Fitch Revises Outlook on Iraq to Stable; Affirms at 'B-'

Oil prices have increased since 1Q16, but Iraq's public and external finances remain highly vulnerable to any renewed slump in the oil price. Commodity dependence is among the highest of all Fitch-rated sovereigns. Oil accounts for more than 50% of GDP and around 90% of fiscal revenue.

The bulk of oil production facilities and export infrastructure are located away from areas of insecurity. After strong growth in recent years, oil output in the south was largely stable in 2016 at 3.5m b/d on average, given lower budgeted government payments to international oil companies, which has constrained investment. We expect production and exports to plateau in 2017 given similar amounts budgeted by the government for IOC payments this year. The majority of exports from the north are being sold independently by the KRG.

The banking sector is under-developed and fundamentally weak. Private sector credit to GDP is one of the lowest of any Fitch-rated sovereign. The two large state-owned banks, Al-Rafidain and Al-Rasheed, which have high non-performing loans and exceptionally low capital adequacy, dominate the sector. The government has appointed auditors as required by the IMF, but it remains unclear how the banks will be restructured or what this might cost in terms of recapitalisation by the government.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Iraq a score equivalent to a rating of 'B' on the Long-Term 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 rated peers, as follows:
- Structural features: -2 notches, to reflect political and security risks which are not sufficiently captured by the governance indicators in the SRM and because of the exceptionally weak banking sector.
- External finances: +1 notch, to adjust for the legacy debt to GCC countries which the authorities do not face any pressure to repay or service and to reflect financial support from the international community, including multilateral organisations and the US guarantee for Iraq's January bond issue.

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