Fitch Ratings has affirmed Iraq's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B-' with a Stable Outlook.Key Rating DriversCredit Fundamentals: Iraq's 'B-' rating reflects its high commodity dependence, weak governance and high level of political risk. This is balanced by high foreign-exchange (FX) reserves supported by consistent, albeit lower, current account surpluses and a favourable government debt profile. High oil prices previously improved many of Iraq's credit metrics, but weaknesses in the structure of the economy and economic as well as fiscal policy weigh on the rating.Oil Production to Pick Up: We expect Iraq's oil production to increase as the authorities gradually phase out production cuts to meet higher spending, reaching 4.28 million barrels/day (mmbbl/d) in 2025 and 4.54mmbbl/d by 2026. We estimate production to average 3.97mmbbl/d in 2024, from 4.12mmbbl/d in 2023, due to increased compliance with OPEC quotas.Budget Deficit to Widen: We forecast the budget deficit to widen to 8.0% of GDP in 2024, from 2.0% in 2023, and to an average of 12.4% over 2025-2026. We forecast revenue to edge down to 38.4% of GDP in 2024 owing to a 2pp decline in oil receipts, from the combined effects of lower production and oil prices (Fitch Brent forecast: USD80/bbl in 2024, USD70/bbl in 2025 and USD65/bbl in 2026). We anticipate revenue will average 34.1% in 2025-2026 as lower oil prices more than offset higher output, and as the authorities have limited flexibility to raise non-oil revenues.We expect total spending to surge to 46.4% in 2024 (+4pp of GDP yoy) due primarily to a higher wage bill and pension transfers ahead of the 2025 elections, while capex remains stable at 7.1% of GDP. We expect expenditure to average 46.5% over 2025-2026, with current spending remaining high at 41.5%, reflecting the authorities' limited flexibility on salaries and transfers. We believe the bulk of fiscal adjustment will come from capex, which we expect to decline significantly after the elections and average 5.0%. The government has a track record of adjusting capex to compensate for lower revenue.Government Debt Rising; Risk Contained: We expect government debt/GDP to pick up to 47.7% by end-2024 and reach 56.5% by 2026 (2023: 44.2%) as the government increases borrowing to finance higher deficits. Most of the government financing is likely to come from the Central Bank of Iraq (CBI) through indirect purchases of government securities. CBI's total claims on the central government represented around 63% of domestic debt stock and 30% of the total debt stock at end-2023. A smaller portion will come from the government's cash deposits, which amounted to 20% of GDP at end-2023.We believe refinancing risks to be contained by CBI's intervention. Sharp increases in CBI's claims on the government previously led to heightened pressure on FX reserves, resulting in a currency devaluation in 2020, but we consider the current reserves to be large enough to absorb the expansion of CBI's balance sheet without putting pressure on the exchange-rate peg. The government's substantial cash deposits provide an alternative financing option.International Reserves Provide Substantial Buffer: We forecast FX reserves to remain strong at around 16.7 months of current external payments over the forecast horizon (2023: 16 months) on the back of the current account surplus. This will provide a substantial financial buffer, including relative to annual external debt service, of around 1.8% of GDP over 2024-2026. The majority of the external debt is owed to official creditors. Iraq faces a total of USD1.2 billion in repayments through 2028 for its only outstanding eurobond.Pressure on Parallel Exchange Rate: We expect pressure on the parallel exchange rate to persist as we believe the incoming US administration will increase scrutiny of Iraqi banking transactions. The parallel exchange rate is about 15% weaker than the official rate despite the robust FX reserves and sufficient US dollar supply on the official platform. This is due to scrutiny of access to dollars through CBI auctions and to the US barring some Iraqi banks from conducting dollar transactions. Washington seeks to limit the flow of US dollars to sanctioned neighbouring countries, mainly Iran and Syria. (ICE AMMAN)

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