Closing the rift with Baghdad

13 November 2014

The Kurdistan Regional Government needs to broker an oil revenue-sharing deal with Baghdad to help stabilise its economy in the wake of Isis’ advance

Iraq’s Kurds have experienced as turbulent a year as any of the past 23 since they established an enclave under international no-fly zone protection in the aftermath of the 1991 Gulf War.

When Islamic State in Iraq and Syria (Isis) forces routed Peshmerga lines around Sinjar in early August, forcing thousands of Kurdish-speaking Yazidis to flee from the northwestern Iraqi town, Erbil’s bubble of confidence was popped as quickly as it had inflated. Just two months earlier, the Kurds had looked newly powerful as they took over abandoned Iraqi army positions in the disputed oil province of Kirkuk, gaining control of oil fields they regarded as being in their ancestral heartland.

Confidence shaken

When more than 1,000 Peshmerga fighters retreated from Sinjar in August – abandoning the Yazidis to advancing Isis forces – it was a major blow to Kurdish self-esteem, heavily grounded in the near-mythical potency of its national guerrilla-style army.

With Isis overrunning Kurdish positions in the buffer zone outside the formal control of the Kurdistan Regional Government (KRG), coming within 25 kilometres of the capital Erbil, a palpable sense of panic took hold. This only subsided once US President Barack Obama’s administration signalled it would intervene to protect its Kurdish allies, supplying arms and undertaking air strikes on Isis positions.

For now, [the Kirkuk issue] is not a major bone of contention between Baghdad and Erbil

Suleimaniyah-based political analyst

Although Isis remains a potent force across much of Iraq, the Kurds have won back some of their former confidence in the past couple of months. Peshmerga fighters have pushed jihadists out of some of the border areas. Their Kurdish brethren in the Syrian town of Kobane may be under siege, but the three KRG-administered provinces of Dohuk, Erbil and Suleimaniyah appear safe for now.

“The risk in [the northern Kurdish region of Iraq] has abated somewhat because of the American involvement, and they seem to be committed to making sure that KRG territory is not going to be at great risk from Isis,” says Shwan Zulal, head of Carduchi Consulting, a London-based Kurdistan region-focused business consultancy.

In terms of business, this provides a backstop reassurance for investors. “If you have the might of the US military behind you, that is enough for investors to feel reassured,” says Zulal. “In some ways, now there is more reassurance. Before, nobody knew what the US would do, but now it is clear they will protect Kurdistan.”

KRG investment by sector, 2006-12 ($m)
Industry 3,804.6
Tourism2,047.5
Trading2,600.3
Housing13,536.9
Agriculture270
Health378.5
Education659.4
Communications220.9
Services38.8
Art11.8
Banking740
Sport740
Total24,387.5
Source: Kurdistan Regional Government (KRG)

For all that, the KRG economy remains in critical condition, even if oil exports are starting to build up cash at Turkey’s Halkbank, with an estimated $400m in the account at the end of October.

The disruption to the regular transfer of funds from Baghdad since January 2014 has forced rising austerity in Iraq’s north. The federal government withheld monthly payments due from the KRG’s 17 per cent share of the national budget as punishment for Erbil’s attempts to sell its oil independently of the State Oil Marketing Organisation (Somo) pipeline network. The Kurds say they have been deprived of up to $10bn as a result of the budget freeze. The resulting shortfalls have left about 50,000 civil servants unpaid, and an estimated $2bn owed to local contractors active in public works projects.

It is the budget crisis, as much as the Isis challenge and the 1 million-plus displaced people who have found a home in the KRG region, that has stoked concern this year. The KRG needs approximately $1bn a month to keep its economy going. The Kurdistan Investors Union estimates that more than 400 contractors and companies have had to declare bankruptcy.

Sector standstill

Construction and project activity has been badly affected, with most public sector-backed schemes coming to a standstill. With wages delayed and projects dried up, many Kurdish firms and consumers are wary of spending. That is a particular challenge for an import-dependent, service economy such as the KRG’s.

“When the money cycle slows down, so does everything with it, and that has had an effect on all industries,” says Zulal.   

To keep up payments to the Peshmerga, the KRG has been forced to tap loans and mortgage its oil sales. This has, at least, enabled Erbil to maintain payments to oil companies, with a commitment made to pay $75m to oil producers in November. These are stop-gap measures, however. A deal with Baghdad is urgently needed to restart federal payments, but the cash-strapped central government may not be inclined to cooperate.

Nowadays, fewer people [in the Kurdish region of Iraq] are talking about Turkey as the most important ally

Suleimaniyah-based political analyst

The drain on resources posed by the more than 1 million refugees in the Kurdistan region, mainly in Dohuk province, is another challenge, although with that refugee influx have also come wealthy displaced Iraqis and Syrians who are able to spend in the local economy. The property rental market has felt a benefit from this inflow of wealth. In Erbil – where houses can exchange hands for more than $1m – there has been no sign of a weakening of prices.

The KRG does still have a few cards up its sleeve in seeking to secure a favourable deal on the budget.

With the destruction of large parts of the Kirkuk-Cehyan pipeline used by Baghdad, and the Kurds taking ownership since June of formerly North Oil Company-operated fields in Kirkuk, the KRG now has a mechanism to help bring about a revenue-sharing deal with the federal government. This would force Baghdad into making a more fulsome budget contribution to the care of the many displaced Iraqis resident in the north.

With six members in the cabinet of Iraq’s federal Prime Minister Haider al-Abadi, and Hoshyar Zebari, a senior Kurdistan Democratic Party figure, as finance minister, the Kurds still have some sway in the capital.

Kirkuk dispute

They may choose not to play hardball on Kirkuk, given that much of the oil and gas infrastructure has been destroyed by Isis and is, therefore, of little value to either side. “Pushing hard on the Kirkuk issue is not a priority, though it may become one at a later stage. For now, it is not a major bone of contention between Baghdad and Erbil,” says one Suleimaniyah-based political analyst.

At the moment, it is a matter of muddling through for Erbil. “The authorities may find the money to pay the most important bills, but investing in infrastructure and in larger projects is still a long way off,” says Zulal. “Also, the KRG has to service loans taken out with local firms.”

There is then added reason for Erbil to consider tapping other forms of finance. On 19 October, the KRG cabinet approved a bill that would allow the regional government to attract debt financing. Erbil has sounded out investors and financiers regarding debt financing, but there are still several issues to be ironed out. If anything, the events of the summer and the long-running budget standoff have strengthened the Kurds’ resolve to seek greater financial independence from Baghdad. However, full independence, which the KRG’s President Massoud Barzani tantalisingly hinted in July would soon be put to a referendum, remains something of a taboo.

For one thing, neither of the KRG’s main allies, Turkey and the US, is in favour of Kurdish independence. Another close friend of the Kurds, Iran, is equally against it. Practical considerations will trump the evident desire to break the remaining ties with a regime in Baghdad with whom Kurds have lost confidence.

Baghdad, though, will struggle to stop the Kurds from selling their oil on the global market and accruing the revenues, despite its use of legal measures to bar buyers from taking KRG crude cargoes.  

“Baghdad used the ‘nuclear option’ under [Nouri] Al-Maliki [Iraq’s former prime minister], and that boosted the resolve of the Kurds to seek financial independence. Baghdad doesn’t really have any more cards to play and the Kurds are sticking to their guns,” says Zulal.

Beneath the bluster of the Baghdad-Erbil dispute, behind-the-scenes talks between senior Kurdish and Arab politicians are ongoing and may eventually find a solution amenable to both sides. For without a reinforcement of the revenue-sharing formula, there will be little incentive for the KRG to commit to a future in a united country.

And if the events since June have revealed anything, it is that Iraq’s fragile state security forces need as much help as they can get in containing Isis, meaning a continued key role for the Peshmerga.

Turkey, with whom the Kurds signed a 50-year deal last year to sell crude, remains a strategic ally that will be of valuable use, even if the Isis challenge has revealed growing tensions in the Kurdish-Turkish relationship.

While Erbil has increasingly looked to Ankara in recent years to offset its dependence on Baghdad, Turkey’s diffidence about the Isis challenge, and its seeming readiness to see the jihadist group triumph over Syrian Kurds, have provoked consternation in Iraqi Kurdish ranks.

“The Kurds have realised they can’t replace Baghdad with Ankara, and President Erdogan [of Turkey’s] stance on the Isis issue has prompted a shift in public opinion in [Erbil]. Nowadays, fewer people are talking about Turkey as the most important ally,” says the Suleimaniyah-based political analyst.

Paper tiger

There is greater cause for confidence in the return of the international community as pivotal allies, with the US, UK, France and others finally prepared to equip the Peshmerga with modern weaponry. They are also willing to assist the Kurds in the substantial humanitarian commitment to cope with all the refugees.

“After the Americans left Iraq in 2011, it seemed natural to look to Turkey as the main external partner, but with the international allies back – and more American diplomatic presence in Kurdistan these days – that is a reassurance,” says the analyst.

The melting away of the Iraqi armed forces in June in both Mosul and Kirkuk has revealed to the Kurds that Baghdad – although it holds the purse strings – is something of a paper tiger.

Isis, for now, is contained as far as Iraq’s Kurdish northern region goes, but the Kurds know only too well from history that there is no room for complacency. And with the KRG’s economy struggling, the need to broker a comprehensive deal with Baghdad to get the budget funds flowing is pressing.

Key fact

The Kurds say they have been deprived of up to $10bn as a result of the budget freeze

Source: MEED

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