The U.S.-Israeli war against Iran has contributed significantly to the deterioration of Iraq’s economic indicators. Stagflation has intensified, oil revenues have fallen sharply, and the fiscal deficit has widened. These developments have accelerated the growth of public debt, reduced foreign currency reserves, and weakened the dinar’s exchange value. The war also resulted in the suspension of a cash shipment from Washington to Baghdad. Taken together, these pressures led to a downgrade of Iraq’s sovereign credit rating.
The Iran war has generated economic, social, and political disruptions across the world. The scale of these disruptions, however, differs from one country to another. Iraq has been among the most severely affected. Militarily, it is the only country simultaneously exposed to strikes from the United States, Israel, Iran, and local armed militias aligned with Iranian influence. Geography has further amplified the security repercussions of the conflict.
While the Gulf Cooperation Council states possess massive sovereign wealth funds capable of absorbing external shocks, Iraq lacks a financial buffer able to withstand the consequences of war. Iraq also remains subject to U.S. decisions concerning its financial, trade, and banking relations with Iran.
Under these conditions, the war has produced a severe economic crisis in Iraq. Iraqis are now experiencing stagflation, a combination of declining growth and rising prices.
In October 2025, the International Monetary Fund issued its global growth forecasts for 2026. In April 2026, it revised those forecasts in response to the impact of the Iran war. Iraq’s projected contraction was initially estimated at 6.8 percent. By April, the figure had worsened to 10.4 percent, making it the second-highest recession rate in the Arab world after Qatar.
Commodity prices rose sharply following the closure of the Strait of Hormuz. Iraq imports goods worth $25.6 billion annually through the strait, equivalent to 64 percent of its total merchandise imports. The closure increased shipping costs and drove up the prices of consumer goods, particularly food products.
As a rentier economy dependent on oil revenues to finance imports, Iraq has seen the war become a major driver of declining living standards, particularly among low-income groups. Iran ranks among Iraq’s leading suppliers of food products, industrial goods, and raw materials. Despite being one of the world’s largest oil exporters, Iraq imports petroleum products from Iran, along with electricity and natural gas used to generate power in several southern cities. Iraq currently has no viable alternative to these energy supplies. They are vulnerable to two factors. The first is military operations that temporarily damaged Iranian energy infrastructure and directly reduced gas flows to Baghdad. The second is U.S. sanctions on Iran. As a result, these energy imports depend on periodic U.S. waivers renewed according to Washington’s political calculations and conditions.
The war has also affected Iraq’s balance of payments. The country relies heavily on tourism revenues estimated at $5.7 billion annually, generated primarily by approximately eight million Iranian visitors each year. The conflict disrupted this religious tourism flow and deprived Iraq of a major source of income. Tourism facilities in Najaf and Karbala suffered significant damage as a result.
Fiscal Deterioration
Iraq’s fiscal structure during the Iran war is defined by four central characteristics.
The first is the overwhelming dependence of public revenues on oil income, which accounts for no less than 81 percent of total state revenues. In Saudi Arabia, by comparison, oil contributes around 60 percent despite the kingdom being one of the world’s largest oil exporters. Under such conditions, any decline in oil revenues quickly produces a severe economic and social crisis. To understand the impact of the war, Iraq’s oil sector must be divided into two parts.
The first consists of federal government oil production, which represents the largest share of output. It is extracted primarily from the Basra fields in southern Iraq and exported through the Gulf via the Strait of Hormuz. The war brought these exports close to a complete halt. Before the conflict, Iraq produced 4.5 million barrels per day, including one million barrels for domestic consumption and 3.5 million barrels for export. In March 2026, following the closure of Hormuz, exports collapsed to 600,000 barrels per day. Total exports for March reached only 18 million barrels, compared to more than 100 million barrels in February.
The second component is oil production in the Kurdistan Region, which was less severely affected because it flows through the Turkish port of Ceyhan. Some oil facilities in the region nevertheless came under attack. Estimating the region’s actual production remains politically sensitive. Officially, output stands at 450,000 barrels per day, including 50,000 barrels for domestic consumption and 400,000 barrels for export.
The second defining feature of Iraq’s fiscal system is the dominance of public-sector salaries, which consume roughly half of total government spending. Monthly payroll obligations amount to eight trillion dinars, equivalent to approximately $6 billion. Declining oil revenues therefore frequently lead to delays in salary payments. Such delays directly affect the livelihoods of millions of Iraqis, increase household indebtedness, and reduce consumption across domestic markets. This, in turn, slows economic activity, deepens recessionary pressures, and raises unemployment.
The third feature is Iraq’s chronic and massive fiscal deficit, which exceeds sixty trillion dinars and has worsened during the war. This raises another structural problem concerning how the deficit is financed. Unlike Saudi Arabia, the United Arab Emirates, Qatar, and Kuwait, Iraq does not possess a sovereign wealth fund capable of absorbing fiscal shocks. Baghdad therefore relies on external borrowing, central bank financing, and withdrawals from foreign reserves. The war has consequently deepened Iraq’s indebtedness, accelerated inflation, weakened state finances, and caused a sharp decline in the dinar’s exchange value.
The fourth feature concerns Washington’s extensive influence over Iraq’s financial system.
U.S. Monetary Pressure
Iraq’s financial system remains closely tied to U.S. decision-making because oil revenues are deposited into a special account whose disbursement mechanisms fall under American oversight. Recently, the United States suspended a $500 million cash shipment to Iraq. The decision directly affected public-sector salary payments and reduced the supply of dollars in the domestic market, contributing to a decline in the dinar’s exchange rate.
Washington used this measure to pressure Baghdad on two fronts. The first concerned the appointment of a prime minister. The second aimed to influence the new government to dismantle Iran-aligned local militias targeting U.S. forces. Iran-related tensions have previously resulted in similar restrictions on dollar transfers to Iraq. In 2023, Washington rejected an Iraqi request for a $1 billion cash transfer.
The origins of this American authority date back to May 2003, several months after the fall of Saddam Hussein’s regime, when the UN Security Council adopted Resolution 1483. The resolution included 27 provisions addressing multiple issues, most notably the removal of trade sanctions imposed after Iraq’s invasion of Kuwait. Paragraph 12 established the Development Fund for Iraq, which was designed to receive revenues generated from Iraqi oil exports. Paragraph 14 stipulated that these revenues should be used to meet the needs of the Iraqi people, while Paragraph 13 stated that spending decisions would be made by the Iraqi government in consultation with the U.S.-led Coalition Provisional Authority.
The resolution made no reference to the U.S. Federal Reserve. However, the Coalition Provisional Authority placed the fund under Federal Reserve supervision due to its overwhelming control over Iraq at the time. The stated justification was the need to protect Iraqi assets from international claims linked to Iraq’s large external debts. From a legal standpoint, the United States has no formal right to oversee the fund. UN Security Council Resolution 1956 of 2010 terminated the arrangement effective June 30, 2011.
In practice, however, U.S. control over Iraqi funds has become an important mechanism for monitoring financial flows. This influence is reinforced by Iraq’s entrenched corruption. According to Transparency International, Iraq ranks 136th globally and remains among the world’s most corrupt states. American oversight has evolved into an effective instrument for advancing U.S. policy objectives, foremost among them shaping Iraq’s relationship with Iran.
The Strait of Hormuz and Iraq’s Pipeline Dilemma
In 1973, Iraq and Turkey signed an agreement regulating oil transportation through a pipeline linking the Kirkuk oil fields to the Turkish port of Ceyhan. Under the agreement, exported volumes required the approval of the Iraqi government. After 2010, however, the Kurdistan Regional Government concluded separate agreements with Ankara to sell oil at prices significantly below global market levels while granting Turkey generous financial advantages related to transit fees.
According to Baghdad, these agreements violate the Iraqi constitution, which defines oil resources as the property of all Iraqi citizens. Iraqi authorities also argued that the arrangements breached the 1973 agreement. In 2014, Baghdad filed a case before the International Court of Arbitration in Paris concerning oil exports through the Kirkuk-Ceyhan pipeline without federal government approval. Nine years later, in 2023, the tribunal ruled in Iraq’s favor and ordered Turkey to pay $1.5 billion in compensation.
The ruling increased tensions between Baghdad and Ankara. In July 2025, Turkey announced that it would terminate the agreement effective August 2026.
The Turkish decision poses a major challenge to Iraqi interests, particularly after the closure of the Strait of Hormuz. Ankara used the crisis to impose new conditions for extending the agreement, including higher transit fees and the abandonment of compensation claims.
The closure of Hormuz also revived a broader strategic issue concerning Iraqi oil exports. During the Iran-Iraq War between 1980 and 1988, Saudi Arabia constructed a pipeline linking its eastern oil fields to the Red Sea port of Yanbu in order to secure an alternative export route in the event of a Hormuz shutdown. Saudi Arabia similarly sought to reduce its dependence on the strait.
In 2008, United Arab Emirates built a pipeline connecting the Habshan oil field in Abu Dhabi to the port of Fujairah on the Gulf of Oman for the same strategic purpose. In Iraq, the idea of constructing an alternative export route dates back to the Iran-Iraq War. However, the project remained unrealized until the outbreak of the U.S.-Israeli war against Iran. This delay imposed substantial financial losses on Iraq compared to Saudi Arabia and the UAE.
In April 2026, the Iraqi cabinet approved a pipeline project linking the Basra oil fields to the city of Haditha in Anbar province in western Iraq. The pipeline is designed to carry 2.3 million barrels per day over a distance of 685 kilometers at an initial cost of $1.5 billion. From Haditha, the pipeline would branch into three directions: toward Ceyhan in Turkey, Baniyas in Syria, and Aqaba in Jordan. The shortest route to the sea would be through the Haditha-Baniyas corridor.
The project carries major strategic significance, particularly because it would also connect to Iraqi refineries located along its route.
Credit Rating Downgrade
The Iran war has generated severe economic pressures on Iraq and further weakened an already fragile sovereign credit position.
On April 17, 2026, Moody’s downgraded Iraq’s sovereign credit rating to Caa1 with a negative outlook. This places Iraq at the seventeenth level on Moody’s twenty-grade rating scale. The negative outlook signals the possibility of further downgrades in the near future. The agency based its decision on several indicators, including the sharp decline in oil exports, rising public debt estimated at $129 billion, the depletion of foreign reserves from $73 billion at the beginning of 2026 to $51 billion at the start of 2027, and worsening recessionary conditions.
These indicators are closely tied to the impact of the war. The absence of a serious reform strategy to address Iraq’s structural economic problems has further deepened concerns. Iraq’s deteriorating credit position is not limited to Moody’s. Similar assessments have also been issued by S&P Global and Fitch Ratings.
The decline in Iraq’s credit rating directly affects investment decisions. As sovereign ratings fall, investment risks increase. Credit ratings also influence borrowing costs. Lower ratings lead to higher interest rates on loans, which in turn raise state expenditures and widen budget deficits.
The Iran war has exposed structural vulnerabilities that require substantial revisions to Iraq’s economic strategy. Iraq needs to diversify its GDP base by developing the agricultural and industrial sectors. It must expand the production and utilization of associated natural gas instead of continuing large-scale flaring that generates financial and environmental losses. The Basra-Haditha pipeline project should move forward in order to reduce dependence on the Strait of Hormuz. Chronic fiscal deficits must be addressed through higher non-oil revenues and tighter control over non-productive spending. Iraq also needs to establish a sovereign wealth fund capable of absorbing future financial shocks.
