Author: Benjamin Beasley-Murray
The war in Iraq has called into question much of the architecture of international relations built up since the Second World War. The aftermath might shape the way that money is lent to emerging markets.

In Plato’s
Republic, Socrates argues that it is not always ‘just’ to ‘give what is owed’—you should not, for instance, return a borrowed sword to a man who is insane. Two millennia later, Paris law professor Alexander Nahum Sack came to the issue from the other side when he formulated the doctrine of ‘odious debt’. It is not just, Sack claimed, for a nation to be obliged to repay debts that have been both harmful to it and unasked for by its people.

Sack’s argument—which was formed in the wake of the Spanish American war when in 1898 America forgave Cuba’s debts on the basis that they had been run up by a harmful colonizing power—has had scant impact on international law. The assumption has since been, as expressed in a US ruling, that “though the government changes, the nation remains, with rights and obligations unimpaired.”

But this April, US deputy Defense Secretary Paul Wolfowitz refocused the debate on ‘odious debt’ when he told a US Senate committee that he believed Russia, France and Germany should write off “some or all of” the money owing them from Iraq, and added: “I hope they will think about the very large debts that come from money that was lent to [Saddam Hussein] to buy weapons and to build palaces and to build instruments of repression.”

Iraq's current external indebtedness
Source: Exotix
Because the Iraqi people did not back Saddam’s dictatorial regime, the argument goes, and because they were instead harmed by it, they are not liable for loans that Saddam took. “If you think about the analogy in a private case, if somebody walks into a bank and claims to be me and borrows, I’m not liable for that,” says Michael Kremer, a Harvard professor of economics and today’s foremost cham-pion of the ‘odious debt’ doctrine. “The people of Iraq really never agreed to take out these loans, and many of the loans really weren’t to their benefit,” he says.

The doctrine has a third condition for a debt to be considered odious, which is that lenders must be aware they are giving credit to a regime that is illegitimate and know that the loan is injurious to the country’s people. The fact that not all loans made to ‘bad’ regimes are directly harmful is a key stumbling block for the doctrine. “The odious debt situation doesn’t necessarily track or correlate with the nature of a government,” says James Loftis, a partner at US law firm Vinson & Ellis and co-chair of its international litigation and arbitration group. “Even tyrannies buy food, right?” Loftis points out that whilst the Iraqi government may have put money to bad ends, it also borrowed money for projects like developing oilfields. “Presumably you still have that oilfield and in better condition than it was,” he says. “It will produce an income in the future, and it might be difficult to pay off, but the moral argument that you shouldn’t pay it off is much less powerful.”

The fact that money is fungible is central to this problem. A loan for a country to build water purification plants may in turn allow investment in weapons research. “Money for one thing frees up money for something else,” says Colin Rowat, a professor in economics at the University of Birmingham in the UK. Iraq’s debts rose precipitously during the Iran and Iraq war and, says Rowat, “whatever they were nominally for, I think it’s understood that these were for Iraq to continue to finance its war. Gulf Arab states gave Iraq money since they saw Iraq as fighting a war against Islamic fundamentalism on their behalf.”

Kremer acknowledges that disentangling the purposes behind different loans can be tricky, but says that this is just one upshot of “the current system, where any loan is considered legitimate no matter how bad the dictator or no matter what purpose the dictator chooses.” He argues that if the ‘odious debt’ doctrine is to be put to work effectively, it must be forward-looking rather than just retroactive. He advocates that the international community achieve consensus on regimes’ illegitimacy and announce that thereafter loans to that country ought not to be honoured. “The advantage of setting up some sort of formal system,” Kremer says, “is that, as with any other sanction regime, there could be discussion of when it might be appropriate to make an exception to this particular rule.” So for example, he says, the international community might decide that a loan dedicated to health infrastructure, say, could be legitimate even if a country is ruled by a dictator.
Pending contracts with iraq, by country of origin
Source: Center for Strategic and International Studies

In suggesting that an international body like the UN should judge regimes illegitimate and declare that future loans to that country should not be recognized, Kremer is going further than Sack’s original formula. This, Kremer says, is because only recently has there developed a consensus that a government’s legitimacy rests on democratic procedures.

Up until the end of—and particularly during—the cold war, there was a strong presumption of non-interference in the affairs of other countries. Kremer cites the trial of former Serbian president Slobodan Milosevic and the momentum of the international human rights movement more generally as evidence of a change in international norms. “So I think there’s been a big change since the time of the Spanish-American war until now,” he says.

Kremer believes that if Iraq’s debt is repudiated by the international community and if this is done for avowedly moral reasons, there will be a shift in the way banks and governments view lending. “I would certainly agree that there’s a lot of politics behind this … and a mixture of different motives which are attracting interest in [odious debt],” he says, “but it forces people to think about the issue because there really is a moral principle at stake and once that principle has been articulated it makes it more difficult to get away from.”
Iraq's overall financial burden
Source: Center for Strategic and International Studies

With around $2.6 billion owed in total to London Club commercial lenders, some investors are betting, however, that Iraq’s debts will stand. Among these are holders of commercial debt issued by Iraqi banks in the 1980s. These IOUs are effectively viewed as sovereign obligations since they were guaranteed by Iraq’s central bank on behalf of the government.

“This has been a class which is only very rarely traded,” says Richard Segal, an analyst at London-based illiquid debt brokerage Exotix. But, he says, there is increased interest in the paper, which in May was trading around 30 cents to the dollar. With sanctions still in place and hence US investors barred from buying or selling the debt (the Bank of New York and JPMorgan Chase were amongst holders whose stakes were blocked in 1990) “many American investors are already doing their homework,” said Segal. But what of the forgiving murmurings from Wolfowitz and others in Washington? “These people won’t be in the negotiating meetings, so I think we can discount those comments accordingly,” says Segal.

But Didier De Baere, the head of the legal department at East-West Debt in Antwerp—a debt collection company that also holds Iraqi paper—is, he says, pessimistic. “The prices went up a little bit before the war, when it was thought it would be a quick war and a quick withdrawal afterwards,” he says. “But now there’s a lot of doubt about what’s going to happen,” he says, adding that the Iraqi central bank may be liquidated and replaced by a new one. “I think in that case we can be 90% sure that there will be no [commercial debt] repayment at all,” he says.

Scarcely anyone expects a full pay-out, whether of commercially or state-held debt; it’s just not viable, and there will have to be some kind of discounted restructuring. Even the advocates of the concept of ‘odious debt’ admit that its application might hamstring the way banks now do business in politically volatile parts of the world. “Treasurers may be reluctant to lend to legitimate governments out of fear that a successor regime will just brand them illegitimate,” admits Kremer. As banks and companies contemplate involvement in the reconstruction of Iraq, they might just be looking over their shoulders.

So Just What’s the Bill?
The Paris Club, formed of wealthy creditor nations, said in late April that it would take them several months to work out the extent of Iraq’s debt. Washington-based think tank the Center for International Studies puts the grand total at around $383 billion—$127 billion of loans, $199 billion in reparations following Iraq’s invasion of Kuwait and $57 billion-worth of contractual liabilities. The $127 billion external debt includes nearly $50 billion of accrued interest, since no repayments have been made on this debt since the imposition of sanctions in August 1990. A 2001 report by the US Department of Energy reckoned external debt obligations to be around $62 billion, however. One difficulty in totting up figures is that some advances by Saudi Arabia and Kuwait are considered by these countries to have been loans, but by Iraq as grants.

Exotix, an illiquid asset brokerage in London, put total loans at $116.5 billion in an April report. Assuming GDP of around $30 billion (most estimates fall between $25 and $50 billion) means that Iraq owes around 400% of its GDP.

Outside of the Middle East itself, the major creditor states are Russia and France, which Exotix estimates are owed around $8 billion each. Remaining Paris Club members are owed some $9.5 billion—around $2 billion to the United States, largely on account of agricultural credits from the 1980s, and about £1 billion to the United Kingdom from lines of credit extended by its Export Credit Guarantee Department.

Exotix’s debt reckonings ignore claims from the UN Compensation Committee which, if fully ratified, would account for about two-thirds of the country’s total liabilities. Iraq has already paid out about $17 billion in compensation, but many claims will likely be paid only fractionally. “We’ve heard that the Americans are actually going around to the Kuwaitis telling them to prepare for the fact that they’re going to get nothing,” says one person close to the discussions.

Benjamin Beasley-Murray