Iraq takes another step toward conquering debt

As part of an ongoing restructuring of foreign debt left over from the Saddam Hussein era, Iraq late last year agreed with its commercial creditors on a swap of old debts for new Iraqi bonds. Once the new bonds officially start trading on world markets, investors will get a chance to vote with their wallets on the country's future.

"This is just yet another step on the road to Iraq's normalization with the global financial community. We see this as solid forward progress," says Timothy Adams, the Treasury department's undersecretary for international affairs.

The milestone follows approval last month of the country's first International Monetary Fund credit line, a $685 million package designed to support economic reforms for the next 15 months, and its first World Bank loan in 30 years.

Restructuring Iraq's debt is critical for the U.S.-led effort to revive an economy crippled by a generation of dictatorship, war and economic sanctions. Even as the anti-U.S. insurgency continues, the move is symbolically important in freeing Iraqis from paying the bill for Saddam's opulent palaces and military adventurism.

"It's been a long time coming. It certainly is a landmark," says Richard Segal of Argo Capital Management, a London hedge fund that invests in emerging-market bonds.

In 2004, Iraq was one of the most heavily indebted countries in the world. Its $114 billion external debt was almost 41/2 times total annual economic output, according to the IMF. Today, the figure has been shaved to $51.2 billion, still about 11/2 times the size of the economy.

If a further planned restructuring is achieved in 2008, Iraq's obligations would fall to less than $30 billion, or about half the country's anticipated gross domestic product that year.

With annual oil export revenue of more than $25 billion, Iraq could easily handle debt service payments this year of $300 million.

The debt-for-debt exchange that closes Monday involves about $13.6 billion in private claims. Most of the commercial debt was held by corporations in Europe, Asia and Latin America, according to Anna Gelpern, a Rutgers University-Newark law professor who briefly advised creditors.

Iraq's private creditors, including firms such as JPMorgan Chase and Hyundai, are to receive dollar-denominated notes maturing in 2028 equal to 20% of what they were owed. That may not sound like much of a deal, but it was an improvement over what they had been getting for years: nothing. "They didn't have much of a choice. It was very much dictated," said Mike Noone, director of sovereign research for London-based Exotix.

The 20% figure also is in line with the amount Iraq's government lenders agreed to accept in a November 2004 Paris Club agreement. In the first part of Iraq's debt restructuring, the 19-member lenders group, including the U.S., Europe, Japan and Russia, agreed to forgive 80% of the roughly $37.2 billion in government-to-government debt Iraq owed.

The U.S. went further, wiping from its books the entire $4 billion it was due. Since then, it's leaned on other governments to follow suit. On Jan. 10, President Bush praised tiny Slovakia and Malta for forgiving the relatively small amounts they were owed.

"More nations should do the same so the Iraq people are not held back by the crushing burden of debt accumulated by Saddam Hussein," Bush said.

Iraq's neighbors, who hold the largest unresolved claims, have been slowest to act. Saudi Arabia, Kuwait and other Persian Gulf states have yet to restructure their Saddam-era loans and are negotiating aggressively with Iraqi officials over terms of any deal. "That's still very opaque. It could take one or two years before we have that play itself out," Noone says.

Meanwhile, the new Iraqi securities are drawing interest from institutional investors and mutual funds in Europe, the Middle East and the USA. In preliminary trading in the so-called gray market, bondholders are demanding a yield about 5.4 percentage points higher than on ultrasafe U.S. Treasuries, says Adams.

That means investors regard the Iraqi debt as less risky than that of Ecuador, which has been racked by economic crises, coups and turmoil for several years. U.S. officials also are cheered by the stability of the Iraqi dinar and the IMF's forecast that the economy will expand 10.4% this year after a modest 2.6% uptick in 2005.

Still, pervasive violence is a drag on development. Inflation the first 11 months of last year was 28.5%, according to the IMF. And annual per capita income of about $1,000 is only one-quarter of the level Iraq enjoyed in the early 1980s, when it boasted one of the Arab world's most vibrant middle classes.