EUROPEAN BRIEF (DELETED) FOR 27 JANUARY 1990. IRAQ: NO END IN SIGHT TO DEBT BUR

Created: 1/27/1990

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DIRECTORATE OF INTELLIGENCE0

Iraq: No End in Sight lo Debt Burden

Summary

Iraq faces serious problems servicing ics foreign debt. Baghdad is unlikely to begin paring down its US billion debt any time soon because it considers most debtow priority in favor of spending on strategic military and civilian projects,s incurring new debt

oismal repayment record, Iraq wiU probably continue to secure debt relief-including limited new credits-fram most of us creditors, who have little other cltoice if they hope to receive any repayment or compete in the potentially lucrative postwar Iraqi market M

Debt remains the major constraint to Iraq's postwar economic recovery.

o Debt payments will siphon off financial resources well into.

o Although Baghdad will try to insulate miliiary and oU projeas from financial constraints, us poor repayment record wiU restrict its arrest to new financing of the magnitude needed to fund many reconstruction jfrojeas and to increase imports enough to spur growth in nonoil sectors.

Baglidad probably wants to maintain access to credit guarantees available from the United States despite recent political strains in tlui relationship. Any loss of these guarantees would jeopardize adequate servicing of about S2 billion in Iraqi debt backed by the United States. Baghdad would probably not suspend payments if Washington refused to release the0 million of SI billion in CCC credit guarantees allocated to Iraq forut almost certainly would if tlie entire CCC program, were cancelled or seen to be politically dead because of Congressionalf

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From Richer to Poorer

Iraq's extensive use of foreign loans2 bas transformed it from ooe of the Third .world's richest countries and net creditors into one of its problem debtors. The accumulation of debt stems from President Saddam Husayn's decision to continue pursuing an ambitious economic development program despite tbe outbreak of war with Iranraq boosted civilian spending while military expenditures rose and oU exports fell sharply because of the war. This^euns and butter" policy rapidly drained Iraq's foreign assetsillion0 toillionoreign assets stood at5 billion at the end of lastf

In response to the worsening financial situation, Baghdad adopted domestic austerity measures and began borrowing heavily from abroadi obtained more credits and credit guarantees from foreign governments, commercial banks, and private firms to finance imports-including some military equipment-and projects. We estimate Iraq's foreign debt increased6 buu'on-moslly short-term trade credits--before the war toillion by the endts Persian Gulf allies provided anillion in wartime fujanrial assistance, mostly oil sold on Baghdad's behalf that is unlikely to be repaid.

Iraq bas experienced payment problems3 that have forced it to reschedule the bulk of payments due annually-mduding short-term credits, interest payments, and previously rescheduled debt-and accumulate large arrears. It has negotiated debt rescheduling agreementsilateral basis in an effort to play creditors off against each other and obtain concessional repayment terms. Debt servicing problems climaxedhen world oil prices plummeted and large debt payments fell due. Iraq's already dismal payment record worsened, causing creditors that had not already cut off aerfjUines to do so and forcing Baghdad to scramble to pay for essential civilian imports. fl| gtf

Debt Problems Persist In Postwar Period

Saddam's policy is to treat most debt servicingow priority in favorthe economy, improving depressed living standards, andmilitary spending. Press reports indicate the regime has embarkedinvestment plan for postwar reconstruction and development of mdustryBaghdad has spent several billion dollars since theonstructing ou export facilities, expanding port lacflitics,and rebuilding the cities of Al Basrah and Al Faw,

BPmf It also boosted civilian imports last year^yTurr^Opercentto TueTugnesi level2 to help meet pent-up consumer demand and quiet popular grumbling. Although imports of military materiel were reduced byillion last year, we believe the regime diverted most if not all of these savings to tne development of its own military industries. The acquisition of new financing for postwar projects and imports has complicated debt servicing woes because most of these credits are short-term, adding further burden to Iraq's heavy repayment schedule in the next two years.

We estimate Baghdad met only aboutDjion of at leastillion in principal and interest payments due9percent rise Ln ou revenues for the year. It rescheduled nearlyillion owed to France, West Germany, and Italy and is trying

!9cr-*di*dule "na"ung payments that were due to other creditorsccording to US Embassy and press reportina. To conserve foreign exchange, Baghdad used oil to repay debt lo several major creditors last year, including Japan, Turkey, Brazil, and Yugoslavia. .Allhough we estimate it repaid nearlyillion more9 than the year before, it did so in most cases io unlock new credits, thuset reduction in itsmMW

Baghdad continues to repay iu debtelective basis, giving priority to suppbers of key goods or new crediu as well as to important political allies:

o It generally has made prompt paymenu for important oD projects, including the construction of iu pipeline through Saudi Arabia and tbe restoration of iu oflshore oil terminal at Mina al Bakr.

o Jlie United States has received timely debt paymenu, mostly because it has provided significant new agricultural credit guarantees

o Lraq has granted priority in recent years to repaying iu debt to Jordan-mostly in the form of oil deliveries-because of iu gratitude for Jordanian support during the war as well as concern about Amman's serious economic problems.

0 Baghdad began making back paymenu oo Egyptian remittances lateafter publicity about iu mistreatment of Egyptian workers riskeddisruption of iu relations with this important Arab

In contrast, major creditors!generally have had lo bear the brunt of Baghdad's debt servicing problems,

ersutent debt servicing problems have restricted severely iu accessloans Most commercial banks remain unwilling to extend unsecured loansSeveral govemmenu-in an effort to promote exports-have agreedmore trade and project financing since tbe cease-fire, giving Iraq accessJ5 billion in financing lastost of these crediu are short-term,contingent upon repayment of old debt, allowing Baghdad to merely roll overto some creditors,

Outlook

We believe debt problems wffl remain the major constraint to Iraq's postwar economic recoveryaymenu will siphon financial resources away from more productive uses well mio. Although we believe thc regime will try to insulate mgb-pnonry military and oa" projecu from tu financial constrainu, iu poor debt serviong record will restrict access to new financing of the magnitude needed to fund

Ncuh-iDovernmeni crcdJIi ud credil goods and soviet! from firms ia ihcie couoirict

yucca available to Iraq arc tied to lhe porcbaie of

HrWifBrnmiinTi

Iraq wiD probably not begin paring down iu debt for several years. Repayment of roost old debt wiDelatively low priority in favor of spending on strategic military and civilian projects, particularly in view ot tbe regime's confidence that it can secure concessions from its creditors. In addition, Baghdad wiD incur new debt as it obtains financing for reconstruction projects and higher levels of imports. We believe it wiil try torescheduie at least half of theillion due annuaDy during the next few years. 9 V

Despite its dismal repayment record, we believe Baghdad will continue to secure debt relief in the form of reschedulings and Limited new credits from most of its creditors, including Japan, West Germany, Italy, and the Uniled Kingdom:

o Most creditors probably realize that providing such concessions is the most effective way of eliciting at least some repayment of old debl from Iraq.

o Many creditor governments are heavily dependent on oil imports and want to maintain good relations with Iraq, which possesses the second largest proved ofl reserves in the world.

o

Many governments are likely toimited amount of nwor credit guarantees because'they are under pressure from domestic firms anxious to participate in this potentially lucrauve marfcet.

We believe competition between government creditors to help their firmsoothold in the Iraqi market will continue to discourage them from banding together to force Baghdad to negotiate debt accordsultilateral basis-as most debtors do-except in the unlikely event that Iraq ceases servicing its debt allogcmer.^fl^

Implications For tbe Uniled States

Although ties with Washington have been damaged by several recent events, Baghdad probably wants to maintain access to credit guarantees available from the Commodity Credit Corporation (CCC) and Eximbank. Iraq relies on the CCC program, in particular, toignificant amount of food and other agricultural commodities on credit. In addition, Baghdad believes the provision of these credit guaranteesositive signal to other lenders that Washington bas confidence in Iraq's creditworthiness, according to US Embassy reportint Tbe loss of the CCC program would lead Iraq to seek agricultural goods irom alternate suppliers willing to sell on credit Although few individual countries would be likely to supply new credits to Baghdadevel commensurate to the CCC any time soon, Iraq would probably be able to access smaller credit facilities available from several countries.fl |f

Any loss of US credit guarantees would jeopardize continued adequate servicing of about S2 billion in Iraqi debt backed by the United States. We believe Baghdad would continue to make repayment toriority only if it believed doing so would help restore the credits in the short term. If Iraq believed there was no possibility for new credits, the United States would lose its special repayment status, in our judgment Baghdad would probably not suspend payments if Washington refused to release the0 millionillion in CCC credit guarantees allocated to Iraa forut almost certainly would if the entire CCC programancelled or seen to be politically dead because of Congressional opposition. fl

US-Iraqi Commercial Relations

Tbe provision of US credit guarantees to Iraq bas buoyed tbe substantial increase in bilateral tradehe extension7 billion in credit guarantees by the CCCas helped Iraq become the largest Middle Eastern market for US agricultural goodsajor world market as well. Substantial agricultural sales-which comprise aboulercent of US sales to Iraq-have helped makeajor source of Baghdad's civilian imports. Iraq bas also0 million in short-term credit guarantees available from Eximbank

US imports from Iraq have also increased sigruficantly. US purchases of Iraqi oil have jumped fromo faraboutercenLjof Baghdad's lo'.al oil exports and eight percent of net US oil

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Iraq has pursued closer bilateral commercial ties because it wants to increase its economic importance to the United States in hopes of pffsetling what Baghdad regards as Iran's greater geopolitical value to Washington. In addition, the Iraqis have high regard for US goods and technology. To encourage stronger ties, Baghdad

bas:

o Treated Washingtonavored creditor; as recently as February Iraqi diplomats told US officials Lhat Iraq continues to give preference to repayment of aboutillion in US-guaranteed debt

o Lobbied for medium-term credit guarantees from Eximbank and pushed for tbe formationoint economic commission.

o Stressed the prospects for lucrativeraq in tbe future as well as ine importance of its massive ofl reserves to long-term US and Western energy needs-

Iraq also gave extensive publicity to the US pavillion at the annual Baghdad Trade Fair last November, including the unprecedented visit ofutVj^ne Minister Sadun Hammadi and two other ministers to the paviUioaJfl WT

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