In spite of the daunting security situation, the IMF stressed that Iraq's authorities had maintained a degree of macroeconomic stability and praised them for introducing legislation against terrorist financing and money laundering.

The economy, the report said, rebounded in 2004 and real gross domestic product (GDP) increased by 50 per cent, supported by a reviving oil sector. However, the growth has caused inflation of some 37 per cent. The report says oil production averaged 1.4 million barrels a day (b/d) for the first five months of the year, below the target of 1.8 million b/d.

The new currency introduced in 2004 remains stable, but economic recovery is held back by the security situation, the fund says. The fiscal deficit for 2004 was larger than expected, thanks to increased spending on defence and security. The budget deficit was equal to 41 per cent of GDP.

Donors contributed about $1,000 million to the International Reconstruction Fund Facility for Iraq. The report added that the country must reach an agreement on its private foreign debts along the lines of agreements it made with the government creditors of the Paris Club last year.

The economy remains fragile and the IMF warns that the Iraqi authorities will need to be ready to respond to oil price fluctuations, resist spending pressures and continue with structural reforms to ensure Iraq develops into a market economy.

Until this is in place, the IMF was hesitant to acquiesce to Baghdad's desire for access to the organisation's stand-by credit. The government must first tackle the sources of corruption by eliminating price distortions and phase out politically sensitive petroleum product subsidies.

The report predicts that smuggling of oil products could have cost the provisional government as much as $8,000 million, constituting some 30 per cent of GDP, valuable revenues that should be used for the reconstruction effort.