global demand weighed on prices, and while prices ticked up modestly in the third quarter, production curbs will have offset any gains from this. Iraq missed its OPEC+ targets earlier in the year, but a pledge to make up for this subsequently saw average production drop to an average 3.7m b/d in Q3, compared to 4.2m b/d in Q2.

Oil production (b/d '000) will remain off previous levels

Source: Bloomberg, Emirates NBD Research

These diminished oil revenues led to a sharp expansion to the fiscal deficit, which we estimate to have widened to -15.6% of GDP in 2020, compared with just -1.9% the previous year. The squeeze on government finances caused delays to public servants’ salary disbursements on two separate occasions last year, and the outlook is only marginally better in 2021. We do forecast higher oil prices, projecting an average USD 50/b over the year (compared with USD 43.2/b) in 2020, but the extension of OPEC+ production curbs will continue to weigh on Iraq’s FX inflows. The devaluation will go some way to shoring up government finances as it will boost its relative income in dinar terms, but a planned budget expansion to IQD 150tn and government-projected deficit of IQD 65tn would mean a fiscal shortfall equivalent to an even wider 21.9% of GDP in 2021.

In another signal of just how desperate for cash Iraq has become, in early January the country signed a USD 2bn prepayment oil deal with Chinese firm ZenHua Oil after Iraq announced it was looking for bidders towards the close of 2020. The deal provides for around 130,000 b/d over a period of five years. Given the high yields any eurobond issuance would likely attract, and questions over further devaluations likely giving local debt investors pause, the prepay oil deals could prove an attractive lifeline for Iraq.

Growth will remain weak

While the devaluation was the most headline grabbing, it was far from the only major policy announcement from the government at year-end. The 2021 budget approved by the cabinet in December also provisioned for a new tax on mid-level and senior public servants, which will further weigh on middle class spending power. This is part of broader plans to try and slim down the public sector payroll which has been a major drain on government finances. However, coupled with the negative effects of devaluation-induced inflation, private consumption will remain under pressure in 2021 even as Covid-19-related restrictions recede. In GVA terms, wholesale & retail trade, hotels & others declined -8.4% y/y over the first three quarters of the year. Alongside a -10.9% decline in the oil sector, we estimate that Iraq saw a real GDP contraction of -12.5% in 2020. In 2021 we anticipate that growth will return, but at a projected 3.1% it will remain weak, and the economy will remain substantially smaller than it was in 2019.