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.