Growth Forecasts Revised Downward

BMI View: We have modestly revised downward Iraq's 2014 and 2015 real GDP growth forecasts. Increasing political instability will result in a marked decline in the expansion of the domestic economy, however robust oil exports will ensure that headline growth remains strong until 2016. We have sharply revised downward our five-year growth forecasts. Consumer spending and capital formation will remain subdued, and hydrocarbon production growth will slow significantly due to a lack of investment.

We have revised down our 2014 and 2015 economic growth forecasts for Iraq, as the takeover by jihadist group Islamic State of Iraq and the Levant (ISIS) and its allies of the country's north and west raises risks of a return to sectarian civil war. We project the economy to expand by 8.6% and 8.2% in real terms in 2014 and 2015 respectively, from our previous forecasts of 9.0% growth this year and 9.4% the next. Consumer spending, government consumption and fixed investment will be hit hard by violence. However, robust energy exports from southern Iraq will avoid a sharper downward revision.

We have also revised downward our five-year growth forecasts. We see real GDP growth expanding by an average of 5.6% over the 2014-2018 period, from our previous forecast of 8.2%. Regardless of whether Iraq remains formally united or breaks up, elevated political risk will lead to a drastic slowdown in economic activity ( see 'Rising Risk Of State Collapse - Scenarios Assessed', June 23). Moreover, BMI's Oil & Gas research team revised downward our medium-term oil production forecasts, as investment in the energy segment will be low due to ongoing instability.

Outlook Significantly Worsened
Iraq - Real GDP Growth, % chg

BMI View: We have modestly revised downward Iraq's 2014 and 2015 real GDP growth forecasts. Increasing political instability will result in a marked decline in the expansion of the domestic economy, however robust oil exports will ensure that headline growth remains strong until 2016. We have sharply revised downward our five-year growth forecasts. Consumer spending and capital formation will remain subdued, and hydrocarbon production growth will slow significantly due to a lack of investment.

We have revised down our 2014 and 2015 economic growth forecasts for Iraq, as the takeover by jihadist group Islamic State of Iraq and the Levant (ISIS) and its allies of the country's north and west raises risks of a return to sectarian civil war. We project the economy to expand by 8.6% and 8.2% in real terms in 2014 and 2015 respectively, from our previous forecasts of 9.0% growth this year and 9.4% the next. Consumer spending, government consumption and fixed investment will be hit hard by violence. However, robust energy exports from southern Iraq will avoid a sharper downward revision.

We have also revised downward our five-year growth forecasts. We see real GDP growth expanding by an average of 5.6% over the 2014-2018 period, from our previous forecast of 8.2%. Regardless of whether Iraq remains formally united or breaks up, elevated political risk will lead to a drastic slowdown in economic activity ( see 'Rising Risk Of State Collapse - Scenarios Assessed', June 23). Moreover, BMI's Oil & Gas research team revised downward our medium-term oil production forecasts, as investment in the energy segment will be low due to ongoing instability.

Outlook Significantly Worsened
Iraq - Real GDP Growth, % chg

Domestic Consumption Hit Hard

ISIS's takeover of western and northern Iraq will result in a sharp deceleration in consumer spending in H214 and 2015. The group's control of the northern city of Mosul on June 10 - the second most populous in Iraq - resulted in the displacement of at least 500,000 people. Economic activity has been disrupted, with supply lines and trade routes linking the north with Baghdad and the south having been cut and elevated security risks hindering business activity. Although some inter-regional trade will continue, we do not expect ISIS and its loosely linked allies to be able to support economic growth over the coming quarters, which will result in an impoverishment of northern Iraq. We project private consumption expanding by 5.0% and 4.5% in 2014 and 2015, from our previous forecast of 8.5% growth for both years.

The loss of northern and western Iraq will also result in a drastic contraction of government spending in public services and infrastructure in the north. Baghdad's ability to prop up the economy through spending has been damaged in the south as well, as the central government is unable to give much leeway to spending on public services as it is battling the insurgency. We project government consumption growing by 4.0% in both 2014 and 2015, from our previous forecasts of 8.0% expansion this year and 7.0% the next.

Fixed investment will be hard hit as the government will be unable to undertake projects in areas it does not control, and both domestic and private companies will maintain a wait-and-see approach or suspend operations. We do not expect major new investment to come in for the semi-autonomous Kurdish region, as it borders with rebel-held provinces. Although we do not see an outright retreat of oil majors from the south, new foreign investment in the oil industry will be muted as long as risks to stability are elevated.

Economy Hit Hard By Instability
Iraq - Components Of GDP, IQDtrn & Real GDP Growth, % chg y-o-y

Oil Exports Growing Slowly Over The Next Five Years

BMI's Oil & Gas research team left our net hydrocarbon exports growth forecasts unchanged at 14.5% for both 2014 and 2015, as production in the heavily protected south will remain strong despite violence in the north. We forecast total exports - which are almost entirely composed of hydrocarbon exports - increasing by 14.0% in both 2014 and 2015.

We expect a greater impact further into our oil production forecasts due to delays in new oil developments. We have revised our 2018 forecast down from 4.9mn barrels a day (b/d) to 4.1mn b/d and our 2023 forecast drops from 6.2mn b/d to 4.2mn b/d ( see 'Long-Term Oil Forecast Cut', July 3). As a result, we have lowered our medium-term total exports forecasts, which we project averaging 7.5% over the 2014-2018 period.

We forecast total import growth of 6.0% and 7.0% in 2014 and 2015, from our previous forecasts of 12.0% in both years. Slower expansion of private consumption and fixed investment will markedly reduce the need for imported goods. However, imports of refined energy products will increase as output is damaged by fighting - most notably in the contested Baiji refinery in northern Iraq. In addition, the government will significantly increase its imports of military equipments over the coming months.

Export Growth Decelerating
Iraq - Oil Production, Consumption and Net Exports

Risks To Outlook

Risks to our 2014 and 2015 real GDP forecasts are tilted to the downside. Our core view sees the rebels being unable to take over Baghdad or inflict a decisive blow to the oil industry in the south. However, we cannot preclude ISIS and its allies mounting an effective campaign on Baghdad or conduct high profile bombings in southern Iraq, thus jeopardising oil production and disrupting economic activity in the entire country.

Risks over our five-year forecast period are mixed. A bloodier and more protracted civil war than we expect could result in a further decline in growth. That said, Iraq still holds among the largest undeveloped oil resources in the world with some of the lowest lifting costs. This will keep a large number of major companies interested in the country, and they would look to return investment as soon as stability allows for safe operations.

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