Fitch rates Iraq at below investment grade

09 August 2015

Baghdad’s fiscal position is worsening

  • Fitch gives Iraq a rating of B-
  • Bond isssue is expected by the end of this year
  • IMF approved emergency loan in early August

Fitch Ratings, the international credit rating agency, today assigned a sovereign rating of B- to Iraq in anticipation of the offering later this year of government bonds to finance Baghdad’s budget deficit.

This is the first credit rating for Iraq.

Fitch said that Iraq’s political risk and insecurity are among the highest faced by any sovereign it rates.

“Sectarian conflict has raged with varying intensity since 2003, ISIS militants currently effectively hold three of the 18 provinces, relations with the Kurdish regional government are volatile and governance indicators are exceptionally weak,” Fitch said

Iraq holds the world’s fifth largest oil reserves and significant amounts of gas. Oil production has risen rapidly to 3.3 million barrels a day (b/d) in May 2015, from an average of 2.4 million b/d in 2010. It became the world’s second largest exporter in 2014. Production costs are low. The bulk of oil production facilities and infrastructure are away from areas of domestic insecurity. Investment is under way to further raise production capacity, although infrastructure bottlenecks remain a constraint and investment plans were set back by payment arrears in 2014.

Iraq’s fiscal position has deteriorated rapidly since 2013 and Fitch forecasts a double-digit fiscal deficit for 2015, owing to lower oil prices, higher military spending and costs associated with civil conflict.

“Savings buffers built during previous years of high oil prices have been largely eroded and the deficit will be financed by debt, likely including a Eurobond and funding through an IMF rapid financing instrument that was approved in July,” Fitch said. “Rising oil production and prices should lead to a narrowing of the budget deficit in 2016, although it will remain large and another more substantive IMF programme is likely in 2016.”

Fitch said it forecasts a small government deficit in 2017. The government has cleared the $9 billion of payment arrears to international oil companies incurred in 2014.

Government debt is forecast by Fitch at 51 per cent of GDP at end-2015. The debt/GDP ratio is forecast to peak in 2016. Fitch said the debt figure includes amounts due to GCC countries as a result of loans during the Iran-Iraq war. These amounted to 22 per cent of estimated 2015 GDP.

“Iraq faces no pressure to repay the GCC debt, which has not been subject to a haircut of 80 per cent in line with terms to the Paris Club (in a 2004 restructuring covering debt under the pre-2003 regime),” Fitch said.

“Commodity dependence is among the highest of all rated-sovereigns,” Fitch said. “Oil accounts for around 40 per cent of GDP and over 90 per cent of fiscal and current external receipts. Despite some modest initiatives to introduce new excise and consumption taxes this year, there is little prospect of revenue diversification over our forecast period to end-2017. Limited economic policy tools complicate the response to oil price volatility.”

Fitch estimates that Iraq will have a current account deficit of 7.4 per cent of GDP in 2015 Foreign exchange reserves at the end of 2014 were $67bn. This is enough to cover more than 10 months of current external payments. External debt service ratios are well below the peer median, Fitch said.

Non-oil GDP contracted by an estimated 9 per cent in 2014. Fitch forecasts it will decline further in in 2015, owing to the impact of the lack of security in the country.

“This is offsetting the boost to GDP from rising oil production,” Fitch said. “A return to growth looks possible in 2016. Inflation is lower than peers, averaging 3.7 per cent over the five years to end-2014, supported by the nominal anchor of the exchange rate peg to the dollar.”

Inflation is expected to be below 2 per cent.

Fitch said that Iraq’s banking sector is under-developed and fundamentally weak.

“Private sector credit-to-GDP was just 8.1 per cent at end-2014, the lowest of any rated sovereign,” Fitch said. “The two large state-owned banks Rafidain and Al-Rasheed, which have high NPLs and exceptionally low capital adequacy, dominate the sector. There has been little progress in restructuring these banks; an exercise that Fitch assumes will require recapitalisation by the government.”

Iraq scores the worst of all Fitch-rated sovereigns on the composite World Bank governance indicator, reflecting not only insecurity and political instability but also corruption, government ineffectiveness and weak institutions, Fitch said. Doing Business indicators are below the peer median.

Fitch said it forecast Brent crude will average $65 a barrel in 2015, $75 a barrel in 2016 and $80 a barrel in 2017. Iraqi oil production is forecast to increase to an average of 4.2m barrels a day in 2017.

In early August, the Washington-based IMF has approved a $1.24bn loan to Iraq under its rapid financing instrument (RFI) programme.

The assistance will help Baghdad cover an urgent balance of payment and budget needs caused by the jihadist group Islamic State in Iraq and Syria (Isis) as well as the fall in oil prices.

The fund has increased its RFI loan from the $833m announced in June, reflecting the slow progress Iraq is making against Isis and further oil price declines.

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