Iraq's bonds hint at postwar recovery

While the Iraq war continues to drain lives and resources, the political debate within the US has quietened, out of despair and exhaustion on the Democratic side and a dissipation of even empty expressions of optimism on the part of the administration and its supporters.

There has, though, been a rally in the price of Iraq's traded international debt. Since mid-August, the price of the 5.8 per cent Iraqi bonds of 2028 has risen from its all-time low of 55 to a level of about 60. That brings the yield to maturity down to a still high 10.7 per cent, a bit lower than Ecuador's. And that is on significant volume, particularly for an issue that is not rated by the ratings agencies. The most recent numbers for turnover of the 2028s are for the second quarter of this year, during which $779m (EU546m, £380m) changed hands through bond dealers. The bid/ask spread is about 1 point, which indicates that dealers do not have much inventory, but is considerably lower than Ecuador's 2 to 3 points per trade. According to Mr Market, Iraq is a lot safer than Ecuador.

Also, weirdly, Iraq's currency has been steadily gaining on the dollar, as the central bank manages an upward float on the billions flowing in from oil and American spending.

Since November 2004, when Iraq's creditors granted it relief of about 80 per cent of the net present value of its prewar debt, I have been optimistic about the long-term prospects for the country's bonds, even as the military, political, and especially humanitarian situation has worsened. Until 2011, cash debt service is minimal, about $160m annually. After then, principal repayments begin on the country's official debt.

But even that official debt continues to decline with successive stages of debt relief. Right now, there is a little over $56bn of outstanding government debt, down from $131bn before the 2004 settlements. Pieces are still being whittled away from that burden. Right now, Iraqi officials are negotiating with Chinese bureaucrats over consolidating and writing down old credits extended by state entities. The really big prospective reductions should come from the various Gulf states, who hold a lot of defaulted paper. They have frozen settlement discussions to press the sectarian Shia-dominated Iraqi government into doing better by the country's Sunni minority.

By the end of next year, Iraq's total external debt should be down to $32bn, or a little over 45 per cent of gross domestic product. There is little domestic debt. Presently, forex reserves with the central bank are about $18bn. There are also very large amounts of foreign currency in private hands within Iraq, and in the offshore accounts of Iraqi citizens.

Typically, countries come out of wars in a state of financial collapse, with worthless currencies and an unserviceable state debt burden. That will not be the case with Iraq. Also, there are large, easily produced, readily marketable known oil reserves, a much more visible path to prosperity than was evident in other postwar countries.

This is a long way from saying, as a ridiculous American CNBC television host did a few months ago, that "Iraq is booming". While Iraq's finances are not bad and getting better, the population, which is the base of the real economy, is in a far worse state than before the war. More than a quarter of the country's children suffer from malnutrition. The public distribution system for food rations is collapsing, a rather more immediate threat to the Iraqis than their government's failure to pass unenforceable laws. Most doctors have left the country, and the hospitals do not have most necessary supplies. The government has high cash balances thanks not only to high oil prices but also to its inability to administer the repair of vital public works, including water and electrical systems. There are 2m refugees outside the country, and possibly 2m within the country. The long-term hope for getting out of this disaster, when the war finally sputters down, is in the rapid development of the oil reserves and the reconstruction of what had been a fairly advanced infrastructure. That will be a capital-intensive process, and one that cannot be financed from internal resources. The $160m paid out every year now, and the modest principal repayment schedule that starts in a few years, is, in effect, a cheap call option premium payment on access to funds from international capital markets.

The Iraqis recognise this. Their ancestors did, after all, invent banking. For all the internal fighting, there is no serious disagreement among the political parties or sectarian groups about the need to maintain the country's international debt service on the terms agreed three years ago. The only real threat to the serviceability of the national debt would be a violent, non-consensual partition. Outside of Iraqi Kurdistan, it seems that support for a strong central government is growing. The governments of Iraq's neighbouring states have no interest in sectarian partition, which would only lead to questions about the legitimacy of their own borders.

The Iraqi civil war may have a violent peak soon. But the price of the country's bonds indicates there is hope for its longer-term prospects.