* Low oil revenues, bloated payroll strain finances
* Baghdad negotiating loan with Qatar National Bank
* Eurobond, IMF loan possible funding tools in 2016 (Adds QNB loan)
BAGHDAD, Oct 21 (Reuters) - Iraq's fiscal deficit is expected to hit 11.9 percent of economic activity in 2016, the finance minister said on Wednesday, as the country struggles to fund fighting against Islamic State in the face of dropping crude prices.
The government's budget proposal, which awaits parliamentary approval, envisages expenditure of 106.9 trillion dinars ($95 billion) with a 23.5 trillion dinar shortfall, Hoshiyar Zebari told reporters.
Baghdad is currently facing a budget deficit of about $22 billion, out of a budget of roughly $105 billion.
More than 70 percent of expenditure will be used to pay salaries and pensions of the country's bloated public sector.
Oil is expected to account for more than 80 percent of Iraq's fiscal revenues in 2016, even as crude prices have more than halved in the past year.
"Next year will not be an easy year. According to the estimates ... and the current price of oil, we expect it to be a difficult year for us," Zebari said at the ministry's headquarters.
A global surplus has prompted oil prices to sink to below $50 a barrel from $115 in June 2014.
Moments before Zebari spoke, ministry employees demonstrated inside the building against changes to the compensation system for public workers. Zebari said the revisions were aimed at reducing inequities.
Iraq's deficit is also aggravated by higher military expenditure and other costs associated with the fight against Islamic State militants who seized nearly a third of the country's territory last year.
Zebari said Baghdad had begun negotiating with Qatar National Bank, the largest lender in the Gulf Arab region, for a loan that could be used to help plug the fiscal gap, but did not provide details.
An international bond which the government delayed issuing this month also remains an option for financing the deficit, but Zebari said the 2016 budget allocates only half of the $6 billion initially sought from investors.
The International Monetary Fund said earlier in the day it may provide a large loan to Iraq in 2016 to help stabilise the country's finances, but Zebari would not be drawn on how much money Baghdad might seek. ($1 = 1,123.1000 Iraqi dinars) (Reporting By Stephen Kalin; Editing by Raissa Kasolowsky and Alison Williams)