Political And Security Risks In The Region

Published Date: 02 Nov 2017

The Kurdistan Region undertook a great economic growth since international and Iraqi sanctions on the region were lifted, becoming the most prosperous and dynamic area of the country. Stable and rich in natural resources (oil, natural gas and phosphates), it attracts foreign investors steadily growing its economic potential.

Political and security, economic and financial, legal, operational and internal risks should be analyzed in order to evaluate opportunities and risks of establishing a branch office in the Kurdistan region.

Political and security risks in the region

Concerning political and security risks, the Kurdistan region offers the most stable environment in Iraq. Nevertheless, some aspects remain a source of concern for investors.

First of all, tensions are persisting between Baghdad and Erbil relating to Kirkuk, Nineveh and Diyala provinces and their control. Predominantly Kurdish areas and rich in hydrocarbons, these provinces present the greatest potential for political violence and poses one of the most significant political risks in the region and are considered by the KRG as such. The last peak of tensions with military presence of both protagonists took place in November 2012 in Diyala governorate.

By the same token, the close economic relationship between Kurdistan and Turkey is another risk to keep in mind. Abundant Turkish investments in different economic sectors of the region and the pipeline project transporting oil from Iraqi Kurdistan via Turkey to the international market, bypassing this way Baghdad, are the real source of tensions with the central government. Moreover, another project has been already contracted with Turkey in order to supply it in natural gas. For Iraq that means a financial loss of oil exports, providing more power to the Kurdistan region and isolating it of the rest of Iraq. In long term the Kurdish dependence of Turkey, the implosion of Iraq and the region’s instability are conceivable.

Besides, the Kurdistan region is preparing this year for provincial elections, parliamentary elections and presidential elections. Massoud Barzani has already carried out his two president’s term of office. However, he is clinging to power provoking internal tensions notwithstanding that the relationship between two main political parties (the Patriotic Union of Kurdistan and the Kurdistan Democratic Party) is strained. The Barzani’s third term is received by the population as a dictatorial drift. In this respect, political uncertainty and potential instability are revealed as the risk factors.

Globally, the Iraqi situation is difficult enough. The country is recovering from a nearly nine-year war and regaining its economic development. The situation is considered as fragile due to progressive American withdrawal, poor Iraqi governance, devastated infrastructure, inadequate legal structures and lack of transparency. The country is a subject to social tensions and security risks, so potentially does the Kurdistan region. Currently, Kurdistan is facing the arrival of the Kurdish refugees from Syria. Their installation may disrupt law and order in Iraq.

To sum up, the political and security situation in the Kurdistan region is relatively satisfactory thanks to its economic wealth and regional stability. Yet, the risks involved should be kept in mind and one cannot deny that the situation could change quickly, in particular because of Baghdad. In theory the probability of security risk is high; its seriousness is moderate and it presents an acceptable level for doing business in the region.

Economic and financial risks

Over the last decade the Kurdistan region has shown an unprecedented development of its economy. To illustrate this point, for the period 2003-2008 the national income has raised from $3.842 million to $31.34 million, in other words 46.6% of average growth rate. GDP rate passed from $2.07 billion in 2003 to $23.6 million in 2011. GDP per capita increased from $375 to $4500 for the period 2002-2011. The government revenues amounted $12.5 billion in 2012 comparing to $100 million in 2002. The economy growth in 2012 was about 12%. The Regional Development Strategy for Kurdistan region 2012-2016 foresees an annual GDP growth target of 8%.

According to the Kurdistan Region’s Statistic Department, inflation rose to 5.6% in 2012 related to 2% in 2011 due to a salaries rise and property prices. Moreover, Kurdish prices in 2013 registered an increase of 0.7% compared to 2012.The high rate of employment allows a rise of disposable income which affects positively the consumption and investment demand, provoking this way an increasing of inflation rate. Today, this trend is restricted by the lack of credit availability.

Monetary sector is doing relatively well. In 2012 the monetary reserves were equivalent to $70 billion and 5.5t of gold. It shows that the Iraqi dinar has been stabilized and appreciated, becoming competitive in the foreign exchange market. In 2012 Iraqi’s banking sector increased by 90% its profits approaching $366 million where the Bank of Kurdistan contributed some $45 million.

Concerning foreign direct investment (FDI), it represented $12.5 million in 2010 coming from Turkey, Egypt, United Arab Emirates, Lebanon, Iran, Kuwait, United States of America and United Kingdom among others. According to the KRG’s Investment Board about $3.3 billion have been invested in the Kurdistan region since 2006 by FDI (15% of overall investment). The development strategy of the region for 2016 includes 450 projects valued at $21 billion, 20% of which would be funded by FDI (about $4.2 billion). The Turkey is the largest regions’ investor, representing almost 60% of international investors. The value of annual trade with Turkey has reached $12 million. European and American companies also have begun to invest massively in the region.

The growth of the Kurdistan region’s economy is driving by trade mainly in the private sector. The KRG built the economic growth by implementing liberal investment laws in 2006 (except the hydrocarbon sector) and allowing to international and local investors certain business flexibility. In 2012 about 1 600 foreign and 11 000 local companies have been identified in Iraqi Kurdistan. As a result of all these factors, the Kurdish economy presents a huge capacity development and varied opportunities. Thus, economic and financial risks seem to be relatively low and fully acceptable.

Electricity sector remains the priority of regional economy linked to overall development, as well in industrial, construction, infrastructure sectors as in services. The produced electric power increased to 228% in 2009 compared to 2004. Despite this rise, it is considered that the region suffers from a deficit of 30% in relation to overall demand for electric power. The Regional Development Strategy for Kurdistan region 2012-2016 is focused on "increasing the annual per capita share of electricity up to 3,000 kWh during 5 years" in order to meet a future demand. Concretely, the development of electricity sector offers interesting investment advantages. By the way, the French companies as Schneider Electric or Alstom Grid are already present in the region for electric equipments supply and installation. This fact reveals a growing interest to the region and to the energy sector and may appear the risk of competition.

Legal risks

The corruption risk and the institutional ineffectiveness appear as the largest concern for foreign investors. It is still high in the hydrocarbon sector and less important in another business fields. Giving a fact that the business in electrical area is linked to the energy sector, the corruption risk should not be neglected in order to avoid a possible litigation proceeding.

By the way, Baghdad supervises all oil and gas contracts and financial flows between the KRG and international companies, considering it as void and illegal. As a result, the struggle for influence between the central and regional governments creates the atmosphere of uncertainty for international investors and could trigger the risk of non-payment. The failure of Baghdad to honor its payments to international oil companies will lead the temporary cessation of Kurdish exports. These risks will persist till an agreement on appropriate federal law settles the hydrocarbons’ question, notably in the terms of exploration contracts. Currently, the KRG regulates itself its own oil and gas. In one hand, a non-payment perturbation may lightly affect the sector of energy. This risk is minor, but not inexistent. In other hand, the law’s change, if it intervenes, would disrupt significantly the energy market. The probability of the risk is high, but it is low and acceptable for the electricity sector.

Concerning expropriation risks, they are really low as the KRG tries to open its region in order to promote massive investment. In order to boost foreign investors, the KRG offers more flexible and lucrative production sharing contracts. In this case, a new federal law may once again affect theses liberal agreements.

Operational risks

The infrastructure sector remains the key sector in the Kurdistan region and still in development in order to facilitate economic growth. Consequently, some weaknesses of transportation are conceivable depending on the place of delivery. Delayed deliveries should not be excluded.

As to the risk of a natural disaster, it is established that Iraq occupies the 94th place in the worlds’ list of countries predisposed to this risk. In majority of cases the country is exposed to a flood risk but the acuity level is low in terms of human and material damages.

Internal risks

First, if the corruption risk is not taken into account, the firm is likely to be involved in a bribery scandal which could tarnish the company’s reputation. Considering the fact that the level of corruption in energetic sector is above the average in this region, the all staff of the subsidiary are potentially exposed.

Second, the expatriate employees risk some political perturbations. According to the KRG there was no any kidnapping of foreigners, nor victims among coalition soldiers neither major incidents since 2007. Over the last decade the Kurdish security forces were especially effective in preventing terrorist attacks. But recently journalists complained a murder of young journalist and a persecution of another one in the Kurdistan region. While a level of risk exposure is not necessarily relevant, anyway it should be dealt.

Strategies for risk management

With regard to political risks in the region and within internal risk management some security measures should be undertaken by the firm seeking to establish a subsidiary in Kurdistan. It is preferable to foresee and to facilitate the repatriation of expatriate employees if situation turns dangerous. In this case a hotline must be provided. It is necessary to implement an internal communication between the managing director and its team and external communication with Consulate General of the Republic of France and with the parent company. For instance, the current political situation in the Kurdistan region does not justify the enhanced security measures. Implementation of surveillance cameras and communication management should be sufficient.

As the subsidiary is a legally distinct entity from its parent company, its employees are subject to social system and laws of the host country. The expatriate employees are financially more interesting for the employer than the staff on secondment. Nevertheless, the company could agree for expatriate team some pecuniary benefits in order to maintain its motivation. In one way it could help to prevent a corruption risk.

From an economic point of view the subsidiary may be created with a local partner. In short term a joint venture would help to reduce costs, to ensure high market penetration and to facilitate understanding of local business environment, of its opportunities and of consumers’ habits. Finally, the parent company is free to choose invest with or without local partners. The investment law of the Kurdistan region allows such business configuration. Financial and economic risks being minimal, there is in fact a competitive risk with other French companies. In this case the company should seriously undertake a benchmarking analysis on the Kurdish market.

Actually, a project of subsidiary establishment in Iraqi Kurdistan makes sense. Admittedly, operational risks are likely to slow down the business but the company should play the game and do with some managerial, entrepreneurial and transportation difficulties. There is more to earn than to lose. Even if some risks are considered in theory as potentially important, in reality it could be reduced and justified. First, except political and security risk, a majority of risks identified is insurable. Second, the sectors as infrastructure, electricity, energy are vital for the Kurdistan region’s development and the KRG strives to create a favorable business environment for foreign investors.