The political outlook for Iraq continues to be unstable, with a new government still not in office following the 7 March elections.  After seven years of violence, Iraqis were hoping for a strong government to push ahead with the planned infrastructure development that its politicians have so far failed to deliver.

Almost a third of all Iraqis are presently employed by the state in its swollen civil and security forces

But once the details of power-sharing deal are hammered out, Iraq needs to move forward with reconstruction. IMF expects Baghdad to face two more years of budget shortfalls before stronger oil prices and production lift it back into surplus in 2012.

In a March review of the country’s economy, it forecasts Iraq’s economic growth in 2010 to be 7.3 per cent, significantly stronger than the 4.2 per cent seen last year. However, additional financing is needed to fill a $5bn hole in the 2010-2011 budget. The IMF approved a $3.6bn loan at the end of February to help manage the shortfall.

Budget shortfall

But Iraq is in dire need of revenues, as the incoming government will be acutely aware. The economy was seriously affected by the drop in oil prices from their peak in 2008. With crude exports accounting for 85 per cent of government revenues, the country’s external position deteriorated in 2009. The current account fell into a 20 per cent deficit and the balance of payments was 10 per cent of gross domestic product (GDP). The budget saw a deficit of 23 per cent in 2009, financed by surpluses built up in previous years.

Beyond this, the drop in oil revenues represents a major challenge in view of the country’s vast reconstruction spending needs.

Baghdad has sought to increase oil output, signing 11 production licensing agreements with inter-national oil companies as part of its ambition to lift output from the current level of 2 million barrels a day (b/d) to 6 million b/d by 2016.

But Iraq’s ability to increase exports significantly over the coming years will depend on it upgrading expanding its decrepit infrastructure in the south of the country. According to the Ministry of Oil, crude exports reached 2.05 million b/d in February, the highest monthly average since the 2003 invasion. The majority of the receipts – 95 per cent – are kept in the Development Fund for Iraq, which was established in 2003 as a repository for oil revenues at the Federal Reserve Bank of New York. The fund comes to an end this year, with the UN confident in the country’s ability to assume control of its wealth.

In February, Iraq’s Presidency Council ratified its $72.4bn budget for 2010, based on an average oil price of $60.5 a barrel. The government estimates revenues for 2010 at $52.8bn, more than 90 per cent of which will be derived from oil sales, meaning the country will run a deficit of $19.6bn this year.

The budget allows the Ministry of Finance to borrow up to $4.5bn from the IMF and $2bn from the World Bank in 2010 to cover deficits. In February the IMF provided a two-year, $3.6bn stand-by arrangement to assist the government with its short-term balance of payments deficit. Iraq also signed an agreement with the World Bank in March for two $500m loans.

The government is seeking to reduce the deficits in 2010 and 2011, with a view to returning to a budget surplus in 2012. The bulk of Iraq’s government expenditure of $52bn is consumed by operating expenses, most notably going to salaries, benefits and pensions. Almost a third of Iraqis are employed by the state in its swollen civil and security services.

Basra windfall

The new budget also aims to increase regional oil production and refining. The Ministry of Finance will pay $1 for each barrel of oil produced and the same for refined products. This will be a major windfall for Basra province, home to four of Iraq’s five biggest oilfields.

But the policy is far from universally popular. Some argue that the provision unfairly favours producing regions, with little benefit to provinces with few hydrocarbon resources.

In August, the US will begin the withdrawal of 70,000 troops, bringing an end to formal US combat operations. In their absence, Iraq’s political and internal stability will depend heavily on its ability to increase export revenues to pay for economic recovery. Stability will also hang on Baghdad’s ability to share the revenues gained among the regions.

Sunnis in particular are excluded from much of the country’s oil revenues, which originate in Shiah and Kurd-dominated areas. Indeed almost 80 per cent of Iraq’s oil is produced in the Shiah-led Basra province. This has done little to provide work for the unemployed young men in other provinces or quell the Sunni insurgency that still blights much of the country. The next few years will not be easy for Iraq.