Introduction

Global oil price volatility presents a significant fiscal challenge for oil-exporting nations, profoundly impacting public budgets and economic stability. In the past, it has been different since “downward trends in the oil market, whether or not brought on by weak global demand or technological changes reducing importers’ dependency, transfer market power to demand-side aspects, making the impact of supply shortfalls muted,” historically governments have preferred to focus on issues associated with tracking fluctuations in oil pricesTriggered by weak global demand and technological changes reducing importers’ reliance, downturns shift market dominance to demand-side aspects, making the impact of supply shortfalls muted. It is therefore important for these resource-exporting economies to comprehend the transmission processes of the real effects of oil price shocks, but also to identify which are the effective policy measures which can help to offset the destabilizing effects of such shocks. People over half a world away know about the frailty of depending on heavy oil receipts, Iraq typifies this state of acute susceptibility. Its economy has suffered from deep instability as a result of a combination of pre and post-2003 shocks, such as wars, institutions’ weaknesses represented by a rentier economy, wide spread corruption, and non-oil sectors’ share of the GDP [1,2]. This has entrenched a budget framework that is highly responsive to and dependent on changes in oil revenues, for which external factors determine government receipts and payments. Consequently, oil price declines directly translate into substantial budget deficits, with estimates suggesting each dollar per barrel drop costs Iraq over a billion dollars in revenue, while price increases often lead to commensurate rises in government spending. The period 2004-2020 starkly illustrates this vulnerability. Iraq's fiscal position was severely tested by the triple shocks of plummeting oil prices, the security threat from Da’esh, and political instability in the Kurdistan region, exacerbating its fiscal crisis and deepening oil dependency [3], [4]. The literature finds that oil price shocks have asymmetric effects on fiscal spending, posing challenges for budget planning and execution. In addition, the accumulated pressure placed on the economy by rentier inefficiencies has not only made it difficult to restructure, but also reflectively affected diversification initiatives and the social and political environment, calling for reform of policies to strengthen budget stability and minimize oil revenue risk. In this vein, the current study aims to examine the dynamic linkage between crude oil price volatility and the Iraqi general budget from 2004 to 2020. We hypothesize that from this epoch [5], [6] forward the vagaries of oil prices had critical, complex (both adverse and beneficial) influences on the budget. The study aims to:

1. Study the empirical connection between oil price changes and Iraqi fiscal performance.

2. Predict the likely effects of this association based on historical patterns.

3. Evaluate the resultant fiscal vulnerability and the urgent necessity for effective oil revenue management and economic diversification policies to attain sustainable budget stability.

Fiscal Shocks, Oil Dependence, and Budgetary Dynamics in Rentier States

Government spending shocks undergo rapid modifications in their valuation. This modification can encompass every aspect of public spending, with effects ranging from beneficial to detrimental concerning various economic indicators. Short-term shocks generate minimal economic fluctuations, while long-term shocks produce significant economic ramifications. Original government spending reflects actual financial resources expended relative to planned amounts [7]. A revenue shock refers to unexpected fluctuations in government revenue collection, which can be either positive or negative, akin to the currency depreciation or appreciation experienced by various countries globally. Such shocks may arise from factors external to governmental control, such as export earnings variations, exemplified by oil price shifts within oil-exporting nations [8]. Additionally, these alterations may result from economic shocks occurring both pre-recession and post-recession, characterised by a decline in tax revenue due to reduced economic activity, followed by an increase during periods of economic recovery. Revenue shocks can be broadly classified into two categories:

1. Tax Shock: This phenomenon influences supply and demand, often leading to deflationary conditions due to the increased revenue collected. The oil price shock will be analysed in depth concerning its alternative impact on government revenue, representing a crucial variable in this research

2. Crude Oil Price Fluctuations: In numerous developing nations, particularly those that are oil-producing, crude oil functions as a crucial resource for governmental budgeting, as authorities strategically manage this asset to finance their expenditures. Variations in oil prices represent a significant shock for countries that predominantly rely on oil, such as Iraq [9], [10]. An increase in oil prices leads to an expansionary shock, whereas a decrease results in a considerable contractionary shock, encompassing economic, social, and political consequences. These shocks can arise from intentional changes or occur spontaneously. Such events are categorized as external shocks that originate from alterations in factors that directly affect oil markets, manifested through fluctuations in price, or through a sudden disruption in market equilibrium over a specified timeframe, as a result of factors influencing both supply and demand [11].

James D. Hamilton asserts that while positive shocks to oil revenues yield numerous benefits, adverse oil shocks resulting from a collapse in oil prices can reveal the vulnerabilities of certain oil-exporting economies in the context of economic fluctuations. Consequently, the magnitude of such shocks is particularly pronounced in countries where oil exports constitute a substantial percentage of the gross domestic product and where the contribution of oil revenues to government revenues is typically significant [12]. The short-term repercussions manifest when oil revenues decline in these nations, potentially leading to the cessation of specific production initiatives and causing the economy to spiral into a detrimental cycle characterised by rising unemployment and diminishing aggregate demand, particularly in scenarios where economic activities are predominantly centred around the oil sector, alongside a notable decline in the contributions of other commodity sectors to the gross domestic product Among the most significant shocks to government revenues, transmitted through oil revenues post-2004, are identified in works

1. The 2008-9 oil crisis received broad attention as the oil demand soared, due to, among others, the failure of OPEC to adjust to the substantial global economic growth, which created a shortfall in the global oil supply and caused a jump in the prices across the world. There was a large inflation in oil price at the market because of the increased market speculation and in 2008 the prices were even nearly reached $147 per barrel which became the highest level in the history [13]. After a very large upsurge in oil prices in 2008 hundred dollar a barrel which were fueled by speculation, the fulcrum of the world financial system, American institutions banks and mortgage companies failed, which brought the prices of oil all the back to normal. As a result, by the close of 2008, the market price was $94.45 per barrel, declining to $61.06 by 2009.

2. During the oil shock of 2014–2015, the price of crude oil rose to $105.87 / barrel. But after 2014, these prices have kept falling, reaching a value of about $96.29 US to the barrel and dropping even further, to $49.49 US per barrel in 2015.A significant factor contributing to this decline was the insufficient growth in global demand relative to the surge in oil supply

3. Oil Shock (2019-2020): This event is commonly called the Covid-19 shock (Selmi et al., 2022), Despite the initial virus outbreak in China, OPEC members, particularly Iraq, have experienced significant adverse effects. This impact was exacerbated following the global proliferation of the epidemic, particularly given that China is the foremost importer and the second-largest oil consumer worldwide [14], [15], [16]. Consequently, both consumption and demand for oil diminished leading to prices declining across global markets. Specifically, oil prices fell from $66.5 per barrel in December 2019 to a nadir of approximately $17.7 per barrel in April 2020. Subsequently, oil prices rebounded to $25.2 per barrel in June 2020 due to increased demand and decreased production. However, oil prices continue to exhibit volatility, fluctuating between increases and decreases, influenced by public health closure measures and the expansion of global oil demand [17], [18].

Budgetary Institutions in Rentier Economies: Iraq’s Case

The general budget is an indispensable instrument of governance in the modern era, essential for the functioning of any state irrespective of its political system, economic structure, or type of government. Without an approved budget, government ministries, institutions, and interests lack the financial resources to operate effectively, fundamentally impairing the state's capacity to fulfill its mandated functions. As the primary tool of financial planning, the state budget enables governments to articulate their objectives, formulate policies, and determine the optimal strategic allocation of resources [19]. Authorities employ comparative analysis of budgetary alternatives during its preparation to maximize societal benefits derived from available resources. Consequently, the general budget is formally defined as an annual financial program: a detailed, legislatively approved projection of the state's anticipated revenues and expenditures for a specific fiscal period. Submitted to the lawmaker for approval, it is designed to attain certain economic and social ends. In addition, the budget reflects the economic, political and financial priorities of a country and is an important tool for economic growth and stability planning. Public spending is required for the realization of this end and in order to satisfy the public needs of the population, thereby promoting both economic stabilization and financial coverage of operational and investment expenses. But Iraq’s budget suffers from structural imbalance – a large chunk of it is spending on current items of cost based primarily on an oversized public sector and very little allocation of money for investment. This is fundamentally due to the rentier nature of the economy, where over 90% of state revenues come from oil exports [20]. This business model exposes the country to price shifts in the world oil markets and does not favour economic stability. The weak domestic production capacity, exacerbated by underinvestment, forces Iraq to meet rising consumption demand through imports, depleting hard currency reserves and perpetuating deficits in the balance of payments. Consequently, the state's heavy dependence on oil for budget financing renders it susceptible to periodic fiscal crises, endangering national economic projects. The resulting general budget deficit defined as the excess of expenditures over revenues encompassing all state financial activities reflects adverse fiscal policy effects and budget preparation/execution approaches, while diversified non-oil revenues (like taxes and fees), indicative of economic development, remain critically underdeveloped. The concept can be demonstrated through the analysis of Iraqi budget figures (2004-2004), as presented in Table (1). The external, in particular energy price, is the source of financial shocks, which are imported domestically via a number of channels. These shocks are worsened by the fragility of Iraq’s domestic economic order. Perhaps most important is that, the volatility of oil prices sharply undermines the government's oil revenues which are not only the state's largest revenue source, but also its main tool for financing public spending.

Knowledge Gap: Although oil price consternations are widely-reported, the asymmetrical transference through all portions of the budget (revenues, expenditures, deficits) in Iraq’s war-torn rentier economy is overlooked in the literature, which this study remedies.

Methodology

The ARDL Bounds Test approach by Pesaran and al. (2001) by investigating the dynamic relation between crude oil prices (OIL) and fiscal variables of Iraq [public revenues (RE), public expenditure (EX), and budget deficit (DB)] over the period 2004–2020.The ARDL framework is selected for its robustness in modeling cointegration with variables of mixed integration orders [I (0) or I (1)], superior small-sample performance, and simultaneous estimation of short-run dynamics and long-run equilibrium. The methodology follows a five-stage analytical procedure.

Figure 1. The general budget in Iraq for the period (2004-2020)

Table 1 details the Iraqi general budget from 2004 to 2020 (in million Iraqi dinars, current prices). Initial surpluses marked this period: a surplus of 865,248 million dinars in 2004 (revenues: 32,982,739; expenditures: 32,117,490) grew significantly to 20,848,807 million dinars by 2008 (revenues: 80,252,182; expenditures: 59,403,375), driven primarily by crude oil exports. However, the 2009 global financial crisis caused revenues to fall to 55,209,353 million and expenditures to 52,567,025 million, narrowing the surplus to 2,642,328 million. A significant break came in 2014, when revenues of 113,840,076 million were exceeded by spending, which soared to 119,128,000 million, primarily due to the cost of the military operations to fight ISIS, resulting in a 5,360,605 million-dinar deficit. In the years that followed there were waves of increases and in 2020 receipts dropped to 93,199,689 million (from here in 2019 at 107,567,032 million) and expenses to 76,082,443 million (from here in 2019 at 111,723,523 million) creating a deficit of 12,882,754 million dinars.This final deficit stemmed from challenging global economic conditions, severely exacerbated by the COVID-19 pandemic and plummeting oil prices, which crippled Iraqi oil exports.

Figure 2. Crude oil prices (OPEC basket (2004-2020)

Table 2 illustrates crude oil prices in both foreign and Iraqi currencies, alongside the exchange rate in Iraqi dinars. In 2004, a notable increase in oil prices occurred, rising from 2.73 million to 6.76 million barrels per day due to growing global demand, particularly from the United States, China, India, and other developing nations. Subsequently, oil prices surged to 107.5 million barrels in 2011. Nonetheless, in 2009 the average price of the OPEC basket fell to 61 dollars with an average demand for world oil falling to 84.8 million barrels per day from 86.1 million in 2008 and then again increasing to 107.5 million in 2011. WORLD OIL PRICES: In 2014 world oil prices fell further to 96.3 dollars per barrel, the basket price for OPEC. The decrease was a consequence of slower annual growth in oil demand and appreciation of the dollar. Sometime in 2018, crude oil prices rose with the OPEC basket price exceeding $69.80 per barrel, driven by demand from the then accommodative and renewed Russian-Saudi policy for a second consecutive year. The average OPEC basket price of crude oil in 2019 was $64.00 a barrel, but fell to $41.50 in 2020. Overall, the COVID-19 pandemic, which had a huge impact on global output, while many factories had to shut down, and global demand for crude oil dropped, so the crude oil price was reduced considerably.

Figure 3.

ARDL Cointegration Procedure

Figure 4.

Figure 5.

Results Analysis and Discussion

To test the study hypotheses and achieve its objectives, the model was described as follows:

Table 3. Description of the model variables

Test the stationarity of the time Series.

To increase the sample size and obtain accurate results, the data of the variables under study were converted into biannual data to get the stillness of the time chains [21].

Table 4 indicates that the time chain is stable at the first difference, i.e., integrated level (0). Since the prob value is less than 5%, it accepts the alternative hypothesis and rejects the null hypothesis.

Figure 6. Stability of the time chains at the first difference

Granger Causality Test

Table 5 illustrates the ratio relationship among the variables examined utilizing the Granger method, as a substantial correlation exists between (EX-RE), specifically between overhead and general income [22], [23]. There is also a strong interdependency between (BD-RE), general income, and general balance, and between (RE), general revenue, and oil prices. Moreover, there is a direct relationship between (BD) and (EX), and a significant relationship that also exists between oil prices and (BD) deficit or surplus. This accords with the economic rationale that prices of oil shape rentier dynamics in the economies [24].

Joint Integration Test Using the ARDL Model

The initial phase of the Autoregressive Distributed Lag (ARDL) model involves estimating the correlation between the dependent variables namely public expenditure, general revenue, and deficit or surplus and the independent variable, which is represented by oil prices [25]. Table 6 references the ARDL model, which autonomously identifies optimal time lags.

Table 6. shows that the Adjusted R-Squared value interpreted by Oil (99%) in the EX-RE-DE variants, along with the morale (F), is (0.000000), which is below (5%). This suggests that the morale of the estimated model is low. Additionally, the value (D.W) is (1.858824), indicating no issues with self-association.

Residual Diagnostics Test

Table (7) refers to the Residual Diagnostic Tests. First, it shows the expected distribution test value (0.864676), which is more significant than (5%). The second test appears in the self-correlation value (0.7139) and is more important than the ratio (5%). This means that the model shows a self-correlation problem [26], [27], [28]. The third test is the inconsistency of the variance shown at 0.3472 (greater than 5%), in the sense that there is no inconsistency problem.

Bound Test for Joint Integration

Table (8) refers to the bound test for joint integration through the value (F) calculated at (11.46811), which is greater than the upper and lower bound (4.66) and (3.15) at the level (1%). This means that there is a standard integration between the variables under study and the subsequent balance relationship in the long term [29], [30].

Estimated Short Term Coefficients

Table 9 provides an analysis of the short-term parameters pertaining to the variables under investigation. Specifically, there exists a positive correlation between the Autonomous Variable (Oil) and the variable (ES) in the short term. This indicates that a 1% increase in Oil corresponds with a rise in (EX) valued at 0.948092. Conversely, a negative relationship is observed between (Oil) and (BD); when Oil increases by 1%, it leads to a decrease in (BD) valued at 0.437626. Furthermore, the error limit parameter has also demonstrated a negative and significant value, suggesting a long-term relationship among the variables under consideration [31].

Estimated Long Term Coefficients

Table 10 highlights the long-term negative signal of the independent variable (Oil), along with the positive signal variables (EX, BD), which have a significant moral impact over time. Additionally, it indicates a negative error correction coefficient, marked by a moral value below (5%), signifying a long-term equilibrium among the variables study.

Conclusion

This study empirically establishes that Iraq’s general budget (2004–2020) exhibits extreme vulnerability to oil price volatility, with Granger causality tests confirming unidirectional oil price shocks drive public revenues (RE) and expenditures (EX), while revealing a destabilizing bidirectional feedback loop between expenditures and budget deficits (DB). Univariate and multivariate unit root tests revealed I (1) integration of all the variables so that ARDL bounds testing was justified, additionally it also validated that there were strong long-run cointegrating relationships (F-statistic=11.47>1% critical bound). On the long run elasticities It is demonstrated that there appears rentier susceptibility in Iraq with the fragility (1% = 1.01%) of the oil price leading to a higher rise in expenditure (Table 10) and a marginal decrease in deficit (−0.44%) which means a pro-cyclical spending behaviour. Short-run characteristics (Table 9) further reveal acute sensitivity: expenditures respond rapidly (elasticity: 0.95) to price upturns, whereas deficits deepen sharply (elasticity −0.44) to downturns underpinned by unusually rapid error correction rate (CointEq(−1): −1.14, p = 0.000), implying 114% per annum adjustment towards equilibrium which emphasizes ingrained fiscal instability. Oil prices export revenues 99.8% (Adj.R2) of the variabi- lity. R², Table 6), and model validation diagnostic tests revealed stable model (normality p = 0.84; no autocorrelation p = 0.71; homoscedasticity p = 0.48). These results throw into sharp relief Iraq’s existential fiscal predicament: absent swift diversification away from the 99% oil-dependent revenue architecture, binding fiscal strictures to halt procyclical spending proclivities, and sovereign debt instruments to manage deficits, dramatic budget disruption as hallmarks of volatile global oil market gyrations will continue its ongoing reenactment. However, this analysis acknowledges the methodological limitations of six-month averaging to reveal more frequent volatility and the fact that exogenous shocks such as the Da’esh conflict and political instability (Jiyad, 2018) are not modelled as structural breakpoints. The future efforts will need to be carried out on quarterly basis and include explicit dummy variables for social-political crises, non-oil in GDP (Gross Domestic Product) growth rates, corruption indices, and geopolitical risks within the DSGE (Dynamic Stochastic General Equilibrium) models to “easily” offer policy recommendations.

Acknowledgments

The authors are grateful to both the University of Diyala and the University of Fallujah. We thank our colleagues for their helpful discussions and those who participated in the data collection and analysis.