Iraq’s GDP will likely shrink by 0.5% in 2014 due to the worsening security situation following the ISIS (Islamic State in Iraq and Syria) insurgency and the related economic impact, the IMF said in a statement following a mission visit. In 2013, Iraq’s GDP grew 4.2%, according to the October IMF World Economic Outlook. The GDP’s 2014 contraction forecast is, however, well above the 2.7% contraction predicted in October by the IMF.

Discussions with Iraqi authorities focused on the impact of the double shock of the Islamic State of Iraq and Syria (ISIS) insurgency and the decline in oil prices, the IMF underscored.

The IMF warned that Iraq’s non-oil growth have deteriorated since the start of the conflict due to the destruction of infrastructure, hampered access to fuel and electricity, low business confidence, and disruption in trade. The fund, however, noted that the bulk of Iraq’s oil infrastructure is in the south of the country, out of the reach of ISIS, while oil production in the Kurdish province has resumed. Iraq’s oil output thus should reach 3.3mn barrel per day in 2014, up from 3.1mn barrels a day in 2013, with exports remaining at 2013 levels of 2.5mn barrels per day, the IMF forecasts.

In 2015, Iraq’s GDP will rebound to 2% as oil production and exports increase further, supported by the recent agreement between the central government and the Kurdish autonomy on oil exports from the Kirkuk oil fields, the IMF forecasts.

The central bank of Iraq (CBI) has maintained the peg with the US dollar. The spread between the official and parallel exchange rates narrowed to 2.6% in September as the central bank took measures to liberalize the foreign exchange market, the IMF said.

Rising imports, coupled with declining oil revenues and lower government sales of foreign exchanges to the CBI to finance government spending cut Iraq’s FX reserves from over $77bn at end-2013 to about $67bn at end-November, the IMF estimated. “The government also tapped the Development Fund for Iraq (DFI), the balances of which have now been transferred to the CBI; the DFI declined from $6.5bn at end-2013 to about $4bn in November,” the IMF noted.

The Iraqi government has promised to present a draft 2015 budget to parliament soon, according to the IMF, underscoring that lack of parliamentary approval of the draft 2014 budget has triggered a fiscal rule that has partly limited spending this year.

However, off-budget spending, mainly on security, has fuelled the deficit, which will likely reach about 5% of GDP in 2014, the IMF warned. As projected financing in 2015 will be limited, The IMF now expects the government deficit to decline to less than 2% of GDP.