Following the Kurdistan Regional Government’s referendum in September supporting independence, the central government imposed economic measures—involving oil, revenue sharing, aviation and banking—that threaten a collapse of the Kurdistan Region’s economy. The widespread economic hardship imposed on the Kurdistan Region’s residents is already a threat to political stability there, as witnessed by recent civil unrest in Sulaimaniyah province.

While the Kurdistan Region’s economy can be politically isolated by Baghdad for leverage, its disintegration would have a sharp impact throughout Iraq given the extensive economic linkages, particularly with regard to commercial activity. For example, Iraq’s import-dependent consumer goods sector is supplied primarily overland from Turkey through the Kurdistan Region, in many cases using Kurdistan-based merchants who distribute throughout Iraq.

Negotiations Are Needed

Even more important in the long run, however, will be the Kurdish public’s alienation from the rest of Iraq.

Negotiations between Baghdad and the Kurdistan Region authorities in Erbil are needed—and the sooner they can begin, the less long-term damage to Kurdish-Iraqi relations and the Iraqi economy, and the lower the risk of reigniting the military conflict.

Clearly, questions of the economy cannot be separated from disputes over security, territory, and representation, which pose a threat to the fragile and unsustainable equilibrium. But the government of Prime Minister Haider al-Abadi has a fairly urgent incentive to at least mitigate the economic tensions in the coming months: Easing tensions will help the Abadi government attract international aid and loans to rebuild Iraq after its devastating war against ISIS.  

The core economic issues between Baghdad and the Kurdistan Regional Government revolve around oil policies and the allocation of Iraqi fiscal revenue to the region. The two issues are related; in 2016 oil accounted for 85 percent of central government revenue and the Kurdistan Regional Government (KRG) depends on the oil sector—directly or indirectly—for almost all of its revenue, too.  

Under an agreement reached in 2005, which broke down in 2014, the Kurdistan Region received a share of total Iraqi state revenue based on the region’s share of the population, a number that later became a matter of dispute. Beginning around 2007 the region implemented a separate regional oil policy, attracting oil companies within a more market-oriented framework.

Autonomy on Oil

Disputes over the extent of the region’s autonomy on oil policy and how much central government revenue the region is entitled to are poor prospects for quick resolution; they have bedeviled relations between the KRG and Baghdad for a decade.

In addition, following the Kurdistan Region’s referendum, the central government has used civil aviation policy, control of border entry points, and financial sector policies as levers to reassert central control over the Kurdistan Region. The Iraqi prime minister banned international flights to Erbil and Sulaimaniyah airports and continues to insist on a central government role at border crossings into the Kurdistan Region. The Iraqi parliament, for its part, passed legislation demanding the Central Bank of Iraq cut off Kurdistan-based banks from access to foreign exchange.

With parliamentary elections likely in May, and political pressures in Baghdad working against concessions to the Kurdistan Region, it’s doubtful the central government will make the compromises needed for lasting solutions to the oil and revenue issues prior to elections.

Still, Baghdad would be well-advised to move quickly to prevent an economic collapse in Kurdistan. Absent actions to alleviate hardship for the region’s residents, not only will the Kurdistan Region’s free fall act as a drag on the Iraqi economy, but the continuing crisis will undermine Iraq’s appeal to donors and investors for reconstruction. Political considerations also could drive Abadi toward an accommodation with the KRG. A deal—even a limited one—would allow Kurdish leaders the political space to consider forming a new government with him after the elections.

Kuwait Donors Conference

If the Iraqi authorities hope to attract desperately needed new sources of reconstruction assistance and investment at a Kuwait-hosted donors conference in mid-February, they would be well advised to do what they can to defuse the crisis with the KRG. A country that never resolves longstanding internal conflicts is hardly an attractive investment destination, particularly when the areas most desperately in need of investment (such as Nineveh province) lie close to the still-tense face-off between Iraqi and Kurdistan Region forces. The Iraqi government also would do well to win approval in the next International Monetary Fund review by securing parliament’s passage of an IMF-compliant budget.

There are encouraging reports lately of engagement between the two sides, but progress is slow. A package deal involving such a budget, or at least payment of KRG salaries, reopening border crossings, and allowing flights to resume to Erbil and Sulaimaniyah airports would go a long way to calm the crisis, encourage potential donors and investors, alleviate the hardship of Kurdistan’s people, and stem the alienation of both the Kurds and their political class.