The ISIS war and low oil prices since mid-2014 have severely impacted the economy. Contraction in oil production is resulting in negative overall growth in 2017, but owing to improved security the non-oil growth will turn positive after a three year decline, despite the ongoing fiscal consolidation. The government’s reform effort – but not reconstruction – is supported by a large international financing package. Growth will accelerate in 2018, sustained by higher oil production, despite persistent security risks.
The ISIS insurgency and low oil prices have severely impacted Iraq’s growth, which decelerated in 2014-15, with government non-oil investment declining by two-thirds and rapid contraction of agriculture, manufacturing and construction. Strong oil production sustained economic growth in 2016, while the OPEC agreement to cut production until March 2018 is expected to lead to a contraction in growth in 2017. Non-oil growth has been negative since 2014, but a better security situation and the benefits of an initial reconstruction effort are expected to sustain non-oil growth at 1.5 percent in 2017. The drivers are construction and services on the supply side, and pick-up in government consumption and investments on the demand side. Owing to the pegged exchange rate and subdued aggregate demand, inflation has averaged 0.4 percent in 2016 and is estimated at 2 percent in 2017.
The low oil prices and higher security and humanitarian outlays rapidly deteriorated the fiscal and external balances since 2014 in the Federal Government of Iraq (GOI) and the Kurdistan Regional Government. GOI’s overall fiscal deficit increased to 14 percent of GDP in 2016 mainly because of a 22 percent fall in oil prices in the previous year; in response, GOI is implementing a fiscal consolidation program to reduce the non-oil primary deficit. In 2017, the fiscal deficit is estimated to reach 5.1 percent of GDP owing to a small recovery in oil prices and measures to increase non-oil revenues and to contain salaries and pensions. The GOI is prioritizing its limited investment expenditure for reconstruction in areas liberated from ISIS, and to increase electricity. KRG is also implementing measures to contain expenditure and improve non-oil revenue. KRG fiscal deficit decreased by 80 percent from 2014 to 2016. Spending pressures remain high to assist IDPs and refugees.