3 hours ago
Mon 04 Dec, 2023 - 8:36 AM ET
Fitch Ratings - Hong Kong - 04 Dec 2023: Fitch Ratings has affirmed Iraq's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B-' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS[size][size][size]
Credit Fundamentals: Iraq's 'B-' rating reflects its high commodity dependence, weak governance, political risk and undeveloped banking sector, which are balanced by high FX reserves and a favourable debt profile. High oil prices have improved many of Iraq's credit metrics over 2022-2023, but the absence of structural, economic or fiscal reforms and persistent political risk weigh strongly on the rating.
Heightened Political Risks: Domestic and regional political risks and weak governance will continue to constrain the rating. Iraq is likely to face increasing domestic tensions ahead of the 2025 parliamentary elections, in Fitch's view, and there is also the risk of escalation between Iran-backed Shia militias in Iraq and the US military, against the backdrop of war in Gaza.
Since the beginning of the conflict, the Shia militias have targeted US military bases in Iraq and Syria using rockets and drones. The US response has been contained mainly to the militia positions in Syria, with only one attack on Iraqi soil. While not our baseline scenario, there is a risk that attacks by Iraqi Shia militias escalate, prompting a stronger US response in Iraq.
Inter-Shiite Tension: Provincial elections on 18 December could spark greater domestic political tensions between the Popular Mobilization Forces, which is linked to the governing Coordination Framework, and the Sadrist movement. Moqtada al-Sadr, the leader of the Sadrist movement, called upon his supporters to boycott the electoral process and avoid associating with "corrupt" rivals. The intra-Shiite conflict, which caused violent clashes in 2022 after the previous parliamentary election, could intensify in the run up to parliamentary elections in 2025.
Budget Returns to Deficit 2024: We forecast the budget to be balanced in 2023, following the large 11% of GDP surplus in 2022, owing to an 18% decline in oil revenue (due to lower oil prices and a 6% decline in oil production linked to OPEC+ cuts) and above 10% growth in budget spending. In June 2023, the government agreed an expansionary three-year budget for 2023-2025, which pencils in a surge in salary-related spending ahead of 2025 elections (+60% compared with 2022). We forecast the budget will move into deficits averaging around 4.5% of GDP in 2024-2025, as spending increases and assuming that oil prices trend down to average USD70/bbl in 2025.
We project Iraq's fiscal break-even Brent-equivalent oil price at around USD80/bbl in 2023-2025. Iraq's fiscal break-even oil price is subject to volatility, reflecting a procyclical response of budget spending to oil revenue. The fiscal break-even has moved within a band of USD55/bbl-USD75/bbl in 2015-2022. The 2023-2025 budget risks increasing fiscal rigidities given higher allocations for wages. In terms of the budget's sensitivity to oil prices, a USD10/bbl change in the oil price impacts the budget by around 4% of GDP, assuming unchanged spending.
Debt to Increase: After decreasing to 43.2% in 2022 on the back of higher GDP, we expect government debt/GDP to be largely stable in 2023 (43.4%) and to rise in 2024-2025, reaching 48.7%, due to larger budget deficits that will be funded through a mix of borrowing and deposit drawdowns. Our total debt numbers include an estimated USD40 billion of legacy debt from the 1980s, which Iraq faces no pressure to service following its Paris Club agreement of 2004. Excluding this debt, overall government debt/GDP would be around 30% at end-2023.
Weak Domestic Banking System: The banking sector is underdeveloped, fundamentally weak and dominated by state-owned banks with opaque finances, which creates domestic financing constraints for the government. During oil price shocks in 2015-2016 and 2020, the government needed to both cut spending and resort to indirect monetary financing from the central bank, which continues to hold 58% of domestic debt (around 13% of GDP).
Strong FX Reserves Buffer: We expect FX reserves excluding gold to reach USD92 billion by end-2023, consolidating the substantial gains in 2022 when they were buoyed by bumper oil revenue. We expect reserves to stabilise at around that level through 2025, keeping the current external payments coverage above 12 months, and providing a substantial financial buffer, including relative to low annual external debt service averaging around USD 4 billion (1.5% of GDP).
Exchange Rate Under Pressure: Despite the strength of the economy's FX receipts from oil exports, US dollar supply in the market has been limited by greater official scrutiny over access to dollars through Central Bank of Iraq (CBI) auctions and due to the US barring a number of Iraqi banks from conducting dollar transactions, as the US is looking to limit the potential flow of US dollars to sanctioned neighbouring countries, mainly Iran and Syria.
The gap between official and parallel exchange rates has widened, with the latter standing at around 1600 IQD/USD (20% weaker than the official rate). We expect pressure on the dinar to continue as the CBI announced new restrictions, with US dollar remittances being exclusively withdrawable in dinar starting January 2024.
ESG - Governance: Iraq has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Iraq has a low WBGI ranking just below 10th percentile, reflecting political instability, security risks, weak institutional capacity, uneven application of the rule of law and a high level of corruption.
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade[size][size][size]
Public and External Finances: Significant deterioration of external and fiscal finances, for example, stemming from a sustained period of low oil prices or increased government spending, contributing to government financing stress or rapid increase in debt.
Structural Features: Marked deterioration in the country's security, particularly if this negatively impacts oil production and exports.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade[size][size][size]
Macro: Improvements in the cohesion and credibility of economic policymaking, notably reforms to the public finances, electricity and financial sectors.
Public and External Finances: A sustained period of high oil prices, particularly if combined with higher oil production and exports, leading to a downward trend in government debt/GDP and further increase foreign assets.
Structural: Greater security and social stability together with enhancements to governance and institutional quality that facilitate non-oil economic development.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)[size][size][size]
Fitch's proprietary SRM assigns Iraq a score equivalent to a rating of 'BB-' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Structural: -1 notch, to offset the recent strong improvements in GDP per capita and share in world GDP which are linked to cyclically high oil prices.
- Macro: -1 notch, to reflect weaknesses in policymaking, which is constrained by the political system and which prevents a decline in commodity dependence.
- Public Finances: -1 notch, as recent strong oil prices mean that the SRM output does not adequately reflect both the medium-term challenges to public finances from a weak fiscal structure, including a bloated civil service resistant to reform, and limited financing flexibility, which required the government to resort to central bank financing in 2016 and 2020 during oil price shocks.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The Country Ceiling for Iraq is 'B-', in line with the LT FC IDR. This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
Fitch's Country Ceiling Model produced a starting point uplift of +1 notch above the IDR. Fitch's rating committee then applied an offsetting -1 notch qualitative adjustment to this, under the Balance of Payments Restrictions pillar reflecting increased scrutiny on access to and convertibility of US dollars.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING[size][size][size]
The principal sources of information used in the analysis are described in the Applicable Criteria.
Iraq has an ESG Relevance Score of '5'for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Iraq has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Iraq has an ESG Relevance Score of '5'for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Iraq has a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.
Iraq has an ESG Relevance Score of '4'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Iraq has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Iraq has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Iraq, as for all sovereigns. As Iraq has a fairly recent restructuring of public debt in 2006, this has a negative impact on the credit profile.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.[/size][/size][/size]