Iraq

Oil disruptions driving a sharp contraction ahead of recovery in 2027

The Iraqi economy will record a sharp contraction in 2026 as disruptions to oil production (around 60% of GDP) and exports (around 90% of goods exports) caused by the regional conflict and traffic restrictions through the Strait of Hormuz weigh heavily. Following a decrease to 268 million barrels in the first half of 2026, compared with 606 million barrels a year earlier, total oil exports are projected to contract by about 40% in 2026 (despite higher prices) and increase significantly in 2027. Consequently, oil production is also projected to decline by nearly 30% to around 3.1 million barrels per day (b/d) in 2026, despite a gradual recovery in the second half of the year, before an estimated rise to around 4.5 million b/d in 2027. The sharp rebound in oil production and exports projected for 2027 can be mainly attributed to the anticipated easing of the shocks that disrupted the sector in 2026. While the regional conflict and resulting export restrictions have significantly curtailed production and export volumes, oil fields and production infrastructure largely remain intact. Oil output is expected to recover rapidly as export channels normalise and production gradually converges towards the OPEC+ target. Iraq's OPEC+ crude oil production quota currently stands at approximately 4.4 million b/d. As a result of recent OPEC+ decisions, Iraq's allocation gradually increased from around 4.1 million b/d at the beginning of 2026, supporting a recovery in oil production.

A substantial gap exists between official and parallel market exchange rates. While the Central Bank of Iraq continues to maintain the official exchange rate at around IQD 1,300 per USD, the dinar trades at approximately IQD 1,500-1,550 per USD on the parallel market. The spread reflects ongoing difficulty in accessing the official foreign exchange market, strong demand for cash dollars and the durably large-scale quantity of informal transactions. Nevertheless, recent reforms have contributed to a gradual narrowing of the gap. Key measures include tighter anti-money laundering and compliance requirements, the development of electronic payment systems and greater reliance on formal banking channels for trade finance and cross-border transactions. We expect the CBI to leave its policy rate unchanged at 5.5% at end-2026. In Iraq, where cash transactions and informality dominate economic activity, interest rate changes have only a modest effect on demand and inflation. Consequently, exchange rate management and liquidity tools are likely to remain the main anchors of monetary policy. Monetary policy will remain primarily focused on preserving exchange rate stability. The sharp decline in oil exports has significantly reduced foreign exchange inflows, thereby increasing reliance on the central bank’s reserves to support the dinar peg. The Bank’s foreign exchange reserves fell from a peak of around USD 102 billion in February 2026 to USD 86 billion at end-June.

Volatility in oil exports and prices will weigh on fiscal and external balances

The fiscal deficit will widen considerably in 2026 as the sharp decline in oil production and exports significantly will reduce government revenues (hydrocarbons account for around 90% of fiscal revenues). The impact is amplified by the rigid expenditure structure, particularly the large public sector wage bill (nearly 40% of fiscal expenditure), pensions and social transfers, leaving capital expenditure as the main area for adjustment. The fiscal position is expected to improve in 2027, driven primarily by the forecast normalisation of oil production and export volumes. Deficit financing has relied mainly on domestic channels, notably state-owned banks and, to a lesser extent, the central bank, supplemented by the accumulation of arrears during periods of fiscal stress. The composition of public debt is therefore weighted towards domestic debt and reflects Iraq's oil-based revenues, underdeveloped capital markets and limited recourse to external borrowing.

Disruptions to oil production and exports will push the current account into deficit in 2026. Although higher global oil prices will provide some measure of support, the steep decline in export volumes is expected to more than wipe out the price effect. In 2027, the current account balance is expected to return to a surplus, supported by the anticipated normalisation of oil production and exports volumes permitted by a normalisation of shipping through the Strait of Hormuz. This effect could be reinforced by a higher use of the Kirkuk-Ceyhan (Türkiye) pipe, if oil output from Kurdish fields increases, and the gradual restoration of alternative export routes such as the northern pipeline to Fishkhabur near the Turkish border providing access to Kirkuk-Ceyhan pipe. Meanwhile efforts to develop additional export corridors through Türkiye and Syria should gradually reduce its dependence on Gulf shipping over the medium term, although most of these projects are unlikely to provide substantial additional capacity in 2027.

Domestic uncertainty will prevail amid a volatile regional climate

Iraq’s political and security outlook is set to remain highly uncertain. Risks are likely to stay elevated through 2027 due to the exceptionally volatile regional environment which is exacerbating domestic political fragmentation. Domestically, the fragmented nature of the political system and the continued influence of armed groups outside the government’s full control remain important sources of vulnerability. Current Prime Minister Ali al-Zaidi took office in May 2026. He was appointed as a consensus candidate by the Coordination Framework, the principal group in Parliament. His government faces the difficult task of preserving political cohesion while managing the economic consequences of the conflict, preventing domestic factions from drawing Iraq more directly into regional hostilities and addressing economic challenges such as securing reliable electricity and gas supplies. The trajectory will depend heavily on how the regional conflict pans out, which makes it difficult to count on an outright improvement in Iraq’s political stability, even under an economic recovery scenario.

Externally, Iraq will continue to face a delicate balancing act between warring Iran and the US. While Iran retains considerable political, economic and security influence, relations with the US remain crucial for security cooperation, hydrocarbon development and access to the international dollar-based financial system. The planned completion of the US-led coalition’s military withdrawal by end-September 2026 will mark an important shift in Iraq-US security relations, rather than an end to bilateral cooperation. The transition is expected to be accompanied by continued US pressure on Iraq to bring Iran-aligned militias under state control and curb Iran-related financial and trade flows. At the same time, Türkiye is becoming increasingly important as an economic and strategic partner, particularly for trade, infrastructure and alternative oil-export routes through its port of Ceyhan. Relations with Syria could also improve gradually, especially through cross-border trade and potential energy links to the Mediterranean, although security and political uncertainty may limit near-term progress. Economic ties with China will also remain strategically important. China is Iraq’s largest trading partner and one of the main buyers of its crude, while Chinese companies have a significant presence in the country’s oil, power and infrastructure sectors. A recovery in Iraqi oil exports should therefore reinforce bilateral trade in 2027 while Chinese investment could play an important role in energy capacity and reconstruction in Iraq.

Last updated: September 2026