Global trade tensions have negatively impacted growth projections for near-term oil demand, resulting in prices plummeting to their lowest level in four years before muted gains following the recent flare up in hostilities between Israel and Iran. But the increase in oil prices has largely been subdued by ample market supply and weak underlaying demand, with projections that these conditions are to extend to the end of this decade.
This is bad news for Iraq. Oil makes up almost all exports, and accounts for and contributes to around 90 per cent of government revenues. The impact of lower-for-longer oil prices risks undoing almost three years of relative macroeconomic stability. This stability has been driven by expansionary government spending on the back of steady oil revenues since 2022. Prime Minister Mohammed al-Sudani’s government has increased hiring in the public sector and invested in infrastructure projects, including roads, power plants, hospitals and even a new port that promises to place Iraq as a logistics hub linking Asia and Europe.
In its 2025 Article IV consultation with Iraq, the International Monetary Fund (IMF) concludes that ‘the large fiscal expansion in recent years has increased Iraq’s vulnerabilities, which are further exacerbated by the recent decline in oil prices.’ The assessment also states: ‘A sizable fiscal adjustment is needed to mitigate macro-fiscal risks, contain liquidity risks and stabilize debt in the medium term. In the very short term, the authorities should review current and capital spending plans for 2025 and limit or postpone all non-essential expenditure.’
Collapsing oil prices led to Iraq facing fiscal crises in the past. Downturns in 2014 and 2020 only resulted in superficial attempts at reducing the economy’s oil dependence and reforming the government’s fiscal-management practices. Facing lower oil revenues this year, the government will be reluctant to implement any reforms as the country gears up for parliamentary elections in November.
Iraq has faced multiple security challenges over the past two decades, hindering economic development and governance. The inability to adopt reforms has been a byproduct of entrenched corruption, political competition for state resources and kleptocracy. Rentierism has fuelled the redistribution of oil wealth through inefficient spending, cementing the dependence on oil at the heart of the social contract.
Absent urgent reforms and spending curbs, the government is expected to face a larger budget deficit this year, leaving it no option but to rely on domestic borrowing, which comes with multiple long-term risks. In addition to inflationary pressures and complicating the Central Bank’s efforts to maintain the exchange rate peg, domestic loans are primarily held by state-owned banks that require restructuring. Meanwhile, Iraq’s overwhelming reliance on imports also threatens its current account, adding pressure on foreign reserves currently valued at $96 billion.
Missed reform opportunities: Weathering the storm of low oil prices
Iraq may well hope to sit out this period of low oil prices like it did in the past. In 2014, it faced the twin shock of crashing oil prices and the rise of the Islamic State terrorist group, which led to a staggering deficit of around $25 billion by 2016. The government resorted to borrowing, with the IMF, the World Bank and bilateral creditors providing up to $22 billion in loans on concessionary terms.
The IMF’s $3.5 billion Stand-By Agreement (SBA) in 2016 supported expenditure, helped protect foreign reserves and provided capacity-building assistance. In return, Iraq pledged to implement various reforms over the SBA’s three-year span. The public-sector wage bill, which typically makes up most of operating spending, was to be capped. Generous subsidies and mistargeted social welfare programmes were to be reassessed.
The government also promised to diversify the economy, empower the private sector, attract investment and introduce streamlined taxation frameworks. The intent was to boost non-oil income, which typically makes up less than 10 per cent of government revenues. Iraq also promised to double its efforts to combat corruption and improve governance and administrative capacity.
The government was able to significantly cut expenditure and to preserve the currency peg. But the IMF said in 2019, just before the SBA’s expiry, that several reforms were “reversed or not enacted” while the authorities’ responses to its advice were “mixed.”
The willingness to adopt the reforms largely faded in 2018 as oil prices recovered, resulting in a revenue windfall and a build-up in foreign reserves. This is a feature of Iraq’s procyclical oil dependence, in which lower revenues drive cuts to spending, leading to discussions of reform, only for reform momentum to dissipate quickly once prices rise and revenues are plentiful. As a result of the price recovery, subsequent governments have prioritized short-term objectives, undermined accountability and perpetuated inefficient resource management.
A genuine attempt at redefining the role of state in the economy and at addressing oil dependence was made in 2020 when the Covid-19 pandemic caused a financial crisis. Finance Minister Ali Allawi led the first comprehensive and Iraqi-led initiative in this direction, introducing a White Paper that set out several short- and long-term objectives. Government liquidity was improved by devaluing the dinar, while prompt measures helped overcome the crisis.
But the White Paper was a framework for the future that lacked a step-by-step implementation plan. It also quickly lost political support after the formation of the current government in late 2022, which reversed the unpopular devaluation. The White Paper’s objectives were quietly abandoned as oil prices and revenues started rising from 2021.
Crisis meets elections: Risking long-term stability for short-term political gains
Iraq’s government has no incentive to introduce any harsh austerity measures before elections scheduled for 11 November 2025.
Instead the government is doubling down on spending. The 2023-25 federal budget guarantees expenditure to the end of 2025, limiting the lengthy, and politically contentious, parliamentary budget approval process to updating spending through amendments. Political disagreements over spending typically delay passing a budget well into the new fiscal year.
Meanwhile the number of public-sector employees now stands at more than 4.2 million, in addition to the 3 million pensioners and another 3 million beneficiaries of welfare programmes. These costs combined accounted for at least 60 per cent of the $116 billion in spending in 2024, and, coupled with the dependence on oil revenues, result in budget rigidity.
Prime Minister Sudani’s hopes for a second term rest on his ‘services government’ keeping the momentum of delivering various public infrastructure projects. Additionally, the competitive political environment as the elections approach complicates balancing fiscal responsibility with political and popular demands. An amendment to the budget this year is yet to be agreed. Maintaining high public spending does not only gain the government public support; it also benefits various political actors whose access to state resources sustains Iraq’s ethno-confessional muhasasa system. Consensus within that political power-sharing framework is also key to winning the premiership.
The government-formation process after elections is expected to last into early-2026, which will time with lower oil revenues, impacting government spending. An immediate source of additional cash flow would be resorting to domestic debt, most likely in the form of indirect financing by the Central Bank. Iraq’s domestic debt stock is estimated at more than $65 billion and, even before the recent tariff-induced oil-price decline, the IMF projected government debt to rise from 44 per cent of GDP in end-2023 to more than 86 per cent by 2029 driven by domestic borrowing.
Squaring the circle: The missing will for genuine reform
The government is likely to delay urgent reforms, leaving them to the next one. This risks exacerbating the funding crisis and complicating government formation after the elections. A more constructive path would involve amending the budget now to set realistic spending targets based on plausible oil-price scenarios.
At the core of any meaningful fiscal reform is the need to break Iraq’s habit of oil-driven, procyclical spending. The crucial missing ingredient remains the political will to prioritize long-term accountability and transparency over short-term political gains and public appeasement. The quick abandonment of the 2020 White Paper clearly illustrates this.
Since 2003, Iraq’s political system has been moulded by sectarianism and a social contract centred on state handouts and public-sector employment. As a result, necessary reforms – such as increasing tax revenues, privatising underperforming state-owned enterprises and conducting cost-benefit assessments to reduce unmaintainable subsidies and welfare programmes – are unlikely to be popular with voters.
Realistically, the structural transformation of Iraq’s economy and of the state’s role in it will require a generational shift. Approximately 60 per cent of the population is under the age of 25, yet young people remain largely excluded from political decision-making, despite a growing political awareness following protests in 2019 that were harshly repressed.
Recent banking reforms and the adoption of the Digital Payment Regulation last year should incentivize long-overdue financial consolidation and transparency. Moreover, Iraq’s recent census offers data for more targeted welfare provisions. While shrinking the public sector is politically sensitive, refraining from promises of more hiring and reforming the employment laws for the private sector could encourage the creation of more formal jobs. Empowering the Iraq Fund for Development to partner with local firms could reduce non-oil investment burdens.
In addition to continuing support for Iraq’s financial and private-sector reform agendas, its international partners – including the European Union, the G7 and the World Bank through the Iraq Economic Contact Group – should focus their efforts on raising reform awareness among the country’s youth, laying the groundwork for future grassroots-led change.
This article is part of the Reform Monitor series which provides in-depth insights into the inner-workings of Iraq’s government and evaluates what recent developments – both public and behind the scenes – reveal about the future of the Iraqi state. The Reform Monitor aims to offer policy recommendations to the Iraqi government, international policymakers, multilateral organizations, and NGOs working in Iraq to inform decision-making and programming aimed at building a more stable, accountable and prosperous Iraqi state.
The Reform Monitor series is part of the workstream on the political economy of reform, under the Middle East and North Africa Programme’s Iraq Initiative, led by project director Dr Renad Mansour.
