| LONDON, June 19
LONDON, June 19 Escalating conflict in Iraq is
making holders of the country's international debt nervous about
whether they will get repaid.
The size of Iraq's dollar debt is relatively small - a $2.7
billion bond launched in 2006 in a restructuring of Saddam
Hussein-era commercial debt.
But the bond is held by international investors - including
Franklin Templeton, known for its bets on risky markets such as
Ukraine - and is part of JPMorgan's closely watched NEXGEM index
of frontier market debt, which has performed strongly over the
past two years.
Advances by Sunni insurgents across northern Iraq and the
emergence of an increasingly viable Kurdish state have got
investors worried that Iraq could split. This could lead to a
disruption of interest or maturity payments on the bond,
particularly as there are no clear market guidelines about what
might happen to the debt.
"There is no international framework for a sovereign debt
restructuring. If the remaining state is not viable, it may lead
to a sovereign debt restructuring - there are no rules," said
Stefaan Loosveld, partner and restructuring specialist at law
firm Linklaters in Brussels.
"The situation will be uncertain, not to say messy."
Iraqi government forces battled Sunni rebels from the
Islamic State of Iraq and the Levant (ISIL) - who have secured
cities and territory in Iraq and Syria - for control of the
country's biggest refinery on Thursday as Prime Minister Nuri
al-Maliki waited for a U.S. response to an appeal for air
strikes to beat back the threat to Baghdad.
Iraq had been a popular play with some frontier investors
because of the oil producer's low debt and high foreign
But the unrest changes that.
"We revised our view in Iraq and sold our overweight," said
Marco Ruijer, emerging debt fund manager at ING Investment
Management in The Hague.
"We still do not think ISIL can conquer Baghdad...but they
certainly increased their influence."
Iraq's bond, which matures in 2028 but starts paying
principal from 2020, has fallen 8 cents in the
past week, to 87 cents on the dollar.
Iraq's five-year credit default swaps, used to insure
against debt restructuring or default, are trading at
multi-month highs above 400 basis points, according to Markit.
Although there are no rules on sovereign debt restructuring,
there are precedents.
Ivory Coast stopped making interest payments on its dollar
debt during a civil war in 2011, though it has subsequently
If a country changed its name or borders it could repudiate
its debt, legal specialists said, though this is not a given.
Countries such as Czechoslovakia, which split in two in
1993, were able to make an amicable division of debt.
But this is likely to be harder in the case of Iraq.
"Importantly, (Czechoslovakia) was a consensual split and
the creditor countries had the feeling that they would still be
paid by the successor states," said Loosveld.
"A consensual split with an agreement on the debt division
is not likely in a civil-war scenario."
Iraq's next coupon payment of $150 million, due in mid-July,
is unlikely to come under threat, analysts said.
But the conflict is pushing up the default risk.
"Given the deteriorated security situation...a full
partition, if it takes place, would be more likely to occur in a
violent fashion," said analysts at Bank of America Merrill Lynch
in a client note.
"This would most likely be accompanied by a default event on
But not everyone is so concerned.
Bill Blain, strategist at brokerage Mint Partners, told
Reuters Insider television there had been strong two-way trade
in the bond. reut.rs/1lC4V10)
"The shock has driven most people...to be very concerned, or
driven them right out of the market," Blain said, but added:
"We've seen buyers who think potentially we are headed towards a
This may explain why the bond is at three-month lows, but
has not fallen further.
Iraq's CDS are also well below record highs above 600 bps
hit in 2009, at the height of the global financial crisis.
BoA-ML analysts said a separate Kurdish state would be
unlikely to shoulder any of Iraq's debt but added they did not
think any ceding to that state of territory and oil would be
"materially credit-negative to Iraqi external debt".
The Balkans war in the early 1990s and the collapse of the
former Soviet Union in 1991 also failed to lead directly to
default of debt, which is reassuring some investors.
"The Czech Republic, Yugoslavia and Russia are all good
precedents - as long as there was an official successor state
that recognized the debt, investors would still be paid," said
Richard Segal, analyst at Jefferies.
Iraq's role as OPEC's second-biggest oil producer may also
support its debt.
"Financial resources remain plentiful," Segal said.
(Additional reporting by Angeline Ong and Sujata Rao; editing
by Janet McBride)