Iraq has the world’s second largest oil reserves, but before the 2003 war its human development indicators placed it only just ahead of Sudan and Bangladesh. [1] The war and its ongoing aftermath have left Iraq further shattered. At the most basic level, diseases of poverty are again sweeping through Iraq. Children, as always, will be the main victims, easily catching diarrhea and dehydrating quickly in the unrelenting sun. Making good on the language of liberation used to motivate the war requires not only that this fall be checked but that Iraq be set on a path to normal life again. Much of what this requires is complicated, but one thing is not: it will require money.

Aid money will be vital, helping to open schools and repair water treatment plants, though it cannot serve as the basis of economic development. Nor can Iraq’s present oil income. Oil revenue has supported only feeble growth over the sanctions decade, and it has declined further since the war. According to its own website, the budget of the US-British administration, which is almost entirely funded by optimistic forecasts of Iraqi oil income, is projected to run a deficit despite planning only very modest expenditures.

If Iraq is to hold even, let alone return to prosperity, it must attract investors. Their funds are needed to rebuild Iraq’s oil sector and — possibly more importantly — to help Iraq develop a flourishing non-oil sector. Attracting investors requires assuring them of a financial return. High levels of government debt, by increasing the risk of default, will hinder government borrowing to build public infrastructure. Debt will also crowd out private investment, as the private sector is taxed in order to pay debt service.

By 1990, after the Iran-Iraq war, Iraq’s debt had already become a major economic problem. The economy was in a shambles, and was further crippled with at least $42 billion [2] in debt, costing $3 billion annually to service. [3] By mid-1990, creditors were demanding payment, the inflation rate was 40 percent and cash reserves were equivalent to only three months of imports. [4] In search of a solution to the financial crisis, Saddam Hussein tried to bully the Gulf states into treating the funds they had given during the Iran war as grants not loans. [5] Having failed in this task, he invaded Kuwait.

Today, after two more wars and 13 years of sanctions, Iraq’s economy is even weaker. The debt has ballooned to unprecedented levels. Creditor debt claims total at least eight times Iraq’s entire annual economic output, the highest ratio of debt to gross domestic product in the world. [6] Economic recovery in Iraq requires that the debt overhang be removed. Unless this happens quickly, it is hard to see where Iraqi income will come from for some years. We therefore recommend a “clean slate” program designed to allow Iraq’s next government to take office free from foreign financial obligations. This is not a plan to sell Iraq’s economy to foreigners. Foreign investment in Iraq must be sensitively conducted and in Iraqis’ interests: it is an attempt to, first, help Iraq meet its most basic needs and, then, to flourish. Rapid and extensive debt elimination both makes economic sense and is widely supported by Iraqis across the political spectrum. [7]

Saddam’s “Guns and Butter”

The strong intuitive appeal of debt forgiveness is attested to by the broad coalition of NGOs and think tanks that has formed behind such proposals in recent years. A proper case for debt reduction, however, requires a firmer footing. Development economist William Easterly has set the terms of the debate in recent years by asking a critical question: why do countries become highly indebted in the first place? [8] If bad government policies are responsible for a debt problem, then debt relief may just lead to the continuation of those bad policies. Thus, Easterly has set two necessary conditions to be met before approving debt relief. Firstly, there must be “a proven change from an irresponsible government to a government with good policies.” Secondly, the debt relief must be “a once-for-all measure that will never be repeated” to prevent the countries repeating their mistakes and returning to creditors for fresh relief (as Uganda has done eight times since 1981).

Easterly’s first condition, as it is stated, is impossible to meet at the moment: a non-existent government cannot have proven itself. We believe that this condition can be modified in Iraq’s case, whose political structure is clearly undergoing significant changes. Regardless of who forms Iraq’s next government, it is unlikely that they will repeat the particularly damaging economic policy which ran up the debt in the first place — what Wajeeh Elali has termed “the guns and butter policy” of aggressive militarism and business as usual. This policy “led to Iraq’s imports expanding far beyond the country’s financial capacity” [9] at a time when that very capacity was being seriously eroded by the war with Iran. When Saddam Hussein became president in July 1979, Iraq had cash reserves of $36 billion and no long-term foreign debt. A year later, he launched the war against Iran and began spending up to three quarters of Iraq’s GDP on the war effort. [10] Between 1981 and 1985, oil revenues were just $48.4 billion, while military spending was two and half times higher at $120 billion. [11] Taking 1982 as an example, military imports were $6.4 billion and non-military imports were $21.5 billion while export earnings were just $10 billion, leaving a trade deficit of $17.9 billion that year. It was the high level of imports, both military and non-military, during the war which ran up the huge foreign debt. It is hard to imagine that this situation could be repeated: Iraq will be subject to extreme levels of international scrutiny, and the UN Security Council continues to maintain an arms embargo against it.

Even if such extreme policies are not repeated, what is to prevent the next Iraqi government from engaging in different policies that lead to unsustainable debt levels? In Easterly’s view, the main feature of such irresponsible policies is that they display impatience, typically financing consumption by an elite rather investing in the future. A government’s commitment to the future, though, depends on circumstances — and is usually weakened by political instability. Indeed, economists Tony Addison and Amimur Rahman argue that “the root cause [of impatience] is institutional decline,” [12] which weakens a government’s ability to regulate competition between groups in society. As this ability declines, the government and others in society become opportunistic. A weakly regulated economy is harmful in itself; it also deters investment. Addison and Rahman find that investor uncertainty “is more important in explaining whether a country is [highly indebted] or not than bad policies” in themselves. The looting, lawlessness and tensions in post-war Iraq are all the more worrisome in this light: the benefits of waiting for a new government to prove itself must be weighed against the costs of so doing, namely the increased likelihood of its failure.

A method of eliminating Iraq’s external debt can help break this vicious circle. A new Iraqi government will struggle to establish its legitimacy. Iraqi institutions have collapsed, and many Iraqis will see any new government as a tool of foreign control, as they did the monarchy in the 1950s. If the new government inherits a heavy debt load, it will have fewer carrots to spend on establishing its legitimacy, leaving it to rely on sticks, a pattern of Iraqi governance that should not be extended. Failure to establish legitimacy will reduce its ability to regulate social competition, binding Iraq more deeply to the cycle of opportunistic policies and failure.

A Clean Slate

Easterly’s second condition was that debt relief be “once-for-all.” This requirement is satisfied if the conditions of debt elimination are extraordinary, and in Iraq’s case, they are. The previous regime’s brutality and destructiveness are not in question. Iraq has been subject to the Security Council’s longest and most harmful sanctions regime, which has also prevented it from servicing debt. These circumstances will not be repeated.

The current absence of an Iraqi government is another reason the “once-for-all” condition can be satisfied. Whatever happens during the coming months cannot set precedents for future Iraqi government behavior, nor can it reflect badly on that government’s attitude toward its creditors. Iraqis must be centrally involved in negotiations on debt, and new financial obligations cannot legally be taken on before a government is in place. Nevertheless, the current absence of an Iraqi government need not be seen as a hindrance to eliminating old debt.

If a clean slate is the best policy, how should it be done? Most basically, account must be taken of existing claims. Iraq did not report its debt statistics to the World Bank Debtor Reporting System, leading to considerable uncertainly about their extent. Efforts are now being made to prepare an accurate assessment. The Paris Club, an informal roundtable of 19 major government creditors (including all the G8 countries), published tables of its claims on July 10. These confirmed a principal value of $21 billion, excluding interest (which they estimate to be roughly equal to the principal value).

The International Monetary Fund was expected to report in mid-July on government debt owed to non-Paris Club members. The report has taken longer than expected, possibly because some creditors have been reluctant to make their claims public. The numerous estimates in the public domain vary considerably. The largest component is certainly the contentious $30-50 billion claimed by the Gulf Cooperation Council countries. The remainder is private debt ($8-10 billion), some of which is likely to have expired; [13] a tiny amount of multilateral IMF and World Bank debt ($154 million); and other bilateral debt to countries such as Bulgaria and Jordan ($11.3 billion has been mentioned in the press; no figures have been stated for countries like Egypt, which may be significant creditors). All together, these figures give a total in the range $91-113 billion. [14]

On top of debt, Iraq owes war reparations from the 1990 invasion of Kuwait. The UN Compensation Commission (UNCC) established by the Security Council to handle reparations received 2.6 million claims, seeking over $300 billion in compensation. Under sanctions, $17.8 billion of Iraq’s oil revenue has been used to pay reparations. The vast majority were small claims from individuals, which have largely been awarded and paid. Most of the outstanding $28.5 billion in awards and $97.9 billion in unresolved claims are corporate and governmental, with a few for personal property.

This experiment in war reparations — whose nearest parallel may be those imposed on Germany after World War I — is not economically crippling in itself. Security Council Resolution 1483, which lifted non-military sanctions in May 2003, also reduced the share of Iraqi oil revenues directed to reparations to 5 percent. Nevertheless, these remain significant claims on future Iraqi income. As many Iraqis regard reparations as punishment for the actions of a dictator, maintaining them contributes to a sense of resentment which may have political consequences. (As an aside, UNSC 1483 does not protect Iraq from debt payments; it merely makes Iraqi oil immune from seizure until 2008. Creditors and reparation claimants can use other means to pressure Iraq into paying debt, as Jordan recently demonstrated by seizing Iraqi assets as security against debt payment. [15])

Having accounted for claims on Iraq, how should the reductions be conducted? In recent years, sovereign debt negotiations have largely been coordinated by the Paris Club. Some commentators have suggested that Club negotiations would reduce Iraqi debt by about two thirds, as in the case of Yugoslav debt. [16] Yugoslavia may not be a good guide. Iraq’s debt is much greater both in absolute and relative terms. Furthermore, the Paris Club members were deeply divided on the invasion of Iraq and may be less willing to agree on debt restructuring terms.

A more fundamental problem with Paris Club procedures is that they require a recognized government in place in the debtor country as a counterparty for its terms. This means that the Paris Club process could not get properly underway for at least a year. From then it would take many months to conclude both the Paris Club process and for Iraq to negotiate comparable treatment from all the non-Paris Club creditors (who may be unwilling to accept the Paris Club’s terms). Even by optimistic assessments, the process would
take until at least 2006, during which time investment in Iraq will remain unattractive and economic development unlikely. The road to Iraq’s economic liberation does not seem to run through Paris.

“Odious Debt” Tribunal

Instead, we recommend a two-stage procedure. First, an international tribunal should be established by the Security Council to rapidly assess Iraq’s debts in the light of the doctrine of “odious debt,” and to dismiss debt held to be odious. International legal scholar Alexander Sack first defined odious debts as those “contracted and utilized for purposes which, to the lenders’ knowledge, are contrary to the needs and the interests of the nation.” [17] As such, they are the personal debts of a despotic regime, not binding on the liberated people. This argument has been taken up by organizations as diverse as Oxfam and the Heritage Foundation, and by business leaders such as David Mulford, chairman of CSFB investment bank. [18]

To qualify for payment, creditors would need to argue that their loans were, to a certain extent, beneficial to the Iraqi people. The tribunal would rule on each claim and agree on repayment terms in proportion to the benefit received, in line with the legal principle of unjust enrichment, which apportions costs to benefits. [19] In making judgments, it could bear in mind what each of the creditors might reasonably have been expected to have known about the regime they were lending to, without requiring the insight than hindsight grants us.

Many have good reasons to be wary of further Security Council involvement in Iraq. Nevertheless, we believe that a tribunal established by the Council is the fastest way to free Iraq from its foreign obligations. The Council has the legal authority to nullify debt contracts; the usual channels require the consent of all parties, a much slower process. Additionally, ruling on the basis of odiousness allows case-by-case assessment, again faster than the multilateral channels pursued normally. To further allay suspicions about hidden motives, we recommend that the Council ask the International Court of Justice to recommend judges. The largest number of these should be Iraqis.

The second stage of the procedure would have the US government and its allies commit to purchase any debt judged legitimate by the tribunal at its market price today and unilaterally cancel it. This idea has been discussed with Bulgaria, whose finance minister stated that its $1.7 billion of Iraqi debt is valued at $250 million, about 15 percent of the present value (principle plus interest). The commitment only to pay the current market price of the debt will keep debt holders from holding on to it in the hopes of driving up its price. Those who did not sell their debt — and the US administration could bring considerable pressure to bear — would have to take their chances with a future Iraqi government. (Default, either selective or across the board, would be chaotic, and therefore costly to the international community, and could hamper Iraq’s ability to finance reconstruction and attract investment.)

All of this need not be expensive. Even before assessment by the tribunal, the non-Gulf debt is only worth about $9 billion at market value, [20] which can be seen as an upper limit on the cost to the US — no more than the cost of ten weeks of occupation. If the US led the way, the Gulf countries might recognize that it is also in their own self-interest to forgive
Iraqi debt. Jordanian investment banker Henry Azzam has written that the income lost to Kuwait from dropping its debt and reparations claims “will be more than offset by the major shot in the arm that greater security and a revived Iraqi market would give the country’s private sector.” [21]

There are many advantages to this process. If properly supported, it could be fast. As the US would commit only to purchasing “non-odious” debt, this stage would be inexpensive and avoid the charge of paying governments who “supported Saddam.” Globally, as the maverick financier George Soros said at a Center for Strategic and International Studies conference on June 12, it would “send a signal to the financial markets that it is dangerous to deal with oppressive regimes.”

The UNCC reparation claims also need to be addressed, though less urgently than debt given that there is a 5 percent cap on repayment under UNSC 1483. The vast majority of the extant awards and claims are governmental and corporate, since the claims for damages from individuals, which have the most compelling moral force, have largely been settled and paid. The UNCC has indicated that the remaining claims, such as the Kuwaiti environmental damages claim, are likely to be settled at a low level. The claimants, particularly the Gulf governments, may be prepared to drop their awards for the benefits of seeing a prosperous Iraq and having good relations with the new government.

Beyond Business As Usual

Iraq is burning, in many places quite literally. After 35 years of Saddam Hussein and 13 years of the Security Council’s harshest sanctions, pent-up expectations are being disappointed daily. Iraq’s next government will face, under the best of circumstances, a maelstrom. Without international support, it may not manage, drawing both itself and the region into deeper conflict.

The bombers who devastated the UN headquarters in Baghdad may be drawing their line in the sand, declaring that the US cannot provide Iraq with security and cannot meet even Iraqis’ most basic needs. Unless the Bush administration moves beyond business as usual, it will prove the bombers right. More Iraqis, and people throughout the Arab and Muslim worlds, will see the US as just another imperial power, an invader which has replaced enslavement to Saddam with chaos and enslavement to international creditors. Some will oppose it violently.

The alternative requires vision and boldness. Eliminating the debt would show Iraqis and the world that the US is committed to the long term, committed to giving a free Iraqi government a fighting chance to steer a path toward peace and development for all Iraqis. In doing so, the Bush administration has an opportunity to win hearts and minds and demonstrate firmly that it is neither anti-Arab nor anti-Muslim. Now, more than ever, the US needs to give the Iraqi people hope and to signal to both Iraqis and investors that they are committed to ensuring that Iraq succeeds. Cleaning the slate of debt would do precisely that.


[1] Authors’ calculations based on data from the UN Development Program (life expectancy and mortality) and US Treasury (GDP).
[2] Iraq’s memo to the UN Secretary General on April 29, 1991 enumerates $42.1 billion in debt as of December 18, 1990, but this figure excludes interest and disputed loans from Gulf countries. See Middle East Economic Survey, May 13, 1991.
[3] Sinan al-Shabibi, “Prospects for Iraq’s Economy,” in The Future of Iraq (Washington, DC: Middle East Institute, 1997), p. 58.
[4] Report to Congress, Conduct of the Persian Gulf War (1992).
[5] See Ahmed Jiyad, “An Economy in a Debt Trap: Iraqi Debt, 1980-2020,” Arab Studies Quarterly 23/4 (Winter 2001), for a detailed discussion of the loan/grant dispute.
[6] US Treasury officials estimate that 2003 GDP will be $15 billion. Fortune, June 23, 2003. A conservative debt estimate takes the low end of the $91-113 billion range discussed below, and adds the $28.47 billion in outstanding reparation awards. It does not include an estimate for presently undisclosed creditors or the $97.9 billion of unsettled reparation claims.
[7] Supporters of Jubilee Iraq, which campaigns for Iraqi debt relief, range from those who have worked closely with the US, such as Kanan Makiya, to diametrically opposed critics such as the Iraqi Democrats Against Occupation.
[8] William Easterly, The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics (Cambridge, MA: MIT Press, 2001) and “How Did Heavily Indebted Poor Countries Become Heavily Indebted? Reviewing Two Decades of Debt Relief,” World Development 30/10 (October 2002).
[9] Wajeeh Elali, “Dealing with Iraq’s Foreign Indebtedness,” Thunderbird International Business Review 42/1 (Spring 2000).
[10] Al-Shabibi, op cit.
[11] Elali, op cit.
[12] Tony Addison and Amimur Rahman, “Resolving the HIPC Problem: Is Good Policy Enough?” Paper presented at UNU/WIDER debt relief conference, Helsinki, 2001.
[13] Richard Segal, Iraq: Just the Debt (April 2003). Segal expects to see “a surprising number of claims” which are invalid because the statutes of limitations have lapsed. These “may give a new regime an innovative means to eradicate a good portion of the debt by only acknowledging strong legal claims.” The $8-10 billion figure is Segal’s latest estimate, updated from the figures used in his April report.
[14] See for tables of all debt figures in the public domain.
[15] Arab News, July 16, 2003.
[16] Segal, op cit.
[17] Alexander Sack, La succession aux dettes publiques d’État (Paris: Recueil Sirey, 1929). See for an English translation.
[18] Financial Times, June 22, 2003.
[19] Jeff King, Ashfaq Khalfan and Bryan Thomas, “Advancing the Odious Debt Doctrine” (February 2003) accessible online at
[20] This figure is 15 percent of the $62 billion debt, excluding the Gulf debt and reparations. The 15 percent figure accords with reports from Richard Segal that commercial debt is trading in the region of 30 cents to the dollar in principle terms. Given that at least half of the total present value of Iraqi debt is accumulatedinterest, this equates to 15 percent or less of the total debt stock.
[21] Arab News, April 18, 2003.

How to cite this article:

Colin Rowat, Justin Alexander "A Clean Slate in Iraq," Middle East Report 228 (Fall 2003).

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