Iraq's Odious Debts

Gambling On Iraq’s reconstruction

Chana R. Schoenberger
April 4, 2003

New York: Every vanquished Iraqi Republican Guard division is a hopeful sign for investors who have bought up Iraqi debt. Their best chance for getting their money back is a new regime in Iraq, preferably one that needs to borrow money from international banks and must first drum up credibility by paying off the country’s old debts.

The exact amount of Iraq’s outstanding government loans isn’t known, but it’s estimated that the country owes $120 billion. The debt that’s traded, about $2.6 billion worth, consists of syndicated loans, including principal and accrued unpaid interest. Iraq borrowed the money during its costly war with Iran in the 1980s. An international banking syndicate – including Chase Manhattan, now J.P. Morgan Chase; Irving Trust, now Bank of New York; BNP, now BNP Paribas; and a cohort of Middle Eastern banks – lent $500 million to Iraq in 1983. The original lenders have mainly written off the debts.

The syndicated loans, which were guaranteed by the government, are now trading at around 18 cents to 20 cents on the dollar. That’s more than twice what the loans fetched between 1997 and 2000, when debt holders thought they’d never see their principal again. And though the loans are thinly traded, there can be activity: A White House decree in late March that confiscated all Iraqi official accounts in the U.S. sparked fears that money that could be used to repay the old loans would instead be earmarked for postwar reconstruction projects.

“Buying these bonds today is a vote of confidence that the uncertainty over whether they’ll be restructured has declined significantly,” says Richard Segal, director of research at London-based Exotix, an intermediary for emerging-markets assets. Segal expects the bonds to jump 2 cents to 4 cents when the war ends.

The debt started to default in 1988, when Iraq’s liabilities piled up. Since its invasion of Kuwait in 1990, which triggered the first Gulf War, Baghdad hasn’t been making principal or interest payments. The U.N. embargo and Saddam Hussein’s military buildup have impoverished Iraq. When Hussein signed for the loans in the 1980s, Iraq’s gross domestic product measured about $65 billion, compared with $30 billion today.

Under U.N. sanctions dating to 1990 and U.S. rules, it’s illegal for American companies to do business in Iraq. But foreign firms can hold Iraqi sovereign debt, because it’s considered a liability, not an asset of Hussein’s government. Today’s holders include a handful of hedge funds, exotic-debt funds, offshore banks and debt collection agencies. The loans trade over the counter, in private.

Because of the considerable risk, mainstream funds don’t dabble in this debt. Of the funds tracked by Fund Research, which represent 85% of the assets held in international and emerging-markets funds worldwide, not one has invested in Iraqi sovereign debt, says fund research managing director Brad Durham.

To hold these loans is to place a bet that a future Iraqi government will pay them off. Investors cite a handful of other troubled nations that restructured their debts in recent years, including Russia and Argentina. Depending on the type of debt restructuring, debt holders could get anywhere from 50% to none of the loan’s value back. Iraq could also pay off its creditors with noncash benefits, such as ownership stakes in Iraqi land or state-owned enterprises. Or debt holders could win oil development rights or the ability to bid in privatization auctions.

The scariest possibility, for debt buyers, is that Iraq will be able to borrow new money without paying off its old debts. In that case, anyone holding the old loans will be wiped out. The country could accomplish this by liquidating the entities that borrowed the money, like the Central Bank of Iraq, and reconstituting them as new agencies.

Stiffing the holders of the original loans won’t do much for Iraq’s reputation internationally, but it may not impede Baghdad’s ability to get new loans, says Didier de Baere of East-West Debt, an Antwerp-based debt collection firm that holds some Iraqi loan paper. “Iraq has one incredible asset: oil,” says de Baere. “There will be a number of banks that will be very happy to do business with them.”

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