September 29, 2017 / 12:38 PM / a year ago

Fitch: Kurdish Referendum Shows Persistent Iraqi Political Risk

(The following statement was released by the rating agency) HONG KONG/LONDON, September 29 (Fitch) The referendum in the Kurdistan Region of Iraq underscores the deep political fault-lines in Iraq, although its near-term consequences are highly unpredictable, Fitch Ratings says. It raises some risk of a violent confrontation between the Iraqi and Kurdish governments or of ethnic clashes, but it is also possible that the status quo will be broadly maintained, despite heightened tensions between the central government and the KRG. In this scenario the direct economic impact on federal Iraq would be limited in the near term. Results from Monday's referendum show that 93% supported independence for the Kurdistan Region of Iraq, with a turnout of 73%. The referendum is non-binding and KRG leaders have made clear that it will not lead to an immediate unilateral declaration of independence. Nevertheless, KRG President Masoud Barzani ultimately wants it to pave the way for negotiated independence. At the very least, the KRG hopes to use the result to negotiate greater concessions from the central government. There are very substantial obstacles to independence. Iraq does not recognise the referendum, which included some disputed territories, notably Kirkuk, and Prime Minister Abadi has said that the central government will not discuss the outcome with the KRG. Since the referendum the government has been working to impose transport and border restrictions on the KRG. International opposition to the referendum was also strong and widespread, including from states with considerable economic leverage over the KRG. Iran closed its airspace to flights from the region ahead of the vote and Turkey conducted military exercises near the border and warned that it could shut off the only pipeline for KRG's oil exports. The US state department also warned that the referendum "may jeopardise... international assistance." The referendum's short-term impact on Iraqi politics is unpredictable. It places extra pressure on Prime Minister Abadi to formulate a response that shores up his support among a fragmented Shia base ahead of next year's provincial and parliamentary elections. Politics within the KRG, where overdue presidential elections are scheduled for November, is another source of uncertainty. There is a risk of conflict, for example between Iraqi forces and Kurdish autonomous military forces (the Peshmerga), especially over disputed territories and in ethnically mixed areas, such as Kirkuk. We expect that the US will make strong diplomatic efforts to prevent this. It may be that the status quo largely remains intact. This could pave the way, after next year's elections, for negotiations to start between the central government and the KRG over territorial claims. These, along with management of oil supplies, have been the two main issues undermining relations between the Kurds and the central government, particularly since the war with Islamic State has allowed the Kurds to expand the territory they control. The referendum highlights the manifold and serious political risks that Iraq faces even after Islamic State has largely been defeated. Political risk and insecurity are among the highest faced by any Fitch-rated sovereign, and Iraq scores worst of all Fitch-rated sovereigns on the composite World Bank governance indicator, which also reflects corruption, government ineffectiveness and weak institutions. This credit weakness is incorporated in Iraq's 'B-'/Stable sovereign rating. If conflict between Baghdad and the KRG is avoided, any effect on Iraq's credit profile should be limited over the near term. In principle the federal budget includes revenues from, and transfers to, the KRG. But this arrangement has broken down because oil-sharing agreements have largely failed. Our fiscal forecasts assume that this situation continues. Iraq's fiscal revenue will continue to be largely a function of exports from the south of the country and global prices. If political tensions were to escalate into prolonged conflict this would have a budgetary and economic cost. If the eventual outcome were a Kurdish independent state, Iraqi GDP would be reduced and the country would lose some natural resources. <a href="">MENA Sovereign Credit Overview <a href="(here">Iraq Contact: Toby Iles Director, Sovereigns +852 2263 9832 Fitch (Hong Kong) Limited 68 Des Voeux Road Central Hong Kong Mark Brown Senior Analyst, Fitch Wire +44 203 530 1588 The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. 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