Iraq's Odious Debts

Compelling case for debt relief

Salil Tripathi

April 29, 2003

In 1979, when Saddam Hussein came to power in Iraq, the country had foreign exchange reserves of about $35 billion. By the end of the Iran-Iraq war, it had a foreign debt of about $50 billion. Today, its debt estimates range from $100 billion to a staggering $383 billion, according to some calculations. This includes the money Iraq owes international financial institutions, bilateral loans from countries like Russia and France, short-term commercial loans, and war reparations.

As Iraq’s exports are overwhelmingly composed of oil, which could account for between $14-18 billion a year, it is clear that the country simply does not have sufficient money to service its debt in a meaningful manner. Its gross domestic product is about $30 billion. The ratio of Iraq’s debt repayment as a proportion of its exports far exceeds 3:1, which is considered exceptionally burdensome particularly for poor countries.

As Iraq’s per capita income has collapsed, inflation is likely to follow. To stabilise the economy, the United States has airlifted millions of dollars in $1 and $5 bills to Iraq, and begun paying Iraq’s civil services with salaries of $20 a month, in the hope that a stable currency like the US dollar may calm hyperinflationary pressures.

Many economists and historians now agree that John Maynard Keynes, the British economist, was right when he called on the victorious powers to be generous with the defeated Germany at the end of World War I. Iraq will need more than charity. It will need real debt relief, instantly. It simply does not have the means to service its international debt. And burdening Iraq with a load it cannot service, will not create conditions for a stable, peaceful Iraq in future.

It is true that nations don’t go bust, only companies do. Walter Wriston, who once headed Citibank, had said this in the context of banks lending vast amounts of money to certain countries, even though those countries showed little prospect of being able to repay those debts. Wriston’s logic was impeccable. Companies are different from countries. Companies go bankrupt; countries, technically, never do. When things go really bad for a country, its leadership goes to the International Monetary Fund.

After a week, or less, of intense haggling, the country agrees to initiate gut-wrenching changes by putting in place structural adjustment programmes in return of fresh lending from the IMF. Its government may change (as in Indonesia and Argentina), but the show goes on. Old debt is renegotiated, old lenders are paid off, though at a slower speed, and it is business as usual. With companies, it is different. It may cease to function altogether.

More important, lenders may not receive the money they had lent to the company. This axiom is based on the international custom, that loans are made to states, not regimes. This is why, when Nelson Mandela took over as the president of South Africa, he agreed to abide by apartheid-era debts. Chile, too, honoured its commitments after the departure of the Pinochet regime. Likewise, with the post-Somoza Nicaragua and post-Mobutu Zaire (now Democratic Republic of Congo).

International lenders are betting that the same custom will prevail in the Iraqi context. Saddam Hussein’s government may have gone, but the Iraqi State should honour debts contracted during Saddam’s rule. That will certainly be the case if custom prevails. But two emerging trends may force a different outcome. One is a concept being discussed even within the IMF: that countries can perhaps declare bankruptcy.

If a country’s debt burden is exceptionally high, is it possible for such a country to declare what Americans call Chapter XI bankruptcy, that is, to buy time from creditors while the country does some serious house-keeping and gets its books, and economy back in order? Another is the old concept of odious debt, made popular by the Tsarist finance minister Alexander Sack, who said that states should not be bound to repay odious debts run up by repressive regimes. His logic: a country is not responsible for debts incurred by a “despotic regime” and used for purposes “contrary to the interests of the nation”.

There is historic precedent: in 1898, at the end of the Spanish-American War which saw the liberation of Cuba from Spanish rule, Cubans repudiated the debt they owed to Spain. Cubans said that its people had had no say in the Spanish-colonial decision to borrow the money, and the colonial power had spent the money that harmed Cuba. The new Cuban republic successfully repudiated its debts. A century later, Russia stunned the world by declaring default. It happened at a precarious time, soon after the Asian economic crisis of 1997.

But heavens did not fall. Two Harvard economists, Michael Kremer and Seema Jayachandran, have proposed the creation of an international body that can be authorised to declare particular regimes “odious”. Given the current state of international trust and cooperation, that seems unlikely. But there is virtue in such an institution: it could persuade lenders that if they lend to “odious” governments, they might not get repaid.

Lending, after all, should include an element of risk. What economists call the moral hazard posed by the IMF acting as a lender of the last resort, would vanish. To be sure, some governments could try to misuse the defence under the odious debt doctrine and attempt to renege on their commitments. Every successor government clearly cannot repudiate debt contracted by its predecessor, however unpopular it may have been.

But Saddam’s Iraq may probably be the test case. The international donor community, which will presumably be meeting soon, will have to separate Iraq’s debt into productive and non-productive debt, desirable and socially irredeemable, commercial and bilateral or multilateral, short-term and long-term, and war reparations, for the Operation Desert Storm and the Iran-Iraq war. This does not mean all of Iraq’s public and private obligations of $383 billion should be repudiated. Iraq’s debt to international financial institutions should be honoured. Iraq should also honour its pre-Iran-Iraq war bilateral debt.

But commercial lenders do not fall under that category, for they are used to taking a hair cut; nor do lenders who have provided Iraq with resources to pursue its wars with Iran, Kuwait, and the most recent war. Poor countries have successfully renegotiated with the World Bank and the IMF, by getting debt relief in return of promising, and making, real changes in their development expenditure. Mozambique, for example, has invested in schools.

Other countries in Africa have invested in healthcare and roads. If Iraq’s debt is forgiven or repudiated, Iraq would not be breaking any international law; it would be violating an international custom. In evaluating the value of that custom, the international community will have to balance the importance of that custom with the prospect of Iraq remaining in perpetual debt. The new administration in Iraq, whenever it takes shape, should be able to negotiate a sensible plan with its creditors, even while retaining a substantial burden of debt. Cancelling debt Iraq owes for arming the previous government could be the logical first step.

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