Iraq Ratings Affirmed At 'B-/B'; Outlook Stable

  • The downward shock to oil prices will triple Iraq's fiscal deficit and push the current account balance into a deficit over 2020.
  • Nevertheless, Iraq will remain the world's fourth-largest producer of oil, and one of the lowest-cost producers. This should ensure that the country's merchandise trade position remains deep in surplus despite the terms of trade shock.
  • We expect expenditure reduction and assets from 2018's large fiscal surplus to partially mitigate the full effects of the shock.
  • We are therefore affirming our 'B-/B' sovereign credit ratings on Iraq.
  • The outlook remains stable.

Rating Action

On March 26, 2020, S&P Global Ratings affirmed its 'B-' long-term and 'B' short-term foreign and local currency sovereign credit ratings on Iraq. The outlook is stable.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Republic of Iraq are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2020 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 20, 2019, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is a sharp drop in hydrocarbon prices and our revised price assumptions for 2020 and beyond. The next scheduled rating publication on the sovereign rating on the Republic of Iraq will be on Aug. 21, 2020.

Outlook

The stable outlook reflects our view that Iraq will be able to moderate the effect of oil price shocks with expenditure-side measures, containing risks to debt-servicing capacity.
We could lower the ratings if the government increased spending beyond our expectations, resulting in either a decline in foreign-currency reserves, or a sharp rise in its net debt and debt-servicing costs. This could also occur if oil revenue fell further than we expect and the government was unable to cut expenditure or implement further countermeasures.
We do not expect to raise the ratings over the next 12 months, but we could over the forecast period if higher-than-expected nonoil growth, for instance from reinvigorated reconstruction efforts, resulted in an increase in Iraq's economic growth and higher GDP per capita.

Rationale

On March 19, 2020, S&P Global Ratings materially lowered its oil price assumption for 2020. This follows an earlier significant downward revision of its price assumptions on March 9, 2020. Prices for crude oil in spot and futures markets are more than 55% lower than levels observed during the summer of 2019 when prices increased due to rising geopolitical tensions. When we last reviewed Iraq ("Iraq: Full Analysis," published Feb. 21, 2020, on RatingsDirect), we expected Brent oil prices to average $60 per barrel (/bbl) in 2020 and to gradually decline to $55/bbl from 2021. We now assume an average Brent oil price of $30/bbl in 2020, $50 in 2021, and $55/bbl from 2022 (see " S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 19, 2020).
Oil prices plummeted following OPEC's failure to agree on further production cuts during meetings on March 6. OPEC+ did not agree to a proposed reduction of 1.5 million barrels per day (mmbbl/d) to address an expected significant drop in global demand partly due to the spread of the coronavirus. The proposed reduction was in addition to the current 2.1 mmbbl/d production decrease set to expire at the end of March. Shortly after the meetings, Saudi Arabia announced that it was immediately slashing its official selling price and would increase its production to over 12 mmbbl/d in April after the current production cut expires. These actions possibly signal that, despite a collapse in global demand and shrinking physical markets, Russia and OPEC have engaged in a price war to try to maintain market share and market relevance. Oil markets are now heading into a period of a severe supply-demand imbalance in second-quarter 2020. In line with our economic outlook (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now," published March 17, 2020), we anticipate a recovery in both GDP and oil demand through the second half of 2020 and into 2021 as the most severe impacts from the coronavirus outbreak moderate.
The affirmation of our ratings on Iraq rests primarily on the government's ability to curtail spending as the economy's dependence on oil persists. Iraq has the world's fourth-largest proven crude oil reserves and is the second-largest oil exporter in OPEC. Oil dominates the Iraqi economy, contributing about 50% of GDP, 90% of government revenue, and more than 95% of exports.
We forecast a fiscal deficit of 15.8% of GDP in 2020 with revenues falling by about 40% in 2020 compared with 2019. This forecast takes into account our revised oil price assumption of $30/bbl and an increase in Iraq's production and export of oil as capacity increases and the OPEC+ supply reduction agreement ends. Non-oil revenue will not be sufficient to provide any additional support to the government's fiscal position as its ability to raise revenue outside of the oil sector is limited by weak tax collection administration. The fiscal position should remain in a deficit averaging 8% of GDP to 2023.
In our view, the government will curtail expenditure in 2020 to mitigate the effects of the oil price shock on its fiscal position. The expansionary budget in 2019 increased expenditure by almost 40% over 2018. We expect that the government will undertake to reduce recurrent expenditures from 2019 levels, although these will not return to 2016-2018 levels when Iraq was under an IMF program. In addition, capital expenditure (capex) will be constrained given that a large amount of capex was frontloaded in 2019. There are risks to our forecast given that the political and social pressures that contributed to 2019's expansionary stance have not abated. In our view, reducing the wage bill will be politically sensitive. Also Iraq's reconstruction needs remain significant, placing pressure on the government to increase capex. Both reparation payments to Kuwait and fiscal transfers to the Kurdistan Regional Government will continue.
Although external funding for projects remains, we expect the government to have limited access to bi- and multi-lateral funding lines, given the end of the IMF program and no approved budgetary support in 2019 and 2020. In line with 2019, the government plans to finance its 2020 deficit by using the remaining fiscal assets accumulated after the 2018 budgetary surplus and through a mixture of short-term domestic financing (treasury bills bought by domestic banks) and increasing the pension fund's holdings of government securities. Given this composition of fiscal financing, we expect general government debt net of liquid assets to average 64% over the forecast period. Principal payments on external debt will increase over 2020-2023 as payments to the IMF and two Eurobonds come due.
We forecast the current account deficit in 2020 at 5.2% of GDP after our estimate of a surplus of about 9.1% of GDP in 2019. We expect the current account to return to surplus in 2021, and remain so over the forecast horizon to 2023, as our oil price assumption increases and the volume of oil exports increases. That said, the analysis of Iraq's external flow and stocks is constrained by poor data quality. We believe Central Bank of Iraq data significantly underreports imports, since imports into the region of Iraqi Kurdistan are not included and imports at other entry points are not systematically measured.
Iraq's external position remains highly dependent on the oil price outlook. The expected decline in foreign exchange reserves from the current account deficit should keep Iraq's liquid external assets just below external debt over our forecast period to 2023. We estimate Iraq's gross international reserves at $67.6 billion at year-end 2019, compared with $45.3 billion at year-end 2016. However, we deduct the monetary base from official reserves because we regard them as somewhat encumbered by the need to defend the currency peg in a time of stress. We estimate year-end 2020 usable reserves at negative $11.5 billion.
After a two-year recession, we estimate that headline GDP growth picked up in 2019 to 2.8%. This year, growth should slow to 2.5%, with real growth maintained by increasing oil production. We expect production will average 4.8 mmbbl/d in 2020 up from 4.5 mmbbl/d in 2019. Although total oil production should increase toward 5.1 mmbbl/d by 2023, GDP growth will likely moderate to about 2.5%-2.2% in the longer term as oil production expansion slows.
Nonoil growth has struggled to take off, not least because of slow reconstruction efforts. Low public investment and a difficult business environment have also slowed the post-war recovery. Lower oil prices will likely hamper private consumption in the coming years. The non-oil sector's contribution to growth harbors upside potential. However, the delicate political situation and weak governance will continue to constrain growth outside the oil sector over our forecast period.
Iraq's political situation will remain complex and unpredictable, in our view, resulting in low policy predictability. President Saleh named Adnan al-Zurfi prime minister designate recently, after Mohammad Allawi stepped down at the beginning of March after just two months in his new position. His appointment came after former prime minister Adil Abdul-Mahdi, and current caretaker prime minister, resigned in late November 2019, following anti-government protests.
In our view, Iraq's political and economic development is hampered by widespread corruption and the threat of domestic conflict. The country ranks among the world's worst in the Corruption Perceptions Index and the World Bank's governance indicators. The government has taken active measures to address this issue, including the recent reintroduction of the Supreme Anti-Corruption Council. Strengthening governance, accountability, and transparency could help unlock Iraq's economic potential.

Key Statistics

Table 1

Iraq Selected Indicators
IQD mil.2014201520162017201820192020202120222023
Economic indicators (%)
Nominal GDP (bil. LC)266,333194,681196,924225,722251,064247,771203,172239,021257,968268,916
Nominal GDP (bil. $)228167167191212210172202218228
GDP per capita (000s $)6.64.74.65.15.55.34.34.95.15.2
Real GDP growth2.32.613.8(3.8)(1.0)2.82.52.32.32.2
Real GDP per capita growth(1.5)(0.7)10.6(6.2)(3.2)0.5(0.3)(0.5)(0.5)(0.6)
Real investment growth18.2(2.1)(30.2)(7.8)(3.0)(3.6)(2.7)1.01.01.0
Investment/GDP17.6(1.3)(6.2)(5.6)(8.0)(6.0)(5.5)(5.2)(4.8)(3.8)
Savings/GDP24.5(3.0)(4.9)2.38.23.1(10.7)(4.8)(1.9)(0.9)
Exports/GDP45.761.064.176.186.281.166.669.672.773.0
Real exports growth4.028.313.11.05.04.35.22.52.52.5
Unemployment rateN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
External indicators (%)
Current account balance/GDP6.9(1.7)1.37.816.29.1(5.2)0.42.92.9
Current account balance/CARs17.6(4.8)4.422.736.221.5(14.7)1.27.67.6
CARs/GDP39.434.729.134.544.842.135.236.638.138.3
Trade balance/GDP15.66.67.313.322.417.05.59.611.611.6
Net FDI/GDP(4.6)(4.6)(3.9)(2.7)(2.4)(2.0)(1.0)(1.0)(1.0)(1.0)
Net portfolio equity inflow/GDP0.0(0.0)(0.0)(0.0)0.00.00.00.00.00.0
Gross external financing needs/CARs plus usable reserves81.3105.2105.6105.473.878.0123.1123.8114.7111.7
Narrow net external debt/CARs(32.7)1.923.119.2(7.2)(7.4)6.87.45.55.5
Narrow net external debt/CAPs(39.6)1.924.224.8(11.3)(9.4)5.97.56.05.9
Net external liabilities/CARs(8.8)45.173.259.120.117.440.031.924.621.1
Net external liabilities/CAPs(10.7)43.076.676.431.522.134.932.326.722.9
Short-term external debt by remaining maturity/CARs3.75.87.85.24.04.56.95.75.15.0
Usable reserves/CAPs (months)0.90.6(0.3)(3.4)(1.5)1.0(0.1)(1.9)(2.0)(1.7)
Usable reserves (mil. $)2,942(1,028)(14,216)(7,726)5,555(747)(11,520)(12,543)(11,224)(9,825)
Fiscal indicators (general government; %)
Balance/GDP(5.8)(13.6)(14.6)(1.7)8.3(5.2)(15.8)(6.5)(5.0)(5.0)
Change in net debt/GDP(0.1)15.38.9(0.1)(10.6)5.215.86.55.05.0
Primary balance/GDP(5.7)(13.0)(13.9)(0.6)9.8(3.5)(13.6)(4.4)(2.8)(2.7)
Revenue/GDP39.232.628.233.842.142.231.338.139.639.0
Expenditures/GDP45.046.242.835.533.747.447.144.644.644.0
Interest/revenues0.22.02.53.03.54.17.05.65.55.8
Debt/GDP32.960.767.560.452.054.476.371.471.173.2
Debt/revenues84.0186.1239.6178.7123.6129.0244.2187.3179.6188.0
Net debt/GDP25.449.958.350.735.040.765.462.162.665.0
Liquid assets/GDP7.610.79.39.716.913.710.99.38.68.2
Monetary indicators (%)
CPI growth2.21.4(0.7)0.20.4(0.2)1.01.52.02.0
GDP deflator growth(4.8)(28.8)(11.1)19.112.3(4.0)(20.0)15.05.52.0
Exchange rate, year-end (LC/$)1166.001182.001182.001184.001182.001182.001182.001182.001182.001182.00
Banks' claims on resident non-gov't sector growth8.13.80.74.5(9.5)5.05.05.05.05.0
Banks' claims on resident non-gov't sector/GDP9.613.613.512.310.010.713.712.211.912.0
Foreign currency share of claims by banks on residentsN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
Foreign currency share of residents' bank deposits23.322.719.114.523.625.826.026.026.026.0
Real effective exchange rate growth3.015.50.1(1.7)(4.9)1.10.00.00.00.0
Sources: IMF, Central Statistical Organization Iraq, and Central Bank of Iraq (economic indicators), IMF and Central Bank of Iraq (monetary indicators), IMF and Ministry of Finance (fiscal indicators), IMF and Bank for International Settlements (external indicators).
Adjustments: Usable reserves adjusted by subtracting monetary base and required reserves on resident foreign-currency deposits from reported international reserves.
Definitions: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. e--Estimate. f--Forecast. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Ratings Score Snapshot

Table 2


Iraq Ratings Score Snapshot
Key rating factorsScoreExplanation
Institutional assessment6Weak political institutions create an uncertain and unpredictable policy environment. There is high risk of domestic conflict from religious, ethnic, and political divides in civil society. High levels of perceived corruption hamper political and economic development. The sovereign faces a long-standing risk of conflict with neighboring states or nonstate groups, but we do not expect this to materialize within two-to-three years.
Economic assessment6Based on GDP per capita ($) as per Selected Indicators in Table 1. Weighted-average real GDP per capita trend growth over a 10-year period is at -0.4%, which is well below sovereigns in the same GDP per capita category. National accounts data display material gaps, as shown for instance in incomplete data from some regions of the country.
External assessment5Based on narrow net external debt and gross external financing needs as per Selected Indicators in Table 1. The country is exposed to significant volatility in terms of trade, due to its dependence on hydrocarbons. The sovereign’s external data lack consistency, as demonstrated by errors and omissions at more than 10% of current account receipts.
Fiscal assessment: flexibility and performance6Based on the change in net general government debt (% of GDP) as per Selected Indicators in Table 1. The sovereign has a volatile revenue base, since more than 90% of general government revenue is based on hydrocarbons. The government's ability to raise revenue beyond hydrocarbon production is limited by weak tax collection administration. There are shortfalls in basic services, such as electricity and water, and rebuilding infrastructure and new infrastructure remain much needed.
Fiscal assessment: debt burden6Based on net general government debt (% of GDP) and general government interest expenditures (% of general government revenue) as per Selected Indicators in Table 1. Over 40% of gross government debt is denominated in foreign currency. The banking sector’s exposure to the government is over 20% of its total assets. We view potential recapitalization costs for the weak and under-developed banking sector as a contingent liability of the government.
Monetary assessment6The exchange-rate regime is a conventional peg with the U.S. dollar. Independence of the central bank is limited by perceived political interference. For instance, the government funded fiscal deficits with monetary financing in the past. Weak transmission mechanisms, resulting from the country’s weak banking system, impede monetary policy. Monetary policy tools such as the reserve requirement and the provision of standing facilities are of limited effectiveness. High nonperforming loans burden the banking sector, which does not fully fulfill the lending functions of stronger systems.
Indicative ratingb-As per Table 1 of "Sovereign Rating Methodology."
Notches of supplemental adjustments and flexibility0
Final rating
Foreign currencyB-
Notches of uplift0Default risks do not apply differently to foreign- and local-currency debt.
Local currencyB-
S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.
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