Iraq Business Forecast Report Q4 2007

Hard Times Ahead

Heading into Q4, Iraq's leaders face a period of contrasting fortunes. To focus on the positive side of the balance sheet, the raging sectarian violence that bedevilled the capital last year has subsided.

Sunni tribes in al-Anbar province have united against Jihadist militants linked to al-Qaeda in Iraq, presenting possibilities for corralling Sunni opinion in a more progressive direction. Meanwhile, Washington is not letting its wider strategic contretemps with Iran get in the way of dialogue with Tehran over stabilising Iraq. So much for the good news. The bad, however, stubbornly refuses to ebb away. Overall levels of violence remain high, key pieces of legislation are logjammed and there are alarming signs that some of the regions are starting to hold onto key resources at the expense of the nation.

Iraq's political class faces a difficult task when the Council of Representatives reconvenes in September. The embattled government of Prime Minister Nouri al-Maliki is under intense pressure to make headway on key legislative measures, in order to maintain the continued support of the US. Yet such consensus is lacking, with the government now bereft of half its members and key participants at loggerheads over the most important bill, the much-delayed Petroleum Law. The White House faces its own challenges in orchestrating national reconciliation. Its surge strategy has achieved only partial near-term results, and is insufficient to lay the groundwork for the reassertion of a strong, unified national government. Meanwhile, British forces appear to be preparing for a full withdrawal from the south with the job at best only half-done.

Although we anticipate strong real GDP growth this year of 12.4%, based on an increase in the average OPEC basket price to US$62.50/bbl, the Iraqi economy will not be able to sustain this performance so long as its key economic sector - oil - is constrained from reaching its full potential by lack of investment. The non-oil economy is stagnant, Kurdistan apart, and inflation at 30% year-on-year (y-o-y) is still a serious problem. High revenues will keep the fiscus afloat for a while, but the external position will come under pressure as transfers decline next year. Iraq's central problem is that it remains too reliant on the oil sector, and that its oil sector performance - with exports averaging just 1.55mn b/d - is still far too weak.

There are few indicators to suggest any significant improvement in the business environment, excluding the investor-friendly Kurdistan region. On a positive note, two oil majors, Total and Chevron, signed a services agreement in early August that would lead to the two jointly exploring and developing hydrocarbons from one of the country's biggest oil fields - but crucially, only once the country gets an oil law in place and security improves. There is insufficient evidence to indicate that security will improve anytime soon. Key structural reforms that would elicit greater volumes of investment are stuck in Iraq's arcane political process. There may be some movement on this front in Q4, but it would be unwise to invest too much hope.