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Iraq reconstruction: If oil can't pay who will?

April 03, 2003 20:03 IST

A fire rages on the north side of the Euphrates in the town of Nassariya, in central Iraq. Picture taken April 2, 2003. Reuters/Desmond BoylanThe reconstruction of Iraq will be the most expensive aid operation since the Marshall Plan for rebuilding Europe after World War II, but wrangling between the United States and Europe means it is unclear the funds can be raised.

Any dreams that Iraq, which has the world's second largest oil reserves, could neatly finance its own reconstruction have evaporated due to massive debts and run-down oil infrastructure.

Europe and Japan, which have helped bankroll reconstruction in ex-Yugoslavia and Afghanistan, face budgetary constraints. Some Europeans may not pay for a war they do not agree with and in the absence of a post-war United Nations mandate.

That leaves one source of finance, the United States, which economists say may have to underwrite the cost, estimated by some at $100 billion, using Treasury bonds as collateral, something that would not add to US debt.

Iraq's problems are larger than those of Afghanistan and Yugoslavia. To put its needs in context, $100 billion is the aid given to 36 post-conflict countries in all of the 1990s.

Adjusted for inflation, the figure is almost as big as the amount spent in the post-World War Two Marshall Plan.

"We would really have a contingent liability on the US Treasury," said Professor Valpy Fitzgerald, a development economist at Oxford University and an expert on reconstruction.

US Treasury officials decline to comment on the issue of financing reconstruction, saying they are holding discussions, but if the US runs post-war Iraq, the kind of international solidarity which saw donors dig deep for former Yugoslavia and Afghanistan is likely to be in short supply.

The US is considering $2.5 billion for aid and rebuilding.

Germany has already said that the country which caused the damage should pay and European Union president Greece warned on Wednesday of new difficulties after the war ends.

"The management of issues in the (post-war) period by the attackers will trigger new conflicts and crisis," Prime Minister Costas Simitis said.

Building a chimera on oil

Before the US war on Iraq, there had been concerns Saddam Hussein would damage Iraq's oil infrastructure, thus hitting the country's ability to export and so its ability to pay for rebuilding after the war.

That appears not to have happened, but there are plenty of other pitfalls for a country which was once one of the richest developing nations. Per capita income was $4,000 a year in 1980 and is now $150 a year.

Even before the first US air strikes were launched on March 20, Iraq needed billions to shore up basic services for its 26 million citizens, 60 percent of whom are dependent on food aid, and an oil sector ravaged by 12 years of UN sanctions and decades of economic mismanagement.

The US has suggested Iraq could use $11-$14 billion a year in oil revenues for reconstruction.

But any attempt by the US to take Iraqi oil receipts would be on suspect legal ground as there is around $142 billion in enforceable debt claims on the country as well as up to $300 billion reparations outstanding from the invasion of Kuwait, plus $57 billion in contracts signed by the Iraqi government.

Washington could also create another flashpoint with states like Russia, which is owed $8 billion, if it supports a call by Iraqi exiles for forgiveness of all Saddam-era obligations.

In a benign economic scenario, oil export earnings would rise, enabling the country partly to fund its own redevelopment.

But with oil exports running at around $10-$12 billion a year there would not be enough money to finance humanitarian needs, debt repayments, even assuming a generous debt relief.

Yugoslavia saw 66 per cent of its debts written off after Slobodan Milosevic was ousted as a debt to gross domestic product figure of 150 per cent was deemed unsustainable.

Analysts calculate that Iraq debt payments alone would be $1.6 billion annually for the first five years based on a 66 per cent write-off and a five-year grace period, stepping up to $4.8 billion for the next 10 years.

Repairing existing oil export installations will require $5 billion and rebuilding electric power infrastructure could cost $20 billion to restore its pre-1990 capacity, according to the American Academy of Arts and Sciences.

Gulf, foreign and domestic capital

Other potential sources of capital are Gulf Arab governments, companies and banks which are sympathetic to the plight of Iraq, foreign multinationals and domestic savings.

Gulf bankers said that it was Arab governments -- some of which hold billions of dollars worth of Saddam-era claims -- that would put money in for strategic and political reasons.

"Once there is an acceptable regime change in Iraq, it becomes much more important to them. Afghanistan meant nothing by comparison," a senior Arab banker based in Bahrain said.

"They feel guilty about what is happening to the Iraqi people, plus the fact that a stable Iraq is very important to them," said the banker.

The minimum requirements for private sector capital would be a stable government, not an interim US administration, peace and clear rules and regulations, as well probably as some sort of government guarantee, probably from the US Treasury.

The private sector has the experience, but appetite for projects in developing countries has evaporated in the wake of Enron's experience in India and the sequestration of foreign investors' assets in Argentina after the country went bankrupt.

"The only way to get the private sector involved would be by so heavily insuring the risk and then raising money on the US corporate market to do it," said Oxford's Fitzgerald.

Problems in the global economy are also likely to limit the willingness of firms to risk their own capital as they are suffering from overcapacity in domestic markets, low domestic prices, weak share prices and poor credit outlooks, said consultant Robert Shephard.

"In the current environment, few firms are willing to tell the rating agencies or their shareholders that they are investing in riskier areas of the world," said Shephard, formerly responsible for global project finance at Bank of America and Nationsbank.

There is still capital in the country which could be invested, but that requires a stable currency and central bank.

Typically in post-conflict situations, the International Monetary Fund likes to insist on high interest rates to stabilise the currency, which cuts local risk appetite.

"Domestic investors, peasants, shopkeepers and so on are highly exposed to domestic monetary policy and interest rates which are affected by the IMF," said Oxford's Fitzgerald.

David Chance and Mona Megalli in London/Dubai
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