Iraq is currently navigating tumultuous waters due to the ongoing Middle East conflict, which has transformed its landscape of security and economics. Since February 28, the nation has become a secondary battleground for hostilities between the U.S. and Iran, putting it in a precarious position as it plays host to factions that are at odds with one another. This complex web of geopolitical tensions makes Iraq particularly vulnerable, with both U.S. military forces and Iranian-backed militias operating within its borders. Such dynamics have led to a surge in attacks against U.S. assets, government entities, civilian targets, and energy facilities. Furthermore, Iran-aligned militias have leveraged Iraqi territory to target neighboring countries, including recent assaults on the United Arab Emirates and Saudi Arabia.
Geopolitical Tensions and Economic Vulnerabilities
The regional discord is magnifying Iraq’s inherent state vulnerabilities, highlighting serious deficiencies in its institutional and security frameworks. The ongoing conflict is exacerbating the economic fallout from the closure of the Strait of Hormuz, a critical artery for global oil transport. Unlike the UAE and Saudi Arabia, Iraq lacks alternative export routes, making its economy even more susceptible to fluctuations in oil production and exports. Due to its heavy reliance on hydrocarbons, this disruption is anticipated to bring about significant macroeconomic repercussions. According to projections from the International Monetary Fund (IMF), Iraq could face a drastic economic contraction of -6.8% of GDP by 2026, a sharp decline from -0.4% expected for 2025. Current account deficits are also set to widen, projected at -5.6% of GDP in 2026, while fiscal challenges mount with an anticipated overall deficit nearing -8% of GDP this year.
Socioeconomic Effects and Government Response
The economic shock is likely to further undermine socioeconomic conditions in Iraq. As fiscal pressures increase, the government’s ability to meet payroll obligations may become jeopardized, posing a significant risk since the public sector constitutes a major portion of employment. Additionally, with the Iraqi dinar’s depreciation and ongoing supply chain disruptions, inflationary pressures are expected to rise, potentially agitating social unrest. Despite these challenges, the recent affirmation of Prime Minister Ali al-Zaidi could lead to proactive measures aimed at addressing these pressing issues.
On a more favorable note, Iraq’s substantial foreign exchange reserves, which can cover several months’ worth of imports, provide a crucial buffer against liquidity concerns. However, a key vulnerability remains, as a portion of these reserves is stored at the Federal Reserve Bank of New York. This situation exposes Iraq to risks, especially in light of tightened U.S. sanctions aimed at constraining Iranian influence. The U.S. has recently imposed restrictions on dollar transfers to Iraq, asserting pressure on the government to curtail Iranian-backed militias. Such actions may escalate liquidity challenges and raise concerns over potential further sanctions.
Future Challenges and Risk Assessment
In conclusion, Iraq’s outlook is fraught with challenges, and conditions may worsen amid prolonged conflicts or escalations. A significant risk to consider is the potential long-term impairment of critical oil fields, which could severely limit Iraq’s oil production capabilities. Even with a possible temporary resolution between the U.S. and Iran, full restoration of oil output may take time. Additionally, without a comprehensive agreement regarding Iran’s nuclear program, the risk of renewed tensions remains high, complicating efforts to normalize shipping routes through the Strait of Hormuz. The presence of Iranian-aligned groups further complicates the political landscape, continuing to expose Iraq to U.S. economic pressures.
Given the myriad security and economic obstacles that Iraq faces in the context of the evolving Middle East situation, including the potential for additional sanctions from the U.S., analysts at Credendo have made the decision to downgrade Iraq’s short-term political risk classification from category 6/7 to 7/7.