A. V. Rajwade
Business Standard, India
June 2, 2003

My last column titled “Sovereign debt restructuring” (May 26) ended as follows: “Whatever the sanctity of the rights of creditors, they cannot overcome the laws of mathematics — only current account surpluses will repay debt.

For a deficit country, such surpluses can come only through lower domestic consumption and investment and there are obvious political limits to the amount that can be squeezed.”

An interesting and live case, which is also unique in some ways, is that of Iraq’s external obligations:

The US and its faithful ally, the United Kingdom, are in occupation of the country and will have no difficulty in “seizing collateral” or “controlling the finances” as advocated by Shleifer (see World Money, May 26, 2003). Indeed, the United Nations security council has given the occupying powers control over oil funds;

Iraq also has the world’s second largest reserves of oil and can expect to earn between $ 20 billion and $ 25 billion a month from oil exports in the course of time.

Iraq can therefore be a good test case for the application of the doctrine of creditor rights.

However, there are a few minor problems. The country’s external debt is estimated at a little over $ 100 billion, the two largest creditor-nations being Russia and France. (Did this influence their opposition to the US invasion of Iraq, though both countries are imperialists of considerable standing?)

Besides, there are reparation obligations of the order of $ 200 billion or so, arising from the 1990 occupation of Kuwait and the first Gulf War (5 per cent of oil revenues, say $ 1 billion a year, are to be set aside for these).

Again, President Bush has repeatedly averred that the oil wealth will be used for the benefit of the Iraqi people: preliminary estimates of the amount needed for reconstruction are of the order of $ 100 billion.

In other words, one is talking of claims of the order of $ 400 billion on oil exports of say $ 25 billion a year, less the cost of essential imports like food and medicines.

Whatever the sanctity of the various claims, it is obvious that Iraq’s resources will be nowhere near meeting all of them — even a permanent occupation of the country will not lead to their being satisfied.

The US has called upon France and Russia to cancel their debts in order to help the people of Iraq — it is purely incidental, of course, that the US itself has very little outstanding debt and, therefore, can easily afford to take, for once, a moralistic stance on the subject.

(Incidentally, the price of Iraqi debt has doubled in the secondary market since the end of the war, to around 20 cents to a dollar).

There is another interesting twist to the issue of Iraq’s debt. How far are the people of Iraq responsible for repaying its so-called “odious” debt, contracted by the regime of the erstwhile dictator? In short, the totality of the problem would surely test the sense of justice of a Solomon, as well as the wizardry of the best financial brains in the world. Mouthing the “creditor rights” mantra will lead nowhere.

Argentina’s external debt: The other major debt case is that of Argentina. At the end of 2001, Argentina was forced to abandon its currency board system and declared the world’s largest-ever default — $100 billion in external debts.

For the last 18 months, it has not been able to reach an agreement with the International Monetary Fund (IMF). Meanwhile, gross domestic product (GDP) fell by 12 per cent last year and 60 per cent of its people are now below the poverty line of $ 2 per day, double the percentage before the default. Unemployment is as high as 25 per cent.

Almost miraculously however, even as the financial economy remains in a state of total chaos, the real economy has started improving. Inflation is in single digits, and GDP is expected to grow by 4 per cent per year for the rest of the year.

Argentina could register a surplus on current account of the order of $ 9 billion to $10 billion (thanks partly to the cheaper peso and, partly, to very low investments) before factoring in the interest on existing debt which, in any case, is not being paid. The exchange rate has stabilised at around peso 2.8 to a dollar.

In the financial economy, however, two major issues remain. First, the question of restructuring the existing debt — negotiations for the purpose have not even begun. In the domestic financial sector, there is a yawning mismatch between the assets and liabilities of the banking system.

It may be recalled (see World Money, April 29, 2002) that, in the wake of the crisis, the government froze all deposits, simultaneously decreeing the conversion of dollar debts owed to banks into pesos at the erstwhile parity exchange rate.

It simultaneously ordered the conversion of dollar deposits with the banks into pesos at the rate of 1.4 pesos to a dollar! Recently, the Supreme Court has ruled that the latter conversion was illegal and ordered banks to repay dollar deposits at the going exchange rate.

Since the banking system had a significant proportion of its assets and liabilities in US dollars under the old currency board system, the gap between the banking system’s assets and liabilities can well be imagined.

By any yardstick, the banking system is bankrupt. The new president sworn in last week will clearly have his hands full.