What’s required for Kurdistan to overcome its economic crisis?

On Monday, December 19, anti-government demonstrations started in several cities in the Kurdistan region of Iraq (KRI). Protesters took the streets across the KRI to protest against widespread corruption, lack of basic services and the Kurdistan Regional Government's (KRG) inability to pay civil servants. The demonstrations quickly led to protesters burning the headquarters of all five main political parties, and security forces responded fiercely, wounding dozens and killing at least seven protesters. The KRI has been facing a severe economic crisis since 2014 after the Iraqi central government stopped paying the region's share of the budget. In return the KRG started to sell oil independently to be able to pay its employees and fund the war against Islamic State (ISIS). The region has also hosted over 1.5 million internally displaced Iraqis, which further strained the already depressed economy. In 2014 when the Iraqi army melted away during the ISIS assault, Kurdistan's Peshmerga forces rushed in to secure Kirkuk and the surrounding oil fields. For three years the KRI was in control of the city and exported its crude to ports in Turkey. The KRI enjoyed its golden era between 2005 and 2014, while the rest of Iraq suffered from sectarian conflict and instability. High oil prices, foreign investment and capital made KRI the only stable part of Iraq. Between 2005 and 2014, the region's share of the national budget was 17% and amounted to roughly $1 billion a month. Around $750 million of the budget was spent on an extremely overblown public sector. A million people in the KRI are dependent on the government for salaries and pensions. But with falling oil prices, corruption and the cost of war with ISIS, the KRG was still not able to fully pay public sector employees despite control of the oilfields in Kirkuk. The KRI implemented austerity measures whereby employees saw their salaries reduced by as much as 75%. In September the region held an independence referendum where the overwhelming majority voted in favor of independence. The central government and KRI neighbors Turkey and Iran threatened to close its borders and cut relations with the region. Iran closed its borders and the federal government closed the airspace over the KRI. Then, on October 16, federal forces and Iranian-backed Shi'ite militias attacked Kirkuk, and while the city was well defended and had thwarted several major attacks by ISIS in past years, Peshmerga forces quickly withdrew, without putting up a fight. The loss of Kirkuk, along with corruption and the government's mishandling of the economy, have led to deep mistrust in the KRG by the region's population. When the region controlled Kirkuk and its oilfields, the KRG managed to produce around 700,000 barrels a day and export around 550,000 b/d to Ceyhan in Turkey. With the loss of Kirkuk, KRI oil production is around 350k b/d today and with current oil prices they generate far less in revenue than are needed to pay public employees. Due to the political risk of dealing with crude from Kurdistan, the KRG has been forced to sell crude at a heavy discount and agree to prepayment deals with trading houses. Trading houses like Vitol, Petraco, Trafigura and lately state-owned Russian company Rosneft have paid the KRG in advance for future oil sales and as a result, much of the crude exported by the KRG today is not generating new revenue. With the loss of Kirkuk and the revenue generated from Kirkuk crude, the KRG is having a hard time paying its employees and the debts acquired over the past couple of years, thus putting the region at risk of economical collapse. So what can the KRI do to overcome this crisis? There are two options: The first option is to reach a revenue- sharing deal with the central government whereby Baghdad would pay the KRG's civil servant salaries, and in exchange the KRG would let the central government use KRG's oil pipeline to export crude from Kirkuk and let Iraq's state oil marketing company SOMO sell oil produced in the KRI. A similar deal negotiated in early 2015 with the help of the US stipulated that the KRG was to export 250k b/d from the fields it controlled in the KRI and export 300k b/d from the Kirkuk fields to be sold by SOMO, while in return Baghdad would pay the KRG 17% of the Iraqi national budget. But the deal quickly fell apart and both parties accused each other of breaching the agreement. While a similar deal can be done, there are several difficulties involved in implementing such a deal today. If the central government were to take over the KRG's crude production it would also have to take over the debt the KRG has acquired over the past several years. The KRG owes Turkey nearly $1.5b. in loans and pipeline tariffs, and international oil companies several hundred million dollars, and it also owes trading houses over $1b. that needs to be repaid with crude. Any deal with the central government would also raise questions such as who will pay the IOCs working in the region, and if so will the KRG will have to renegotiate the lucrative production sharing deals they have with IOCs to technical contracts like the central government have with oil companies working in Iraq. Renegotiations of the deals could be a breach of the contracts made between KRG and the IOCs and risk lawsuits against the KRG. A DEAL like this would need serious dialogue and would require concessions from the KRG, meaning giving up the little economic independence it has. The central government would have considerable leverage over the KRG and the KRI would be dependent on central government goodwill for salaries. This would make the region very vulnerable to political changes in Baghdad. The second option is a reform program and in the long term this is a more sustainable option because the region's economy would not be as dependent on unpredictable relations between KRG and the central government. This option would require several controversial steps but would lead to more transparent and sustainable economy not so sensitive to oil prices and relations with governments in Baghdad. It would also be a first step to fight corruption and end the ruling party's hegemony of the economy. The KRG would need to implement a real reform program with the support and help of the entire political spectrum in the region, as well as international partners. To be able to implement this reform process they would need to form an independent auditing commission that would consist of technocrats, political parties and international partners. This commission would oversee the reform process and have a timetable for each step of the process. Before the reform is implemented, the KRG would have to be totally transparent and inform the commission about the debts it has acquired. The KRG would also have to reveal the exact amount of revenue it gets from crude sales and border tariffs. The commission would then inform the public and argue for why these reforms are necessary. The first and hardest step would be to reduce the overblown public sector that is eating up most of the revenue. Over a million people are on the government payroll today and this is not sustainable. The region's citizens need to be informed that neither the KRG nor the federal government is able to uphold this system. In a first step the regional government would have to audit the government employees once again and remove “ghost employees,” then it would slash the public sector employees by a third. There is of course big risk involved in removing a third of the payroll in an already depressed economy, so how can they manage it without sending the economy into a death spiral? The KRG would have to implement these reforms with the help of the international community, which would grant it a large aid package with the condition that it implement the reforms with full transparency and cooperation. It is of course very hard to sack a third of the government's employees without risking civil unrest and without further damaging the economy. So an option could be that the region's employees would have a six-month transition period where the KRG would continue to pay salaries and help them find jobs in other sectors. The next step would be to subsidize the agriculture sector to make the region less dependent on food imports from Turkey and Iran. The KRI has a very fertile agricultural environment but is importing most of its food from Turkey and Iran. This could change if the region were to stimulate the agriculture sector and subsidize farmers. The extra revenue earned from crude sales and tariffs should then be used to pay back debts and be reinvested in infrastructure, job programs and agriculture. And the whole process would be overseen by the independent commission to make sure it's fully implemented. Furthermore, the KRG, with the help of the international coalition, should institutionalize its Peshmerga forces under the Ministry of Peshmerga. This would not only create a strong independent institution but would also create transparency since the exact number of Peshmerga forces is not public as of today. A third of the Peshmerga forces are officially under the command of the Ministry of Peshmerga and the rest under the rule of the two ruling parties, PUK and KDP. KRG's international partners could guarantee continued military support with the condition that all Peshmerga be put under the command of the Ministry of Peshmerga. A unified Peshmerga force would also guarantee that the ruling parties would not use the forces under their command for political purposes and would avoid the disastrous mistakes made during the Sinjar massacre and when Kirkuk was lost to federal government forces and Shi'ite militias. A strong, unified Peshmerga force would also deter any threats to the region by ISIS and other extremist groups, something that is in the interest of the international community. But how to convince the ruling parties to implement these steps? By using carrots and sticks. The international community would only grant the KRG an aid package if it fully committed to these reforms, with full transparency and cooperation. The international community would guarantee continuous military and political support and would mediate between the KRG and the federal government in important issues such as the status of Kirkuk and other disputed areas. Earlier this year the region held a non-binding independence referendum where the vast majority of the population voted yes to independence. It is not a secret that the majority of the Kurdish people want an independent Kurdistan. But the aftermath showed that the region is far from being ready for independence. Even if Kurdistan reaches a revenue sharing deal with the federal government of Iraq, a true reform is needed to have a strong, prosperous Kurdistan that continues to be a beacon of stability in a region plunged into war and turmoil. It's not too late to reform the region's political and economic structure, but if it's not done soon the region risks further division and hardship. If the KRI does not overcome this crisis, the region's problem will become much worse and risk spilling over to neighboring countries, something that is neither in the interest of the international community or of the ruling parties of Kurdistan. The author is head of T&S Consulting Energy and Security, which advised companies working in the Kurdish oil and gas sector

What’s required for Kurdistan to overcome its economic crisis?

The KRI has been facing a severe economic crisis since 2014 after the Iraqi central government stopped paying the region’s share of the budget.

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