Iraqi And Kurdistan Budget Hangs In The Balance

By Alex Dooler and Laura Gardner Cuesta

Despite the Government of Iraq and the Kurdistan Regional Government (KRG) agreeing a deal over its 2021 budget on December 20, the road to parliamentary approval may be bumpy, market participants told Debtwire.

“Parliament has yet to approve [the budget], there is significant opposition to the KRG provisions there and so the deal could be held up, delayed or not implemented,” said Sajad Jiyad, Iraq analyst and fellow at The Century Foundation, a think tank.

“Kurdistan is very flexible in their willingness to deal with Iraq, but the same hasn't be true for Iraq's willingness to deal with Kurdistan,” said Tara Shwan, Executive Director at the American-Kurdish Economic Institute (AKEI).

The draft budget states that the KRG must hand over 250,000 b/d of crude to Iraq’s State Organization for Marketing of Oil (SOMO) in order to receive its share of the federal budget, a clause that has long been a point of contention between Baghdad and Erbil. Other sticking points for the deal revolve around “the nature of the KRG’s deal with Turkey on exports and pipeline access, the debt accrued by the KRG and the size of the public sector payroll,” said Jiyad.

“Baghdad also wants the KRG to commit to transferring customs duties and taxes, and implement federal laws on immigration, transport and judicial powers and other long-term issues unresolved between them,” he went on to say.

Despite these points of contention, a deal is likely to be agreed by parliament, said Howard Shatz, senior economist at the RAND Corporation. “It is fair to say that parliament is less tolerant of a deal than the cabinet is, but I think that a deal will be struck,” he said.

Despite the challenges, funds from Baghdad remain essential to the health of Kurdistan.

“Without those payments, the KRG will be bankrupt and cannot pay its civil servants, oil producers and its creditors. A deal for 2021 will help the KRG meet monthly obligations but is not a long-term solution,” said Jiyad.

Shatz emphasised that the KRG’s financial obligations have grown in recent years. The semi-autonomous region may no longer be able to act independently in the case of a no-deal, as it has in the past.

The health of the KRG is especially pertinent ahead of the near maturing Oilflow $500m 12% 2022 secured bond, which is a prepayment facility to the KRG provided by Glencore, the Swiss commodity trading firm.

Oilflow bondholders ran into trouble in July when the issuer amended its repayment schedule amid a failure to collect funds from Baghdad in April.

A number of bond issuers are also dependent on payments for oil from the KRG, including ShaMaran Petroleum, DNO, Genel Energy, Gulf Keystone Petroleum and Dana Gas.

These issuers faced problems when the KRG failed to pay them for receivables dated November 2019 to February 2020. It had promised to do so once oil prices exceeded $50 per barrel.

Investors will be pleased with news last month that the KRG is looking to accelerate oil debt repayments in light of the recent jump in oil prices. Dana Gas said that it received a payment proposal from the KRG to pay down past receivables during 2021, as long as benchmark Brent crude remains above USD 50 per barrel.

Brent crude currently stands at $50.96 per barrel.

“The KRG will find a way to make payments to oil companies even if it has to continue payroll delays because it understands the importance of retaining those operations in the Kurdistan Region. Some delays in payments and restructuring of past debts or changes in the payment terms can be expected, but this should not deter those companies from continuing their work,” said Jiyad.

Economic reforms

”We welcome the Iraqi Council of Ministers’ approval of the draft 2021 budget, which, we understand, envisages important fiscal reforms,” the IMF said in a December 24 statement. “While difficult, these reforms, combined with the recently announced devaluation of the exchange rate, are critically important steps to help reduce Iraq’s large external and fiscal imbalances and ensure the country’s economic stability.”

If both Iraq and the KRG are to secure much needed further fiscal support from international organizations such as the IMF, they will need to show a willingness to undertake reforms and reduce planned deficits, said Jiyad.

But more reforms are needed to strengthen the country’s economic resilience and to create further fiscal headroom for critical reconstruction and social spending, the IMF went on to say in its statement.

The Iraq government can go further for example in stemming public sector pay-packets, for which so-called ‘allowances’ have ballooned in recent years, said Michael Knights, Senior Fellow at The Washington Institute for Near East Policy. Reform to pay-packet allowances was later stripped out of the budget, he noted.

“It’s fair to say that the IMF probably wasn’t too pleased about that,” added Shatz.

Deeper cuts to the Iraqi public sector wage bill are needed as an essential part of its economic reform program, but these are unlikely to happen until the general election in June 2021, Shatz said.

A year to remember

Iraq is estimated by the IMF to have had the steepest contraction in economic output this year among OPEC members subject to production caps, as shown below.

This is perhaps best highlighted by the fact that federal export revenues for Iraq are expected to come in at just $41.5 billion, well short of the $78.8 billion it saw in 2019.

In light of subdued growth, its borrowing need has risen. Iraq’s budget deficit is set to widen the most since 2004 this year, to a fiscal balance of negative 20%.

Iraq devalued its currency in December for the first time since the US-led invasion in 2003, knocking off 23% of the Iraqi dinar’s value. The move is intended to eke out more dinars from its dollar-denominated oil exports, helping finance its debts.

And to top things off, the problems in the region are not just economic. Recent skirmishes in Kurdistan between Turkey’s outlawed Kurdistan Workers’ Party (PKK) and forces of the ruling KRG have raised fears of a full-scale war.

Calm before the storm

Despite a bleak outlook for Iraq in 2021, especially if an end to US sanctions on Iran subdues oil prices, its real issues are expected to come the year after, Knights explained.

So far, Iraq has found innovative ways to monetise its oil resources to meet its most immediate needs, recently signing its first-ever crude prepayment deal with China’s state-owned ZhenHua Oil Co.

This will enable the federal government to receive money upfront in exchange for long-term oil supplies and could fetch the Iraqi government $2 billion at current crude prices, according to reports. Other similar pre-payment agreements with different oil traders are also on the cards, according to two sources familiar with the situation.

“The question for Iraq is not whether it will survive in 2021, but rather 2022,” Knights said. “Iraq has the reserves and capacity to muddle through to survive until 2022.”

“2021 is a year in which you can scrape the bottom of the barrel with respect to reserves, import cover and public satisfaction in an election year,” he went on. “Iraq is likely to make minor reforms, borrow and burn reserves in 2021 – which will all come due in 2022.”

Alex Dooler is a reporter at Debtwire CEEMEA, covering distressed debt. He can be reached at alex.dooler@acuris.com. Laura Gardner Cuesta is a senior reporter at Debtwire CEEMEA, covering sovereign debt. She can be reached at laura.gardner@acuris.com.