Iraq

Sluggish growth outlook amid limited policy support and oil dependence

Iraq’s economy is projected to contract mildly in 2025, reflecting ongoing oil production restrictions, low oil prices, slow development in non-oil sectors and the challenging business environment. While headline growth is expected to return to positive territory in 2026, the recovery is likely to be gradual and uneven, shaped by increased oil production, the pace of public investment, as well as domestic and regional politics. Government expenditure (20% of GDP) is expected to be the main growth driver, supported by increased public sector wage spending and capital expenditure commitments. Private consumption (45% of GDP) is projected to contribute modestly – curbed by elevated unemployment, weak consumer confidence and limited credit growth. On the external front, exports are likely to recover only marginally, being hindered by ongoing oil supply limits and uncertain global demand. Meanwhile, imports are expected to rise, driven by public investment and household demand, which could act as a drag on net exports (around 10% of GDP). As a result, the overall contribution of net trade to GDP growth in 2026 may be neutral or turn slightly negative. This composition suggests that the recovery will remain largely government-led, underscoring the importance of restoring fiscal space and enhancing public sector efficiency. Private sector activity and external trade are unlikely to offer strong support unless confidence improves and structural bottlenecks are addressed.

Inflation is forecast to remain low and stable thanks to subdued domestic demand, moderating food prices, and a relatively stable exchange rate. In January 2025, Iraq shifted all legitimate international transactions to commercial banks using formal correspondent banking channels, with the central bank supplying foreign exchange based on verified demand. This reform significantly narrowed the gap between the official and parallel exchange rates: whereas the official rate has been 1.300 dinars to one US dollar, the parallel rate was around 1.307 in August 2025, compared with 2.880 in January 2024. Continued progress depends on improving banking access and tightening controls on informal trade.

Growing fiscal pressure and narrowing buffers ahead

Iraq’s fiscal position is projected to deteriorate further, with its budget deficit widening. This erosion reflects higher government spending, particularly on wages and subsidies amid lower oil revenues. In the first five months of 2025, oil revenues comprised 91% of the federal budget, underscoring persistent oil reliance. As oil prices remain low and output is restricted by OPEC+ agreements and capacity limitations, fiscal space is narrowing, which is placing growing pressure on the government to either limit spending or accelerate long-overdue diversification efforts. The country is currently producing below its OPEC+ quota as part of the planned adjustment to compensate for past overproduction (approximately 4.03 million barrels per day (bpd), compared with its OPEC+ quota of 4.86 million bpd). As a result, public debt is set to rise above 55% of GDP by end-2026, reversing the consolidation achieved in previous years and raising concerns over fiscal sustainability in the absence of reforms. More than 80 percent of total government debt is held by domestic creditors, with a substantial share owed to the Central Bank of Iraq.

The current account surplus is expected to narrow further, as oil export revenues decline and import demand remains relatively resilient. Oil exports dominate Iraq’s total exports, typically accounting for around 90% to 95% of the country’s total export revenues. While the external position is still positive, the shrinking foreign exchange reserves leave Iraq more vulnerable to adverse oil price shocks or financing pressures, especially with limited progress on export diversification. International reserves fell gradually from around USD 100 billion at end-2024 to USD 97 billion in May 2025 (roughly equivalent to 12–18 months of imports). Iraq continues to attract significant foreign direct investment (FDIs), with inflows reaching record levels in early 2024 and total FDI stock surpassing USD 110 billion, mainly concentrated on oil and gas, but increasingly in housing, infrastructure and services. Emerging interest in agriculture and manufacturing points to growing diversification efforts.

Risky political outlook

Iraqi politics are marked by community fragmentation and the continued presence of armed groups operating outside of state control. The political landscape is highly fragmented, with power divided among Shi’a, Sunni, and Kurdish parties. Key Shi’a blocs include the Coordination Framework, which is aligned with Iran, and the influential Sadrist Movement. Sunni representation is divided between parties such as Taqaddum and Azm, while the Kurdish political arena is dominated by the rival Kurdistan Democratic Party (KDP) and Patriotic Union of Kurdistan (PUK). Coalition politics will remain critical. On that score, the upcoming parliamentary elections in November 2025 will be pivotal. As political factions realign and new alliances emerge, the outcome will influence the pace of institutional reform, and economic decision-making in 2026 and beyond. The elections are expected to be closely fought, with unresolved issues such as decentralisation, oil revenue-sharing and militia integration casting a long shadow. Given Iraq’s history of lengthy post-election negotiations, forming a new government could take months, which could delay key policy decisions and investment. However, if the electoral process is managed transparently, it could enhance political legitimacy and pave the way for gradual reform. The international community and investors will be keeping a close watch on developments.

Tensions between Baghdad and the Kurdistan Regional Government regarding oil revenue-sharing and exports are exacerbating internal instability. Corruption, unemployment and poor public services are fuelling public discontent and the potential for renewed protests. The broader regional context, with Iraq’s delicate position between Iran and the US, has added to the uncertain environment, particularly given the risk of conflict spillovers.

Iraq’s international relations are expected to continue to be shaped by their delicate balancing act between major global and regional powers. Relations with the US are expected to focus primarily on security cooperation, particularly the presence of US-led coalition troops and efforts to quell the remnants of the Islamic State. Iraq will also continue to maintain strong ties with Iran, given both countries' deep political, economic and security entanglements, ranging from energy imports to the influence of pro-Iranian militias. However, Baghdad is likely to pursue greater autonomy, seeking to avoid being drawn into US-Iranian tensions. Iraq will seek to strengthen ties with Gulf states and Türkiye through economic cooperation, trade and investment, particularly in infrastructure and energy. Instability in eastern Syria remains a key external risk as it could spill over into Iraq, particularly through porous borders and militant activity. The presence of armed groups and smuggling networks along the border will continue to present challenges to Iraqi security and border control.

Last updated:August 2025