MIDEAST MONEY-Deteriorating security stifles Iraq's economic promise
* Violence worsens since start of the year
* Economic growth forecasts being cut back
* Oil means balance of payments, budget crises can be avoided
* But government distracted from economic policymaking
* This means unemployment, poverty may not be addressed
BAGHDAD, Aug 26 (Reuters) - In the past month, bombs exploding down the street from Fawzy Hassan's snack shop in central Baghdad have frightened away many customers, and those who do still come to stock up on fruit, potato chips and candy are spending less than before.
"People bought one kilo before - now they only buy half," said the 73-year-old Hassan, who has worked on the street since he was 10 years old. "People are suffering financially because year after year, making a living gets more difficult."
Such gloom underlines a deterioration in Iraq's economic prospects over recent months. A year ago, many Iraqis were optimistic that a long, oil-fuelled boom that would raise living standards and, over the next decade, narrow the prosperity gap between Iraq and its wealthy Gulf Arab neighbours.
Now, rising political and sectarian violence is forcing businessmen to scale back investment plans and economists to cut growth forecasts. The promise of the country's vast oil wealth has not disappeared, but realising that promise is proving slower and more painful than hoped.
"The security situation has killed the economy, investment, reconstruction and public services in Iraq," said lawmaker Nahida al-Dayani, a member of the economic and investment committee in the national parliament.
Prices fluctuate chaotically and money is not being properly invested by the state, said analyst Maijd al-Swari from the Iraqi Economic Forum, a research body.
He thinks one of the main problems is personal consumption, which should be a motor for the economy but has remained relatively sluggish even as economic output has grown - perhaps because worried Iraqis are saving instead of spending. Some savings are sent abroad for safety, to countries such as Jordan.
"Iraqis are not motivated to carry out normal daily social and economic activities," he said.
The country has one of the biggest reserves of crude oil in the world and production has increased rapidly over the decade since the U.S. invasion in 2003, causing gross domestic product per capita to more than quadruple to $6,300 in 2012, according to the International Monetary Fund.
The growth was due in part to an improvement in security, as authorities clamped down on bomb attacks and other militant violence. Economic expansion raised hopes for a virtuous circle in which rising living standards and the reduction in violence would reinforce each other.
This year has diminished those hopes. A Sunni insurgency and other violence have revived; once again, Baghdad often wakes up to the sound of explosions, wailing sirens and police helicopters. National death tolls from sectarian violence this summer have reached around 1,000 people a month, the highest for five years.
The impact on day-to-day business activity can be seen at the checkpoints which have proliferated around Baghdad, slowing traffic and sending cars on winding, time-wasting journeys.
Iraqis are again avoiding crowded shopping areas prone to bomb attacks. This is obvious on the streets of Karada, an upmarket Baghdad district on the banks of the Tigris River.
"There is no one here because of the security situation," said 46-year-old government official Zainab Zukuk, browsing open-air garment stalls with her daughter. "We plan to go home immediately because we are worried. This is a sensitive place."
Poor security in urban areas might have only a minor impact on the economy as a whole if Iraq's oil industry were unaffected. But the insurgents have begun to target the industry because of its strategic role in the economy.
Iraq's oil exports reached 2.62 million barrels per day last November, the highest level in decades, and the country hopes to increase them eventually to as high as 6 million bpd. But security and maintenance problems mean they have stopped rising and totalled about 2.54 million bpd this month, below the government's target for this year of 2.9 million bpd.
One of the main reasons for the fall is damage inflicted by insurgents on the Kirkuk pipeline, built in the 1970s to bring 1.6 million bpd to the Turkish Mediterranean port of Ceyhan. The pipeline has been attacked at least six times this month.
Partly because of the security crisis, economists have gradually scaled back their estimates of Iraq's future growth. In April 2012, the IMF predicted Iraqi GDP growth of 13.5 percent in 2013 and 11.0 percent in 2014; it now forecasts rates of 9.0 percent and 8.4 percent for those years.
Such growth is still well above the pace of expansion of Iraq's population, so thanks to oil, the country as a whole may continue to get richer in coming years as long as a minimum level of security exists to keep basic infrastructure operating most of the time.
Oil exports mean the country's external position is comfortable enough to avoid heavy pressure on its currency; the IMF estimates Iraq's foreign reserves at about $70 billion, covering 10 months of imports - much higher than levels of three or four months for struggling states such as Egypt and Tunisia.
So even if security continues to worsen, Iraq may avoid the balance of payments and state budget crises suffered by other, resource-poor Arab countries caught up in political unrest.
But the violence may hurt Iraq's long-term prospects by preventing wealth from spreading through society. Distracted by the security challenge and by partisan political feuding, the government can do little to improve education, housing and other infrastructure - policies which are needed to reduce unemployment and poverty.
"The positive trend in oil production and exports contrasts with the weakening economic governance deriving from an increasingly difficult political process and worsening security," the IMF said in a report.
Unemployment was officially estimated at 11 percent in 2011 but the IMF said actual levels were likely to be considerably higher, especially among the young. About 40 percent of the population is under 15, and if these people do not find jobs in coming years, political tensions may worsen further.
In south Baghdad, taxi driver Ahmed Abul Hussein said he was struggling to make ends meet because he spent so much of his time in traffic jams caused by checkpoints. A journey costing a passenger just 6 or 7 dollars can take over an hour, he said.
"Sometimes I am not able to earn back the amount that I paid for the fuel," the 44-year-old said. "But this is the only way I can earn a livelihood for my family."
(Additional reporting by Sylvia Westall; Editing by Andrew Torchia and Susan Fenton)