Iraq Business Forecast Report Q2 2008

Sustained Improvement Ahead With Major Risks

The improvement in security will be sustained, allowing for the rebuilding of confidence levels in a country that has been through a highly unstable period. The current thrust of Iraq policy is to build on recent security gains in order to create a climate that would allow policymakers to make long-term decisions in the strategic interests of the country. This may prove trickier to accomplish than bringing a semblance of stability to the capital, the undoubted achievement of the US surge strategy more than one year on from its introduction. Efforts to bolster reconciliation between Sunni and Shi'a Iraqis are failing to make headway, while Iraq's Kurds are increasingly at odds with their compatriots in the southern two-thirds of the country over key strategic goals.

Despite pressure to withdraw troops in light of the improvement in security, Washington will resist these blandishments; it sees a continued threat from al-Qaeda in Mesopotamia which is targeting the north, Mosul in particular, as a new theatre of conflict. Shi'a militias are also posing a stiffer security challenge, even if the Sunni insurgency has lost momentum. The splitting off of the Sunni insurgency from al-Qaeda combatants is one of the more lasting gains of the US military, and of- ficials will attempt to build on these relations at the grassroots level - although this is viewed with growing suspicion by the government in Baghdad.

Tehran is likely to play a more low-key role in Iraq, though it retains strong influence in parts of the south. The likely future focus of US policy towards Iraq will become clearer over the forecast period, as the US presidential hopefuls hone their own policies for the country to sell to the American electorate. The Republican favourite, Senator John McCain, has cast himself as the most hawkish of the candidates, and has talked of the possibility of a long-term US troop commitment in Iraq.

The Democrat camp has a less clear-cut strategy: both Barack Obama and Hillary Clinton want to pull back troops, though they disagree over timetables - and about what they would do if violence starts to increase.

We expect a sustained improvement in the Iraqi economy, with the combination of high oil prices and larger export volumes underscoring a healthy fiscal outlook over the forecast period. Furthermore, there is evidence that the government is starting to win the battle against inflation. The government will ensure a tight grip on current expenditure, though it may struggle to effect an ambitious 0% increase in capital investment, as outlined in its 2008 budget. Iraq continues to lack the capacity to disburse the oil bounty and catalyse wider economic development. Progress on the Petroleum Law is also set to disappoint, though the government is displaying a more pragmatic bent, starting talks with oil majors over short-term technical support contracts that the government hopes will increase Iraq's oil production by up to 00,000b/d within two years. An oil licensing round is also due, though we are sceptical about the announced timeframe of H109 for contracts to be signed.