BAGHDAD: The agreement is credit positive for Iraq because it will improve liquidity at a time of heightened fiscal and balance-of-payments risks. Iraq’s economy and government finances are suffering from the ongoing conflict with the Islamic State of Iraq and Syria (ISIS) and the steep drop in oil prices since mid-2014. The conflict has destroyed infrastructure, reduced economic activity in ISIS-occupied areas, and strained government resources, with expenditures now more heavily tilted toward military operations against ISIS. Meanwhile, lower oil prices have taken a toll on government revenues and the country’s external current account balance because oil accounts for more than 90 per cent of total government revenues and almost 100 per cent of goods exports.
The tight fiscal situation has also affected the government’s oil infrastructure development plans, which, in the absence of a recovery in oil prices, the country needs in order to increase oil receipts. The buildup of arrears to international oil companies led to subsequent downward revisions to investment budgets by about 50 per cent, rendering the government’s 2020 production target of six million barrels per day (mbpd) less attainable. Oil production averaged 4.4 mbpd in the first five months of this year, while exports averaged only 3.3 mbpd. Exports have not kept pace with production increases because of oil pipeline sabotage in the north.
With oil prices staying lower for longer and near-term export volume increases unlikely, the Stand-By Arrangement is critical for lowering external liquidity pressures. The IMF projects Iraq’s large fiscal deficit will widen further this year to 15 per cent of GDP from 14 per cent in 2015 and the current account deficit will widen to 11 per cent of GDP from 6.4 per cent over the same period. The government has financed the fiscal deficit largely from domestic banks, but also from the accumulation of domestic arrears. To fund the balance-of-payments shortfall, the authorities primarily resorted to drawing on foreign exchange reserves.
In 2015, year-over-year net foreign direct investment inflows declined by 30 per cent to $3.2 billion, and net portfolio inflows dropped by 86 per cent to about $630 million. Net other investment outflows nearly doubled to about $8.5 billion. At the same time, the country registered a current account deficit of about $10.4 billion.
The gap between the current account and the capital and financial account was largely filled by a drawdown of foreign exchange reserves, which fell by $10.5 billion in 2015. In the first five months of this year, foreign exchange reserves fell by a further $4.9 billion.
