David Mulford and Michael Monderer
The Financial Times, U.K
June 22, 2003

A new conflict has begun among western nations over Iraq’s future, this time over its foreign debt, estimated at more than $100bn. Like the pre-invasion skirmishes, the battle lines reflect divisions between France, Germany and Russia, and the US.

Senior US officials initially called for debt forgiveness in the light of Saddam Hussein’s evil regime. More recently they have backed off, employing the term “debt relief,” which covers anything from short-term deferral to forgiveness. US Treasury officials have also agreed that Iraq’s debt should be handled in the Paris Club of creditor nations. Germany, however, has made clear that this means rescheduling only – a position probably shared by France and Russia.

The US should resume its original position on forgiveness but for a different reason: assisting Iraq’s recovery. And the Paris Club should not be the forum for negotiations. Anything less would compound the tragedy suffered by the Iraqi people during decades of Ba’athist oppression.

There is ample precedent for successor states being responsible for the debts of predecessors. Russia and the former Yugoslav republics accepted the debt of their predecessor governments. Vietnam agreed to repay economic debt owed to the US by South Vietnam. Without the principle of state continuity, default would become commonplace. Nevertheless, compelling economic and financial reasons exist for creditors to forgive Iraq’s debt, estimated at more than $100bn, not including some $200bn due in 1991 Gulf war reparations.

Iraq is a world-class debtor on a par with Argentina but its gross domestic product – estimated at $32bn in 2000 – is an eighth of Argentina’s. Even assuming a resumption of oil exports at 2m barrels a day, Iraq’s debt/export ratio would exceed 700 per cent, the highest in the world. Clearly, Iraq cannot rebuild its economy, establish conditions for growth and development and simultaneously service all its outstanding debt.

France, Germany and Russia believe that Iraq’s debt should be rescheduled without write-offs or forgiveness and with interest continuing to accrue and compound. Those countries – the most vociferous opponents of the war – have the most to gain by conventional Paris Club treatment. In a process controlled by France, and despite a call by finance ministers from the Group of Seven for a new approach, Paris Club methodology is biased against debt write-offs for middle-income countries and oil exporters, even those that are obviously insolvent. It uses often inaccurate economic projections and assumes that all export receipts and capital inflows accrue to the government and that funds not used for imports can be used to repay debt.

When the US wrote off Egyptian military credits in 1991 and sought similar action from European Paris Club members none would initially admit to being owed military debt, since their military sales were financed by commercial credits.

Then there is the question of how borrowed funds were used. Loans that financed internal repression, weapons and military adventurism should not be made whole at the cost of US and British blood spilt to liberate Iraq. In 1997, as a precondition for Russia’s joining the Paris Club, it was forced to write off Soviet military loans before including other debt in Paris Club restructurings. Iraq’s creditors should do the same.

Last, many Iraqi creditors – including Saudi Arabia, Jordan, Kuwait, Morocco, the Gulf States, Turkey, Bulgaria – are not members of the Paris Club and are owed more than half the debt. They should not be forced to accept a solution made in Paris.

There is a better approach to Iraq’s debt burden. First, there should be a three-year moratorium on Iraqi debt payments without interest accruing. Second, an international Iraqi debt commission of financial “wise men” should be established to examine all claims and to disallow debt used for state security or military aggression. Only loans for verifiable economic purposes should be collectable.

Third, the commission should chair negotiations to restructure the remaining legitimate debt with a substantial reduction in present value through a partial write-off or extended rescheduling. The commission should be empowered to force unco-operative creditors to accept an agreement consistent with Iraq’s reconstruction and development needs.

Fourth, there should be a debt/equity swap programme to encourage private investment in Iraq and give companies a role in the rebuilding. Claims could be sold to investors at deep discounts and redeemed into private sector investments or privatisations.

There are precedents for giving Iraq special treatment, including the debt agreements with Germany in 1953 and Indonesia in 1970, debt forgiveness for Poland and Egypt in 1991 and the treatment of Yugoslav debt owed by Bosnia-Herzegovina and Serbia-Montenegro. Such a plan for Iraq, implemented without delay, would not hinder political and economic recovery and would help a stable Iraq to join the international economy.

David Mulford is international chairman of Credit Suisse First Boston and a former undersecretary at the US Treasury. Michael Monderer is a consultant on sovereign debt and a former director of the US Treasury Office of International Debt Policy