US policy on Iraq's foreign debt may have collateral benefits for developing nations

Is America's need to assist Iraq about to pay massive dividends to one of the poorest nations on our planet? For nine months James Baker, the US special envoy on Iraq, has travelled the world seeking to drum up support for generous debt relief for Iraq.

Iraq has a foreign debt of $US120 billion ($175 billion), much of it accumulated by Saddam Hussein in the late 1980s to fund his wars. Of this, only $US40 billion is owed to Paris Club creditors - rich nations, including Australia. 

Under the World Bank's Highly Indebted Poor Country (HIPC) program, average debt relief of 65 per cent has been promised to 27 countries, but relief of only 19 per cent has been delivered, with a similar amount committed but not yet delivered unconditionally.

To qualify, nations have had to reform their economies and establish a good track record of poverty reduction. Yet nations are "graduating" from the HIPC program with debt burdens that, on the World Bank's own criteria, are unsustainable.

Now the US wants relief for 90 per cent of Iraq's debts. France, Germany and Russia are refusing to comply citing Iraq's oil wealth and the exclusion of their corporations from postwar reconstruction contracts in Iraq. France is offering to forgive 50 per cent of Iraq's debts, Russia 65 per cent.

Iraq owes Australia $700 million arising from sales of wheat to Iraq that we financed in the late 1980s. On May 31 the federal government said we would forgive $600 million - 85 per cent of the debt. But after criticism in Parliament, subsequent announcements have been vague on how much relief Australia will provide.

Iraq has the world's second-largest oil reserves. It certainly needs massive reconstruction aid. But a functioning government and economy will give Iraq sizeable debt-service capacity. Does it really need this unprecedented degree of debt relief?

But here is the rub: the US is owed less than four per cent of Iraq's debt. It is thus far cheaper for America to promote debt relief for Iraq than to give aid, most of which the US will have to supply.

So far, this story is unsurprising - the US pushing its own interests over those of its allies, and our government displaying its deeply ingrained instinct to give America whatever it requests.

Yet last week at the G8 summit in Georgia, things got very interesting. For two years Britain has been strongly promoting, and the US opposing, greater debt relief under the HIPC initiative.

Last week the US announced it would support 100 per cent debt relief for HIPC countries. The G8 did not take up this challenge but the US turnaround is dramatic. In addition, the US unveiled its "debt-for-democracy" initiative.

The idea is for developing nations to issue bonds with interest rates tied to the debtor's GDP growth rate.

Therefore, when the debtor's economy is growing slowly its interest burden will be reduced and, in good times, when growth is high, the debtor will pay a much higher interest rate to its foreign creditors.

This first-rate proposal will achieve two important ends: it will dissuade excess borrowing in good times - a temptation to which developing countries often succumb - and it will ameliorate their debt burden in hard times.

Our present global financial system does precisely the opposite. As most external indebtedness is denominated in a foreign currency, interest rates are low in good times as rates on foreign borrowings are lower than on local debt.

However, once a country encounters troubles, its currency is likely to devalue, thus dramatically increasing the real cost of servicing the debt.

This US proposal would counter this effect by tying the interest burden to debtor country growth.

Now, we only need the US to promote the idea of the New Zealand development expert, Peter Dirou, for Paris Club creditors to denominate all or part of the debt they are owed in the currency of the nation that owes it.

This would make the global financial system far more stable and promote prosperity for the debtor nations and their international creditors.

Finally, in an initiative of five members of the US Congress - three Democrats, two Republicans - a Bill was introduced on June 3 proposing a Jubilee Act that would require the US Treasury to work to achieve complete cancellation of the debts to the International Monetary Fund of the 50 poorest nations in the world. This marvellous initiative builds on the ongoing work of the Jubilee network.

If enacted, it will revolutionise poverty reduction in the poorest of countries.

Foreign debts are the single biggest impediment to poverty reduction in most poor nations, many of which spend five or more times as much on servicing their foreign debts as they do on health and education combined.

Foreign indebtedness takes children out of classrooms and food from their mouths. America needs progress on debt relief for Iraq now.

This imperative is prompting enlightened thinking on the problems of the desperately poor nations, nations that rarely show up on the American radar. Might this be the silver lining to the grey Iraqi cloud?