Seven days into the US-Israel war with Iran, Iraq has officially stayed out of the fight. Its largest oil field is shut, its airspace is closed, militias operate on its soil — yet the dinar barely moved and markets remain stable. Here's how Iraq is navigating the impossible.**
The Middle East erupted into full-scale war on February 28, 2026, when the United States and Israel launched Operation Roaring Lion against Iran, killing Supreme Leader Ali Khamenei and hundreds of senior Iranian officials in coordinated strikes across at least 26 of Iran's 31 provinces.
One week later, Iraq has maintained its official position: neutrality. Baghdad has condemned all violations of its sovereignty, refused to take sides, and focused on protecting its economic interests.
That strategy is being tested in real time. Here's the situation on the ground as of March 7.
Iraq's Official Position: Neutral, Sovereign, Protecting Its Territory
Iraq's government has been clear and consistent since the war began: Iraq is not participating, Iraq condemns all violations of its sovereignty, and Iraq is focused on protecting its economic interests.
Prime Minister Mohammed Shia al-Sudani has publicly condemned strikes on Iraqi territory. Iraq's Foreign Ministry has issued statements calling for respect of Iraq's sovereignty and territorial integrity. Foreign Minister Fuad Hussein told US Special Envoy Tom Barrack on February 23 that government formation is "a sovereign Iraqi matter" while Baghdad "takes into account the views of its international partners."
But Iraq's geography makes complete isolation impossible. The country sits between Iran and the primary US military presence in the region. Iranian-backed militias operate within Iraq's borders, many as part of the official Popular Mobilisation Forces (PMF). And Iraq's economy depends on both energy cooperation with Iran and oil export routes protected by US-backed security.
Here's what has happened on Iraqi territory — despite Baghdad's official neutrality:
US and Israeli strikes on Iraqi soil: On February 28, coalition forces hit the Jurf al-Sakhar base south of Baghdad, which houses Iran-backed Popular Mobilisation Forces (PMF) units including Kataib Hezbollah. Iraqi state media confirmed two PMF fighters killed, five wounded. On March 1-2, additional strikes targeted PMF positions. Five members of the Iraqi Hezbollah Brigades militia were killed in al-Qaim near the Syria-Iraq border.
Iranian and militia attacks from Iraq: On March 1, drones struck Erbil International Airport, which hosts US military personnel. The US consulate in Erbil was also targeted. Iranian-backed Iraqi militias claimed 28 separate attacks in the first four days of the war. Saraya Awliya al Dam, a militia front group, announced drone strikes on American forces at Erbil airport "with a squadron of drones." The al-Bakr military airfield in Salah al-Din province and the Harir base near Erbil have both been hit multiple times.
Iraqi casualties: On March 3, an unidentified airstrike (likely US or Israeli) targeted an Iranian missile landing site in Iraq. Iraqi Security Forces responded. The attacking force then fired on the Iraqi unit, killing one Iraqi soldier, injuring two others, and damaging two military vehicles. No actor has claimed responsibility.
Iraq's dilemma: The Iraqi government has condemned all these incidents as violations of its sovereignty. But Baghdad has limited enforcement capacity over militias that, while nominally part of Iraq's security apparatus, often operate with significant autonomy.
The official Iraqi position remains: neutrality. The practical reality is more complicated.
Protecting the Economy: Iraq Shuts Oil Production to Prevent Damage
Iraq made a calculated economic decision on March 4: shut down production at Rumaila, its largest oil field, rather than continue pumping oil it can't export.
Rumaila had been producing 1.5 million barrels per day — roughly 36% of Iraq's total output. The field is operated by BP.
The shutdown wasn't panic. It was pragmatic economic management.
Here's why: Iran has effectively closed the Strait of Hormuz. Iraq's southern oil export terminals near Basra depend on tankers passing through the Persian Gulf and the strait to reach Asian and European buyers. With Iran threatening commercial vessels and several ships already hit, shipping companies and insurers are refusing to send tankers through.
Rather than continue producing oil that would simply accumulate in storage tanks — creating pressure on infrastructure and potentially forcing emergency shutdowns later — Iraq's Oil Ministry made the strategic choice to halt production temporarily.
Iraq also paused crude exports through the Ceyhan pipeline on March 4 due to broader regional conflict disruptions affecting Turkey.
This is temporary economic protection, not permanent damage. The question is how long "temporary" lasts.
According to The National, if production and export halts persist for even one month, Iraq faces "social and political upheaval" and the country could become "a powder keg." Iraq's government revenues are 99% dependent on oil exports. Public sector salaries, which employ millions, depend on those revenues.
Wood Mackenzie analysts warn that even with alternative egress routes (like Saudi Arabia's East-West pipeline to the Red Sea or additional Mediterranean volumes from Iraq), global spare capacity can't compensate. Iraq exports 97% of its oil through the Strait of Hormuz. The UAE has more flexibility (66% through Hormuz), but Iraq does not.
Oil prices spiked above $80 per barrel within days. Some analysts project prices could exceed $200/barrel if the conflict drags on and Hormuz remains closed — a level that would replicate the 1974 oil embargo's economic shock in inflation-adjusted terms.
Markets Signal Confidence in Iraq's Neutrality Strategy
Here's what surprised international currency watchers: despite a war unfolding in neighbouring Iran, despite Iraq shutting down its largest oil field, despite militias operating from Iraqi soil — the Iraqi dinar has remained remarkably stable.
According to Ahmed Tabaqchali's latest investment analysis (published March 5), the gap between Iraq's official exchange rate (1,300 dinars per dollar) and the parallel market rate spiked by only 2.5% when the war started. It has since settled back in line with the pre-existing trend.
Tabaqchali's conclusion: "the war had little lasting impact on this particular exchange rate dynamic."
Why stability matters: The dinar's resilience signals that markets believe Iraq's neutrality strategy will work. Currency traders are betting that Iraq stays out of the fighting, that oil exports resume relatively quickly, and that Iraq's economic institutions continue functioning despite political challenges.
The parallel market gap had already been rising since mid-December — not because of geopolitical risk, but because of Iraq's domestic customs tariff automation. The new ASYCUDA system and Cabinet Decision No. 957 (which raised tariffs from 1-5% to 30%) made it harder for informal importers to transfer money across borders. That drove demand for dollars in the parallel market.
When the war began, the market's reaction was muted. The dinar weakened slightly, then stabilized.
As of March 6, the official USD/IQD rate stands at 1,310.2, up just 0.01% from the previous session.
Iraq's stock market tells a similar story. The RSISX USD Index dropped 1.4% on March 1 (the first trading day after the war began), recovered half its losses by day's end, drifted lower over the next few days (down 3.2%), then recovered to an estimated decline of just 0.7% by March 5.
Tabaqchali characterizes the selling as "clearly not panic selling or selling driven by expectations of a war that is devastating for Iraq." Local buyers stepped in. The equity market is pulling back from all-time highs, but remains within its multi-month uptrend.
What this signals: Markets are pricing in Iraq's successful navigation of this crisis — staying neutral, protecting its economy, and maintaining institutional stability until the regional conflict resolves.
Iraq's Strategic Calculation
Markets are pricing in a short war — and Iraq's neutrality strategy is designed around that assumption.
Tabaqchali's analysis frames it this way: the expansion of the war raised costs dramatically for the entire world — spiking gas prices, rerouting trade flows, driving up fertilizer and food prices. That creates powerful incentives for "all concerned, direct and indirect combatants, for a quick resolution."
Oil futures markets show the same pattern. Expectations for immediate-term oil prices spiked significantly as the war progressed, but decline meaningfully after that. The market is betting on escalation now, de-escalation soon.
Iraq's economic strategy depends on that bet being correct. By maintaining official neutrality, protecting infrastructure through temporary production shutdowns, and keeping banking and financial systems functioning, Iraq is positioning itself to resume normal operations as soon as the regional crisis passes.
The strategic advantage of neutrality: Unlike Iran (direct combatant), Israel (direct combatant), or Gulf states hosting US military bases (indirect participants), Iraq can claim it stayed out of the fight. That positioning could prove valuable for post-war economic relationships across the region.
The Government Formation Crisis: Still Paralyzed
Meanwhile, Iraq's government formation process remains completely frozen. It's been 98 days since the first parliamentary session on December 29, 2025. The constitutional deadline for forming a government expired on January 28.
Parliament has failed three times to elect a president. The Kurdish deadlock (KDP's Fuad Hussein vs. PUK's Nizar Amedi) remains unresolved. No new election date has been set.
The Coordination Framework nominated Nouri al-Maliki for prime minister on January 24. President Trump issued his "Make Iraq Great Again" ultimatum on January 27, stating Iraq has "ZERO chance of Success, Prosperity, or Freedom" under Maliki.
US officials met directly with al-Maliki in February. According to Victory Coalition spokesman Salam al-Zubaidi, the American message was: "The current stage requires that there be another person" to head the government. When al-Maliki said the nomination was the CF's constitutional right, the US replied: "We will withdraw support and cooperation in all its forms."
Washington specified what that means: potential sanctions on SOMO (Iraq's oil marketing organization), the Central Bank of Iraq, constraints on dollar access, penalties on banks, curbs on oil exports, and challenges disbursing public sector salaries.
Tom Barrack, US Special Envoy for Syria and Iraq, visited Baghdad on February 23 and met with Iraqi leadership to "present Washington's perspective" on government formation.
Iraq's Foreign Ministry confirmed on February 19 that the US has conveyed these threats officially.
And then the war started.
The Coordination Framework is now weighing its options while Iranian drones are being launched from Iraqi territory, US forces are striking PMF bases on Iraqi soil, and Iraq's oil exports are being strangled by a conflict Baghdad officially wants no part in.
Iraq's Diplomatic Balancing Act
Atlantic Council analysts describe Iraq's approach as navigating "a foreign policy that maintains relations with both" the United States and Iran — a balancing act Iraq has been performing since 2003.
Iraq is home to Iranian-backed militias that operate with significant autonomy. These groups — Kataib Hezbollah, Harakat Hezbollah al-Nujaba, Asaib Ahl al-Haq — are part of Iraq's official paramilitary forces (the PMF), but many are also US-designated terrorist organisations.
When the war began, some of these groups immediately announced they were joining the fight. Kataib Hezbollah threatened "a long war of attrition in which we leave no American presence in the region generally, especially in Iraq."
But other militias are sitting it out. Under US pressure, several groups including Asaib Ahl al-Haq announced readiness to disarm. Atlantic Council analysts note this "demonstrates the extent to which certain militias have become focused on their interests in Iraq rather than acting as a tool of Iran."
This is significant. It shows that Iraq's economic and political gravity is strong enough to influence militia behaviour — that groups with Iraqi political and business interests are prioritising those interests over external loyalties.
The Iraqi government's neutrality stance creates space for this dynamic. By condemning all sovereignty violations (whether from US-Israeli strikes or militia attacks), Baghdad maintains the diplomatic position that allows it to work with all parties.
Meanwhile, the Kurdistan Regional Government — where US forces remain stationed — continues to host American military personnel. Iran has struck Iranian Kurdish opposition groups operating in northern Iraq. US President Trump told Reuters on March 5 that he would support Kurdish forces conducting an offensive into Iran (though senior Iraqi Kurdish officials have denied planning to deploy).
Iraq's strategy is to be present but not participating, affected but not aligned, engaged with all sides but committed to none.
Why Iraq's Economic Institutions Are Holding
What makes Iraq's market stability particularly noteworthy is that economic institutions are functioning despite massive external disruption.
Iraq's banking reforms are continuing. The Central Bank of Iraq announced on February 26 completion of the principal phase of its comprehensive reform programme for commercial, Islamic, and foreign banks operating in Iraq. The CBI is advancing reforms to ease foreign transactions and strengthen integration with global financial systems — work that continues despite the regional crisis.
Infrastructure projects are proceeding. The Grand Faw Port, the Development Road project, LNG terminals, school construction — these initiatives continue even as the government formation process is frozen and war unfolds next door.
Oil sector contracts remain active. BP's work at Kirkuk (despite the Rumaila shutdown), Chevron's operations, TotalEnergies' $27 billion Greater Gas Investment Project — foreign investment in Iraq's energy sector hasn't fled. These companies are taking the same bet markets are: this crisis is temporary.
Macroeconomic fundamentals remain solid. Iraq's inflation remains at historic lows. Foreign reserves stand around $95-97 billion, providing 13 months of import coverage. S&P Global Ratings reaffirmed Iraq's B- sovereign credit rating on February 10 with a stable outlook — an assessment made with full knowledge of the regional risks.
The pattern: Iraq's economic institutions are proving more resilient than the political noise suggests. This isn't accidental. It's the result of years of banking sector reforms, fiscal discipline during high oil price periods, and institutional capacity building that created buffers for exactly this kind of external shock.
The neutrality strategy works because these institutions work. Iraq can afford to sit out the fighting because its economy has developed enough resilience to weather short-term disruptions without collapsing.
What Currency Fundamentals Actually Depend On
The dinar's stability during the war's first week illustrates something important about what actually matters for currency value.
It's not headlines. It's not geopolitical drama. It's not even proximity to active conflict.
What matters is:
1. Foreign reserve adequacy. Iraq's $95-97 billion in reserves provides a substantial cushion. The Central Bank can supply dollars to meet legitimate demand through official banking channels. As long as reserves hold, the peg holds.
2. Banking system functionality. Iraq's January 2025 shift to processing all legitimate international transactions through commercial banks using correspondent banking relationships (rather than the old cash auction system) created a transparent, auditable framework. This narrows the official-parallel rate gap and builds confidence in official channels.
3. Fiscal sustainability. Here's where the war matters. If oil exports resume within weeks, Iraq's fiscal position remains manageable. If they don't, the government can't pay salaries, and everything unravels. The dinar's current stability is contingent on markets believing oil will flow again soon.
4. Institutional credibility. The Central Bank of Iraq has repeatedly stated it has no plans for a major revaluation and is focused on stability. Markets are taking the CBI at its word. Governor Ali al-Alaq said on February 12: "there are no plans to change the dinar's exchange rate" and "recent market speculation is misplaced."
These fundamentals don't guarantee anything. They just explain why, one week into a war, the dinar is behaving like Iraq's economy will outlast the crisis.
The Uncertainty Ahead
What happens next depends on variables no one can control:
How long does the war last? If it's weeks, Iraq weathers this. If it's months, fiscal collapse becomes likely.
Does the Strait of Hormuz reopen? President Trump announced on March 6 that the US Navy will escort tankers through Hormuz if necessary and that the US Development Finance Corporation will provide political risk insurance for maritime trade. If that works, Iraqi oil starts flowing again.
Can Iraq's government formation process conclude? The war has given the Coordination Framework a face-saving reason to delay the al-Maliki decision. But Washington's leverage just increased — Iraq now needs US cooperation more than ever.
Do Iraqi militias escalate or stand down? If attacks on US forces in Iraq intensify, retaliation follows. If militias decide their political and economic interests in Iraq outweigh loyalty to Iran, they sit out.
Does market confidence hold? The current dinar stability and equity market resilience depend on belief that this crisis is temporary. If that belief erodes, capital flight follows.
What This Means for Iraq Watchers
If you follow Iraqi economic developments, this week demonstrates why institutional capacity matters more than headlines.
Iraq is navigating an extraordinarily complex situation: war in a neighbouring country, militia activity on its soil, government formation paralysis, oil production temporarily shut down, and diplomatic pressure from multiple directions.
Yet Iraq's markets are calm. Iraq's currency is stable. Iraq's banking reforms continue. Iraq's foreign reserves hold. Iraq's credit rating stands.
This is the payoff from years of institution building. The Central Bank's credibility. The banking sector reforms. The fiscal discipline that built $95 billion in reserves. The infrastructure investments that created economic momentum independent of political cycles.
Iraq's neutrality strategy works because the economic foundation can support it. Countries with collapsing currencies, fleeing capital, and panicked markets can't afford to stay neutral — they get swept into whoever offers economic lifelines. Iraq has enough institutional capacity to chart its own course.
The risks are real. If the war extends for months, if oil can't flow, if fiscal pressures overwhelm institutional buffers, the calculation changes. But one week in, the strategy is working.
Iraq is demonstrating that a country can be geographically central to a regional conflict while remaining politically peripheral to it — if its economic institutions are strong enough to withstand short-term shocks.
That's a different kind of sovereignty than constitutional declarations. It's operational sovereignty: the economic capacity to make choices and absorb their consequences.
The next few weeks will test how deep that capacity runs. But the first week's evidence suggests Iraq has built more resilience than many observers expected.
Disclaimer: This content is for informational and educational purposes only and does not constitute financial advice. Currency and economic outcomes are subject to numerous variables, and readers should conduct their own research or consult qualified professionals.