Syrian Conflict Moves Closer to Iraq

Bottom Line: Syrian regime leader Bashir al-Assad has a tougher grip on power than he has since the start of the conflict, but it is far from over, and clashes hit a key border crossing into Iraq, the sectarian situation there is disintegrating and even fearless investment bankers are having second thoughts.

Analysis: For the first time in months, Syrian leader Bashir al-Assad appears to be enjoying renewed power in Syria, as the disparate rebel factions disintegrate through in-fighting. The Free Syrian Army (FSA) has dissolved into those who have definitively joined the jihadists in the form of al-Qaeda-linked groups, and those who have now hedged their bets with the regime.  Intelligence points to talks of potential cooperation between the regime and FSA defectors. This represents a major transformation of the conflict, which is still far from over. Saudi Arabia is continuing-and even increasingly-arming jihadist groups whose ranks are swelling with a greater momentum than ever before. On another front, the Syrian Kurds are resurging to protect the territory they dominate in the north. The conflict is now being overshadowed by US-Iranian negotiations. At the same time, the conflict is moving closer to Iraq in the form of increased clashes between Syrian Kurds and al-Qaeda-linked Syrian rebels on the border with Iraq.

Following days of clashes with Islamic fighters, on 26 October, Syrian Kurd gunmen took control of a key border crossing with Iraq. As of the time of writing, Syrian Kurds still hold the border point-Yaaroubiyeh-in north-east Syria. The significance of this is that this border crossing is one of only two key border points between Syria and Iraq.

While bankers have traditionally retained their voracious appetite for Iraq despite the increasing sectarian violence and the spillover from Syria, there has been a notable reduction in investor confidence over the past 3-4 months. In October, Barclays Plc's investment-banking unit reduced its 2013 projection gross domestic product projection for Iraq to 9.1%--down a full percentage point from earlier projections of 10.1%. It also reduced its 2014 estimate from 10.2% to 9.3%. In 2012, Iraq managed to spark a revival of its oil output and see 8.4% GDP growth, and this raised investor confidence despite the security situation. However, these sentiments are now being revised quickly.

Recommendation: Syrian Kurds managed to take the crossing without intervention by Iraqi military forces, but if they lose ground, Iraqi military forces will be brought in to prevent a spillover and this will have a major impact on the ongoing sectarian warfare inside Iraq at this time. Violence in Iraq has continued on its upward trend over the past two weeks, and we see no respite for this. What is keeping Iraq from completely disintegrating is the level of investment in the country, which rides on the fragile optimism of its massive oil resources. Indeed, the French also appear to be aggressively looking to increase investment in Iraq despite the worsening security situation. But one of the best barometers is banking, and Barclays recent downgrading of its estimates for Iraq speaks volumes about the security situation.