Iraq’s new constitution was a good outcome for the country’s Kurdish provinces but now the landlocked area faces the challenges of encouraging investment and energising the economy in a volatile region with a troubled past. There is cause for optimism – and opportunities for those prepared to grasp them. But it is not a prospect for the squeamish or the risk averse.

For the Kurds, the creation of a federal Iraqi Kurdistan is a way marker in a struggle that dates back at least to the Treaty of Lausanne in 1921, punctuated by bitter regional fighting, internecine conflicts and a largely indifferent outside world. It also confers recognition on the self-rule possessed by the Iraqi Kurds since the end of the first Gulf War, when vicious reprisals by Saddam Hussein in the north and against the Shia in the south precipitated the creation of a no-fly zone protecting the three majority-Kurdish governorates of Arbil, Dohuk and Suleymaniya.

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In 1992, the Kurds held multiparty elections, in effect entrenching the mini-regimes of Kurdish Iraq’s two political giants (longstanding foes of Saddam and, on occasion, each other): Jalal Talabani of the Patriotic Union of Kurdistan (PUK), in the east of the region, close to the Iranian border, and the Kurdistan Democratic Party’s (KDP) Mahmoud Barzani, son of the legendary Mustafa, in the city of Arbil.

At that time, the Kurds described their autonomous region as a de facto federal province, initiated as a necessity to fill a power vacuum. Saddam’s influence was never far away though: central Iraqi forces kept up a constant campaign of harassment, intimidation and infiltration. Arguably, the Kurds did not much help their own cause. By 1994, fighting had broken out between the two key factions, the PUK and KDP, each side variously siding with external allies, including Iran, Turkey and the Saddam government, in their bitter battle for regional dominance. A deal brokered in Washington in 1998 spelled an end to that and since then, the two key power bases of Suleymaniya and Arbil present themselves as thriving, commercial, and at peace with each other.

Quick off the mark

Whatever misgivings anyone else might have about the war in Iraq, its outcome put the Kurds in an advantageous position and they were quick off the mark in trying to consolidate this commercially. In the immediate months after the occupation, Mr Barzani gave a mandate to the Kurdistan Development Corporation (KDC), a self-financing inward investment agency manned both by members of the Kurdish political elite and non-Kurdish entrepreneurs, to market the region and generate new economic activity.

Since then, the corporation has seized that challenge with a vigorous marketing push. It describes Kurdistan both as “Iraq’s gateway” and “the other Iraq” and is running a campaign that says “thank you” to a US public supportive of the Iraqi invasion.

From a marketing perspective, Iraqi Kurdistan is caught in the horns of a subtle dilemma: selling itself as “the other Iraq” portrays the north as a parallel universe in which the uncertainties of the rest of the nation do not apply. That might be accurate to an extent but the region must be careful not cut itself adrift from the rest of the country because there are no friendly neighbours to whom it can attach itself, and the hazards of political and economic isolation are not worth considering.

The Iraqi Kurdish elite is savvy enough to know that. Its elder statesmen are in the main worldly wise and well-received around the world. Many were busy courting international opinion throughout the time that Saddam was considered a pariah and, in commercial and economic terms, that can only pay off.

Logistical hubs

The KDC says that any ambiguities vis-à-vis the identity of Iraqi Kurdistan work in its favour. Kurdish cities such as Arbil and Suleymaniya, the argument runs, should be regarded as logistical hubs for companies wary of chancing their arm in the hotter and more violent south.

These are not unreasonable selling points. Cool weather and comparative security distinguish Iraqi Kurdistan from the rest of the country. The Kurdish armed militia (Peshmerga) is a battle-hardened and battle-weary force that the new constitution accepts as the north’s security force. In combination with a sophisticated intelligence-gathering apparatus, it has been remarkably effective in preventing a major overspill of insurgent violence. There have been bombings in both Suleymaniya and Arbil but there has been nothing like the scale of unrest witnessed in Baghdad or even the Shia south, and life for the vast majority of citizens escapes the lottery that prevails elsewhere.

In terms of geography and population density, the Kurds like to draw a comparison between their region and Austria. Both occupy a similarly sized, largely mountainous region. The population of each is about five million. And Iraqi Kurdistan, like Austria, is landlocked.

It is on this front that the Kurds have been trying to make headway. New airports opening in both Suleymaniya and Arbil will obviate the need to change planes at Baghdad airport. In late September, the new Kurdistan Airlines flew an inaugural flight from Frankfurt to Arbil. The airline intends to run a weekly flight, and for the Frankfurt link to be followed by links to London, Amsterdam and Stockholm. Road access from Turkey is also much improved, with hundreds of lorries passing through the border at Zakho on a daily basis.

Investor friendly

The legislative terrain is also looking more friendly for investors. The new Iraqi regime provides, for example, that any existing agreements and contracts made with the Kurdistan Regional Government (KRG), or with private parties in Kurdistan, since 1992 are valid provided that they do not contradict the new constitution. And whereas under the Transitional Administrative Law (TAL) there was uncertainty over oil contracts signed with the Kurdish regional government, the Kurds say the new constitution provides that, in the event of a clash of laws over areas of shared competences (such as oil and other natural resources), regional law would come out on top.

Hinting at the degree of autonomy that Iraq’s federal areas will enjoy, the new regional government is empowered to pass its own laws. Currently before the Kurdish National Assembly is an investment law that appears extremely FDI friendly. If implemented, it would ensure: exemption from income and property tax for five years for foreign companies; similar exemptions for fixed assets including equipment, land, vehicles and furniture as well as imported raw materials; no local employment quotas or restrictions on capital invested when entering into partnerships; and that all economic activities, except oil and gas, are to be fully open to foreign investment.

The KRG also plans to build a 42 million square metre industrial city, Arat, providing industrial development units for local and foreign investors.

Political relics

There are legacy issues for the Kurds to address, however. One relic of the old political schism is that, although Mr Barzani is president of Iraqi Kurdistan (and Mr Talabani is president of Iraq), two sets of ministries effectively administer the country: a KDP-led ministry in Arbil, and a PUK-led ministry in Suleymaniya. Full merger is timetabled for March 2007. No-one suggests that this will be easy, especially in sensitive areas such as security and internal affairs. There is always a chance that, until the two are fully unified, investors may face a duplication of bureaucratic process.

Companies are nevertheless showing an interest, according to the KDC. In October, it signed an agreement with the distributors of GM Chevrolet in Iraq, Al Mansour Iraqi Automotive Company (MAC) Iraq. And a recent trade fair in Arbil attracted sponsorship from, among others, General Electric, Kellogg Brown & Root, Immarsat, DHL and Fargo.

The KDC says that investment partners are reluctant to be named, citing security issues, but it insists that it is “working with companies from Turkey, Iran, Lebanon, Kuwait, Egypt, Canada, Russia, the Netherlands and the UK”.

Much of that trade is going to be with Iraq’s neighbours. There is ample evidence of small volumes of cross-border trade in a small frontier town in Iran, where traders are making a good living selling Iraqi and Turkish orangeade, soap, washing powder and alcohol. But it is not all small: Turkey’s minister for trade recently said that he expected Turkish exports to Iraq to total about $2.7bn by the end of 2005. Almost all will have passed through the northern Iraqi Habur Gate crossing, which was a lucrative generator of customs revenue for the Kurds before the war as now.

Gaps to fill

Apart from transport links and relative security, what does Iraqi Kurdistan have to offer? Anyone who has tried to make a phone call to Kurdistan knows that there are opportunities to be had in the telecoms sector, from the ground up. Similar infrastructural needs apply to almost all other sectors. The region is crying out for the new roads, housing, medical and educational facilities that the Oil for Food programme failed to provide adequately when it held the purse strings during the sanctions regime. There is also a desperate need for more financial services, without which indigenous businesses will continue to be stymied by lack of liquidity.

Consumer expectations are rising fast: the KDC boasts that there are now more than 1000 dollar millionaires in the north. There is a commensurate rise in construction projects and demand for retail outlets – Kurdish cement plants have never had it so good. Money for major construction projects is likely to come from government coffers for the most part, fuelled by customs receipts, a degree of multilateral assistance and central government. And then there is oil.

Oil prospects

The Kurds say they have no wish to become another oil-backed fiefdom with all the vices that generally attend; they say they are planning for a diversified and well-hedged economy. In the past – and even during periods when relations between the Kurds and the central Iraqi government were strained – the forests, mountains and lakes of the Kurdish north were seen as a welcome retreat from the south’s summer heat, and tourism thrived. Soon after the war that tradition was revived, and Arab dish-dashes could be seen once again among the trademark baggy trouser suits of the Kurds.

Kurdistan was also Iraq’s bread basket, exporting grain throughout the Middle East. Both these sectors could flourish again. Mr Barzani is alleged to be particularly keen on the cultivation of organic crops and, according to sources, is a knowledgeable apiarist.

However, there is no escaping the fact that Kurdistan’s underground riches will play a major part in the region’s destiny.

These are early days in the history of the new, federal Iraq and a good working relationship between its regional and central parts has yet to appear. In principle though, the regions will share oil revenue on existing fields with central government and the two will work closely on the development of new fields. Mr Barzani told a London conference recently that the distribution would be made on the “equitable basis” of percentages of population.

The constitution postpones until 2008 the complicated issue of Kirkuk, which gives its name to the ethnically mixed city that the Kurds call their “jewel in the crown”, the surrounding county and the oilfield beneath it, which is one of Iraq’s largest. By that time, a census is timetabled to be complete, the outcome of which is to determine who governs Kirkuk and how oil dividends are shared out.

Kirkuk is not the only field. A gas and condensate field was discovered at Chamchamal in 1953 by the Iraqi Petroleum Corporation but was undeveloped on the grounds that no market could be found for the gas. There are two wells at Taq Taq, in the region’s east close to the Iranian border, which are producing 2000-3000 barrels a day. Recent surveys at Demir Dagh suggest a field of perhaps 40km, which experts describe as having “a bright future”. The KRG is thought to be particularly anxious to sign a production-sharing agreement with a multinational oil company interested in this field.

Risk factors

Long term, though, investors might want to keep an eye on proceedings before they discount intra-Iraqi tensions as a risk factor. This observation, arguably, applies to less long-term investment prospects than major oil projects. The Kurds, optimistic and energised by their new constitution, know that they have a good news story to tell the world. Investors, who are wary of second guessing the future in a difficult and unpredictable region, will tread cautiously.

Ultimately, the region’s success as a thriving economy is only partly in its own hands – it needs the blessing and support of the outside world. However much some Kurds might wish otherwise, it will be hard for the region to grow in isolation from the rest of the country. Peace will be key to prosperity.