Iraq's Odious Debts

Iraq’s debt solution ruffles feathers

Joanna Chung
Financial Times
December 21, 2005

Pressure has been mounting to swiftly resolve a debt burden of about $120bn that was accumulated during the Saddam Hussein era.

It is seen by the Iraqi government as a significant step towards economic rehabilitation and central to the war-torn country being able to conduct international business.

But some of the large commercial creditors owed a sizeable portion of the debt say they are being treated unfairly and are getting a worse deal than government lenders.

Today, their responses to Iraq’s offer for settling the majority of the roughly $20bn of commercial claims could help determine whether Iraq’s strategy for wiping clean its financial slate has worked.

Iraq launched the offer to the larger private creditors last month, giving them a choice of exchanging the debt owed to them for either bonds or loans. The offer, orchestrated by US banks JPMorgan and Citigroup, follows the completion of cash buyback deals with smaller commercial private creditors. It comes a year after the Paris Club of leading creditor nations decided, in a politically charged deal, to write off 80 per cent of about $39bn owed to them.

The deal is to be done in three phases over 23 years, along with the implementation of an International Monetary Fund economic programme. Iraq is also negotiating debt reduction agreements with other government lenders, including the Gulf states.

Ali A. Allawi, Iraq’s minister of finance, called the debt exchange offer last month “a major milestone”. Iraq, he said, was “demonstrating its commitment to treating all creditors in a fair, transparent and even-handed way”.

But those on the receiving end of this offer say that is far from the case. Save for one meeting in Dubai in May, there have been no two-way negotiations, they claim. One person close to the so-called London Club, which represents many of the main banks, says Iraq has pursued a take-it-or-leave-it approach that is “unilateral” and “coercive”.

Another individual who is working with Hyundai, the South Korean car company owed more than $1bn by Iraq, said: “Iraq has not followed any principled process.” Among the most contentious issues for private creditors is the treatment of past due interest.

The interest is being calculated according to a Libor-based uniform accrual rate, not on the basis of the original contractual provisions of the claims. “The debt write-off for the private sector is well in excess of what was announced jointly by Iraq and the Paris Club,” said Richard Segal, chief strategist at Argo Capital, the hedge fund.

“When it’s all over, the private sector will receive half the 20 per cent net present value proclaimed by the Paris Club.”

One of the reasons that the restructuring process is moving so quickly is that commercial creditors lack leverage. A 2003 United Nations resolution prevents creditors from resolving their debt claims through litigation or attempting to attach liens on Iraq’s energy resources until 2007.

Also, the Paris Club agreement is being strictly used as the template for negotiations with all other creditors. According to a copy of the November Paris Club agreement obtained by the Financial Times, Iraq cannot give to non-Paris Club nations, commercial banks or suppliers, treatment more favourable than that accorded to the Participating Creditor Countries.

The document goes on to say: “If the Participating Creditor Countries determine that these conditions are not substantially fulfilled, the provisions of the present Agreed Minutes will become null and void. If the Government of the Republic of Iraq has not met its payments obligations under this Agreed Minutes, the Participating Creditor Countries may decide to suspend the present Agreed Minutes.” But some private creditors argue that the assumptions that went into the Paris Club deal were flawed.

They were based on IMF debt sustainability calculations that assumed a price of $26 for a barrel of oil. Oil prices are hovering just below $60.

Moreover, while Paris Club lenders have not changed, commercial debt has changed hands over the years.

Indeed, Iraq’s commercial debt encompasses a complex array of instruments. They include bank loans, defaulted letters of credit, suppliers’ credits, unpaid amounts under construction contracts and foreign workers’ remittances.

The claimants range from banks and companies to hedge funds and even individual creditors.

They are spread across 50 countries.

Peter Bartlett, managing director of Exotix, the London broker that trades in Iraqi paper, said: “The speed of the process may risk excluding some significant Iraqi debt holders from the restructuring process because they simply have not received or seen the exchange offer and so have not reviewed their options.”

He added: “There are a lot of people who want to see a more open and consensual settlement, but due to the tight timetable and pressures for a quick and clean exchange deal that has not been part of the equation this time around.”

Lee Buchheit, partner at Cleary Gottlieb, the law firm advising the Iraqi government, said: “It is simply not possible to negotiate separate deals with each creditor or even each creditor group. Every creditor has an argument for why it, above all others, should receive a better deal.

“But it is lethal to start down the road of giving preferential treatment to individual creditors or groups of creditors.”

Disgruntled creditors might still accept Iraq’s offer by today for lack of other options. Sources close to Iraq’s advisers say they expect a significant participation rate.

Some creditors, however, say the government is alienating the very financiers and suppliers they need. “They are killing their best friends,” said one.

“The mismanagement of existing creditors will jeopardise the reconstruction of Iraq.”

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