A referendum on independence for Iraqi Kurdistan set for September 25 comes as the autonomous region faces the worst economic crisis in its short history.

Plunging government income, the challenge of fighting the Islamic State group and the cost of hosting hundreds of thousands of refugees have combined to punch a gaping hole in the Kurdistan Regional Government's budget.

"The KRG's coffers are empty and it's burdened with debts," Ruba Husari, an expert on Iraq's oil industry, told AFP.

The World Bank said in a recent report that the fiscal crisis and the security challenge posed by IS "have had a significant adverse impact on economic growth".

The region has benefitted from an influx of investment since the 2003 fall of dictator Saddam Hussein in a US-led invasion.

It won a measure of autonomy in the 2005 Iraqi constitution and has been seen as an island of stability in a country plunged into anarchy.

The drowsy regional capital Arbil was transformed as investors built towers, plush buildings, shopping malls and hotels to host foreign executives on business trips.

All that collapsed in 2014 as the price of oil plunged, IS jihadists seized a tranche of northern Iraq abutting the KRG and more than a million displaced Iraqis and Syrian refugees fled to the autonomous region.

That was compounded by Baghdad's decision to suspend payments to the KRG of 17 percent of Iraq's national budget.

The transfers, worth some $12 billion (10 billion euros), made up 80 percent of the region's budget revenues.

Wages, including those of peshmerga fighters, were slashed.

"The fiscal shock is severe," the World Bank said.

It said the regional government has dealt with the cut in revenues by borrowing money, postponing projects, and delaying payments -- including the salaries of government employees.

- 'Dire economic situation' -

The combination of crises slashed GDP growth from eight percent in 2013 to three percent in 2014, the World Bank said in 2015.

A senior KRG official said that by the end of that year, public servants' salaries had been cut by 60 percent.

For the past two months, the region's 1.2 million civil servants and retirees have not been paid at all, he told AFP.

Fathi al-Mudaress, an adviser to the KRG, said the crisis "stems from the fact that (the region) has made oil revenues its main source of income."

"Two years into the crisis, the autonomous region's government has adopted policies of austerity and income diversification, notably through tourism, agriculture and industry," he told AFP.

Kurdistan on average produces some 600,000 barrels a day, of which 550,000 are exported via Turkey.

That includes some 250,000 from the oil fields of disputed Kirkuk province, seized by Kurdish forces when IS took control of Iraq's second city Mosul.

The KRG sells oil through advance contracts, in effect taking out loans from firms including Swiss commodities giants Vitol and Glencore and repaying its debts with barrels of crude.

The KRG has used this system to borrow more than $3 billion in the past three years.

Recently it borrowed $1 billion from Russia's Rosneft to pay damages to European-Emirati consortium Pearl Petroleum, which is in a dispute with the regional government.

Rosneft will also be paid in barrels of oil.

But with oil prices still depressed, Kurdistan has been unable to pay investors developing its fields, and its debts are growing.

The World Bank warned in 2016 that "arrears in payments to oil companies and contractors create an uncertain business environment".

Husari said the crisis is much more severe than the Kurdistan government admits.

"The obvious 'yes' result of the referendum will not lead automatically to a declaration of an independent state but will open battles on several fronts," she said.

"For Barzani it's a leap forward to stay in power while diverting attention from the dire economic state of the region."

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