Dilemma in Iraq over investment

Iraq’s sovereign debt outperformed issues from the region this year, with hedge fund managers betting on healthy oil revenues and growing economic and financial strength for the country.

But the current political crisis has raised worries the recent bond rally may fizzle out.

The Paris Club agreement was set up in 2004 to restructure Iraq’s pre-Saddam era public debt of US$37 billion (Dh135.9bn), of which creditors agreed to cancel 80 per cent, while the remaining $7.4bn was rescheduled into a series of loans denominated in currencies.

Iraq’s 5.8 per cent dollar-denominated bond due in 2028 has rallied from $76.06 in January to $90.75, trading at a 13-month high. The yield is just under 7 per cent.

But there are now signs of caution.

“The days of equity-like returns on Iraqi debt are behind us,” said Bartle Bull, a partner at the New York investment group Northern Gulf Partners.

Violence and bombings have escalated since the withdrawal of US troops in December last year.

And the prime minister Nouri Al Maliki, who belongs to theShiite Islamic Dawa Party, has sought to unseat the vice president Tariq Al Hashemi, who belongs to the rival mostly Sunni Iraqiya party.

Relations between Iraq and the Kurdish regional government remain tense over oil rights.

All these factors are casting a gloom over the economy. The IMF had predicted it would grow 11.1 per cent this year but there are now questions about this forecast.

Hadi Ahmed, the owner of a plastics factory in Baghdad said there were signs the economy was slowing, especially for businesses that operate in the private sector.

“The market is frozen,” he said. “When a political crisis happens, the economy becomes secondary, contractors have seen delays in obtaining licences to build projects, retail has been affected in a major way. Everyone is watching to see what will happen.”

“In the absence of a structural change in the Iraqi story or its perception in the West, bonds have historically struggled to perform above $90,” said Jean-Michel Saliba, an economist at Bank of America Merrill Lynch global research, based in London.

Iraq’s 2028 benchmark bond has offered investors a return of 19.3 per cent so far this year. That compares with a return of 6.5 per cent of the HSBC/Nasdaq Dubai’s Middle East Conventional Sovereign US Dollar Bond Index. The Iraq’s benchmark debt’s yield is 6.7 per cent, the highest among issues from Middle East countries. Egypt’s benchmark bond yields are at 5.4 per cent, while Spain’s yields on 10-year bonds are at 5.6 per cent.

“You can argue that other countries in the region and elsewhere have a better political outlook but not as a good financial outlook,” said Gabriel Stern, a senior economist at Exotix, a boutique investment bank based in London that specialises in illiquid debt.

“The dilemma with any Iraq investor is you have poor institutions versus a strong financial outlook.”

Both public and external debt in Iraq are about to be put on a firmly sustainable footing, as more than six years of debt restructuring are nearing completion.

“The yield is very high but financially we are very good despite the politics,” said Mudher Kasim, the deputy governor at the Central Bank of Iraq in Baghdad. “The oil revenues could cover the upcoming challenges.”

Before the Paris Club agreement, Iraq’s external debt was 552 per cent of GDP. By 2009 the ratio was 142 per cent.

“We are approaching under 40 per cent this year,” Mr Kasim said. “So that’s pretty healthy.”