War-torn country left exposed to asset seizures as trust fund winds down
Iraq's vulnerability to creditor and war-reparation claims will rise after June when the trust fund established after the US-led invasion to finance its reconstruction and food purchases is dismantled.
The winding down of the Development Fund of Iraq (DFI), set up after the 2003 ouster of Saddam Hussein, could see commercial and sovereign claimants intensify efforts to seize Iraqi assets, often in compensation for events in the first Gulf War.
"Uncertainty over the magnitude of any potential claims may present a risk that bond holders may want to take note of," said Jean-Michel Saliba, Bank of America-Merrill Lynch economist.
Estimated at $7.5bn in cash and other liquid assets at the end of 2010, the fund holds the bulk of proceeds from Iraqi carbon and oil export sales. To allow it to focus spending on national reconstruction, food and debt restructuring, the United Nations granted the fund immunity from legal claims.
But this protection ends in July when the DFI is replaced, most likely by two separate accounts held at the New York Federal Reserve - including one to hold five percent of Iraqi oil revenues due to Kuwait for war reparation.
"The question is whether there is any pending litigation and whether creditors will initiate action. It's a tail risk," said a holder of Iraqi bonds.
With crude trading well above the $85 per barrel that Iraq's 2012 budget assumes, appetite for Iraq's global bonds of restructured Saddam-era commercial claims is strong.
The bonds, worth $2.7bn in sum, are trading at a yield of around 6.85 percent, close to their lowest since their 2006 issue.
But Iraqi debt still pays a bigger premium over US Treasuries compared to the JPMorgan EMBI Global Index, trading at 342 basis points compared to the benchmark's 314 bps.
"The bonds have widened some 25 bps to the index since mid-April. This could be partly due to concern over the end of the DFI but I definitely don't see a selloff," said Ashok Parameswaran, senior analyst at Invesco.
Given its moderate public debt - which the International Monetary Fund sees hitting 40 percent of output this year - and its wealth of natural resources, Iraqi debt should be trading through the index, said Invesco's Parameswaran.
But bond prices remain checked by uncertainty ahead of the US troop withdrawal at the end of this year and the chronic acts of violence that test the coalition government, he said.
Still, Iraqi finances have improved post-Saddam. In 2003, the country's external debt was $130-$140bn but that went down to about $88bn last year.
The Paris Club of 19 rich creditor nations agreed in 2004 to write off 80 percent of roughly $40bn debt to Iraq. Progress on debt forgiveness talks with non-Paris Club creditors remains uneven though the United Arab Emirates canceled Iraq's debt in 2008.
Estimates of Iraq's non-Paris Club debt vary but Kuwait, Turkey and Saudi Arabia are among the notable hold outs. Saudi Arabia is owed about $30bn while Kuwait is owed some $22bn in addition to war reparations likely to be fully repaid by 2016, BA-Merrill Lynch estimates.
Most analysts expect the remaining sovereign creditors to reach some agreement on debt forgiveness for Iraq.
"There are few signs that these countries will pursue their claims. It's more politics rather than finance," said Gabriel Sterne, senior economist at Exotix.
But war-related compensation remains an ongoing concern.
Last month, Iraq's parliament agreed to a $400m deal to compensate Americans held by Saddam as human shields during the 1990-1991 Gulf War.
The expiry of UN restrictions on financial claims on Iraqi oil assets could fuel other legal claims.
Baghdad remains in a long-running legal battle against Kuwait Airways which is seeking $1.2bn from state-owned Iraqi Airways in compensation for aircraft and parts seized when Iraq invaded Kuwait in 1990.
Though Kuwait Airways has obtained rulings in its favour, the UN protection on the bulk of Iraq's national revenues has hobbled its ability to enforce them.
This month, Kuwait Airways successfully seized millions of dollars from bank accounts in Jordan and the UK belonging to Iraqi Airways and other Iraqi state entities.
"Up to now it's not possible to seize Iraqi oil proceeds due to the UN resolution but after June, it makes it possible to do so," said Christopher Gooding, the lawyer acting for Kuwait Airways.
"It has been a long process but Iraq is beginning to re-enter the trading and commercial world and it will feel increasing pressure," he added.