The Kurdistan Regional Government (KRG) recently sought to borrow up to $5 billion from international banks in order to meet its financial needs amidst a severe economic crisis. This decision seemed appropriate, given the KRG’s insolvency after disputes with the central government in Baghdad, which froze the budget transfer in early 2014.
However, hopes of the KRG obtaining a loan promptly disappeared due to internal disagreements. There was strong opposition from Parliament when several political parties voted against the process fearing that it would fuel corruption, and even boycotted the legal process. The subsequent presidential dispute during the month of August was the last nail in the coffin. These developments seriously damaged the confidence investors had in lending money to the KRG.
However, the only other way out of the current economic crisis, at least in the short term, is to re-take efforts to bring in fresh capital to cover for the money Kurdistan is unable to generate internally. There is no other alternative that is economically or politically feasible. One-off revenues such as privatisation do not tackle the main issue of how the public revenue is generated. A clear alternative would be to settle disputes with Baghdad, but the political distance between each party seems larger than ever. Therefore, the authorities should start new negotiations for loans from the international markets. Re-building confidence requires better transparency in the process as well as a clearer vision on how and where to invest the funds.
Making the burden financially worthy
The World Bank reported in its Region’s Impact Assessment in early 2015 that Kurdistan Region’s public debt rose from near zero a year ago to up to 20% of the GDP this year. Now this ratio is even higher as the total public debt is between $10 to $17 billion, depending on the source cited. An additional $5 billion is indeed a heavy but necessary burden. However, the interest rate is the most problematic issue. In previous negotiations, the rate requested by the financial institutions stood at 12%, far above Iraq’s 8%. This shows a lack of confidence in Kurdistan’s policy-making. A better rate should not be expected, as Kurdistan is implementing Iraq’s same institutional model of rentier state.
In order to overcome these issues, and justify the extra debt burden, the incoming capital must be substantively used as leverage to pull Kurdistan out of the current crisis, and not as a temporary patch. The KRG has two options. It can use the capital to pay the salaries in arrears to public employees, and resume the stalled public infrastructure works. Or, it can use it to repay the money owed to the international oil companies operating in the region, thereby reactivating the oil industry. The two options are discussed below.
The financial situation of most families in Kurdistan has severely deteriorated in the last year, as the majority of the employed population , directly or indirectly, on the public sector. The fact that the KRG has not received its full share of the Iraqi budget since 2013 implies that salaries cannot be paid regularly and public contractors are not remunerated. Small businesses not linked to the government also suffer in turn, as private consumption is at its minimum.
According to data available, families have been relying on informal borrowing to sustain their living standards, depleting savings that soon will reach an end. Paying salaries and resuming public contracts will certainly help introduce liquidity and reactivate the local economies. It will also reestablish previously lost employment positions and contribute to alleviating the social emergency created by both the economic and humanitarian crisis.
On the other hand, there is the oil sector in Kurdistan. A significant part of the public debt is actually owed to international oil companies. The KRG Minister of Natural Resources stated that oil companies are collectively owed more than $3 billion, while other analysts double or triple this amount. Lack of payment has put some companies in a dangerous financial situation. Even more critically, it has interrupted the flow of investment and the plans to scale up operations by most of the oil operators in Kurdistan. The KRG’s recent decision to allocate a portion of the revenue from its direct crude oil sales to the producing oil companies on a monthly basis offers little hope of a full reversal of the deteriorating confidence environment.
With development plans hindered and gloomy prospects for investors, the region will not be able to reach the production targets that could have granted the government financial viability. This requires levels far beyond the current 500,000 barrels produced per day. In the end, oil exports, either through independent sales or through Iraq’s SOMO, are the only source of revenue for the KRG.
Conflicting allocation of the resources
If the Kurdistan Region was not a rentier state and the concept of tax-payer had existed, it would be sensible to inject the borrowed money into the local economy by paying salaries and resuming infrastructure projects. Then, as the economy revives the public sector could gradually reap the benefits and sustain its expenses, including salary payments or debt maturities. The loan would have had social returns. However this is not the reality, and the KRG would eventually end up in the same situation as today: unable to make payments, with oil production stalled and creditors anxious for their loans.
Instead, the better option to avoid this vicious cycle is to invest the capital in ameliorating the prospects in the oil sector and scale up production. With a gradual increase in production, revenues for the government would increase up to a level whereby it is possible to sustainably fund governmental expenses and meet the largely unfulfilled social needs.
It is unfortunate that, because of the functioning of the State, borrowed money cannot be used to directly address the extreme social situation in the region. It would be inappropriate to aim to solve the social crisis without solving the KRG’s financial sustainability. Without the latter, any future plan would be jeopardised. Sustainability right now stands, unfortunately, on the shoulders of the oil sector due to the lack of structural reforms in the past. Therefore, some homework for the future: the oil sector should complement rather than substitute a tax system.