KURDISH BONDS: A dream delayed

ErbilPolitical pressures forced the Kurdistan region of Iraq to shelve plans to issue its own bonds. Sharmila Devi asks whether the region will ever be an independent issuer.

The mood was optimistic when officials for the Kurdistan Regional Government (KRG), which governs northern Iraq’s semi-autonomous Kurdish region, explored the idea of a bond issue.

After hiring Deutsche Bank and Goldman Sachs, the Kurdish team met 80 potential investors in London in June. A senior official, who helped to organise some of the talks and wished to remain anonymous because of their sensitivity, says there was “a lot of interest” in the plan.

“When we go ahead with the bond, we’ll get a lot of buyers,” says the official, who is aligned with the dominant Kurdistan Democratic Party. “But around the time of our discussions, there was turmoil in Greece and in China. We were also deciding to go for independent oil sales then. It was seen to be more politically polite to let Iraq go first [with a planned $5 billion bond issue, its first debt sale in nine years].”

The KRG has therefore delayed indefinitely its plans to raise some $500 million through the debut bond while Baghdad goes ahead (having hired JP Morgan, Citibank and Deutsche Bank). The decision to delay is a blow for those hoping for greater financial independence from Baghdad. But the experience of pitching to investors is instructive. Should the KRG ever be successful in issuing its own bonds, would they be worth buying?

The coupon of the KRG bond would have been between 11% and 12%, says the official, compared with the more than 8% level where the Republic of Iraq’s existing $2.7 billion bond, due in 2028, has been trading. The premium reflects the KRG’s sub-sovereign status, the fact that an investment-grade credit rating remains out of sight, and high political risk.

If investors had taken that risk, they would have been handsomely rewarded, says a Kurdish businessman, who did not want to be named because of his regular dealings with the KRG.

“We expected only 25-30 meetings with investors but had around 80 in blocks of eight to ten. The KRG made a good presentation while they asked all the right questions. Some of them were damning but others were encouraging,” he says. 

“[Deputy prime minister] Qubad Talabani led the team and did well. But we’re a nascent baby state and we’re going to wobble as we learn to walk.”

A Kurdish consultant, who also spoke on condition on anonymity, says more than 50 investors expressed interest in the bond, including hedge funds and banks.

“Usually bonds like this are packaged to spread the risk. If the yield was 12% over five years, they’d get half their money back as profit. Even if the KRG defaulted, the bond could be sold as a distressed asset and there are investors with appetite for this.”

However, the consultant worries about the debt-ridden KRG taking on more liabilities in the absence of a clear way forward with Baghdad. Meanwhile, reforms are needed in an economy that’s dependent on oil and where most employment comes from an inefficient public sector.

Several of the Kurdish parliament’s opposition members expressed concern when the KRG pushed through legislation authorising it to approach the international markets.

“A lot of people don’t trust our politicians to manage the process properly and to agree how to spend the money,” says the consultant. “There’s been mismanagement and some eyebrows are being raised at the high fees being paid for this bond.”

Some Kurds from the Gorran party have questioned the advisory role of Rebwar Berzinji, president of investment firm Pericles Capital Advisors.

But the senior KRG official dismissed the criticism. “Rebwar Berzinji is an adviser, yes. There seems to be some rivalry among the advisers, so I would take that statement [about alleged high fees] with a pinch of salt.”

A general distrust of the Kurdish government is commonplace among businesses in the region, however. Hiwa Talabani, chairman of oil services company Kelkan Group, is one of the few businessmen to speak openly about internal challenges.

“We have a crazy public sector, with thousands of people getting salaries who shouldn’t. I blame it on mismanagement by this government and the previous one,” he says. “We need taxes. Not on the people barely able to survive but on businesses, landowners and people with second homes.”

In the near future, the KRG remains committed to seeking agreement with Baghdad over budget payments and oil exports, as this would provide more revenues, says the senior official. Any revenues raised through a bond would be a “drop in the ocean” compared with the sum owed to the KRG by the federal government.

“Baghdad owes us at least $13 billion from 2014 and more from this year because it hasn’t been making full payments.”

Baghdad insists Erbil, the capital of the Kurdistan region, does not have the right to export oil independently from fields developed under contracts signed unilaterally by the KRG with oil companies. Baghdad has resorted to legal action to stop such exports, including in the US, saying all export proceeds must be paid into central accounts.

Erbil points out it has failed to receive the 17% of Iraq’s entire oil receipts that it is entitled to under the constitution.

Washington has discouraged the KRG from making any moves that might damage the territorial integrity of Iraq. However, the sweep of Islamic State across Iraq last year might prove to be a game-changer.

“The US used to be very hostile to our plans but now officials shrug their shoulders and say, ‘You sort it out,’” says the senior official. “They say, ‘We prefer you talk to Baghdad and if agreement works, you’ll be better off.’ It’s true we would be better off if we got 17% but historically, we’ve never got it. Selling oil independently means we get less than 17%, but it’s more than we’ve actually been getting from Baghdad.”

Kurdish officials say full-blown independence remains a far-off goal but part of a process that is underway. The bond plan is the most significant step towards greater autonomy since the KRG sold its first cargo of oil at Ceyhan, Turkey, independently of Baghdad in May 2014. More than 9 million barrels were sold in June.

Potential investors would have welcomed the KRG’s announcement on August 3 that international oil companies will begin receiving monthly payments in September for their crude exports, the first such payments since last December. The oil companies are owed more than $1 billion, according to analysts’ estimates.

In a statement, the KRG’s Ministry of Natural Resources said: “The KRG… recognises the patience of the producing [companies], which, despite receiving hardly any payments for their crude oil production since May 2014, have maintained operations and have continued to invest to support Kurdistan’s crude oil export.”

Another factor that will affect the KRG’s ability to issue bonds is political turmoil in the region, which is expected to remain high. Turkey’s recent decision to join the US-led coalition against the Islamic State was accompanied by attacks against Turkish Kurdish militants in Iraq’s mountainous north. This was followed by bombing attacks on the oil pipeline by the militants, raising questions about the KRG’s ability to maintain steady exports.

Some analysts hope Baghdad may tacitly if not overtly allow Erbil to export independently and not, for example, launch fresh legal action. But Baghdad will also be cautious of being seen to encourage other regions, such as Basra, from seeking greater control over their resources.

The actual issue of any KRG bond would provide proof of how much investors and financial institutions are willing to risk Baghdad’s anger. Theirs would be a similar choice to that made by international oil companies over whether to invest in the Kurdistan region at the risk of being excluded from the rest of Iraq.

“Baghdad and Erbil do need a deal over oil exports,” says Ali Kurdistani, a political analyst. “They’re both facing a financial crisis and war.”

©2015 funds global mena

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