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The IMF annual meetings should provide an opportunity for around half of the countries yet to reach an agreement with Iraq on its restructuring to do just that, and fall into line with terms set out in November 2004 by the Paris Club. The countries that fail to strike a deal in Singapore should sign up by the end of this year, leaving the country free to concentrate on reestablishing its financing credentials. Richard Jory reports.
Aseries of deals struck in the wake of the restructuring of Iraq's Paris Club debt in November 2004 have endorsed the haircut of around 80% agreed. With the Paris Club sovereigns and also the majority of commercial creditors in tow, it only remains for around 15 non-Paris Club sovereigns to agree to the same deal before Iraq can say it is clear of its financial restructuring.
Of the near 50 non-Paris Club countries that Iraq had to reach agreement with, only 15 have debt restructuring talks still in progress. While countries such as Slovakia and Malta have signed their deals with Iraq – both allowed Iraq to write off debt in full – so have fellow EU accession nations Czech Republic and Hungary.
Of the 15 that remain, the most influential is undoubtedly China – which has discussions that are still in progress. Debts racked up to the former Republic of Yugoslavia are the subject of negotiations that are in progress; and Turkey is in well-advanced talks that are progressing quickly to conclusion.
"The public sector has often accused the private sector of being slow to act," said William Rhodes, senior vice-chairman of Citigroup, which with JPMorgan advised Iraq on the commercial creditor debt. "But here is a case where not all sovereigns have signed up, but where the private sector has already taken its hit."
"In the Argentina restructuring, the private sector took all the hits," said Rhodes, who noted that Iraq had also to contend with a variety of creditors, unlike the restructurings of the 1980s and 1990s. Of the roughly two thirds of creditors signing up to the Argentina restructuring, around 20% were local investors, and there is still no full agreement to the workout.
Speed with a firm hand
The careful manner in which the talks are being conducted says everything about the delicate political nature of a restructuring that has drawn plaudits for its speed but also anger – largely among commercial creditors – for a firm handedness described by some as miserly and unfair. After all, once recovered, the underlying and significant oil wealth will ensure an economy that could be one of the richest in the world in GDP per capita terms.
Other debt to be rescheduled is being negotiated between Iraq and its regional neighbours. While a number of bilateral arrangements have been finally agreed, some suggest countries like Kuwait may have achieved deals that are perhaps a cut above terms come to with other creditors.
But there is little evidence of more lucrative terms being achieved. "I would be really astonished if the Iraqis had agreed something non-comparable with the Paris Club after two years of negotiations," said an observer close to the negotiations.
It is hoped that up to half a dozen of the remaining non-Paris Club countries will sign agreements at the IMF annual meetings in Singapore on September 19–20. The delay has been attributed in part to a lack of legal and political infrastructure that the Paris Club countries benefited from. The Club offered a procedure allowing members to negotiate and implement quickly discounts on outstanding debt. It is a relatively efficient institution and used to these processes.
Often countries not part of the Club have had problems when they are, sometimes for the first time, on the creditor side of the table. With no mechanism for accepting discounts for instance, these countries need to go through their parliaments and finance ministries. Paris Club countries do not need to go through this rigmarole because they have given over some of their sovereignty to the Club.
The deal cut most recently – a new bond that provided the proceeds to settle most of the commercial creditors' outstanding debt – was met with a better-than-expected reception, once those most aggrieved had either accepted the large haircut or opted to hold out.
"Total commercial claims cancelled amounted to US$19.7bn, with 11,776 claims cancelled," said Citigroup's Rhodes. "The middle tranche saw 100% of claims settled, the same as in the Mexico restructuring of the mid-1980s; 96% by value of eligible claims had settled."
Commercial banks were among the main losers in a deal that saw those with debts of less than US$35m forced to get back around 10-1/4% of their interest. "Everyone wanted a higher percentage of repayment; however, Iraq is in the midst of a civil war," said Rhodes.
"We had to convince the largest institutions – including some financial institutions – to join the deal," he added. "To get Iraq to sign off was tough because the conflict was still going on and given the difficult political and security situation. The prime minister and the whole cabinet signed off on the deal."
The complication for the advising banks lay in the inclusion of all creditors, particularly trade creditors, including direct contractors such as those from South Korea who had not properly registered debt with their own government. Trade creditors are not normally part of large sovereign restructurings.
The switch into a bond for creditors owed more than US$35m offered the benefit of getting slightly more back, as the bonds rallied on their release. Hedge funds and bank prop desks were the initial buyers, and they sold on to other hedge funds in order to take their own profit.
Bonds, and in some cases, loans were only offered to larger creditors because of the amount of legal paperwork involved, said people close to the proceedings. That said, the largest creditor BNL participated, as did BNP Paribas, although the latter has yet to sign any agreement with Argentina in its restructuring.
"Since issue the bonds have traded in a price range of roughly 65–74 and on a yield basis of 10.1% on 65 and 8.5% on 74," said a trader at a large investment bank. "Daily volume is around US$10m–$20m on average, but the market is a bit hit and miss. Hedge fund/prop guys tend to buy it, and there was some real money at the start but not so much since it's been issued."
After the initial excitement around an issue at a recent peak in emerging markets, interest in the bonds has subsided. The newly labeled debt was welcomed into the JPMorgan indices, making it a buy for index-tracking funds.
Initially trading as high as 73, the bonds have more recently settled around 65, making for a yield of around 10%, an attractive catch for investors, especially those that believe the due 2028 bonds have the implicit support of the US government.
"Bond prices in Iraq have really been hit hard and were knocked down to around 65–66 from 73–74 in February," said Peter Bartlett of Exotix. "So it has taken a beating and investors have not been seduced by the high yield [around 9.60%] because I suspect their appetite for a country in virtual civil war is waning, especially as a lot of this class of investors has taken hits in places like Turkey and possibly in the EM equity downturn. I still think they will continue to service this debt but it will remain firmly stuck in the high-yield high-risk spectrum," he added. The first coupon has been paid on the bonds.
No natural buyer base
However, as the bonds have fallen in price they have not found a natural buyer base to hold them up. Estimates from a number of large investment bank traders that the bonds see volume of US$10m-$20m a day have been rejected by some broker dealers. However, it has been hard to gauge activity during the seasonal summer slowdown and recent dip in EM debt.
The sell-off in EM over the last three months was inspired by an initial drop in EM equities, and then a rapid loss of interest in EM local debt, all of which took the sheen off the more exotic external debt, such as Iraq's. The sell-off has clipped the wings of those investing in the asset class and certainly those looking at investing in Iraq's bonds.
Once investors take the time to reevaluate their investment in the more exotic debt that EM has to offer, some observers suggest that they will return to forming a buyer base for Iraq, especially when they look at yields like the 6.9% on offer at the end of August for Serbia. Competition for investor interest will more likely come from LatAm debt, such as Peru and Ecuador.
"Iraq has seen a reasonable correction," said Exotix's Bartlett. "At around 10% yield, investors subscribing to the philosophy that it's a quasi-US protectorate find it attractive. However for investors who doubt the US's long-term commitment to Iraq the yield is far too modest."