Fitch Rates Iraqi Debt as 'Junk'

Commodity dependence is among the highest of all rated-sovereigns. Oil accounts for around 40% of GDP and over 90% of fiscal and current external receipts. Despite some modest initiatives to introduce new excise and consumption taxes this year, there is little prospect of revenue diversification over our forecast period to end-2017. Limited economic policy tools complicate the response to oil price volatility.

Fitch estimates Iraq's net external creditor position to have totalled 22% of GDP at end-2014, reflecting current account surpluses averaging 7.5% of GDP in the decade to 2014. However, we forecast a current account deficit of 7.4% of GDP for 2015; this should gradually narrow as oil revenues rise. Foreign exchange reserves, at USD67bn at end-2014, were sufficient to cover over 10 months of current external payments. External debt service ratios are well below the peer median.

Non-oil GDP contracted by an estimated 9% in 2014 and Fitch forecasts it to decline faster in 2015, owing to the impact of the lack of security in the country. This is offsetting the boost to GDP from rising oil production. A return to growth looks possible in 2016. Inflation is lower than peers, averaging 3.7% over the five years to end-2014, supported by the nominal anchor of the exchange rate peg to the USD. Weak domestic demand and subdued external price pressures have pulled down inflation to below 2% so far in 2015.

The banking sector is under-developed and fundamentally weak. Private sector credit-to-GDP was just 8.1% at end-2014, the lowest of any rated sovereign. The two large state-owned banks Al-Rafidain and Al-Rasheed, which have high NPLs and exceptionally low capital adequacy, dominate the sector. There has been little progress in restructuring these banks; an exercise that Fitch assumes will require recapitalisation by the government.

Monetary policy flexibility is constrained by the exchange rate peg, weak banking system and limited monetary and credit transmission in the economy. At times this year, a small spread between the parallel market and official exchange rate has opened up as the central bank holds limited auctions of foreign exchange.

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