The correct answer is option 2 - Iraq.

Karbala is the holy city of Shia Muslims and it is located in Iraq. It holds great religious significance as it is the site of the Battle of Karbala in 680 AD, where Imam Hussain, the grandson of the Prophet Muhammad, was martyred. Every year, millions of Shia Muslims from around the world travel to Karbala to commemorate the martyrdom and participate in mourning rituals and processions. The city is home to the mausoleums of Imam Hussain and Abbas ibn Ali, which are important pilgrimage sites for Shia Muslims. It is worth noting that while there are other important holy cities for Shia Muslims, such as Najaf and Mashhad, Karbala holds a unique place in Shia religious and cultural heritage.