Once again Baghdad and Erbil are disputing Iraq’s annual budget, underlining the unresolved tensions over authority and rights in the state. The Kurdistan Regional Government (KRG) continues to request more revenues than its current 17 percent allocation, while Baghdad wants to reduce the KRG’s relative share.

The difference today is the context in which the budget dispute is unfolding, which is not in the KRG’s favor. It follows a period of worsening relations between Baghdad and Erbil, as well as the KRG’s expanding financial obligations — including honoring international oil company (IOC) contracts without any viable, alternative revenue source in sight. Even if both sides reach another temporary side deal, the budget imbroglio reveals the KRG’s financial vulnerability in the Iraqi state, its inability to fully pay IOCs, and the ultimate need for a grand compromise between Baghdad, Ankara and Erbil over hydrocarbons exports. 

Given the KRG’s ongoing attempts to challenge Baghdad, the Iraqi central government is pushing back in the one area where it retains leverage over the KRG: the budget. With about 95 percent of KRG revenues derived from the central government, which have increased exponentially from about $2.5 billion to over $10 billion from 2005-2012, and with the KRG’s ever-expanding expenditures and social-welfare function, Erbil has become increasingly dependent on Baghdad. A significant cut in these revenues could instantly undermine the KRG’s economy and its investment future.

Part of this predicament is a consequence of the KRG’s achievements within an ambiguous legal and political environment. While Iraqi provincial administrations have failed to spend their full budgets — or to implement projects effectively — the KRG has done just the opposite. Only ten years after ex-President Saddam Hussein’s overthrow, the region has surpassed most other Iraqi provinces in development levels. The KRG now demands $4 billion in additional funds for its energy sector and IOCs payments alone. Baghdad has offered to pay only a fraction of that amount, about $625 million. It contends that the KRG has failed to meet its end the export bargain, having smuggled or bartered away its crude and failing to export an official 175,000 barrels per day as agreed.