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Dear Investors and Friends,

The Central Bank of Iraq (CBI), devalued on 7^th October 2026 the exchange rate of the Iraqi dinar (IQD) vs the U.S. Dollar (USD) by 13.3% from USD 1 = 1,300 IQD to 1,500 IQD. This had an immediate negative impact on the performance of the AFC Iraq Fund; however, we believe the devaluation creates an attractive entry point to participate in Iraq’s economic transformation. This is particularly so as the devaluation increases the country’s oil revenues by 15.4% just as oil exports recover to 75% of pre-war levels, while at the same time future oil price expectations are shifting higher – with the combination magnifying the effects of the devaluation on oil revenues.

The reaction of the market immediately following the devaluation was lacklustre, with prices trending lower on very thin volumes, considerably below the already low volumes of the last few weeks, suggesting a lack of selling pressure as a result of the devaluation. The market had a similar lacklustre reaction immediately following the 18.5% devaluation (the dollar was higher by 22.7%) in December 2020, in which prices declined in the two to three weeks following the devaluation before rallying strongly in the subsequent weeks (day of devaluation marked by green line in the chart below).

Rabee Securities U.S. Dollar Equity Index

Background, Context, and Near-term Outlook

Oil Exports, Oil Revenues, and the 2026 Budget

The closure of the Strait of Hormuz in early March 2026, following the onset of the U.S.–Israel war on Iran, led to the effective shutdown of Iraq’s oil exports, 95% of which had passed through the Strait before the war. This could have had an immediate impact on the government’s ability to meet its expenditures, as about 90% of its revenues come from oil exports. This, in turn, could have hurt the wider economy, given the state’s outsized role, both through its provision of goods and services and through the public-sector payroll.

However, this initial loss of oil exports did not represent an immediate hit to oil revenues, which continued to flow into March–April, benefiting from the roughly two-month lag between oil exports and the receipt of their revenues. Nevertheless, the loss of oil exports in March–May translated into sharply lower oil revenues for May–July, with the beginning of oil export recovery in June reflected in the strong recovery of oil revenues in August (charts below). Oil exports continued to recover, reaching about 68% of pre-war levels in August and 75% in September, with preliminary reports suggesting that the momentum carried into early October. This export recovery should begin to show in stronger oil revenues from September, with those for October–December benefiting further from the dinar’s devaluation. Somewhat mitigating the drop in oil revenues was the strong growth in non-oil revenues, up 24% in January–August versus the same period in 2025, which benefited from the implementation of a new automated customs tariff system at the end of 2025.

Actual and Projected Oil Exports for 2026

Actual and Projected Revenues and Expenditures for 2026

The state’s expenditures are dominated by rigid current expenditures – made up of public-sector salaries, pensions, social security, benefits, and subsidies – which, reflecting the country’s political economy, are exceptionally difficult to reduce even when oil revenues decline below expenditures. As such, the prior government, and the current government in office since May, continued with the usual cash-management toolkit – employed by all prior governments when oil revenues fall below expenditures &nndash; such as ad hoc cost savings and accumulating arrears to third parties, including domestic contractors and International Oil Companies (IOCs), together with the freezing of all new capital and investment spending projects. Despite these measures, there was a gap between revenues and expenditures in 2025, which continued into 2026 (chart above), but which increased significantly in April–June, then began to narrow in August, and is projected to narrow further as the year comes to an end (table below).

Actual and Projected Revenues and Expenditures for 2026

Foreign Reserves and the Exchange Rate

The government’s continued spending, in particular its current expenditures, sustained domestic consumption, which in turn sustained the demand for imports. Surprisingly, this demand was relatively strong in the context of the disruptions brought by the closure of the Strait of Hormuz, as reflected in cross-border transfers (chart below), which are mostly used to pay for imports and are thus a proxy for domestic consumption. The application of the new automated customs tariff system at the end of 2025 had an initial depressing effect on demand, as reflected in the sharp drop in January, but demand recovered in subsequent months, with the drop in August being a function of new CBI procedures that constrained transfers.

Cross-Border Transfers (USD billion)

The continued drawdowns of foreign reserves to meet demand for cross-border transfers, not replenished by the conversion of oil revenues from dollars into dinars, led to a sharp decline in reserves, which by the end of September were down 23% from the levels at the end of 2025.^† However, current levels are healthy, comfortably supporting around 12 months of imports,^‡ and are much higher than those that prevailed prior to the 18.5% devaluation in December 2020. As such, the current decision to devalue the dinar was a proactive one, buying the government time to decide on fiscal reforms, which is in sharp contrast to the historic head-in-the-sand stance of the country’s political elite during periods of crisis.

In the near term, the pressures on foreign reserves should ease substantially, as reserves should be replenished by the conversion of increased oil revenues in October–December into dinars, while demand for cross-border transfers should be dampened somewhat by the effects of the dinar’s devaluation on domestic consumption.

Foreign Reserves (USD billion)

Near-term Outlook

The near-term outlook for government finances, the economy, and foreign reserves is highly dependent on the continuation of the recovery in oil exports and on the continuation of the pause in the tit-for-tat attacks between the U.S. and Iran. While a few strong oil export months do not make a trend, especially in this highly fluid and dangerous period, current market expectations for future oil prices, as measured by Brent futures contracts, promise a measure of stability for all three.

Expectations for future oil prices following the collapse of the Islamabad Memorandum of Understanding have consistently shifted higher, suggesting an acceptance that the current pause in the tit-for-tat attacks between the U.S. and Iran is evolving into a surreal new normal of no-war/no-peace (chart below).

Market Expectations for Future Oil Prices (USD per barrel)
As measured by Brent futures contracts

As such, the combination of likely higher near-term oil prices, continued strong oil export recovery, and the 13.3% devaluation of the dinar would substantially improve the government’s financial position for the year (budget table) and provide a measure of stability for the economy and foreign reserves – although reserves would still trend lower, albeit at a much slower rate.

The three positives of higher oil prices, continued strong oil export recovery, and the 13.3% devaluation of the dinar, while necessary, are not sufficient to sustain economic stability without addressing the budget’s structural imbalances of rigid expen­ditures and revenue volatility. Nevertheless, they have provided the government with breathing space to decide on fiscal reforms, in particular those that could come with an IMF programme, such as the Stand-By Arrangement (SBA) signed in 2016, or, better still, the more substantial Extended Fund Facility (EFF). Any IMF programme would face extreme resistance from the public and the political elite, who together rejected the White Paper for Economic Reform, which came in response to the financial crisis of 2020 and aimed to address the economy’s structural imbalances.^§ That said, the continued need for debt to augment oil revenues, irrespective of the future direction of oil prices, requires the issuance of foreign debt in the form of Eurobonds, which would not come without an IMF programme, to supplement domestic debt – as the issuance of domestic debt on its own will continue the pressure on foreign reserves, while foreign debt will increase them.

Despite domestic resistance to an IMF programme, the proactive decision to devalue the dinar – breaking the historic head-in-the-sand pattern – signals the seriousness of the government’s tentative engagement with the Fund over recent months. That engagement has since solidified: at the close of the IMF–World Bank Annual Meetings in Bangkok on 17^th October 2026, the IMF’s Managing Director confirmed that the authorities had requested a programme, pledging “both money and policy support”.

While such an engagement would likely take many months to conclude, the three positives outlined above have opened a window of up to a year for these discussions, as can be seen from the near-term implications of Brent crude prices under the assumption of continued oil export recovery. Current expectations imply an average Brent price of USD 92.5 per barrel (USD/bbl) for 2026, a projected average of USD 95.1/bbl for 2027, and USD 81.2/bbl for 2028, which, for Iraq under the current assumption of no-war/no-peace, means prices lower by about USD 32/bbl for the balance of 2026 and for 2027–2028. Assuming expenditures over the next two years are in line with those projected for 2026, this suggests that the budget’s deficit for 2027 could be better than that of 2026, but that the deficit for 2028 could be worse. In the short term, this would allow domestic debt to fund the deficit without significantly eroding reserves, while in the medium term foreign debt would be needed – all of which support the conclusion of an IMF programme.

Conclusion

The devaluation does not affect the high quality of the AFC Iraq Fund’s holdings or their long-term earnings growth, which should continue to drive its performance irrespective of any volatility that the next few months might bring. In fact, we believe that the devaluation has created an attractive entry point to participate in this long-term earnings growth. However, considerable risks remain, notably that the pause in the tit-for-tat attacks between the U.S. and Iran may collapse, reigniting a conflict that could escalate well beyond the control of the participants, both direct and indirect, and become an all-out war engulfing the region.

Notes

* Methodology: Projections for oil exports assume incremental month-on-month increases from September’s estimated levels. Blended oil prices for southern oil exports assume a discount of USD 32 per barrel (USD/bbl) to Brent crude prices, while northern oil exports assume a discount of USD 5/bbl to Brent (September reflects actual Brent spot prices; December reflects futures prices as of 16 October 2026; October and November are interpolated between the two). Budget oil revenues are derived from projected export receipts (0.44 × current month + 0.56 × two months earlier), less a 15% haircut, and converted at 1,461 IQD/USD in October and 1,500 IQD/USD in November–December. Projected non-oil revenues assume full-year growth of 16%, down from 24% year-on-year in January–August. Projected expenditures assume continued cost controls; each month’s projected expenditures are based on the average of the preceding three months and include oil capital expenditures (15% of oil revenues), which were minimal in January–August.

† Reserves are created when the Ministry of Finance (MoF) converts its dollar oil revenues into dinars: the Central Bank of Iraq (CBI) buys the dollars from the MoF and sells it the equivalent in dinars. Cross-border transfers, on the other hand, are the reverse transaction: the private sector, through the banks, sells dinars to the CBI and buys dollars from its reserves. Reserves therefore increase when the CBI buys more dollars from the MoF than it sells to the private sector, and decline when it sells more than it buys. See: (1) Ahmed Tabaqchali, “A Fistful of Dinars: Demystifying Iraq’s Dollar Auction,” LSE Middle East Centre, 18^th April 2024, pp. 7–11,;  (2) Ahmed Tabaqchali, “The Empire Strikes Back: Trump 2.0 and Iraq’s Dollar Accounts at the Federal Reserve,” LSE Middle East Centre Blog, 4^th March 2025,

‡ Reserves as of the end of September, divided by the 18-month average of cross-border transfers, would cover at least 12 months of transfers. A CBI official at the MERI Forum in Erbil on 13^th October 2026 stated that reserves cover Iraq’s imports for a year or more. See: Al-Mada, “Central Bank: Our Foreign Reserves Cover Iraq’s Imports for a Full Year or More” (in Arabic), 14^th October 2026

§ Ahmed Tabaqchali, “Missed Opportunities for Economic Reform,” in Iraq 20 Years On: Insider Reflections on the War and Its Aftermath, Chatham House, 4^th May 2023, 

AFC Iraq Fund Marketing Information as of 31^st July 2026

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NAV as of 30^th September 2026 and performance table since inception

Regards
 
Ahmed Tabaqchali
Chief Strategist AFC Iraq Fund
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