Moody's assigns provisional rating of (P)Caa1 to Government of Iraq's USD bond issuance; Outlook stable

Frankfurt am Main, September 20, 2015 -- Moody's Investors Service (Moody's) has today assigned a provisional rating of (P)Caa1 to Government of Iraq's planned USD-bond issuance with a stable outlook. The rating was initiated by Moody's Investors Service and was not requested by the rated entity. It is being assigned ahead of planned issuance of USD-denominated debt by the Iraqi government in the United States under Rule 144A. Moody's expects to remove the provisional status of the rating upon the closing of the proposed issuance and a review of its final terms.

The (P)Caa1 issuance rating reflects the following underlying key factors:
1. Iraq is a sizable economy with robust growth prospects, which are based on the country's large oil wealth, but are counterbalanced by a lack of economic diversification.

2. Very weak institutional strength as reflected in very weak governance indicators and issues regarding the availability of fiscal and economic data.

3. Moderate fiscal fundamentals, as debt-relief since 2004 has lowered the government's debt burden, while at the same time facing challenges from a low oil price environment and rising debt burden.

4. Very high susceptibility to event risk, which is predominantly driven by the challenges posed by deeply entrenched sectarian and ethnic tensions, and the ongoing insurgency by the Islamic State of Iraq and the Levant (ISIL).


Moderate economic strength: a sizable but undiversified economy with robust growth prospects

Iraq is oil-rich and has a lot of potential for economic development and growth. According to the BP Statistical Review of World Energy 2015, Iraq's proven oil reserves were 150 billion barrels in 2014, the fifth largest in the world, accounting for 8.8% of global proven reserves.

Real GDP growth has averaged 7.7% between 2008 and 2013, making it the 15th fastest growing economy in the world based on IMF data. According to Moody's estimates, growth was particularly strong in the oil sector, which expanded by almost 12% on average, whereas non-oil real GDP grew much more slowly, by around 5.5% on average. In 2014, real GDP declined by 2.1%, driven by a sharp contraction in non-oil growth, whereas oil production continued to grow by around 4.5%.

Looking forward, Moody's expects oil production to continue to increase by an average of 10% per year, reaching around 5 million barrels per day (mbpd) by 2019. Together with a recovery in non-oil growth from 2016 onwards, this will help lift real GDP growth to an average 8% per year between 2016 and 2019.

Iraq's robust growth outlook is counterbalanced by the lack of economic diversification, with oil accounting for 50% of nominal GDP and close to 100% of exports, and the non-oil sector dominated by the public sector. Manufacturing and construction together account for only 10% of GDP in 2014, and while services have a share of 37%, more than one third of this comes from general government services.

Very low institutional strength

Iraq ranks at the very low end when compared across all Moody's-rated sovereigns for the World Bank's Worldwide Governance Indicators -- particularly Government Effectiveness, Rule of Law, and Control of Corruption. In Moody's view, the lack of a budget law for 2014 and low budget execution rates illustrate shortcomings with regard to government effectiveness.

According to the 2004 Central Bank of Iraq (CBI) Law, the central bank is independent from the government. The CBI's primary objectives are domestic price stability and a stable and competitive market-based financial system. The central bank has successfully reduced inflation rates and consumer price inflation averaged 2.7% between 2008 and 2014.

While detailed and monthly oil sector data are available, the analysis of the non-oil sector is hampered by the lack of high-frequency activity indicators and quarterly expenditure side national accounts data. Quarterly balance of payments data are only available with a lag of three quarters.

Moderate fiscal strength

Iraq's fiscal metrics have strengthened since 2003. The fiscal balance has recorded an average surplus of 0.3% of GDP between 2005 and 2014. Following external debt reduction in 2005, total government debt declined from around 344% of GDP in 2004 to 32% in 2013, according to data from the IMF.

The decline in oil prices since mid-2014 has hit government revenues as oil accounts for around 90% of total revenues. Moody's projects an average Brent oil price of $55 per barrel in 2015 and $57 per barrel in 2016. Government revenues have been declining since 2013, and Moody's expects them to drop by 35% in 2015 compared to 2014. While the rating agency also expects some expenditure reduction, the resulting deficit will be very large, amounting to 18% of GDP. Although oil exports will likely grow in 2016, the fiscal deficit will stay wide at around 15% of GDP.

Financing these deficits will increase the government debt ratio to around 79% of GDP by the end of 2016. But Moody's expects the debt ratio to decline subsequently, to slightly less than 70% of GDP in 2019, as oil prices recover and oil production rises. However, government revenues will remain vulnerable to oil price swings.

The insurgency by ISIL is pressuring government finances, via increased spending on security and social spending for internally displaced persons, as well as on reconstruction of affected areas. The other channel is via decreased revenues from ISIL controlled areas, where the federal government has continued spending on public services without receiving any revenues.

Very high susceptibility to event risk

Political and security risks are very high, driven by underlying ethnic and sectarian tensions, and by Iraq's location within an unstable region. Even if dissolution or disintegration is unlikely, the combination of domestic and geopolitical risks affects the government's capacity to service its debt which weighs very heavily on Iraq's rating.

The ISIL insurgency poses the key immediate threat. However, external support for Iraq is increasing, and it is unlikely that ISIL would threaten either Baghdad or the south of the country where most of the population and oil wealth is located. However, overcoming the insurgency is likely to take many years, and to require time-consuming and costly reforms to the security apparatus (professional intelligence, military capacity and organization), and considerable expenditure both on reconstruction and on education and social services. It will also require ongoing external support from Iraq's allies and others in the region with a strategic interest in containing the insurgents.

Domestic political challenges are also very high, with deep, longstanding ethnic and sectarian divisions existing within the country. The current government has focused to a far greater extent than its predecessors on promoting national unity and national identity. For instance, key cabinet positions such as finance minister and defense minister are held by members of the non-Shia population groups. In Moody's view, this holds out the prospect of more cohesive, stable and effective governance of the country in years to come. The challenges it faces in unifying a country facing such deep divisions are nevertheless severe.

While political event risks dominate Moody's assessment, the sizable and weak banking sector, heavily shaped by publicly-owned banks, poses a source of contingent liabilities.

Risks to Iraq's external payments position are mitigated by a large stock of net foreign reserves, which amounted to $59 billion as of August. However, these reserves have been falling since May 2014 when they peaked at $79 billion. According to Moody's estimates, the external vulnerability indicator, which compares short-term external liabilities to the available stock of assets, will rise, but remain below the important threshold of 100%.


The rating could move up should political and geopolitical tensions reduce materially and sustainably. Over the longer term, greater economic and fiscal diversification which reduces the government's and the economy's dependence on oil would also be credit positive.

Conversely, a further intensification of domestic political struggle, unexpected gains by ISIL or a return to civil war would put downward pressure on the rating. The rating would also come under negative pressure should budget deficits remain wide and government debt fail to decrease, such as in a scenario of global oil prices staying below $50/barrel for the next five years, production falling off and the government failing to respond with adequate fiscal reforms.

GDP per capita (PPP basis, US$): 14,571 (2014 Estimate) (also known as Per Capita Income)
Real GDP growth (% change): -2.1 (2014 Estimate) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 1.6 (2014 Actual)
Gen. Gov. Financial Balance/GDP: -5.3 (2014 Estimate) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.7 (2014 Estimate) (also known as External Balance)
External debt/GDP: not available
Level of economic development: Moderate level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 18 September 2015, a rating committee was called to discuss the provisional rating to the senior unsecured debt to be issued shortly by the Government of Iraq under Rule 144A in the US. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, the issuer's institutional strength/framework, the issuer's fiscal or financial strength, including its debt profile and the issuer's susceptibility to event risks.

The principal methodology used in this rating was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable