Kurdistan: Battling on all fronts

As conflict rages on, Iraqi Kurdistan badly needs foreign investment to keep its machinery running smoothly.
Not so long ago, Iraq’s Kurds were accustomed to earning the plaudits of foreign investors. They conceived of the semi-autonomous region as a business-friendly safe haven from the chaos in the rest of the country. Even when the Kurdish region was at loggerheads with the government in Baghdad, which reached its height under former prime minister Nouri al Maliki, the Kurdistan Regional Government (KRG) was still a magnet for Gulf, Turkish and other foreign investment.

These days, the Kurdish economy has lost much of its brio. Constrained by low oil prices and burdened by at least 1.7 million refugees fleeing the Islamic State (IS) and other militias in Syria and Iraq, business is grinding to a halt. The Baghdad government’s decision to withhold budget payments owed to the Kurds is effectively stopping its public employees from getting paid. In this context, the KRG is struggling for an economic lifeline, and mooting raising a major bond issue to enable it to fund much-needed project activity in the infrastructure sector.

Earlier this year, the World Bank starkly warned that the KRG would need at least $1.4 billion in assistance to stabilise its economy after growth slowed from eight per cent in 2013 to just three per cent last year, and poverty doubled, increasing from 3.5 per cent to 8.1 per cent. The stabilisation cost for 2015 is estimated at $1.4 billion in additional spending above and beyond the KRG budget. Much of that extra expense is associated with the influx of refugees and internally displaced persons (IDPs).

There’s no getting away from the decisive impact that the fight against IS – even when as in the KRG’s case, it has enjoyed a measure of success – has had on its economy. According to the World Bank report that was issued in February of this year, the IS crisis has had a significant effect in thwarting the trade of goods and services. Transport routes have been disrupted. Foreign direct investment flows have declined and operations of foreign enterprises have been adversely affected. Disruption of public investment projects has had a negative impact on the economy.

The spending needs associated with an estimated 28 per cent increase in the population that has come as a result of the 1.7 million refugees and IDPs presents a substantial drain on already scarce resources.

While some refugees at the start brought money with them, and rented accommodation, which had a positive impact on the local economy, that has abated over time.

“Many IDPs who had cash, bringing it with them from Mosul, have now seen this diminish to nothing. They’ve ended up in refugee camps and that is a huge strain,” says Shwan Zulal, head of Cardouchi Consulting, a Kurdistan-focused business consultancy.

The Kurdish economy is on the verge of becoming dysfunctional, warns Zulal.

The shopping list of problems is long and getting lengthier. For the KRG government, the collapse of the late 2014 budget agreement with Baghdad has proved disastrous in preventing it from paying its own workers.

That deal, finalised between Baghdad and Erbil in December last year, revolved around a ‘quid pro quo’ deal that anticipated the KRG contributing to the federal government’s budgeted revenue through oil exports at 300,000 barrels per day (b/d) of oil from Kirkuk (formally outside the KRG region) and 250,000 b/d from the Kurds’ own fields, in return for a 17 per cent share of the total Iraqi budget. Kurdistan says it is still committed to the December deal with Baghdad, but it appears irrevocably broken, with Baghdad continuing to hold back money that the Kurds claim they are owed. The Iraqi federal government, for its part, says that it has been forced to cut payments because the KRG is not meeting its commitment to provide necessary barrels through the federally-controlled State Oil Marketing Organisation (Somo).

In May, the KRG received $426.7 million in budget payments from Baghdad. Yet this is about half of what it is entitled to under the 2015 budget. Under these circumstances, the KRG has felt the need to take action, in the form of selling oil directly rather than through the Somo system. By cutting all crude transfers to Baghdad’s oil marketer since mid-June, Erbil has signalled it is prepared to go it alone by loading oil onto KRG chartered vessels and its tanks in Ceyhan port in Turkey. In June alone, it placed an average of 571,021 b/d there.

The effect of the halted budgetary payments is becoming painfully evident, even if the KRG has sought to limit it by covering the cost of services and paying civil servants by borrowing locally and not paying oil companies.

But the shortcomings of this approach are becoming increasingly clear. “Public sector wages are running about two to two and a half months behind schedule, so if you’re a teacher, you will only have just been paid for working in May,” says Zulal. “The backlog is substantial when you consider that the wages and basic service provision costs the KRG about $750 million a month. That means some $1.5 billion in arrears from just two months.”

That figure just represents arrears on payments. For investment projects, much needed funds are absent. That means almost all of them are currently on hold. For local contractors and companies, the pain is felt strongly as they have benefited from government spending on infrastructure and basic projects in the last ten years.

“There’s been a huge industry created in terms of local companies winning contracts, helping government carry out these projects. These companies are all out of work now and a lot of them have pretty much given up,” says Zulal.

So far, though, the Kurdish oil sector has managed to avoid the worst of the excesses, because of the longer investment cycle that oil companies operate under, which creates a lag effect. Still, the effect is starting to be felt in the oil patch; whereas the rig count one year ago in the Kurdistan region was running at just below 30, now it is just two or three. The lack of funding is wearing oil companies’ patience levels thin.

International oil companies (IOCs) have been pressing hard for payment, and are owed arrears from the KRG that are reckoned to be in the region of $3.5 to $4 billion. There are rumours that August will see payments restart for oil companies, though it is likely to be very small, in the region of about $150 million. Even so, this represents a start after a tough year. “This will give some confidence back to the market, and if it becomes a regular thing, the oil companies will get more incentive to invest as currently they are not getting paid,” says Zulal.

Erbil’s increasing desperation has prompted it to look well beyond its oil sector for financial salvation. Plans are afoot for Kurdistan to tap the international debt capital market, with talk of a sale of $500 million to $1 billion of quasi-sovereign debt – the first time the KRG would have embarked on a bond issuance.

In June, the Kurdish parliament voted narrowly to approve a debut bond sale, meaning it is able to raise up to $5 billion from capital markets in order to fund infrastructure projects. It has hired Goldman Sachs and Deutsche Bank to help with the bond sale. The expectation is that the debt would be categorised in the highest risk class, making it expensive; the KRG is likely to pay 11 to 12 per cent a year for a five-year maturity. That makes it more expensive than the equivalent Iraqi federal bond, where a 2028 bond trades with a yield of 8.25 per cent.

The proposed bond sale still has numerous hurdles to overcome. “Symbolically it is important, but when you look at the details – the cost and the yields – there are some issues with it,” says Zulal. Having access to the international capital market would be a big deal for Kurdistan, besides reinforcing the region’s financial autonomy from Baghdad.

“The KRG budget is not well managed because nearly 90 per cent of it goes on the public sector,” says Zulal. That provides for a less compelling proposition for international investors.

In these straightened times, there are few shreds of comfort for the authorities in Erbil. That said, they have managed to attract some Gulf investment. Emirates Airlines is restarting regular flights to the Kurdish capital after their suspension last year. And it has also tapped Gulf financial assistance in dealing with refugees, with Kuwait chipping in with $200 million in fresh assistance.

The best-case scenario for Iraqi Kurdistan is if oil prices regain some of their former strength. Oil prices north of $80 per barrel would provide a financial lifeline for the Kurds, as it would enable them to reap much bigger rewards, given the increase in crude production that has been registered recently.

Getting a decent oil price would enable the Kurds to repay oil companies and enable them to continue to take the financially draining option of taking the fight to the IS, while ensuring their own long suffering public sector workers and private sector contractors receive their dues.

By James Gavin – The GULF