Iraq Business Forecast Report Q4 2008

Relative Peace And Strong Growth

The improvement in security will be sustained but political differences remain between Iraq's sectarian groupings. Following the success of government security forces in overcoming militants in Baghdad and Basra, the focus has shifted to Kirkuk in the north. Its strategic importance is due to its position on the edge of Iraqi Kurdistan and the presence of a supergiant oilfield underneath it, and the resolution of its status is a key test for Baghdad. Oil will remain the life-blood of Iraq for the foreseeable future, and the prospects for the sector are positive. While the issue of foreign investment in Iraq's oil industry is politically delicate, Baghdad is keen to bring in international oil companies over the coming years in order to help rehabilitate the sector, which has been plagued by underinvestment for decades. The non-oil sector will grow rapidly, boosted in part by increasing investment inflows from abroad.

While the security situation has significantly improved in recent months, political progress remains slow. Iraqi President Jalal Talabani's rejection of a controversial election law in July means that the provincial elections planned for October 1 look set to be delayed. Currently the most serious political flashpoint centres on the city of Kirkuk, whose future status is mired in controversy. Kurds are thought to be in the majority in the city, and they are pushing for Kirkuk to officially join Iraqi Kurdistan. While a constitutionally mandated referendum to decide the city's status would likely favour the Kurds, this could spark violent opposition from Kirkuk's Arab and Turkmen citizens, and possibly provoke a military response from Turkey.

Iraq's post-war recovery is inextricably tied to its oil sector, and we are optimistic that production levels will steadily increase over the coming years. One-year technical service contracts with international oil companies should help boost output in the short-to-medium term, and the Iraqi government expects to sign longer-term deals in 2009. In light of the oil sector expansion we expect real GDP growth to average 8.0% annually between 2008-2012. Baghdad will direct greater expenditure towards reconstruction and infrastructure development, although it may encounter difficulties in spending the entire investment budget. This increased expenditure, as well as declining oil revenues in line with our expectations of lower global prices, will help to push the central government budget into deficit over the coming years.

The government has largely succeeded in its fight against inflation and this outcome will considerably improve Iraq's business environment. Inflation is likely to be controlled as long as the security situation does not deteriorate and the central bank continues to behave decisively. Foreign direct investment will continue to pick up, especially in Iraqi Kurdistan where the security situation is most stable, but also increasingly in other parts of Iraq. Confidence will be boosted by Iraq's attractive investment law, which allows for machinery and production facilities to be imported duty-free, and for taxes on corporate profits to be potentially waived for up to 10 years. However, rampant corruption remains a key risk to commerce.