Downsizing Saddam's Odious Debt

by Justin Alexander | published March 2, 2004

In a surprise move on December 5, 2003, George W. Bush named James Baker as a special envoy charged with seeking "the restructuring and reduction" of $130 billion in foreign debt piled up by the regime of Saddam Hussein. Until Baker's appointment, the United States and the international community had largely sidestepped this minefield, pleading uncertainty about the size of the debt, the need to focus on more pressing matters or the fact that only a sovereign Iraqi government can hammer out debt relief agreements in the end. Since Baker picked up the debt portfolio, however, discussions are happening at a frenetic pace, with the former secretary of state jetting off to Europe, Asia and the Middle East to jump-start the conversations.

How did the deposed Iraqi regime, sitting as it did on the second largest oil reserves in the Persian Gulf, come to owe such a staggering bill? In brief, loans approved by many other countries financed the regime during its bloody and expensive war against Iran from 1980-1988, through the genocidal Anfal campaign against the Iraqi Kurds and right up until Iraq invaded Kuwait in 1990. As hundreds of thousands of Iraqis were killed and Iraq's once vibrant economy went into a tailspin, Saddam Hussein's government converted a $36 billion cash reserve into an enormous foreign debt. After the conclusion of the Iran-Iraq war, a dire economic and fiscal crisis in Iraq, including the annual $3 billion cost of debt service, was the immediate motivation for the invasion of Kuwait. The 13 years of comprehensive economic sanctions which followed, during which time Iraq could not make payments on the loans because it had no legal source of foreign currency, caused the debt to increase through interest to its present level. The UN ceasefire resolution after the 1991 Gulf war added war reparations to the already crushing financial load.

Upon the announcement of Baker's mission, White House Press Secretary Scott McClellan staked out the moral high ground, telling reporters that "the future of the Iraqi people should not be mortgaged to the enormous burden of debt incurred to enrich Saddam Hussein's regime." Some journalists immediately pointed out the special envoy's potential conflicts of interest, including his senior partnership in the law firm Baker Botts, which represents the government of Saudi Arabia, the country claiming the largest amount of debt. In response, Baker agreed to forego earnings from clients with obvious connections to the debt. Others argued that Baker's track record on debt relief is dubious. As treasury secretary under Ronald Reagan, he developed the unsuccessful Baker Plan which provided poor, indebted countries with new loans to service old ones—provided that these countries adhered to damaging economic policies prescribed by the International Monetary Fund. Those with good memories recalled that in 1989, when he was secretary of state, Baker met in Baghdad with Tariq Aziz, then the Iraqi foreign minister, and promised to increase US lending to Iraq to $1 billion in the ensuing year. Still others commented wryly that the Texan lawyer had been summoned yet again to clean up a Bush family mess, as if his mission were primarily an exigency of American electoral politics.

But the problem of the debt burden imposed upon Iraq by its imprisoned former dictator is real and severe. The more important measures of the success or failure of the Baker mission, and the administration's intentions, will be the extent to which Baker tackles the core of the problem and the extent to which he consults Iraqis about their country's economic needs. For all of his international travels, the Republican master diplomat has yet to visit Iraq.

Talking About Talking

Media reports on Baker's itinerary to date have often given the misleading impression that the countries he visited had written off Saddam's debt on the spot. In fact, the agreements that Baker has secured, while important, are only agreements to start negotiating.

In the five weeks between December 16, 2003 and January 22, 2004, the former secretary of state went on a whistlestop tour of world leaders, visiting ten of the former Iraqi regime's major creditors in Europe, Asia and the Gulf. He appeared to receive a universally positive reception, and was given a further boost by Saddam's capture a few days before his first meetings with French President Jacques Chirac and German Chancellor Gerhard Schroeder. Those meetings produced a joint statement to the effect that "France, Germany and the United States agree that there should be substantial debt reduction for Iraq in the Paris Club in 2004." The Paris Club is an informal roundtable of major creditor governments, including the so-called G-8 countries, whose role, according to its website, "is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor nations." Paris Club negotiations normally end in agreements to reduce and defer a poor country's loan payments dependent on strict conditions—not forgive them outright. Still, the US-French-German statement, coming after the bitter transatlantic disagreements over the legality and necessity of the Iraq invasion, was received internationally as a public sign of rapprochement. Similar statements favoring a standard Paris Club deal followed in Italy, Britain and Russia.

The next leg of Baker's journey took him to the Far East. Behind the scenes, Japan had been the most resistant of Iraq's creditors to a Paris Club deal, preferring to extend a moratorium on repayments for a few years, in the hope that Iraq's economy would recover to a point at which it could fully service the debt. So the Japanese foreign ministry's statement after Baker's conclave with Prime Minister Junichiro Koizumi was a kind of breakthrough: "Japan would be prepared to eliminate the vast majority of its Iraqi debt...in the context of a Paris Club agreement." Chinese Premier Wen Jiabao's agreement was "a little bit less definitive," as Baker put it in the February 11 Washington Times, but was followed by an announcement that "China is considering [the possibility that it may] write off Iraq's debt [because] we are sympathetic to the humanitarian situation." A planned trip to South Korea was canceled for reasons that are unclear (though probably because the bulk of the Korean claims are held by companies such as Hyundai rather than the government).

Baker arrived in the Gulf on January 20 and secured commitments from Qatar and the United Arab Emirates to write off "most of" the debt incurred by the former Iraqi regime with their treasuries, according to statements from their respective state news agencies. Kuwait was a little less forthright, with Prime Minister Sheikh Sabah Al Ahmad Al Sabah merely saying after his meeting with Bush's emissary that "Kuwait is willing to begin negotiations regarding this issue." The prime minister stressed the need for an Iraqi government with which to negotiate and, as per Kuwait's long-standing position, insisted that war reparations owed to Kuwait under the 1991 ceasefire resolution were a separate issue entirely. In Saudi Arabia, the kingdom's de facto ruler Crown Prince Abdallah said that he was ready to enter into negotiations "to substantially reduce the Iraqi debt." Will all these talks about downsizing the debt actually ameliorate the problem, or only lead to more talking?

Self-Interest Society

Baker appears to be optimistic. In a speech at the Center for Strategic and International Studies (CSIS), a center-right Washington think tank, the special envoy explained the agenda behind his globe-trotting. "What I have asked of the major creditors is agreement on three principles. First, that Iraq cannot be reconstructed successfully without debt reduction. Second, that any reduction must be substantial, or a vast majority of the total debt. And third, that we must begin now to have any chance to complete the project in 2004." He added that his remit did not include war reparations or privately held debt, and emphasized that "Iraq's debts are simply too onerous and the issues too complicated and too urgent to wait…until a new Iraqi government is formed."

But Baker's reliance on the mechanism of the Paris Club is not a good sign. The Paris Club is a self-interest society, in which creditors attempt to salvage as much as they can from a country in danger of defaulting on debt payments. Yet the $130 billion debt left by the Baathist regime is so vast that the technically correct service payments would probably exceed Iraq's entire annual revenue. A Congressional Budget Office (CBO) study released in January points out that the current Iraqi budget only allows $200 million annually for debt service, equivalent to just $10 billion of debt at an extremely low 2 percent interest rate. The only way the regime's creditors can hope to retrieve anything is by substantially reducing the size and changing the schedule of their claims.

By how much will the Paris Club reduce the debt load? Baker has been careful not to cite a figure, saying, reasonably enough, that "the exact size of the reductions is the most difficult issue, and you cannot put it up front if you want to have any hope for diplomatic progress." The consensus appears to be that the burden will shrink by about two thirds, though the Paris Club has not yet officially agreed upon this amount. Yugoslavia's debt was reduced by two thirds after the demise of the Slobodan Milosevic regime, and World Bank President James Wolfensohn has given this figure as appropriate for Iraq. At the recent meeting of the G-8 countries in Florida, Russian Finance Minister Alexei Kudrin appeared to confirm the figure, saying: "The Paris Club conditions [agreed upon for Afghanistan] will be applied in Iraq, but in the Iraqi case it is 65 percent, not 80 percent." At the donor conference in Abu Dhabi on February 28, the Iraqi interim planning minister, Mahdi Hafedh, told reporters that "in principle we have a 60 percent reduction," but later retracted the statement, apparently prompted by the US. "My remarks have been misunderstood," said Hafedh."I did not mean to imply there is a specific percentage of debt reduction at this time…[It] will of course have to be agreed upon by negotiations among the parties."

Falling Short

The Paris Club only holds about a third ($40 billon) of the debt claims being made of Iraq. The Club always requires debtor countries to seek comparable debt relief terms from other creditors, but has no legal authority to require other creditors to follow its lead. Some creditors seem adamant that they will not agree to this scale of debt relief. The Korean company Hyundai, which is claiming about $1.1 billion, has stated: "We are 100 percent confident that Hyundai will eventually redeem all of its outstanding income from Iraq." Eastern European countries such as Bulgaria and Romania—each of which claims about $1.7 billion—have also been insistent about repayment. In the best-case Paris Club scenario, assuming that all the other creditors are in agreement, the debt might be reduced to about $45 billion. This amount may sound significant, but on top of it must be added $28 billion and climbing in reparations, as well as new loans to Iraq that are being contracted to fund the huge reconstruction operation.

CSIS has argued that "any plan that does not include reparations, and that results in Iraq owing more than $35 billion overall, is unwise." That is less than half of the amount expected to remain owed to Saddam's creditors after the best-case Paris Club deal. The CBO study constructed various scenarios to demonstrate "how sensitive Iraqi reconstruction funding is to the debt issue," including worst-case scenarios which "leave no funds in the Iraqi budget for capital investment and produce substantial shortfalls in the government's ability to meet its day-to-day operating expenses." Debt relief as designed by the Paris Club is not based on consideration of the economic and social needs of the indebted country, but on fixing debt at a level which will maximize debt service revenues for the creditors over the long term. There is no way for Iraq to begin to service $130 billion of debt; without debt relief, therefore, it will default and the creditors will receive nothing. But even after a reduction to $45 billion, Iraq might still have to "sustain" regular payments of $4-5 billion a year. Such "sustainable" debt payments would divert a quarter or more of government revenues away from essential social spending and reconstruction.

Odious and Dangerous

Aside from falling short in financial terms, the kind of Paris Club deal being brokered by James Baker has two major problems. First, it completely ignores the issue of whether the claims against Iraq are legitimate in the first place. Second, it will require Iraq to follow the dictates of the IMF, which will devalue Iraqi democracy and could be socially devastating.

There is considerable controversy about whether the Gulf countries' claims represent genuine debts. Iraqis maintain that the Gulf states made grants to assist the deposed regime in the war with Iran, in order to protect themselves from the perceived external threat from Iran and the perceived internal threat of Islamic revolution. Certainly, no official loan documents have been produced by Gulf countries to prove that the funds they provided were intended to be repaid. Even if such documents do emerge, they will not address the most serious question of legitimacy, namely, that loans made to support Saddam Hussein's aggression are what is known in international law as "odious."

The doctrine of odious debt states that when creditors lend to a dictatorial regime which they know is not using the loans to benefit the population, then debt payment cannot be demanded of those people once they are free. Iraq, which was an increasingly prosperous country until Saddam came to power, expanded the military and invaded Iran, offers a remarkably clear case where the doctrine should be applied. Iraqis are firm on this point. As Perweez Mohammed of the Patriotic Union of Kurdistan put it to a rapporteur for Jubilee Iraq: "The creditors' cooperation enabled Saddam to preside over atrocities such as Halabja. Saddam never spent money for the benefit of the Iraqi people, but just for himself and his followers." As for the creditors, Hajim al-Hassani of the Iraqi Islamic Party adds that "the Gulf countries should not receive a single dinar. The Iraqi people lost hundreds of thousands of lives because of the Iran-Iraq war, which would probably have ended much earlier without the money they provided."

Marek Belka, the former Polish finance minister who organised the Madrid donor conference in October 2003, has estimated that "about 90 percent of Iraq's virtual debt is war-related," while L. Paul Bremer, the chief civilian administrator of the US-British occupation authority, attributed the debt before Congress to "Saddam's economic incompetence and aggressive wars." Yet the Paris Club refuses to consider whether loans might be odious, and Baker has not yet said anything on the subject.

Typically, Paris Club debt relief is conditional on the acquiescence of debtor countries in IMF-recommended "structural adjustment" schemes. Describing a possible Paris Club plan for Iraq, Lex Rieffel from the Brookings Institution wrote in the February 6 Miami Herald that, after initial rescheduling until 2005-2006, debt reduction "would be stretched out over three years with each years reduction linked to meeting performance targets under a new IMF program." The experience of countries such as Argentina, where such IMF programs have been disastrous, should be taken as a warning. The IMF's toolkit of rapid privatization, trade and capital flow liberalization might exacerbate unemployment and poverty, contributing to political instability, and create a new class of corrupt oligarchs, as was the case when Russia's Soviet-style economy was overhauled in great haste. Even if one believes that IMF policies are likely to be beneficial, their imposition by force would rob Iraq of an important aspect of sovereignty. The interim oil minister, Sayyid Ibrahim Bahr al-Uloum, tends to favor IMF policies, but says with pride: "We are Iraq! We were the cradle of civilization, and I don't want to see anyone controlling our economy by any means."

Fairest Way Forward

James Baker has made significant progress in preparing the way for a Paris Club agreement on relieving Iraq of the obligation to repay some of Saddam's debt. More importantly, however, Baker has not yet addressed the view of Iraqis and many others that most of the debt claims are illegitimate. If the Bush administration is genuinely committed to empowering Iraqis to build a peaceful, prosperous and democratic nation, then it should unconditionally write off American-held debt and reparations claims. Bush should further instruct his special envoy to work alongside Iraqis for a just solution to the debt and reparations problem. The fairest way forward would be transparent international arbitration—an "odious debt" tribunal—to determine which loans benefited the Iraqi people and which merely underwrote the wars and domestic repression of Saddam Hussein's regime.

Why is the US not promoting this approach? A cynic might suspect that Washington is embarrassed about how the administrations of Reagan and the elder George Bush backed Saddam until 1990. Perhaps the White House would rather not remind anyone of Baker's $1 billion pledge to Tariq Aziz. A cynic might further surmise that an Iraq with a reduced, but nonetheless significant, burden of debt will be dependent on foreign aid, presumably much of it from Washington. With his eye on the quiet negotiations over what prerogatives the US military will have in Iraq after the June 30 dissolution of the occupation authority, the younger Bush may prefer a weak, indebted Iraq that it can control to a debt-free Iraq which could stand on its own two feet. To prove the cynics wrong, Bush and Baker will have to deliver much more than a Paris Club deal that reinforces the status quo.

If creditors refuse to place their claims under the light of an odious debt tribunal, then Iraq will be justified in repudiating the debt. Creditors might try to bully Iraq by claiming that repudiating odious debt would threaten future credit ratings. Yet the opposite is true, since a debt-free Iraq would be much more able to repay future loans. A February 26 report by Fitch Ratings, a US-British credit rating company, estimated that even if the debt was reduced by 90 percent to $14 billion—far more than the Paris Club is likely to offer—Iraq would still only qualify for a B+ credit rating, four notches below investment grade and on a par with Ghana and Senegal. Something far more dramatic is needed, and only a tribunal or a repudiation based on the odious debt argument seems to fit the bill. Even the editors of the Wall Street Journal, not otherwise known for their forgiving disposition toward debtors, concur. They wrote in April 2003: "We wouldn't blame Iraq's leaders if they decided that some of those financial obligations are indeed odious. And given that this is such an extreme case, international lenders probably wouldn't hold it against them for long."

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