Improving oil outlook will boost Iraqi economy

With most of the vote now counted, Iraq’s post-election horse-trading can begin, with Muqtada al-Sadr’s Sadrist movement having secured the most seats and likely to be able to take a determining stance in forming Iraq’s new government. Whatever the form the new government takes, it will have to deal with persistent economic challenges, and try to win over a disillusioned population following a record low turnout in Sunday’s general election (41%). We anticipate that real GDP growth will have remained very weak this year with a forecast of 1.1% following 2020’s double-digit contraction, weighed down by OPEC+ oil production curbs and the ongoing Covid-19 pandemic. This will accelerate to 5.3% next year on the back of higher oil production and easing pandemic pressures, but with elevated inflation and ongoing power shortages, the non-oil sector will remain vulnerable.

Real GDP growth, % y/y

Source: UN, Emirates NBD Research

The new government will benefit from rising oil prices that should alleviate some of the pressures on its finances, and easing production curbs that will provide a real boost to the economy. In terms of production, output averaged 4.0mn b/d over the first nine months of this year, down -4.9% on the same period in 2020, as the OPEC+ wider oil producers bloc looked to shore up prices by curbing output in the face of weak demand. With oil still accounting for the bulk of the Iraqi economy (around two thirds), any cut in output exerts a major drag on GDP growth. However, going into the final quarter of the year, the OPEC+ agreement to boost output by 400,000 b/d will provide a fillip to Iraqi growth through Q4 and into 2022. Already production has risen to 4.1mn b/d in August and September.

Oil production, b/d '000

Source: Bloomberg, Emirates NBD Research

At the same time, prices have taken a leg higher, and while we do not expect them to remain at the present multi-year highs of over USD 80/b, our forecast that Brent will average USD 68/b next year is an upgrade from our previous projection of USD 65/b. Alongside greater output, this will help Iraq to balance the books. Accounting for over 95% of exports, the boost this year will help bring Iraq’s current account deficit back into surplus after falling to -2.6% of GDP last year. We forecast a surplus of 7.5% this year and 7.8% in 2022 which should limit the need for any more currency devaluations of the like seen in December 2020 when the IQD was moved to a fixed rate with the dollar about 23% lower than it had previously.

International reserves, IQD mn

Source: Bloomberg, Emirates NBD Research

While the devaluation helped stem the decline in the central bank’s reserves, it also served to fuel inflation, and was widely unpopular as it added further pressure to already constrained household finances. Price growth had climbed to 7.4% y/y by July and averaged 5.9% over the first seven months of 2021, compared to a series average (from January 2016) of just 0.7%. Rising commodity and energy prices have also contributed to the rapid acceleration in price growth, even though electricity supply is unreliable, another source of grievance for many voters. We do expect that many of these price pressures will dissipate next year, falling to an average 3.0% y/y. Nevertheless, combined with the still salient threat of the coronavirus pandemic (cases are now falling but were at record levels as recently as July, while vaccination rates remain very low at just 7.3%), the outlook for the non-oil sector is not as bright as that for oil production.

CPI inflation, % y/y

Source: Haver Analytics, Emirates NBD Research

Last year Iraq’s budget deficit widened to nearly -20% of GDP, but we expect that this will narrow to -6.9% this year and -4.7% in 2022. The bulk of this will be driven by the recovery in oil revenues, with efforts to curtail expenditure on pension bills and government wages likely to have less success. In August, finance minister Ali Allawi pledged that the 2022 budget would have a ‘reform dimension’, but he noted the political constraints upon this even before the recent elections. Nevertheless, it is likely that the new government, once formed, will continue to pursue a new deal with the IMF, which would provide not only funding but also serve as a stopgap and policy anchor that would help encourage foreign investment in Iraq. Iraq’s 2028 eurobond is trading at a yield of 6.5%, a significant improvement from the 2020 spike and lower than the security’s average yield of 6.9%.

Iraq 2028, % yield

Source: Bloomberg, Emirates NBD Research