Iraq’s economy faces brewing storm
13 May 2025
Policymakers in Baghdad are facing some tough decisions this year. A toxic mixture of external shocks – lower oil prices eroding the country’s earnings and the follow-through from US President Donald Trump’s tariff regime – and self-inflicted problems, notably the expansionary public spending associated with the 2023-25 budget, raise the prospect of recession and a spiralling of the country’s debt to alarming levels.
Prime Minister Mohammed Shia Al-Sudani’s government is going into an election year with a troubling economic inheritance. Put simply, oil prices trading at about $60 a barrel present an existential threat to a state budget for which the breakeven oil price has been set significantly higher. The Washington-based IMF sees Iraq heading into a current account deficit if prices average just $65 a barrel.
Much of this situation is structural in nature, even if the situation has been rendered more acute by the consequences of the government’s high-spending budget of June 2023.
“The most material credit constraint for Iraq remains the longstanding reliance on the hydrocarbons sector of the economy, government finances – more than 90% of government revenue stems from oil – and external accounts, exposing the sovereign to declines in global oil demand and prices,” says Mickael Gondrand, assistant vice president and analyst at Moody’s Investors Service.
Weak public expenditure controls, and a tendency to increase spending in a procyclical manner when oil revenue rises – as observed through the expansionary triennial budget for 2023-25, which hiked current spending by 21.5% – have further amplified this vulnerability to oil price shocks.
Not that the government is panicking just yet. As Gondrand points out, the Central Bank of Iraq's foreign-exchange reserve position, at $84bn or about a third of GDP as of January 2025, provides a degree of resilience against external shocks.
Yet those external shocks are growing more acute as a result of the ripple effects flowing from Trump’s Liberation Day tariff announcement.
Unsupported spending
What makes the situation particularly challenging is that Iraq has entered into a declining oil market on the back of very high fiscal expenditure. Oxford Economics, a consultancy, puts the fiscal breakeven price for the budget this year at $110 a barrel. That is a significant jump from just $68 a barrel in 2022.
“Looking at the oil price going forward, there's no way that they can cover their fiscal deficit. Oxford Economics expects the accumulated funding gap for 2025-27 will reach $230bn, which is the equivalent to around 140% of Iraq's 2023 nominal GDP,” says Tianchen Peng, an economist at Oxford Economics.
This will exert a massive impact on Iraq’s fiscal balance, and will translate into more domestic debt issuance, fuelling concerns about a full-blown foreign exchange liquidity crisis happening in the next couple of years.
There is now a policymaking dilemma facing Iraq’s political leaders, who are under pressure to keep increasing fiscal expenditure in exchange for public support. In this context, the political calculus in Baghdad will be to drive up spending rather than de-escalate.
“The economic growth methodology is for the government to spend on hiring more people into the public agencies, and making the government become the country’s economic engine. That is leading Iraq into a fiscal trap,” says Peng.
Meanwhile, modelling by Oxford Economics shows that if the government starts to cap the fiscal expenditure now, it could avoid such a crisis. However, if this is only enacted after the election, in the 2026-27 period, it could be too late.
Capital spending risk
The other danger associated with delaying an attempt to address state finances is that, with public sector wages and pensions absorbing upwards of 40% of the country’s budget outlays, there is a squeeze on the amount needed for investment in growth-oriented projects. With salaries and benefits ringfenced, the only route for keeping spending under control would be to lower public investment.
Such expenditure restraints could bring non-operational spending to a halt, notably the logistics corridor plans set out in the Development Road project, a Turkish-backed regional cross-border scheme that positions Iraq as a major geo-economic hub between East and West. With phases one and two of the estimated $17bn-$20bn scheme due for completion in 2028 and 2033, Iraq will need to secure funding for this road, rail and ports project soon.
“The Development Road project is a positive the Iraqi economy, and will contribute to stability. But if Iraq experiences fiscal stress, then it definitely will impact the progress of that project. It may not be the life saver of the Iraq economy that the government hopes,” says Peng.
Alongside the Development Road stands the Basra-based Gas Growth Integrated Project (GGIP), a TotalEnergies-backed scheme that aims to unlock associated gas, eliminate gas flaring and develop 1GW of solar power.
On this front, there may be room for guarded optimism. In April, the government approved two major energy contracts that form part of the GGIP, one of which is to develop the Ratawi gas field, which is also known as the Artawi field.
Building up Iraq’s untapped gas potential is central to the authorities’ ambition to end the expensive and inefficient current method of importing gas and power from Iran, with unreliable access to electricity proving a constraint to growth in the non-oil sector.
“Imports of Iranian gas remain critical to supporting Iraq’s strained electricity generation capacity, particularly during the annual summer demand surges,” says Moody’s Gondrand.
In March 2025, the US suspended its rolling waiver to Iraq for the import of Iranian electricity, but a waiver for gas imports remains in place.
“The government has sought alternative supply sources – for example by targeting greater integration into the GCC electric grid – and has also announced several large-scale energy investment projects in recent years. Progress on these projects would help diversify Iraq’s sources of energy, reduce reliance on costly gas imports and allow greater utilisation of gas that would otherwise be flared,” says Gondrand.
However, diversifying energy supplies will take time and require additional infrastructure, while many investment projects are still at an early phase.
Few would want to be in Prime Minister Al-Sudani’s position when he is forced to inflict some necessary pain on the Iraqi public sector in a bid to ensure that a looming fiscal and foreign exchange market crisis can be averted.
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