Fitch Affirms Iraq Outlook at B-
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Fitch Affirms Iraq at 'B-'; Outlook Stable
Thu 28 Nov, 2024 - 3:38 AM ET
Fitch Ratings - Hong Kong - 28 Nov 2024: 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
Credit Fundamentals: Iraq's 'B-' rating reflects its high commodity dependence, weak governance and high level of political risk. This is balanced by high foreign-exchange (FX) reserves supported by consistent, albeit lower, current account surpluses and a favourable government debt profile. High oil prices previously improved many of Iraq's credit metrics, but weaknesses in the structure of the economy and economic as well as fiscal policy weigh on the rating.
Oil Production to Pick Up: We expect Iraq's oil production to increase as the authorities gradually phase out production cuts to meet higher spending, reaching 4.28 million barrels/day (mmbbl/d) in 2025 and 4.54mmbbl/d by 2026. We estimate production to average 3.97mmbbl/d in 2024, from 4.12mmbbl/d in 2023, due to increased compliance with OPEC quotas.
Budget Deficit to Widen: We forecast the budget deficit to widen to 8.0% of GDP in 2024, from 2.0% in 2023, and to an average of 12.4% over 2025-2026. We forecast revenue to edge down to 38.4% of GDP in 2024 owing to a 2pp decline in oil receipts, from the combined effects of lower production and oil prices (Fitch Brent forecast: USD80/bbl in 2024, USD70/bbl in 2025 and USD65/bbl in 2026). We anticipate revenue will average 34.1% in 2025-2026 as lower oil prices more than offset higher output, and as the authorities have limited flexibility to raise non-oil revenues.
We expect total spending to surge to 46.4% in 2024 (+4pp of GDP yoy) due primarily to a higher wage bill and pension transfers ahead of the 2025 elections, while capex remains stable at 7.1% of GDP. We expect expenditure to average 46.5% over 2025-2026, with current spending remaining high at 41.5%, reflecting the authorities' limited flexibility on salaries and transfers. We believe the bulk of fiscal adjustment will come from capex, which we expect to decline significantly after the elections and average 5.0%. The government has a track record of adjusting capex to compensate for lower revenue.
Government Debt Rising; Risk Contained: We expect government debt/GDP to pick up to 47.7% by end-2024 and reach 56.5% by 2026 (2023: 44.2%) as the government increases borrowing to finance higher deficits. Most of the government financing is likely to come from the Central Bank of Iraq (CBI) through indirect purchases of government securities. CBI's total claims on the central government represented around 63% of domestic debt stock and 30% of the total debt stock at end-2023. A smaller portion will come from the government's cash deposits, which amounted to 20% of GDP at end-2023.
We believe refinancing risks to be contained by CBI's intervention. Sharp increases in CBI's claims on the government previously led to heightened pressure on FX reserves, resulting in a currency devaluation in 2020, but we consider the current reserves to be large enough to absorb the expansion of CBI's balance sheet without putting pressure on the exchange-rate peg. The government's substantial cash deposits provide an alternative financing option.
International Reserves Provide Substantial Buffer: We forecast FX reserves to remain strong at around 16.7 months of current external payments over the forecast horizon (2023: 16 months) on the back of the current account surplus. This will provide a substantial financial buffer, including relative to annual external debt service, of around 1.8% of GDP over 2024-2026. The majority of the external debt is owed to official creditors. Iraq faces a total of USD1.2 billion in repayments through 2028 for its only outstanding eurobond.
Pressure on Parallel Exchange Rate: We expect pressure on the parallel exchange rate to persist as we believe the incoming US administration will increase scrutiny of Iraqi banking transactions. The parallel exchange rate is about 15% weaker than the official rate despite the robust FX reserves and sufficient US dollar supply on the official platform. This is due to scrutiny of access to dollars through CBI auctions and to the US barring some Iraqi banks from conducting dollar transactions. Washington seeks to limit the flow of US dollars to sanctioned neighbouring countries, mainly Iran and Syria.
Heightened Regional, Domestic Risks: We anticipate that Iran-aligned groups will continue attacking Israel against the backdrop of Iranian-Israeli conflict, potentially resulting in localised Israeli attacks on Iraqi soil. On the domestic front, Iraq is likely to face increasing tensions ahead of the 2025 parliamentary elections, as antagonism between the ruling Coordination Framework and the rival Sadrist Shia Patriotic Movement could develop into violent infighting, as seen in August 2022.
ESG - Governance: Iraq has an ESG Relevance Score of '5' for both Political Stability and Rights and for Rule of Law, Institutional and Regulatory Quality, and Control of Corruption. These 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 the 10th percentile, reflecting political instability, security risks, weak institutional capacity, uneven application of the rule of law and a high level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
- Public and External Finances: Significant deterioration of public and external finances, such as that stemming from a sustained period of low oil prices or failure to adjust public spending after the elections, leading to sustained wide budget deficits and a rapid build-up of government debt/GDP. This risk would be compounded if recourse to material monetary financing from CBI were to lead to a significant deterioration in FX reserves.
- Structural Features: Marked deterioration in the country's security, particularly if this has a negative impact on oil production and exports.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
- 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 in foreign assets.
- Macro: Improvements in the cohesion and credibility of economic policymaking, resulting for example in structural fiscal reforms, economic diversification and stronger private sector growth. This could lead to the removal of the -1 notch on macro.
- 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)
Fitch's proprietary SRM assigns Iraq a score equivalent to a rating of 'B+' 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: No adjustment.
- Macro: -1 notch to reflect weaknesses in policymaking, which is constrained by entrenched political-economy dynamics, preventing a decline in commodity dependence.
- Public Finances: -1 notch, to reflect Fitch's expectation that government debt/GDP will increase markedly over the next five years above the level currently captured in the SRM, and a weak fiscal structure, including substantial exposure to oil price volatility.
- External Finances: No adjustment.
We have removed the -1 on structural features. The negative notch was introduced to account for cyclically high oil prices that inflated the SRM output through GDP per capita and share in world GDP variables. The impact on the SRM has ebbed with the reduction in oil prices.
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.
Country Ceiling
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 scrutiny on access to and convertibility of US dollars.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
The following limitations were identified and addressed: for the balance of payments data (BoP), the IMF highlights various deficiencies, which reduce our confidence in the accuracy of the data, and the data on Iraq's international investment position stops at 2014. The availability of reliable data on FX reserves mitigates the weaknesses of the BoP data and we derive our own estimates of IIP using the available balance of payments data from the IMF. The data treatment and mitigants above provide us with sufficient confidence in our analysis of the credit profile to maintain the rating.
ESG Considerations
Iraq has an ESG Relevance Score of '5' for Political Stability and Rights as WBGIs 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 WBGIs 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 WBGIs 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/esg.
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
Country Ceiling Criteria (pub. 24 Jul 2023)
Sovereign Rating Criteria (pub. 24 Oct 2024) (including rating assumption sensitivity)
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
Country Ceiling Model, v2.0.2 (1)
Debt Dynamics Model, v1.3.2 (1)
Macro-Prudential Indicator Model, v1.5.0 (1)
Sovereign Rating Model, v3.14.2 (1)
ADDITIONAL DISCLOSURES
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy
ENDORSEMENT STATUS
Iraq EU Endorsed, UK Endorsed
DISCLAIMER & DISCLOSURES
All Fitch Ratings (Fitch) credit ratings are subject to certain limitations and disclaimers. Please read these limitations and disclaimers by following this link: https://www.fitchratings.com/understandingcreditratings . In addition, the following https://www.fitchratings.com/rating-definitions-document details Fitch's rating definitions for each rating s
Solicitation Status
The ratings above were solicited and assigned or maintained by Fitch at the request of the rated entity/issuer or a related third party. Any exceptions follow below.
Endorsement Policy
Fitch’s international credit ratings produced outside the EU or the UK, as the case may be, are endorsed for use by regulated entities within the EU or the UK, respectively, for regulatory purposes, pursuant to the terms of the EU CRA Regulation or the UK Credit Rating Agencies (Amendment etc.) (EU Exit) Regulations 2019, as the case may be. Fitch’s approach to endorsement in the EU and the UK can be found on Fitch’s Regulatory Affairs page on Fitch’s website. The endorsement status of international credit ratings is provided within the entity summary page for each rated entity and in the transaction detail pages for structured finance transactions on the Fitch website. These disclosures are updated on a daily basis.
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