By Abbas Alnasrawi
Middle East Economic SurveyMarch 29, 2004
It can be said without exaggeration that the collapse of the Iraqi economy was unique among developing countries in the 20th century. Having risen to the status of upper middle-income countries the economic decline which started in the 1980s has pushed the Iraqi economy to a level comparable to those of heavily indebted poor ones. This paper will focus on one aspect of the collapse: foreign debt. It will argue that the bulk of this should be declared odious and the people of Iraq should not be required to repay it. In order to understand Iraq's current debt crisis one needs to review certain landmarks and turning points in the country's recent history. These include the evolution of the oil sector, the Iraq-Iran war of 1980-88, the Gulf war and the economic sanctions, and the 2003 invasion of Iraq and the current occupation.
The Oil Factor
It is no exaggeration to say that discussion of Iraq's debt cannot be disassociated from the role of oil in the national economy as evidenced by these few indicators. In 1970 Iraq's revenue from oil amounted to $520mn, but rose 10 years later by 52 times to $26bn in 1980, only to plummet to $10bn in 1981. The economy had to wait for nearly two decades (until 1999) for oil revenue to surpass the level of 1981 – and then only for four years. Given the fact that the oil sector contributed more than one half of GDP one can easily appreciate the impact of these fluctuations on the economy. The phenomenal rise in oil revenue in the decade of the 1970s, which resulted from higher oil prices and output, placed at the disposal of the state enormous economic resources and political power. These revenues enabled the government to expand social services, increase development spending, expand the armed forces and accumulate some $40bn in international reserves. It is worth noting that Iraq's oil revenue from 1931 to 2002 amounted to $266bn. Of this, $261bn was received and spent (or misspent) under the rule of the Ba?th regime and Saddam Husain.
Economic indicators for the period 1970-80 show that GDP grew annually by 12%; gross fixed investment by 28%; consumption by more than 13%; construction by 28%; and manufacturing by 13%. Only agriculture remained stagnant, growing by just 1% a year. These positive rates of the 1970s turned negative in the 1980s due to the changing conditions of the oil industry and above all the 1980-88 Iraq-Iran war from whose impact and consequences the country and the economy are still suffering.
The Iraq-Iran War 1980-88
Why was this war so important? In simple terms the longest conventional war in the 20th century bankrupted the country and set it on the path of self-destruction on which it finds itself at the present time.
One of the more significant effects of the war was the militarization of the economy. In 1975 Iraq had 3% of its labor force (or 82,000 persons) in its armed forces. By the time the war ended in 1988 around 21% of its labor force (1mn people) was in the military. This sharp increase in the size of the armed forces led to a steep increase in military expenditures – from $3bn in 1975 to $26bn in 1984. In some years in the 1980s military spending exceeded oil revenue and even GDP. In short, the following were some of the consequences of the war:
1. Iraq's oil exporting capacity was either destroyed, blocked or closed;One may ask how the government managed to finance its expenditures: the answer is that it did not, since it was forced to curtail imports and social services, abandon development plans, resort to suppliers' credit, exhaust its international reserves (the $40bn above), receive grants (or loans) from Arab oil countries, and resort to foreign debt.
2. Heavy industries were damaged;
3. Infrastructure was damaged;
4. One fifth of the labor force was in the army;
5. Agricultural and industrial growth was stagnant or negative;
6. Rural workers were either drafted into the army or drifted to the city;
7. Dependence on food imports increased;
8. Inflation became a structural problem;
9. Privatization failed;
10. Iraq became a debtor country;
11. Imports declined;
12. Development planning and spending virtually ceased;
13. The promised higher living standards could not be delivered; and
14. The stage was set for the invasion of Kuwait in 1990.
The unfulfilled economic promises and the continued degradation of the economy, combined with weaknesses in the oil sector, seem to have propelled the Iraqi government in August 1990 to invade and occupy Kuwait in the hope that the latter's wealth and oil reserves might provide an easy solution to the country's economic crisis.
War And Sanctions
The Iraqi government's blunder in invading Kuwait, leading to the Gulf war of 1991, resulted in further destruction of the economy and its assets and infrastructure. The economic effects of the war with Iran and the bombing campaign of 1991 were aggravated by the comprehensive system of economic sanctions which the UN Security Council imposed upon Iraq immediately after the invasion. One of the hallmarks of the sanctions regime was that it barred Iraq from exporting its oil. Given Iraq's heavy dependence on its oil exports this boycott led to unprecedented economic and social losses. Suffice it to say that the combined effects of the Iraq-Iran war and the sanctions pushed down real (1990 prices) per capita GDP from $6,200 in 1980 to $4,400 in 1989 and to $600 in 1996. In December that year, the UN Security Council allowed Iraq to export limited quantity of its oil. Iraq could not generate the necessary foreign exchange to service its debt, so this continued to grow, even in the absence of fresh borrowing.
An Estimate Of The Size Of The Debt And Other External Obligations
There are perhaps as many estimates of Iraq's foreign debt and other external obligations as there are estimators. According to the Iraqi government itself its foreign debt amounted as of the end of December 1990 to $42.1bn, excluding interest. Had the government been able to service the debt within five years total payment would have amounted to $75.1bn by the end of 1995 (MEES 13 May 1991, p D6).
In addition to the $75.1bn debt acknowledged by the Iraqi government there are other external obligations. One is the debt claimed by the Arab Gulf states – Saudi Arabia, Kuwait and the UAE – which is estimated at $47bn, plus pending contracts of $57bn (Congressional Budget Office 2004). It should be noted that the Iraqi government maintained that funds received from these Arab states were received as grants in support of Iraq's war effort against Iran and not as loans.
Another external obligation is the reparation compensations authorized by the UN Security Council under resolution 687 of April 1991. Such payments by the UN-created Compensation Fund amounted to $18bn or 38% on awards of $47bn. Pending claims for compensation have been estimated at $199bn. Applying the same ratio to these pending claims, expected awards should amount to $75bn. Adding up all these elements we arrive at a total figure of $299bn – a burden Iraq will never be able to shed, given its economic prospects in the long run.
An Odious Debt
Iraq's debt was incurred in the 1980s in the context of the Iraq-Iran war. Although Iraq had some $35-40bn in international reserves at the start of the war the intensity and length of the conflict forced the government to exhaust these reserves and borrow heavily to finance the war effort. Given the authoritarian nature of the regime it was to be expected that some of these borrowed funds would be used to repress political opposition to the regime and its policies. What helped the regime's staying power was the willingness of lenders across the globe to extend loans and credits whenever the regime needed them.
The large number of lenders meant that they were driven by complex motives. These included the desire to protect previous loans and credits, the hope of benefiting from post-war oil deals and reconstruction contracts, the hope of maximizing interest earnings on loans, and the desire to weaken the military/political position of the government of the newly established Islamic Republic in Iran by bolstering Iraq. Doubtless, since the government of Iraq was waging an unanticipated, intense and protracted war, most of the loans were used to pay for imported weapons, ordnances and other war materiel.
Regardless of the motives of the lenders they were all well aware of the fact that they were dealing with a government which practiced all forms of oppression and repression against its citizens. In other words these lenders were providing loans not to help with economic development but to shore up a government which had a long history of violating its citizens' human rights, compounded by the fact that it was waging a long war with its neighbor.
Iraq's case was made more particular by the disasters brought about by the invasion of Kuwait, the bombing of 1991, the 13-year regime of economic sanctions and the US-led invasion of 2003. Neither the economy of Iraq nor its people have had any meaningful respite from economic problems, war and violence for most of the past quarter century. This exceptional condition of Iraq was recognized by Professor Joseph Stiglitz when, in 2003, he concluded that: "As for the current, urgent case of Iraq, the public claims of the Iraqi people for debt restructuring and relief must take precedence over the debt obligations that now saddle the country."
Why Is Iraq's Debt Odious?
Simply stated, the odious debt doctrine maintains that societies should not be required to pay back a debt if the borrowed funds were not used to the benefit of the population or were used contrary to the interests of the nation. In other words, a nation is expected to pay back those loans that were used for benign purposes and repudiate those that were used for objectionable ones. But to declare a debt odious certain conditions must be met:
1. The debt must have been incurred without the consent of the people;In the case of Iraq all three conditions are met. The loans were contracted without input from the population since the country was ruled by a dictatorship. They were used to prolong a war that the people had no say in declaring or executing. Indeed, it can be argued since those loans enabled the regime to prolong the war with Iran a great deal of harm was inflicted on the people of Iraq which could have been avoided had the loans not been extended. As for the lenders' knowledge of conditions in Iraq it can be said that they knew the nature of the political system and were aware that most of the loans were being used to finance the war with Iran. After all, most of the proceeds of the loans were spent in the economies of lending countries to purchase war materiel.
2. The debt can not have benefited the people of the debtor country; and
3. The lenders must have been aware of the preceding conditions.
In light of these observations it is difficult to reach any conclusion other than that the bulk of Iraq's debt is odious and the lenders should forgive most of it.
Debt Relief?
In the business world an individual company which cannot repay its creditors can seek relief from them by declaring bankruptcy until such time as it can reorganize its operations and be in a position to start repayment. In the world of international lenders and borrowers there are no bankruptcy laws or courts. A debtor country will have to deal with its creditors on a case-by-case basis. And while there are organizations such as the Paris Club which negotiate on behalf of industrial countries, developing debtor states have no such organization. This in turn makes the resolution of the debt problem dependent on the balance of bargaining power between a debtor country and its creditors. In addition to the built-in difficulties in the international system which Iraq will have to deal with there are complicating conditions in the case of Iraq which set it aside from all developing countries. Iraq, for instance, is obligated by a UN Security Council resolution to pay all its debts. Thus resolution 687 of April 1991 states "that all Iraqi statements repudiating its foreign debt are null and void, and demands that Iraq scrupulously adhere to all its obligations concerning servicing and repayment of its foreign debt." But the same Security Council has already deprived Iraq, because of the sanctions, of the opportunity to sell its oil to generate funds to service the debt.
There is also the Security Council-created Compensation Fund which receives 5% (down from 30%) of all oil sales to effect payments for damages incurred in the course of the 1991 Gulf war. There is also the Development Fund for Iraq which Security Council resolution 1483 created last May. This fund is a unique institution in that it is managed by the Coalition Provisional Authority (CPA) and all oil revenue and other revenues flow into it. And it is the CPA which has exclusive authority over any disbursement of money. In short, the fund has displaced most national economic policy-making agencies. Another Iraq-specific feature is that while the country could be classified as one of the highly indebted poor countries it is, at the same time, rich in natural resources. With its considerable oil reserves Iraq could, if allowed to optimally develop its oil resources, pay at least part of the overhang of its debt. The key point here is that under the current political conditions of occupation and in the absence of a sovereign government the problem of the overhang will continue to stifle prospects for economic rehabilitation and renewal.
What Are The Options?
Iraq's dilemma, and that of its creditors, is that normal measures to deal with the debt problem are not feasible when the country is living under abnormal conditions. At the present time the country is under occupation and there is no legitimate national authority which can speak for the interests of the Iraqi people. And the longer the occupation authority rules Iraq the larger the debt will become and the longer it will take to tackle. Assuming, and it is a big assumption, that normal political conditions return and a legitimate government is in place the question then arising is how the debt problem should be tackled.
As the preceding analysis attempted to show, there are several components to the solution, some of which are relevant only in the Iraqi context. The first step is to seek the removal of the UN Security Council injunction that Iraq is obligated to pay all its debts. Most debtor countries do not have such an injunction. UN Security Council involvement in Iraq's debt was an extension of its involvement in the future of the country in the aftermath of the Gulf war. Another component in Iraq's case is the election of a government that would be independent and be recognized by the rest of the world as such.
Obviously the most important part of the solution is the position of creditors towards the kind of concessions they are prepared to offer toward Iraq's debt of some $128bn. There are two groups of countries which, between them, hold the bulk of Iraq's debt. First, there is the Paris Club group of 19 which holds one-third of the debt ($40bn) or 31% of principal and interest. The other group is composed of three Arab Gulf countries which hold 37% of the debt or $47bn. Between them these two groups of rich countries hold close to 70% of the debt. It goes without saying that Iraq's burden would be lighter if the Arab debts were to be reclassified as grants as the Iraqi government had always maintained that they were.
Given the Paris Club's experience in dealing with debt issues and the economic and political power of its member countries, the solution to the problem may in the final analysis hinge on how its negotiators approach this particular debt problem. Another question is whether the Paris Club terms for dealing with the debt will be acceptable to other creditors, keeping in mind that in dollar terms the club's share of the debt does not constitute a majority. Although the club, historically, has been opposed to outright reduction in debt, not to mention cancellation, there are cases (Serbia and Poland) where most of the debt was forgiven.
Iraq's predicament is that it will not be able to engage in successful reconstruction and development so long as the overhang of debt remains. Iraq's vicious circle is that it needs to produce and export oil in line with the size of its reserves to be able to pay that part of the debt that is not forgiven. But in order to do that it will have to have a reduction in debt to be able to rehabilitate and develop its oil sector. As a matter of fact the G8 countries have already considered and rejected the idea of writing off Iraq's debt and indicated that the Paris Club is the forum where Iraq may seek relief from it. Yet former Secretary of State James Baker has already secured promises from major creditors for serious reductions in the debt.
There are too many proposals for debt relief to be reviewed here. They range from a new allocation of special drawing rights by the International Monetary Fund to debt restructuring of principal payments. Some of the mechanisms for debt relief available to developing countries include partial cancellation of non-concessional loans, reduced interest rates, or extended maturity of payments. There is also the debt-for-equity or debt-for-nature swap, as well as: the Naples terms scheme which allows debt cancellation of up to 67%; the Lyon scheme which allows up to 90% cancellation; and the Cologne scheme which also allows up to 90% cancellation.
All these schemes suffer, from the perspective of Iraq, from at least two drawbacks. The first is that they were designed with the highly indebted poor countries in mind and not middle-income ones with considerable natural resource endowment like Iraq. The second drawback is that they do not solve the debt problem but merely postpone it to another day.
Where Do We Go From Here?
Iraq and its creditors are caught in a serious dilemma the solution of which is in the hands of the creditors. This is because, relative to the GDP of the creditors, Iraq's debt is truly insignificant. By contrast Iraq's debt burden is simply unprecedented. If Iraq's creditors were to insist on full payment then its prospects for development would be stifled. If this were to be the case then Iraq would not be able to meet its obligations to its creditors. Debt restructuring and debt forgiveness are not only desirable but necessary if the creditors hope to be paid.
If economic policy decisions are transferred to an internationally recognized government by the end of this year and domestic stability is restored, then one can draw up the following fiscal scenario, assuming that, effective 2005, Iraq oil exports are 2.5mn b/d and the price of this oil is $25/B, yielding annual income from oil exports of $22.8bn per year. Against this level of revenue there will be many claims for spending for reconstruction, economic growth, imports, public sector civilian and military needs, oil industry requirements, social services, general consumption and foreign debt. In the absence of relevant data one must resort to estimates which can be adjusted upward/downward in response to the availability of more accurate data.
During the decade of the 1980s Iraq's pre-embargo civilian imports amounted to $508 per person. Applying this figure to a population of 27mn yields a level of imports of $13.7bn. If, for the sake of argument, we say that rehabilitation of the infrastructure, rehabilitation and development of the oil sector, and investment in the rest of the economy (industry and agriculture) will require $5bn per sector or a total of $15bn per year, then the total claims will amount to $28.7bn as opposed to oil revenue of $22.8bn or a resource gap of close to $6bn. And this does not include any payment to service the debt.
It can be seen from these figures, or any other combination of them, that Iraq will not be able to meet its minimum economic and social requirements and service its foreign obligations. If Iraq's burden of debt and reparation is not relieved, one is compelled to conclude that its economic and political crisis will continue with unforeseen implications for the Iraqi people, as well as the entire region.
Abbas Alnasrawi is Professor Emeritus of Economics at the University of Vermont.
Selected References:
Congressional Budget Office, Paying for Iraq's Reconstruction. Washington, DC: January 2004.
Middle East Economic Survey, various issues.
Stiglitz, J "Odious Rulers, Odious Debts" The Atlantic Monthly, November 2003.
www.jubileeiraq.org
www.odiousdebts.org
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