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Last Updated: Friday, 16 July, 2004, 15:53 GMT 16:53 UK
Iraq prepares to launch bond market
By Kabir Chibber

Adel Mahdi
Iraq's newly appointed finance minister Adel Mahdi
If you woke up tomorrow and were the finance minister in Iraq, what would you do first?

"You have a collapsed economy that is a quarter of the size it was back in 1979 before the Iraq-Iran war, an economy essentially bankrupt, internally and externally. The state system collapsed along with Saddam," said Jan Randolph, chief economist at World Markets Research Centre.

So your choices will be crucial to restoring the country's economy.

On the advice of the US Treasury, the new Iraqi finance minister Adel Mahdi has made his first major decision.

Iraq will launch a bond market, beginning with an issuance of 150bn dinars (54m, $100m) worth of treasury bills on 18 July.

The bills will have a 91-day maturity period and will yield between 5% and 8% annual interest, quite low even by emerging market standards.

Building confidence

A bond, or debt, market is one of the three pillars - as well as a stock exchange and a foreign exchange market - of what is generally referred to as the banking system.

The establishment of a bond market is an essential kick-starting of the financial markets
Jan Randolph, chief economist, World Markets Research

The new Iraq Stock Exchange, with a fully automated trading floor, opened on June 24.

"The establishment of a bond market is an essential kick-starting of the financial markets," Mr Randolph said. "Without the turnover of borrowing and lending, the banking system can't function properly."

Advanced economies have longer term bonds. "But before governments can issue 25- or 30-year bonds, they have to establish creditworthiness and a track record in payment," he said.

Usually, before markets can work, it is the government that goes in and offers these short-term bonds to anchor the system and generate investor confidence.

Iraqi money changers
Money changes fast in Iraq

A US Treasury official in Baghdad, who has been instrumental in setting up the Iraqi bond market, said he expected 99% of the bond buyers to be Iraqi commercial banks.

Not only will the demand for the bonds set new market-based interest rates, but Iraqi banks "need to invest somewhere to make some money" said Mr Randolph.

"At the moment, banks are not earning anything and they have nothing to offer their customers.

"This is nothing to do with politics. It's strictly economics," he said.

But in a country like Iraq, where the per capita income has fallen from $3,200 in 1979 to roughly $500-600 per person now, the politics and economics are unavoidably linked. Iraq is launching a bond market now because it needs cash.

Foreign aid

On June 4, former US administrator Paul Bremer signed the public debt law, meaning the government has to pay all its previous domestic debts to Iraq's commercial banks under Saddam Hussein.

The Coalition Provisional Authority (CPA) also passed a law in January creating the central bank and giving it independence, meaning the government cannot use the bank as their own personal checking account, as the former dictator did.

With local debts as well as a cash shortage, most analysts agree that a bond market was the most obvious way to move.

Iraqi oil refinery
Iraq has a "one-item" budget - black gold

There is little information available about the Iraqi budget, but it is agreed that the interim government has largely been dependent on foreign aid.

But even that has not worked out as expected. Of the $18.8bn marked for Iraq by the US Congress, only about $3.7bn has actually been spent. $2bn of that went into restoring Iraq's electricity infrastructure, another $500m went to security forces like the police and the rest has been used to try and guarantee clean, running water.

Most of Iraq's other revenue comes, unsurprisingly, from oil. The US official said Iraq has a "one-item budget: oil".

He said a bond market creates another source of revenue in the event insurgents were to damage more pipelines or world oil prices dipped.

Tax barriers down

While it was in charge, the CPA aimed to signal a break from the Saddam regime by instituting one of the most deregulated and liberalised tax regimes in the Middle East, with a maximum rate of tax of around 15%. Most of the CPA's economic policies have been carried over by the interim government.

Iraqi women shop for grain
The shopping experience is improving for the Iraqi people

When former US administrator Paul Bremer removed tariffs on most imports, it created a 'Berlin Wall down' effect, Mr Randolph said, where Iraqi households were finally able to buy satellite dishes and western goods.

But he said these changes from pent-up demand are largely cosmetic and do not mean that the economy is improving as rapidly as the aesthetic changes to Iraq suggest.

Even if the bond market was to jumpstart the economy and Iraq began to get a lot of foreign investment, it would still be a while before the Iraqi economy would return even to Saddam-era levels, which were never larger than the supermarket chain Tesco in total market value.

Religious tourism

However, Iraq's future is brighter than most other war-scarred countries. Iraq sits on the second-largest oil reserves in the world.

If I am permitted to dream, Iraq will develop into the Japan of the Middle East
Talib al-Tabatie, chairman Iraq Stock Exchange

While oil will be the main driving source of the economy, there is also the prospect of Islamic religious tourism. Iraq has two of the holiest sites in the Shiite Muslim faith and many Iranians are clamouring to visit them.

And the nascent Iraq Stock Exchange, with 27 listed companies held over from the Saddam era, had more than 500 million shares traded on its opening day, more then the former Baghdad Stock Exchange ever did.

Talib al-Tabatie, chairman of the exchange, said he expected an index of 180 to 200 public companies by the end of the year. "If I am permitted to dream," he said, "Iraq will develop into the Japan of the Middle East".

"Potentially, the prospects for Iraq are good. If the security situation gets sorted out, then we can make progress on the politics and economics," said Mr Randolph. "And business depends on a secure environment as much as human beings do."



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