The Iraqi government does not support the US sanctions on Iran, but will abide by them, Prime Minister Haider Al-Abadi announced last month. He was finally speaking out about Iraq's position following the controversial US withdrawal from the Iran nuclear deal.
"We consider them [sanctions on Iran] a strategic mistake and incorrect but we will abide by them to protect the interests of our people," Al-Abadi explained. "We will not interact with them or support them but we will abide by them." The move prompted an instant backlash from Tehran and pro-Iran circles in Iraq, with many claiming that the government's stance was treacherous.
Just one week later, the prime minister appeared to have reversed his decision, stating that trade with Iran was still taking place using other currencies: "I did not say we abide by the sanctions, I said we abide by not using dollars in transactions. We have no other choice."
Al-Abadi's swift backpedalling signalled that in the space of a week, the government had come to realise the magnitude of the commitment that US sanctions demanded of it. Iraq's economic and political dependency on Iran has only been entrenched in the years since the 2003 US invasion, and the sanctions are already wreaking havoc on the country's fragile post-war rehabilitation. Yet with Iran's own economic circumstances deteriorating rapidly, eschewing the US and the dollar market altogether would be risky for the future. Attempting to balance its links with both Washington and Tehran, Iraq's future looks volatile either way, with ordinary Iraqis standing to lose the most.
Ties that bind
Iraq's economic reliance on Iran is substantial, particularly as the nation struggles to return to its pre-Daesh production levels. The country recorded negative growth this year for the first time since 2003; it is heavily dependent on foreign aid as it looks towards civil reconstruction.
Iraq and Iran share a 1,400 kilometre border with an estimated $6 billion worth of non-oil trade between them, amounting to some 16 per cent of all Iraqi imports. Iran is also Iraq's main supplier of natural gas, with contracts worth around $12 billion. While Iraq possesses substantial gas reserves, it lacks the infrastructure to refine it for domestic use and depends upon Iranian gas to generate electricity. In return, Baghdad provides Iran with oil in payment for its imports and electricity. This appears to be non-negotiable for Iraq, whose oil minister pledged in June that any return of sanctions would not have an impact on crude oil swaps.
Furthermore, Iraq is also dependent on Iran for its water supplies via the Rivers Tigris and Euphrates. The country is already facing serious drought, with many major reservoirs threatened by desertification. The lack of adequate water purification and sewage facilities has been complicated further by subsequent oil spills, many of which were perpetrated by so-called "Islamic State" fighters. If it chose to do so, Iran could divert as much as 13 per cent of Iraq's water resources – Tehran has already cut supplies to towns in the northern Kurdistan region – a move which would see tens of thousands of people affected.
Still emerging from the bitter defeat of Daesh militants, Iranian imports have come to dominate Iraqi markets, with everything from basic foodstuffs to construction materials crossing the border. Violence across Iraq prompted farmers and tradesmen to flee from rural areas, while many towns and villages were laid waste in battles involving the international coalition. Consequently, production levels of non-petrol related goods have plummeted, with crude oil making up 93 per cent of the country's exports. One of the other few remaining sources of income, religious tourism, has also been impacted negatively by the sanctions. Some five million Iranians used to visit Iraq each year, numbers that have fallen sharply with the arrival of economic hardship next door.
Iraq is also tied to Iran politically, with the former still struggling to form a new government after an inconclusive parliamentary election in May. Tehran has expanded its influence by backing Hadi Al-Amiri's Fatah Alliance which came second in the election, with its position in a coalition looking likely. The apparent siding of Al-Abadi's government with Washington over sanctions could cause a major schism in a future administration.
An American exception?
As affirmed by Al-Abadi, trade between Iraq and Iran has continued so far, with local traders and businessmen ditching the dollar in favour of the Iraqi dinar, Iranian rial or the euro.
"We were encouraged by the position of European Union states toward Iran in respect to the American sanctions," a central bank official told reporters. "They keep dealing with Iran in euros so why shouldn't we?"
At the end of last month, officials revealed that Baghdad was preparing to ask for a formal exemption from abiding by the US sanctions. There is a precedent for such action; when the UN imposed sanctions on the late Iraqi leader Saddam Hussein from 1990 to 2003, for example, neighbouring Jordan was exempt.
With the Trump Administration's history of erratic policy making, though, Iraq could see its request denied in a bid to punish Iran further. Abiding by the sanctions entirely would prove near impossible for Baghdad, but it is ill positioned to weather any retaliatory action from Washington. The US could opt to freeze the Iraqi Central Bank account with the US Federal Reserve System, a move which significantly damaged the economy in the 1990s by restricting government spending.
However, risking US anger and being excluded from the dollar market would also see Iraq struggle in the long run, particularly with Iran's economic prospects looking increasingly uncertain.
Whilst the Iraq-Iran trade network remains crucial, the level of integration has already led to Iran's economic woes spreading over the border. The value of the Iranian rial has plummeted to historic lows over the past month, staggering investors and diminishing the savings of thousands of Iraqis who poured millions of dollars into Iranian banks that were offering interest rates as high as 25 per cent following the nuclear accord, in the hopes of stability. Iraqi investors are scrambling to salvage what is left of their money, but Iran's banks have placed strict restrictions on withdrawals to stem the crisis, limiting them to just $200 per day.
With Iraq the second-largest purchaser of Iranian exports, Tehran is likely to use every avenue to keep trade flowing across the border through smuggling networks and by winning the sympathies of Iraqi traders. However, as demand falls from other trade partners, soaring prices could further strain the pockets of Iraqis looking to secure basic goods.
Iran is also likely to use its political leverage in Iraq to its advantage. With the cost of the war in Syria increasingly unpopular at home amid further financial strain, Tehran will seek to prove that its political expansionist project has yielded some allies. Iran has been investing in projects linked with paramilitary forces, promising funds for reconstruction, in a bid to prevent Iraq from turning to Turkey and the Gulf states as alternative trade partners.
Protests over conditions in Iraq have already started. Over the past week, the southern city of Basra has witnessed demonstrations and riots that have left at least 12 people dead and dozens injured. The oil-rich city has been faced with an electricity shortage for months, as well as water pollution that spread illness amongst thousands of residents in August. Protestors burned government buildings and the Iranian Consulate, calling for an end to corruption, mismanagement and Tehran's interference in domestic affairs.
Iraq's next move will prove crucial for the country's future economic development. Negotiating for exemptions from the US sanctions is necessary in the short run, with countries such as India likely to ask for the same consideration. Nevertheless, the government needs to take drastic steps towards economic reconstruction, starting with political mobilisation, so as to work towards some degree of relief from its regional dependencies. Currently, Iraq cannot limit itself to Iran or the US exclusively; Baghdad will have to be active on the diplomatic front to stem the economic impact of its neighbours' difficulties on Iraqi citizens.
The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.