How US sanctions on Iran will harm Iraq's economy

In response to the new set of sanctions imposed by the United States on Iran on August 7, Tehran is now vigorously seeking to expand its stakes in the non-oil trade, energy and engineering markets of neighbouring Iraq.

This was a widely expected move by Tehran, as Iraqi non-oil imports from Iran already amount to more than $6bn and Tehran has significant influence over the federal government in Baghdad. Moreover, Iranian traders have long enjoyed relatively easy access to Iraqi markets. The actions of other regional powers, such as Saudi Arabia and Turkey, are also pushing Iran to increase its trade share in Iraq.

While a substantial increase in trade with Iraq may help revitalise Iran's worsening economy, it will probably stifle Iraq's economic development.

Flooding Iraqi markets with cheap products

Iran has already been flooding Iraqi markets with cheap products for over a decade, and the latest round of US sanctions imposed by the Trump administration are expected to further exacerbate the problem.

If a pro-Iran coalition government is formed in Iraq in the coming days, it would mean minimal implementation of US sanctions and it would pave the way for Iraq to become the most important market for Iranian exports. Last month Iran's ambassador to Iraq, Iraj Masjedi, met Iraqi trade officials to discuss the prospects of higher economic cooperation and Iranian private sector investment in the country.

Moreover, trade with the Kurdish Regional Government (KRG) is booming again after Iran lifted a temporary embargo imposed in the aftermath of the Kurdish independence referendum last year.

After the reversal of punitive measures in January 2018, the KRG started to renovate its border-crossings with Iran, and both sides agreed on allowing to drop duties on certain commodities. Today, one-third of Iran's non-oil exports to Iraq are destined for the KRG.

First Deputy Chairman of Erbil Chamber of Commerce Ibrahim Muhammad Kanabi told me in a phone interview that he expects some Iranian manufacturers to relocate to the KRG to overcome the obstacles caused by the US sanctions. As a result, low-cost Iranian products are likely to overwhelm the KRG market, despite the fact that they are of relatively poor quality, compared with their Turkish equivalents.

The water crisis

The water crisis in Iraq is also providing Iran with an opportunity to further increase its trade share in the country. Both climate change and the upstream dams Turkey built on the Euphrates and Tigres rivers, which supply Iraq with most of its water needs, caused the country to become more and more dependent on agricultural and foodstuff imports from Iran and Turkey.

Iran's exports of agricultural products and foodstuffs to Iraq are worth more than $2bn annually.

Due to the increasing severity of the water crisis and the inability of local producers to compete, this dependency is likely to increase in the coming days, giving Tehran (and Ankara) more leverage to grow its share of the market. This is despite the fact that Iran is also suffering from a water crisis of its own.

However, to maintain and ramp up its exports to Iraq, it is resorting to more sophisticated trade strategies such as re-exporting raw products such as wheat in the value-added form of flour. Turkish officials see this as an Iranian attempt to emulate Turkish trade strategies in Iraq.

Nevertheless, it is unclear to what extent a water-scarce Iran can continue to export agricultural and foodstuff products to Iraq at the current rate.

The role of Turkey and Saudi Arabia

The strengthening of Turkey's trade links with Iraq is also encouraging Iran to invest more in trade with the country. Turkey's trade with Iraq has long been dependent on the cooperation of the KRG, as most goods are transferred between the two countries through the Ibrahim Khalil border-crossing on its border with the Kurdish region.

However, after Erbil proceeded with its plans for an independence referendum despite its neighbours' vocal opposition in September 2017, Ankara felt the need to end its dependency on the KRG.

In August 2018, Turkish President Recep Tayyip Erdogan and Iraqi Prime Minister Haider al-Abadi, reiterated their commitment to building a new, "direct" border-crossing between Turkey and Iraq in Ovakoy -Faysh Khabur, bypassing the KRG. This border crossing would not only allow Turkey to circumvent the KRG in its trade relations with Iraq's federal government, but it will also allow Turkey to increase its market share in Iraq.

At a time when Iran is hit by a new set of US sanctions, it is logical to assume it will do everything in its capacity to prevent a loss in its trade revenues in Iraq. Over the past months, Iran has already been building new border markets with Iraq to increase religious tourism-driven trade activity.

Saudi Arabia is another driving force behind Iran's economic expansion towards Iraq. Riyadh has a new engagement policy, with trade cooperation at the top of its agenda, and it wants to increase its market share in Iraq. It does not have the accumulated geo-economic experience that Tehran has developed over the past decade in Iraq, but it appears to be targetting economic areas where Iraq and Iran have disputes, including energy.

Saudi Arabia is offering to supply Iraq with triple the amount of electricity it is getting from Iran at a significantly lower price (if the contribution of Iranian natural gas exports to power generation in Iraq were to be excluded). With these soft power moves, Riyadh is attempting to cripple Iran's economic leverage over Baghdad.

To counter Saudi Arabia's soft power strategies and help neutralise the impact of US sanctions, Iran has no option but to increase its trade with Iraq. To achieve this, it will likely engage its loyal Iraqi paramilitary networks in business and reconstruction efforts, transforming them into a lobbying force against Riyadh's trade and investment schemes.

By doing so, Tehran would seek to relieve itself of some of its financial commitments to them and turn them potentially into economically self-sufficient proteges.

The latest wave of protests in Iraq that commenced in July 2018 reflects, in part, how Iran's strategy of exporting cheap products have harmed Iraq's economic development. The latest set of sanctions imposed on Iran and the ambitions of other regional actors will only intensify its negative impact over the development of the Iraqi economy in the coming few years.