Iraqi Kurdistan's proposed international bond marks step towards financial autonomy but domestic political instability increases risks

In a statement released on its website on 22 June, the KRG announced that it was organising the semi-autonomous region's first bond release "in the near future". The statement confirmed that Goldman Sachs and Deutsche Bank had been hired to gauge appetite for the bond issuance. Under legislation passed by the Kurdistan Parliament in June, the region can raise up to a total of USD5 billion overall for funding infrastructure projects. However, the initial bond is being delayed by a combination of factors likely to include market uncertainty caused by Greece and concerns over the viability and legality of the bond sale itself.

Seeking to alleviate fiscal pressure

The intention to issue bonds marks the latest attempt by the Kurdistan Regional Government (KRG) to gain greater autonomy from Iraq. However, this is the biggest such development since the KRG sold its first cargo of oil at Ceyhan, Turkey, independently of Baghdad in May 2014. Although sales have continued apace – more than 9 million barrels in June – the region is struggling to pay public sector salaries and fees to international oil companies (IOCs), as it rarely receives its full allotted budget payments from Baghdad. A bond issue would alleviate such fiscal strains. However, the issue will be viewed as highly risky by potential investors, who will require a very high yield to invest.

Clear and obvious concerns

There are two primary concerns for potential investors. First, Iraq's ambiguous constitution means that the legal status of the bond is unclear. The KRG bond would be underwritten by Kurdish oil reserves, however, Baghdad and the KRG disagree over whether this oil is owned by the Iraqi state or the regional government. A resolution to this matter is unlikely in the near future and the November 2014 deal between Baghdad and the KRG on the export of Kurdish oil via Turkey is faltering. There is a severe risk that Iraq would mount a legal challenge against any bond sale by the KRG.

The second concern for investors is the Kurdistan Region's lack of a credit rating, which will deter many risk-averse buyers. Those willing to risk purchasing Kurdistan's bonds would be banking on the region's relative security from Islamic State attacks and its current political stability. However, this political stability is coming under increasing strain from many directions.

Debates over the constitution and presidential powers

There is considerable political uncertainty within the Kurdistan Region, stemming from the expiry of President Massoud Barzani’s presidential term on 19 August and ongoing efforts to draft a constitution (see Iraq: 22 May 2015: Iraqi Kurdistan president likely to cite constitutional uncertainty and security perils to extend presidential term). Concurrently, two of the Kurdistan Region's most prominent political parties – the Patriotic Union of Kurdistan (PUK) and the Gorran Movement – are seeking to amend the 2005 Presidency Law so that the president is elected by parliament rather than popular vote. Although neither the PUK nor the Gorran movement are strong enough to force Barzani and his Kurdistan Democratic Party (KDP) into making major concessions, they are likely to secure greater parliamentary oversight over the president.

Despite this mounting uncertainty over the Kurdistan Region's political system, Massoud Barzani's chief of staff, Fuad Hussein, announced on 13 June that a national presidential election will be held on 20 August. Barzani is aiming for his third term in office – despite the draft constitution mandating a maximum of two terms – after securing a two-year extension to his second term in August 2013. Moreover, the two-month timeframe to organise the election is extremely tight, and the Kurdistan Independent High Electoral Commission (IHEC) stated on 20 June that this is insufficient for the body to have all the necessary legal requirements in place. Any election result therefore risks legal challenges.

The Kurdistan parliament subsequently met on 23 June to discuss the proposed amendments to the presidency law, that if passed would raise further uncertainty over the legitimacy of the planned 20 August election. Underlining this political acrimony, the KDP's 38 MPs boycotted the meeting, stating that such a major reform should fall under the mandate of the committee on constitutional reform.

Although the combined Gorran and PUK MPs outnumber the KDP, with 42, this still falls short of a majority in the 111-seat parliament. As such, they will be seeking to court smaller parties such as the Kurdistan Islamic Union, which has 10 seats, the Islamic Group in Kurdistan, with six seats, and the MPs in seats reserved for minority groups in order to pass their planned amendments.

Outlook and implications

The KRG promotes itself to potential foreign investors as a safe haven in comparison to Iraq, especially with regards to the security threat posed by the Islamic State. However, the bond issue will have to overcome concerns over the Kurdistan Region's lack of a credit rating, the risk of a legal challenge by the Iraqi government , and uncertainty surrounding the Kurdistan Region's internal politics. These factors combine to damage potential risk perceptions and increase the potential cost of issuance. Although President Barzani's political opponents lack the strength to field a viable candidate against him, there would be a high risk that they would mount a legal challenge against any election held on 20 August, even if just to use as leverage in negotiations over constitutional reform. This political upheaval risks delaying measures to boost privatisation and diversify the economy away from its dependency on oil and the construction sector. Without these structural reforms, the KRG will continue to struggle to pay civil servant salaries, IOCs, and potentially any investors in a bond sale. Nevertheless, successful international debt issuance would mark a significant step towards financial autonomy from Baghdad.