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Iraq’s Economic Outlook- July 2016

How is Iraq Reacting to Low Oil Prices?

Falling oil prices and civil war have increased the risk of political and fiscal instability in the country. Despite a large increase in oil production from 3.1 million b/d in 2014 to 4.3 million b/d on average in 2016 and in exports to about 3.8 million b/d in 2016 from both Basra and the Kurdish region, finances keep worsening due to the government’s pro-cyclical policy of over spending during the oil boom years, in addition to the cost of war and conflict. Oil constitutes over 90 % of government’s revenues and with prices falling from their peak of $147, the budget deficit is estimated above $30 billion in 2016.

To cope with the effects of reduced oil revenues, the government cut public spending by 40 % last year - mostly capital spending - and canceled some military contracts. The cut to public investment will affect the pace of reconstruction in areas recaptured from Daesh, and could result in worsening of sectarian tensions given that the destruction is almost entirely taking place in Sunni areas.

The government has also dipped into its foreign reserves, which are expected to fall to about $43.9 million in 2016 and $36 billion in 2017 from $66.7 billion two years ago. As a result, the Iraqi Dinar was devalued slightly by 1.37 % against the U.S. Dollar. If oil prices stay low, further devaluation of the currency may be needed.

The Kurdistan Regional Government (KRG) authorities have responded by cutting government salaries as much as 75 % for high-ranking officials and seizing funds from local branches of the Iraqi central bank. Given the sharp drop in oil revenues in the amount of $46 billion in 2015, new measures were adopted to increase public revenues including the introduction of sales taxes.