Masrour Barzani, prime minister of the Kurdistan region
In 2015, Deutsche Bank and Goldman Sachs were tasked with an unusual mandate: sounding out international institutional investors on the prospects of a bond from Kurdistan. To which the first question of many investors was: what’s Kurdistan?
There is no official country of Kurdistan; there are regions of both Iran and Iraq that carry that name informally, but it isn’t a sovereign state. On the Iraq side, the 2005-approved constitution set Iraq up as a federation of 18 provinces, of which three, jointly – Erbil, Sulaymaniyah and Duhok – are considered a semi-autonomous region under the Kurdistan Regional Government (KRG). (The decision in 2014 to turn Halabja into a province made Iraq 19 provinces and Kurdistan four.)
Kurdistan has its own government, the KRG, and it would like to be independent from Iraq, but that’s not immediately on the cards.
Nevertheless, back then, it seemed that the region – usually far safer than the rest of Iraq, with direct flights into its cities of Erbil and Sulaymaniyah on international airlines such as Lufthansa, Emirates and Qatar Airways – could at least issue in its own name.
“If you look at the federal laws versus the regional laws, it’s stated that anything that isn’t mentioned as a federal authority could be legislated by the provinces themselves,” says someone who was involved in the original pitch.
“That includes debt. The region [of Kurdistan] should be able to establish its own borrowing capacity as a sub-sovereign. Other provinces globally are able to issue bonds; in the US you have municipal bonds. That was the idea.”
At the time, Kurdistan was something of an oasis, a special case in turbulent Iraq. Rabee Securities, the brokerage, used to run an annual conference there. The region had its own armed forces and its own borders within Iraq itself.
But then there was a problem: ISIS. When the group took control of Mosul, which is a matter of miles from Kurdish territory, the whole security situation changed. The conferences stopped and so did foreign interest in the region.
That gave the bond an uneasy context, as Euromoney wrote in 2015, since one explicit need for the funds was to fight ISIS.
“Do institutional investors want to be financing wars, no matter how much they might appear to be backing the more just side?” we wrote. “Just how comfortable can one be with the repayment profile if it depends somewhat heavily on not losing that war?”
That, however, is apparently not the main reason the bond didn’t go ahead. Instead, it was more to do with the budgetary relationship between the federal and regional government, and how that fed into the credit story bankers were putting to investors. At the time, about 12% to 13% of the federal budget of Iraq supported the Kurdistan credit story, since that was the allocation to the relevant provinces from the national coffers.
“When we met with investors, that is how we drafted the credit story: that budgetary relationship,” remembers one banker. “But at that time a couple of things happened. The relationship between the government and the KRG started to deteriorate. The KRG started to speak about independent oil sales, which exacerbated tension.”
I don’t think we would all have gone through that entire exercise if we didn’t have some reasonable idea that there would be some market appetite. In fact, there was- Banker
And at the same time, the price of oil itself began to change. That affected the likely pricing of a bond and eventually moved it to a point where the borrower and investors were not going to find common ground. So the deal was pulled.
Otherwise, bankers say, it would have gone ahead.
“These were sophisticated emerging market investors,” says one. “I think there was a reception to the idea, based on the credit story that we had provided.
“I don’t think we would all have gone through that entire exercise if we didn’t have some reasonable idea that there would be some market appetite. In fact, there was.”
Many accounts spent a long time looking at it seriously and analyzing the credit story.
In the years that followed, the Republic of Iraq itself issued sovereign bonds at the federal level, one of them US government-guaranteed and another free-standing.
ISIS thrived for a while but was eventually, painfully driven out. Kurdistan held a nonbinding referendum showing that 93% supported independence from Iraq – with a 73% turnout – which only really succeeded in annoying Iraq.
Fitch noted at the time that the referendum “underscores the deep political fault-lines in Iraq” and “raises some risk of a violent confrontation between the Iraqi and Kurdish governments or of ethnic clashes.”
That didn’t really happen, but the KRG president did he say he hoped the referendum would pave the way to negotiated independence, something vigorously opposed in Iraq.
So, from 2015 onwards, Kurdistan appeared to be a place that finance forgot. It had the economic credentials to be a successful independent issuer, with an attractive oil economy, but was shackled to a sovereign its people didn’t want to be a part of, a nation more dangerous and polarized than Kurdistan itself is.
It is interesting to remember this in light of last year’s parliamentary elections in both Iraq and Kurdistan.
“Certainly under the current administration there seems to be a honeymoon period of a robust, strong relationship between Erbil and Baghdad,” says one Iraqi banker.
The next four years will be a defining time for us, our neighbours and our allies- Masrour Barzani, PM
Clearly there are some useful relationships: the current president of Iraq, Barham Salih, is the former prime minister of the KRG and a former deputy prime minister of the Iraqi federal government.
In July, a new government was formed for Kurdistan within the broader federal structure; on July 18 Masrour Barzani, who is the prime minister of the Kurdistan region, wrote an open letter in The Washington Post painting the region as being at a moment of rebirth, having got rid of ISIS.
“The next four years will be a defining time for us, our neighbours and our allies in which we… look past our recent traumas, consolidate our place in the region and secure a presence on the international stage,” he wrote. “In short, we want to make a new start.”
He talked about resetting the relationship between Baghdad and Erbil, but also noted that the agreed allocations from the Iraqi budget “are rarely delivered in full”.
Is this therefore a time when Kurdistan might look back to its 2015 experiment and seek the support of international capital once again?
Barzani said in his letter that full independence is not the immediate order of business: “Our priority now is to create a strong, stable Kurdistan region anchored within the international community.” Accessing international debt like any other semi-autonomous province might be a good way of securing that anchor.
They certainly need the money. Barzani refers to billions of dollars of debt, and the province is thought to have borrowed quite heavily from Turkey, as well as entering into forward contracts on oil sales to get by. Some estimate the true debt figure, which is not entirely transparent, is as much as $17 billion, well over 100% of GDP.
One could also argue that the Iraq sovereign bonds create a curve to price against, as sovereigns have always done for sub-sovereigns around the world.
“I don’t think the presence of a sovereign bond dilutes the need for a Kurdish one,” says one banker. “But is there a need for it? You would have to ask the KRG. Given the amount of reconstruction finance they require, I would think so.”
The transition into a new government is making the KRG hard to reach for on-record interviews right now. But Barzani’s open letter is a sign that they are trying to recast their image on the world stage. Don’t be surprised if this place that finance forgot ends up being remembered after all.