Reducing Iraq’s Foreign Debt

Lex Rieffel
Lex Rieffel
Lex Rieffel Former Brookings Expert

February 6, 2004

The G-7 finance ministers begin meeting in Boca Raton today. According to the host, U.S. Treasury Secretary John W. Snow, the topic at the top of the agenda will be boosting global economic growth. If anybody can do it, these officials can because the seven countries they represent account for almost 45 percent of the worlds economic activity.

But dont expect much in the way of results. Nothing these officials can do will lift growth by half a percentage point this year above the group pace of around 3.5 percent. Furthermore, the Europeans and Japanese are more concerned about the weak dollar, and the finance ministers from the countries with the hottest big economies today — China and India — have not even been invited to the meeting.

As a result, two other issues will be more interesting. Iraqs debt mess is on the agenda, and Iraqs finance minister has been invited to the meeting. Argentinas debt mess has not been mentioned as an agenda item, but it should be one.

How and when Argentinas debt mess gets cleared up will have much more of an impact on the international financial system than how and when Iraqs debt mess gets fixed. So why is the G-7 giving more attention to Iraq?

A clue to the answer can be found in President Bushs decision to call James A. Baker III back to service to broker a quick deal that will reduce Iraqs debt burden to a comfortable level. The emphasis here is on quick. The so-called Paris Club — an informal group of 19 creditor countries that account for most government loans to developing countries — has completed more than 350 debt-restructuring deals over the past 50 years. Most have involved debt rescheduling (deferring payments for 10-20 years), but dozens since the late 1980s have involved debt reduction (canceling some of the debt) for low-income countries.

Barely three months ago, the Paris Club announced a change in its rules that opens the door to debt reduction for middle-income countries such as Iraq, but only through a multiyear “staged process.”

Transfer of power

Applying the new Paris Club process to Iraq would involve five steps.

  • Transferring power from the Coalition Provisional Authority to a ”legitimate” Iraqi government. The Bush administration wants the authority transfer to happen no later than June 30.
  • Agreement by the provisional Iraqi government on financial support from the IMF, linked to a credible economic recovery program. The IMF appears to be working toward having such an agreement in place by the end of September.
  • An interim rescheduling agreement with the Paris Club. Immediately after formalizing a plan with the IMF, the bulk of Iraqs debt would be rescheduled to the last day of its recovery program, notionally at the end of 2005 or 2006.
  • A debt-reduction agreement with the Paris Club in December 2005 or 2006. Based on the experience of Nigeria in 2000, this critical step would depend on successful implementation by Iraq of its IMF-supported program. If Iraqs performance is poor, the debt-reduction step would be postponed.
  • Phased implementation of debt reduction. The agreed reduction — as much as 80 percent — would be stretched out over three years with each years reduction linked to meeting performance targets under a new IMF program.

Is Argentina next?

It looks as though Bush wants Iraqs debt reduced this year, and he realizes that some heavyweight arm-twisting will be required. As Florida knows, Baker is a champion arm-twister. This job should not be hard for him to pull off.

Lets hope that his next assignment is Argentine, where the stakes are higher. If a successful deal is not concluded by the end of this year, Argentinas economic recovery is likely to be short-lived and the IMF could be gravely damaged. Also, global growth would be stuck below its potential as financing for emerging market countries with good prospects becomes more expensive.