Feb 18, 2016 | 21:18 GMT

5 mins read

Bluffing Through a Budget Agreement in Baghdad

(SAFIN HAMED/AFP/Getty Images)

Iraqi and Kurdish officials have resumed negotiations over a budget deal, but there might not be much relief in sight for the cash-strapped Kurdistan Regional Government (KRG). As is the case for many of the world's oil producers, persistently low oil prices have cut into the KRG's revenue, leaving it behind on payments, including government employees' salaries. Worker protests have erupted across Iraqi Kurdistan, and the already low popularity of KRG President Massoud Barzani has plummeted even further.

In response to the KRG's growing financial concerns, Iraqi Prime Minister Haider al-Abadi offered in a televised Feb. 15 interview to pay Kurdish salaries in exchange for Iraqi Kurdistan's oil. Taken in context, his proposal was likely more a jab at Barzani, who is facing allegations of corruption, than a serious suggestion. However, Kurdish officials called his bluff by accepting the deal two days later.

Though such arrangements between Baghdad and Arbil are not unprecedented, they have rarely held together for long. In December 2014, the two sides reached a deal in which the Iraqi government promised to give 17 percent of its budget — approximately the amount needed to cover the KRG's spending obligations — to Kurdish officials if they allowed Baghdad's oil marketing company to sell Iraqi Kurdistan's oil. But the accord broke down in a matter of months as Arbil failed to deliver the promised volumes, and Baghdad refused to make good on its payments.

It is unclear whether the latest proposal, if implemented, would be more successful than its predecessor. On one hand, Kurdish officials might have more reason to adhere to an agreement now than they have in the past. Financial strain is taking a political toll on the KRG, and Barzani's legitimacy as a leader is being increasingly called into question. Much of the KRG's fiscal problems stem from the fact its oil revenue falls far short of its expenses. The KRG exports about 600,000 barrels per day, and with oil prices at around $30 a barrel, this output brings in about $550 million each month. However, according to the KRG's Feb. 17 statement, the monthly cost of its employees' salaries alone stands at around $890 million. (This figure does not account for the salary cuts of between 25 and 75 percent that the KRG recently passed, which have spurred greater protests.) Since oil prices show no sign of rebounding anytime soon, and Iraqi Kurdistan probably will not be able to substantially raise its production levels in 2016, it is unlikely that the KRG will be able to pull itself out of its economic slump.

Therefore, a deal with Baghdad would work to Arbil's — and Barzani's — advantage, at least in the oil market's current state. If al-Abadi were to follow through with his promise, he would essentially be paying the KRG $890 million each month for oil that is worth only $550 million on the market. Of course, this raises the question: What would Baghdad gain from overpaying for Kurdish oil?

There are two possible answers: political leverage and Kurdish dependence. The Iraqi government has long tried to use financial assistance as a way to increase its influence over the KRG, withholding and releasing funds at various times to dial up or scale down pressure on Kurdish officials. This tactic is what drove the KRG to start exporting oil independently of Baghdad in June of last year. If the KRG begins selling its oil to the Iraqi government once again, Baghdad could regain some of its clout in the region. The deal would also stall the KRG's recent move to call for a referendum on independence, slowing the region's gradual shift toward greater autonomy.

Despite these potential benefits, Baghdad's own financial constraints might prevent the deal from solidifying. An oil producer itself, Iraq has not been immune to the damage low oil prices are causing; Baghdad has already accrued huge budget deficits and is in the midst of negotiations with the International Monetary Fund for an emergency bailout. In addition, its efforts to beat back the Islamic State are a substantial drain on its coffers. Therefore, it might not have enough of a financial buffer to absorb the losses inherent in the Kurdish oil deal without some guarantee that the agreement would remain in place in the event that prices rise. (Oil prices would need to reach about $48 per barrel before current Kurdish output would be worth $890 million a month.) That said, because the KRG is able to export oil itself if it chooses, it would have every incentive to simply break its contract with Baghdad once oil prices — or its own output — increase enough to ensure revenue sufficient to pay its bills.

And so, while it might make sense for the KRG to pursue a money-for-oil deal with Baghdad in the short term, it is unlikely that the same can be said for the Iraqi government. Therefore, a final agreement will probably remain elusive as al-Abadi's latest publicity stunt is revealed for what it likely is: a bluff. 

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