April 3, 2003
What war and its aftermath may mean for Iraq’s creditors
DESPITE the murder of Zoran Djindjic, prime minister of Serbia, on March 12th, the secondary-market price of defaulted Yugoslavian government debt has remained buoyant, at 50 cents on the dollar. Speculative buyers of the debt, mostly loans already restructured in 1998, are gambling that the Serbian government will ultimately pay them more—pending, among other complications, the resolution of a dispute between the creditors’ agent bank, J.P. Morgan Chase, and the National Bank of Yugoslavia. Their appetite has increased considerably since 1999, when the debt fetched only five cents on the dollar.
Will speculators one day show the same relish for Iraq’s loans? Already, traders say, the secondary-market price of two big Iraqi loans has doubled, to around 19 cents on the dollar. Some believe that Iraq is a safer long-term bet than Serbia, because it has oil and is not (yet) hostage to a business mafia. This week a Serbian bankruptcy court sold a steel mill for $23m, ignoring the $1.7 billion the mill had borrowed from some now furious western governments and companies.
All depends on how long the war in Iraq lasts—and on how a future government deals with its legacy of debt. There is $116 billion of official and commercial debt, plus some $200 billion of reparation claims following Iraq’s invasion of Kuwait in 1990 and the first Gulf war. Even for a country that might earn $25 billion a year from oil, it is an impossible burden.
The market view is that Iraq will negotiate the write-off of between 70% and 90% of the $116 billion. Traders also guess that the United Nations Compensation Commission (UNCC), which is handling unpaid reparation claims, will cut these to perhaps $40 billion. So Iraq’s existing obligations could be reduced to between, say, $50 billion and $75 billion.
Who gets repaid, and how much, depends on which creditors a new Iraqi government would need most to help rebuild its economy. The creditors fall into three groups: the IMF and World Bank; governments that provided trade credits and bilateral loans; and private banks and companies (see chart 2). Iraq owes only $1.1 billion to the first group. Assuming they can be kept happy, the chances of other creditors depend on whether America sets up an officially funded reconstruction programme like the Marshall Plan for western Europe after the second world war, or whether Iraq has to rely mainly on private funding. If the first, it will have to repay its official creditors, known as the Paris Club. If the second, it might follow Nigeria’s example, repaying private creditors and ignoring official debt.
Above all, bankers argue, to return to the international capital markets, Iraq will have to show that it is at least willing to pay something towards its properly documented obligations. That would not include bills for sanctions-busting arms shipments, for example. But it would include bank loans, especially two big ones totalling $1 billion, syndicated in the 1980s, which have become a benchmark for Iraq’s future creditworthiness. Although the price is only 19 cents on the dollar, a final repayment, including back interest, of up to 75 cents on the dollar is conceivable.
So far, there are few buyers—perhaps one or two a week—although the number of inquiries has soared lately, says Peter Bartlett of Exotix, an emerging-market-debt trading house. American entities are forbidden to trade. The buyers are mostly banks or a handful of funds that specialise in the debt of “pariah” states. Other Iraqi loans are traded too, such as letters of credit and other paper from the central bank, and two other banks, Rafidain Bank and Rashid Bank.
Trading, or even holding, Iraqi paper is loaded with traps. Its validity can expire every few years, according to the statute of limitations in various jurisdictions. Renewing it requires some acknowledgment from the borrower, and that was difficult even before the war. Assigning the debt from buyer to seller requires the borrower’s assent, and the Iraqi banks have been unco-operative since 1988. The trick is to apply during public holidays, or when communications are down (as they are now), because the borrower’s failure to respond within ten working days can be taken as agreement.
An alternative is to buy a sub-participation in a loan, but then the buyer takes on the credit risk of the intermediary as well. “All right if it’s Deutsche Bank,” says one investor, “but not so good if it’s a bank in Japan or the Middle East.” Prices are adjusted accordingly. There are long chains of sub-participations, compounding the risk of an already risky investment.
The complexity of Iraqi debt may not match that of Serbia, which is fraught with debt swaps between former Yugoslav republics and commercial debts that were turned into bilateral official lending. Still, it is complicated enough. The UNCC is working through reparation claims, but many of the biggest may take years to resolve. Omni Whittington, a Dutch firm that specialises in debt recovery from pariah states, is sceptical that prospects in Iraq will improve, even after the regime has been changed.
However, some commercial creditors have been able to unfreeze Iraqi assets abroad, except in America, and receive payment, as long as they demonstrate that the proceeds will not return to Iraq. Iraq’s economy is centralised and reasonably simple. If the oilfields survive without heavy damage, there will be access to export earnings. The economy is almost bound to grow, albeit from a low base. That should encourage the purchase of speculative assets while they are still cheap. Vietnam may offer a better parallel than Serbia. In 1989, one pariah fund bought Vietnamese debt at four cents on the dollar. In 1995, it sold at 80 cents. That is not a bad return for a recovery that some thought inevitable.