Reconstruction of Iraq: Sustainability of Debt Service and Reparations Payments, By Ali Merza

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External debt

Although various estimates and figures are being published and exchanged the stock of external debt is not precisely known. Moreover, as it had not been serviced since its inception the added capitalisation of accumulated interest is also problematic. Furthermore, much of the Gulf countries’ debt took the form of transfers, i.e. they were not contractual. The IMF was entrusted with the task of enumerating the debt. So far it has not published a report. Until it does one has to be content with the circulating figures. Exaggerations are, thus, quite possible.

Table (2-2) adopts a figure of about US$ 122 Billion, comprised of Gulf, Paris Club and commercial (or private) loans (including capitalisation of interest). This falls in the range cited by many references, (e.g. see detailed figures in www.jubleeiraq.org).

It is now advanced by many writers and organisations that much of this debt is of odious character (e.g. Stiglitz, Kaiser and Queck, Alexander). But even if this argument is accepted and furthermore sanctioned as so by an international tribunal, national courts of law, in creditors’ countries, could overturn such ruling (Segal 2003). This leads to claims and difficulties for Iraq in the markets of concerned countries and thus could affect negatively the reconstruction efforts at the time when Iraq is in need of the goodwill of the international financial community. Therefore, the consent of all creditors’ countries is a preferred outcome. Paris Club prefers, it seems, partial (some suggest substantial) debt forgiveness. According to this view about 60-80% of the debt could be forgiven. The repayment of the remaining debt would start in 2010 but interest payment starts in 2005. Assuming a reduction rate in the range (60-80%) this would reduce the debt from US$122 Billion to between US$24-49 Billion. Interest payment alone (assuming 3% rate), then, would amount to about US$0.5-1.0 Billion to start payment in 2005. From 2010, up to 2029, annual interest and principal payment amount to about US$1.5-3.0 Billion, (20-year repayment period), table (2-3).

Reparations

Claims for compensation of the consequences of Iraq invasion of Kuwait were submitted to the UnitedNationsCompensationCommission (UNCC), a body set up by the UN security council to receive compensation claims, look into them and decide the eligible claims (decision is final). The status of the reparations as of March 19, 2004 is shown in table (1).

Total claims amounted to about US$ 349 Billion. Most claims (76% of value) have been resolved. By March 19, 2004 the awarded claims amounted to US$ 48.2 billion. The award rate is 18% of the original claims. Extrapolating for the unresolved claims (US$ 82.6 Billion) suggests further awards of about US$ 15 Billion, making total awarded & to-be-awarded reparations US$ 63 Billion, table (1). About US$18.2 Billion had already been paid by March 19, 2004. The remainder is US$44.9 Billion (table 4). Adding this figure to the stock of external debt and we have total obligations in the neighbourhood of US$ 167 Billion.

After May 2003 annual ‘service’ of reparations was diluted to 5% of the gross value of oil exports instead of the 28.3% accrued before that date.

Sustainability of debt service and reparations payments

It is difficult to assess sustainability without an agreement on its meaning. If the latter and its measure were defined then the answer would critically depend on the minimum reduction, in external debt, needed for service to be sustainable. This can be an iterative process, as shown below.

Let us first define sustainability of debt service in terms of sustainability of economic growth, i.e. the ability of the economy to service debt (principal and interest) within the repayment period and at the same time be able, within this period and beyond, to develop and grow on a sustainable path. We will argue below that relating the balance of payments (BOP) gap to a GDP-targeted growth path is a better measure of debt service sustainability.

The widely used measures of sustainability, i.e. outstanding debt/GDP and debt service/exports do not relate well to the sustainability of economic growth, which is of critical importance in the case of Iraq.  Consider the extreme case of no debt reduction and that debt to be repaid within 20 years at 3% rate of interest and that repayment of principal starts in 2010.  Take the ratio of debt & reparation service to exports as the measure of sustainability. The ratio will be between 21% in 2005 to 13% in 2009. In 2010 it jumps to 27% after principal payment is added to the interest payment, which would have started in 2005. The ratio declines to 24% in 2014, (table 4). If 25% is taken as a yardstick over which the burden becomes heavy then debt service seems largely tolerable even without debt reduction; obviously unacceptable conclusion. Now take the ratio of total obligations (outstanding debt and reparations) to GDP. For a debt reduction of 0% table (4) indicates a ratio of 758% in 2005 declining gradually to 225% in 2014; although quite large, in both years, yet difficult to compare to a yardstick.

Therefore, both measures fail to fit the Iraqi case. They could be justified for countries passing through ‘ordinary’ course of development, i.e. have not been exposed to sever structural breaks. For a war-ravaged economy, by themselves these statistics could be misleading. The decline of per capita GDP from US$1354/person in 1989 to US$581/person in 2002 (2002 prices, table 3) implies a sharp deterioration in standards of living. Sustainable economic growth, therefore, is to be defined in terms of a reasonable target and growth path, taken together. One can suggest the per capita GDP or GNP of 1989 as a reasonable target to attain at the end of the coming decade (2014).

Sustainability of this growth path can only be assessed directly through investigation of the adequacy of the ‘retained’ export proceeds (after paying for obligations) to finance needed imports. Needed imports are taken to mean imports for reconstruction (i.e. investment) and consumption necessary to support the targeted path of economic growth. An interesting by-product of projections in our longer paper (referred to in footnote 1 on page1) is to assist in this regard. In these projections the coming decade is divided into a transition period 2004-2009 and an aftermath 2010-2014.

Vital expenditures to see Iraq through 2009 and to 2014 will hinge squarely on its retained oil export proceeds and, therefore, the ability to finance its imports. This will determine its path of economic growth. Therefore, the balance of payments’ gap (retained exports revenues – imports) will be of paramount importance. By the same token sustainability measure (of debt service) should concentrate on this gap. The main question becomes, then, what is the minimum reduction rate in the external debt that equates the BOP gap with the promised external aids? In order to determine the minimum or critical reduction in external debt, accumulated BOP gap for 2004-2014 (as well as the two sub periods 2004-2009 and 2010-2014) is shown below for four cases of debt reduction, 100%, 80%, 60% and no reduction 0%:

Accumulated BOP Gap (Retained Oil Revenues – Imports), US$ Billion

Source: based on parameterisation of the debt reduction rate intables (2-1) & (2-2) and consequent calculations in table (4). Tables (2-1) & (2-2) show the case of 0% reduction. Table (2-3) shows the other cases (i.e. 60%, 80% and 100% reductions).

Assume first 100% reduction in external debt[1]. This implies that there are neither interest payments during 2005-2009 nor full service in 2010-2014 and beyond. Even though, the accumulated deficit (in the BOP) will amount to US$ 21.2 Billion in 2004-2014. This total, however, hides the much bigger deficit during the transition period, which is about US$ 36.8 Billion. The figure is larger than aids pledged in Madrid Conference (US$33 Billion); that is if all promises are made good. Later on, when oil exports increase, accumulated surplus, during period 2010-2014, could amount to US$15.6 Billion, assuming US$ 22/barrel for crude oil, from 2005 onward (admittedly lower than the level reached in 2003 and early 2004 but optimistic by historical trends, the same goes for the level of exports [2]).

On the other end with no reduction in debt the accumulated deficit for the period 2004-2014 amounts to US$71.4 Billion. Of this figure US$49.2 Billion will be accumulated during the transition period 2004-2009. This eats up all the aids pledged in Madrid Conference with a remainder in need of new borrowing (US$16.2 Billion, i.e. 49.2 minus 33). In the year 2010 full service (principal & interest) would commence. After exhausting the promised aids and resorting to new external borrowing in the transition period, Iraq has to resort to further borrowing in the second period, 2010-2014, which would amount to an extra US$ 22.2 Billion. The new bout of debt would inflate service to more than what is shown in tables (2-1) and (2-2). Service of new debt during 2005-2014 is not included in the calculations of these tables. Consequently, the Iraqi economy will be hostage to repeated borrowing and mounting service for a long time to come. This possible outcome by itself presents a forceful case for debt reduction.

It is suggested (Kaiser and Queck, others) that about 60% or even more could be forgiven. This eventuality will no doubt relive the situation compared to the no reduction case. However, the burden continues. Under the possibility of 60% reduction the accumulated BOP gap (or deficit)[3] during the period 2004-2009 is expected to amount to US$ 41.8 Billion swallowing the whole promised aids, with further need for new borrowing.

To keep the accumulated BOP gap (or deficit) equal to the promised aids (US$33 Billion) the above table indicates that a reduction rate closer to 80% is necessary. Our exact calculations (based on parameterisation of the debt reduction rate in tables 2-1 and 2-2) show a required reduction of 77%.  This reduction would result in an accumulated deficit of US$ 39.7 Billion in the first period 2004-2009 and accumulated surplus of US$6.7 Billion in the second. In conclusion 77%-80% reduction is the minimum needed to take into consideration the borrowing in the first period that will be repaid by the surplus of the second period, (including the accrued interest). Furthermore, in addition to this reduction in external debt Iraq, still, needs badly the aids package, promised in Madrid, to materialise. Otherwise the level of external debt and debt service will start to grow right from the beginning, i.e. 2005.

References

Alexander, J., Downsizing Saddam’s Odious Debt, Middle East Report Online, March 2, 2004

Central Bank of Iraq, Statistical Bulletin (Special Issue) 1991-June 2003, and Yearly Bulletin 2003, Statistics and Research Department, 2003.

Kaiser, J. and A. Queck, Odious Debts – Odious Creditors: International Claims on Iraq, Dialog on Globalization, Occasional Paper No. 12, Berlin, March 2004.

Merza, A., Reconstruction of Iraq: Debt, Construction Boom and Economic Diversification, MEES Website. July 2004.

Ministry of Finance & Ministry of Planning, Budget 2004, Republic of Iraq, October 2003.

OPEC, Annual Statistical Bulletins 2001 and 2002 and Monthly Market Reviews, January-December 2003 and January-April 2004.

Segal, R., 2003: The Year in Iraq Debt, EXOTIX Limited, December 2003.

Stiglitz, J., Odious Rulers, Odious Debts: Should the people of Iraq be forced to pay back money borrowed by Saddam? The Atlantic Monthly, November 2003.

United Nations/World Bank, Joint Iraq Needs Assessment, October 2003.