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Iraq positions itself for growth after Kurdish referendum, ISIS rout

  • Iraq's military victories against ISIS have been tempered by a society still at odds with itself.
  • Investors see risks, but lots of potential rewards, as the country rebuilds.
  • The rebound in oil and a massive reconstruction effort should boost the opportunities.
Baghdad
Phototreat | iStock/360 | Getty Images
Baghdad

War-weary Iraq has notched huge strategic victories by routing ISIS from its strongholds across the country, yet also suffered a symbolic setback by a Kurdish independence referendum that revealed a deeply divided society.

For Iraq, sectarian divisions and the battle against extremism work at cross purposes. As the country struggles to reconcile both dynamics, some market investors are encouraged about the country's upside. A June State Department report cited Iraq's "long-term potential" for foreign investment, given its vast oil reserves and massive reconstruction needs.

Bolstered by a $5.4 billion financing agreement approved by the International Monetary Fund last year and a $1 billion tranche of debt guaranteed by the U.S., some investors say the country stands a solid chance of becoming a draw for international investors despite its many challenges.

"The almost unanimous international support for a unified Iraq should lead to financial support for its reconstruction and reinforces the argument made in the past," said Ahmed Tabaqchali, chief investment officer of Asia Frontier Capital's Iraq Fund.

"The realignment of interests of regional players in dealing with the root causes of the conflict — namely the deep economic and political disenfranchisement that bred such fertile ground for the rise of extremism — is one factor Iraq should focus on to dissuade further action on a split within the country."

'Much more is needed'

Iraq oil
Essam Al-Sudani | Reuters

In the wake of Iraq's military victories, infrastructure rebuilding and a boost from oil will help propel the economy's recovery. Yet for the time being, the impediments are legion.

Despite the huge military victory earlier this month in ISIS' so-called capital in Raqqa, Syria, many market observers are not convinced the sky's the limit for Iraq — or for other besieged Middle East countries.

"While the successful campaign against Islamic State is definitely a big positive, we do not believe that the victory in Raqqa is a key game-changer for Iraq," said Raphaele Auberty, a BMI Research risk analyst for the Middle East and Africa.

"It does point to a reduction of security risks in the region, but [ISIS] will continue to pose security threats through bombing attacks, and Iraq is still facing several other security challenges," Auberty added.

Yet glimmers of hope are emerging, mainly in the country's battered oil sector. The rebound in oil prices is definitely positive for the Iraqi economy, Auberty explained, given the over-reliance of government revenues and exports on oil proceeds.

"Therefore, we see this as positive for investor sentiment, but much more is needed to see a spike in investment in non-oil sectors, given the lack of economic diversification," the analyst added.

Political risk within Iraq has been and remains the biggest deterrent for potential investors. Even as the Iraqi Security Forces continue working to oust ISIS from the country, various political challenges remain, according to analysts.

"Even if the Iraqi government gets bogged down in conflict with Kurds, the negative economic implications, particularly on investment, will be more than offset by the rout of ISIS." -Garbis Iradian, economist, Institute of International Finance

While BMI Research expects improved growth outside the oil sector, the firm also expects it to "remain modest over the coming years, therefore limiting specific opportunities for investors." Iraq's private sector ranks near the bottom on measurements of transparency and corruption.

"Iraq will also be prone to ethnic and religious tensions, as highlighted by the recent referendum," Auberty told CNBC, an independence vote overwhelmingly approved by Kurds but opposed by Iraq's central government. "This, coupled with social instability means that we could see episodes of violence re-emerging across the country," Auberty added.

Still, Iraq's investment profile has improved over the past year, amid rising oil prices and the financial lifeline from the IMF. The country is OPEC's second-largest producer, pumping more than 4 million barrels per day.

Separately, global ratings agency Fitch Ratings upgraded the country's outlook from negative to stable in March, enabling the government to tap international debt markets in August.

According to BMI, companies that are benefiting from support from their governments are the most likely to get involved in the rebuilding of Iraq. The United Kingdom, for example, has offered loans worth at least 10 billion British pounds ($13 billion) for the reconstruction process, with British construction companies set to benefit from these contracts.

Garbis Iradian, chief Mideast/North Africa economist of the Institute of International Finance, said the tension between the central government and the Kurds' regional leadership in northern Iraq is unlikely to escalate or lead to a war.

Both parties, pressured by the U.S. and the EU, may eventually strike a deal on "limited independence," he said. This should keep regional tensions high, with Iraqi Prime Minister Haider al-Abadi authorized by parliament to send government troops to the flashpoint city of Kirkuk.

"Even if the Iraqi government gets bogged down in conflict with Kurds, the negative economic implications, particularly on investment, will be more than offset by the rout of ISIS," Iradian said.

"The impulse from the "end of war with ISIS" or their defeat, will attract significant foreign investment to the energy sector in Iraq. Most sectors of the Iraqi economy are expected to benefit, including the energy, mining and the financial sector," the economist added.