James Sterngold
San Francisco Chronicle
May 23, 2004

As the debate intensifies over what kind of government will take over Iraq on June 30, one certainty is that the new leadership will have to manage one of the most destabilizing legacies of Saddam Hussein’s rule – a crushing debt burden.

To equip and run his immense armies for Iraq’s war against Iran during the 1980s and the Persian Gulf War of 1991, Hussein transformed what had been one of the wealthiest Middle Eastern oil states into one of the poorest and most heavily indebted nations on Earth.

Numerous countries, including the United States, Russia, France and Saudi Arabia, had eagerly supplied Hussein with billions of dollars in loans, which Iraq then stopped repaying more than a decade ago as its economy all but collapsed.

The Bush administration’s war has removed the old dictator, but not his debts.

Iraq is thus burdened with an estimated $120 billion it owes. The enormous load, 900 percent the size of the national economy, dwarfs the approximately $33 billion the international community has so far committed to Iraq’s reconstruction. The infrastructure is in ruins and the country is almost completely dependent on one industry, oil, according to the International Monetary Fund, which is leading the effort to analyze Iraq’s economic prospects.

“People realize that although Iraq has very large oil resources, its capacity to produce oil just isn’t sufficient to pay for both reconstruction and debt servicing,” Lorenzo Perez, the head of the IMF’s Iraq team, said in a recent IMF publication.

And the debt is separate from an additional $125 billion or so of reparation claims – mainly from Kuwait and Saudi Arabia – from the Gulf War.

Any new Iraqi government will be saddled with a battered economy and unhappy creditors. Iraq’s long-term survival, experts and international financial officials say, will depend on what would be one of the largest – and possibly one of the most contentious – debt forgiveness programs in history.

James Wolfensohn, president of the World Bank, which has been organizing the extensive aid required for reconstruction, has also warned that without a huge debt forgiveness program, the new government may be looking at a financial black hole.

“Frankly, it’s hard to see how the new Iraq can be solvent without this,” said Allen Keiswetter, a scholar at the Middle East Institute in Washington and a former senior State Department official for Middle Eastern affairs during the Clinton administration.

Making matters worse, the task of reducing the debt load depends on the Bush administration’s success in extracting concessions from countries that it has angered over the war, notably Russia, France and Saudi Arabia, among others. They have hinted at offering substantial concessions, but that may depend on obtaining from the United States more of a say on Iraq’s reconstruction and more contracts for their nations’ companies.

“This is really like a Houdini act or something,” said Fredrick Barton, co-director of the Post-Conflict Reconstruction Project at the Center for Security and International Studies, a Washington research institute. “You have to pull out the tablecloth without breaking any of the china.”

He said Iraq’s creditors cannot just delay repayment or stretch it out over many years, the traditional approach, but instead must forgive an unprecedented portion of the debt. He said the largest previous debt forgiveness program involved the former Yugoslavia after its division, when creditors agreed to slash 66 percent of what was owed. Iraq needs an even larger reduction if it is ever to prosper.

And, Barton said, creditors must also create conditions that allow Iraq’s new government to begin borrowing. Not having that ability, he said, could create a crisis for the post-June 30 government.

“I think this could be a time bomb,” Barton said. “There are people who could move these issues forward, but a lot of people aren’t really ready yet to look at this in a fresh way.”

Late last year, President Bush appointed James Baker, a former secretary of state and secretary of the Treasury, as his special envoy on the debt issue. Baker traveled to Europe, Asia and the Middle East to confer with Iraq’s major creditors, but came home without firm commitments.

Creditors merely promised that, once Iraq has a functioning, sovereign government, they would enter negotiations in good faith on forgiving some of the debt and stretching out repayment of the remaining sum.

Oil wealth helps

Experts say that was probably the best that could have been expected. And, they say, there are two factors in Iraq’s favor: Its great potential for oil exports is likely to encourage even the most reluctant creditor to come to terms eventually, and high current oil prices have increased Iraq’s export earnings, despite periodic sabotage by insurgents.

“The Arab countries were a little vague,” said one State Department official knowledgeable about the talks. “We can say the responses were generally positive, headed in the direction of substantial debt reduction.”

Asked how specific the talks had been, the official acknowledged, “We don’t have a number yet.”

Adnan Pachachi, a member of the Iraqi Governing Council who is regarded by some as a potential future president, has pushed for a quick resolution of the debt problem out of concern that the country will receive less favorable terms from its creditors as it recovers from its current woes.

“If the economic situation improves, then (creditors) will be inclined to ask more of us,” he told the Financial Times late last week. “So the next government will try its luck at the debt issue.”

The attitude of Saudi Arabia – which is owed more than $20 billion of principal and interest, making it Iraq’s largest creditor – is illustrative. The Saudis are in no rush to negotiate, wanting first to see a stable government and an end to the insurgency that has racked the country. Such uncertainties could slow the flow of fresh capital into Iraq.

“This is something we will discuss with the legitimate Iraqi government,” said Nail Al-Jubeir, the spokesman for the Saudi Embassy in Washington. “We refuse to get into a debate until there is a legitimate Iraqi government.”

But he said any discussion of reducing the official loans is separate from war reparation claims, which the Saudi government will not seek to reduce, meaning that the new Iraqi government will still have to contend with billions of dollars of such claims.

“We cannot waive that right” of private parties to file reparations claims, Al-Jubeir said.

Gulf War reparations

Iraq currently owes $29 billion in war reparations – payable from oil revenues – that have been approved by a special international court established by the United Nations after the end of the Gulf War. There are an additional $96 billion in claims waiting to be adjudicated by the court.

Another critical question is what the major creditor countries will want in return for forgiving billions of dollars in debt.

Last December, Russian President Vladimir Putin told members of Iraq’s Governing Council that Russia was ready to write off more than half of Baghdad’s $8 billion total debt to Moscow in return for Russian companies receiving access to Iraqi reconstruction contracts, and, particularly, favorable treatment for Russian oil companies.

The Russian media then cited unnamed government sources as saying the Kremlin might write off up to $4.5 billion of Baghdad’s debt.

France, Russia, Germany and other members of what is known as the Paris Club – an informal grouping of 19 industrialized countries that manages international debt crises – also responded to Baker’s visit by promising substantial concessions once there is a functioning government in Baghdad.

However, some Eastern European countries that had lent heavily to Iraq have been more explicit in demanding reconstruction contracts in return or better debt terms, an official at the Paris Club said.

Keiswetter of the Middle East Institute said some countries may reduce their debt in return for not having to send troops to Iraq or providing other kinds of reconstruction aid.

Of Iraq’s debt, about $21 billion in principal and a similar amount in interest is owed to the wealthy Paris Club countries. About $60 billion to $65 billion is owed to other countries, largely Middle Eastern states, and an additional $15 billion is owed to private commercial lenders, according to the IMF. The United States is owed $2.4 billion in principal and an additional $2 billion or so in interest.

Another critical step in the debt-reduction process is the completion of a major study of Iraq’s economy and financial situation being prepared by the IMF. It is expected in a few weeks, but there is no deadline, officials said.

Clearly, though, the signs are grim.

Disastrous drop in GNP

Despite its oil resources and great potential, Iraq’s per-capita gross domestic product, a basic measure of wealth, has plummeted from about $3,600 in the early 1980s to $566 this year, according to the IMF.

The economy shrank 22 percent in 2003 and 21 percent in 2002. The Iraqi government, under the American occupation, is expected to run an $8.5 billion deficit this year, or more than 50 percent the size of the national economy, the IMF says.

A conference of international donors in Madrid in October garnered pledges for about $32 billion to $36 billion in aid for Iraqi reconstruction, of which $22 billion came in the form of grants and the rest in loans. As much as $8 billion of the total could come from the IMF and World Bank.

Judith Kipper, director of the Middle East Forum at the Council on Foreign Relations, said that Iraq security issues will be far more important than financial concerns for some time, but that when the economic problems come up for debate, they could prove thorny as the new Iraqi government seeks to establish its own financial priorities.

If the government finds its hands tied by its creditors, that could be a new source of friction.

“The real question is, who’s going to decide how the money will be spent and on what,” said Kipper. “It can’t be only the Americans, and the Europeans will want to make sure of that.”

Hussein’s huge debt

Amounts Iraq owes to major industrialized countries, in millions of dollars: The Paris Club, a group of creditor nations, is owed more than $21 billion, excluding interest, incurred by the regime of Saddam Hussein. Iraq owes additional debts to Middle East and Eastern European nations, and to private commercial lenders.

$30.8               Denmark
$54.7               South Korea*
$96.7               Netherlands
$117.5             Switzerland
$152.2             Finland
$184.5             Belgium
$185.8             Sweden
$192.9             Brazil*
$321.2             Spain
$499.3             Australia
$564.2             Canada
$813.1             Austria
$930.8             United Kingdom
$1,726             Italy
$2,192             United States
$2,403.9          Germany
$2,993.7          France
$3,450             Russia**
$4,108.9          Japan
$21,017.9        Total

*These creditors have been invited by Paris Club permanent members to join their discussions on Iraq.

**Russia says this figure represents the amounts due after adjustment on Soviet era claims.

Source: Paris Club.