Britain is set to close its full consulate in Iraq's second city, the government is expected to announce.
The Foreign Office will keep an office in Basra, southern Iraq, but there will be no permanent staffing.
The decision has already been condemned by British business leaders with investments there.
But ministers will argue that British interests in the oil-rich south of the country will be protected by increased staffing at the embassy in Baghdad.
Diplomats and trade officials will fly down from Baghdad when needed and the embassy in the capital will be built up.
Foreign Secretary William Hague is expected to say that this approach will be more effective and save a substantial amount of the £6.5m a year the current consulate costs.
However, some representatives of British business say Chinese and Korean entrepreneurs will now secure more of the major infrastructure projects in southern Iraq.
They complain that Britain risks losing vital relationships with Iraqis, who often favour those who fought against Saddam Hussein rather than the Chinese, who opposed invasion.
British troops spent six years in Iraq after the fall of Saddam Hussein in 2003 - most serving in and around Basra - with 179 service personnel losing their lives.
Meanwhile, the Iraq Britain Business Council (IBBC), in London, called the changes a scandal.
IBBC executive chairman Baroness Nicholson told BBC Radio 4's Today programme she regretted the upcoming announcement because the "British business presence down in Basra is absolutely critical".
"I hope it is a step sideways and not a step backwards," she said.
"I think this is a foolish short-term thing but I don't think that's a Foreign Office decision. I think it is something that is done from the Treasury."
She added: "I'm very hopeful that Foreign Office cuts, which I think should not have happened and should not be affecting Basra, may be reversed before too long."
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