The Iraqi economy remains firmly centred around the oil and gas sector which accounts for more than 50% of GDP and 90% of the country’s industrial activity. Despite the continuing conflict with ISIS in its western provinces, oil production increased by 20% in 2016, the fastest since 2004. Average oil production reached 4.3 M bpd with 3.3 M bpd from the southern oilfields and 0.45 M bpd from Kurdistan. The introduction of two authorised oil grades for export (Basra Heavy and Basra Light blend label) and reactivation of a number of pipelines (connection of the northern oilfields to the pipeline linking Kurdistan and Turkey) allowed an increase in exported volume. Moreover, the levels of oil and gas prices had very little impact on the sector as the average cost of production was lower than the price per barrel in 2016 and major investments had been made before the oil price slump. However, oil production growth should be limited in 2017as production is expected to stabilise at 4.3 M bpd according to the Vienna Agreement set the 30 November 2016 by OPEC members. The increase in oil and gas output has masked the continuing contraction in the non-oil economy which continues to suffer from internal conflict spill over. Infrastructures’ destruction in battle area , population displacement from the war-ravaged regions, as well as multiple terror attacks in the capital Bagdad, are undermining economic activity. The recapture of Mosul could however be the green light to renewed reconstruction efforts. Any reconstruction work could however be limited by the critical state of the public finances at the federal level. A support program from the International Monetary Fund was launched in 2016 and should cover the period 2016-2019. An amount of US$ 5.4 Bn, with an initial release of US$ 1.24 Bn in July, will help provide relief for the country’s public finances.

With 80% of budget revenues from the oil and gas sector, the slump of oil and gas prices in 2016 weakened public finances. Indeed, despite the growth in production, the fall in prices automatically resulted in reduced budget revenues of 40% at a time where the state is facing an increase in its military expenditure. Oil prices recovery, coupled with higher level of production expected for 2017 (4.4 M bpd) should help budget consolidation and reducing the public deficit. The government also needs to cut subsidies and hold down state employee wages (the public sector accounts for almost 60% of jobs). Investment spending, in particular on infrastructure, will also be greatly reduced. Budget cuts are not expected to include social assistance provided for refugees as well as those displaced by the conflict. The public debt increased further in 2016 because of the scale of the public deficit and cannot be sustained. Looking at the external accounts, the current account balance deficit widened in 2016 but contract in 2017. Iraqi exports should benefits from the slow rise in prices in 2017. Nevertheless, this effect could be less beneficial than hoped if Iraq comes within the production quotas set for 2017 by OPEC.

The Iraqi security situation became extremely acute with the conquest of part of the country by Islamic State (IS). This conflict altered the balance of power and split the country into those areas held by IS, the autonomous Kurdish areas and those controlled by the federal government. The recapture of Mosul could mark the beginning of the end of this war but Iraq could emerge more divided. There are more than 4 million refugees and displaced persons. The military successes of the Iraqi army do not preclude the emergence of tensions in other areas with religious or ethnic minority groups controlling certain regions. Beyond the conflict itself, Iraq is going through a period of acute political instability. The removal of a number of Sunni ministers from the government on the grounds of corruption has revived ethnic and religious rivalries. Relations with Kurdistan remain tense and the role played by Kurdish forces in liberating part of the country has bolstered the negotiating position of the autonomous region.