By Lester Pimentel
Aug. 29 (Bloomberg) -- Iraq's bonds are delivering the biggest returns in emerging markets as oil export revenue bolsters government finances and violence declines.
The country's $2.7 billion of 5.8 percent bonds due 2028 gained 45 percent since August 2007, according to Merrill Lynch & Co. indexes. Investors demand 4.84 percentage points more in yield to own the debt instead of Treasuries, down from 7.26 percentage points a year ago. The spread is narrower than for notes of Ohio banks National City Corp. and KeyCorp, suggesting Baghdad may be safer for bond investors than Cleveland.
Oil exports will climb as high as $86 billion this year, more than double the $30 billion annual average from 2005 to 2007, helping the country post a $52.3 billion budget surplus, according to the U.S. Government Accounting Office. A reduction in bloodshed has allowed the Bush administration to consider a ``general timeline horizon'' for troop reductions.
``The main driver'' of the rally is oil revenue, said Gunter Heiland, who manages $12 billion in emerging-market debt, including Iraqi bonds, at JPMorgan Asset Management in New York. ``The other is implied U.S. support. It's half a commodity story, half a political story.''
Yields on the bonds fell to 8.65 percent from a high of 11.81 percent in August 2007, according to data compiled by Bloomberg. The price of the securities surged to 73 cents on the dollar from a low of 54 cents a year ago.
`More Upside'
``There's still more upside,'' said Edwin Gutierrez, who manages $5.5 billion in emerging-market debt, including Iraqi bonds, at Aberdeen Asset Management in London.
Iraq, which has the world's third-largest oil reserves, sold the debentures in January 2006 as part of a settlement with creditors who agreed to forgo claims on debt issued under the regime of Saddam Hussein.
The price of oil, Iraq's biggest export, rose to a record of $147.27 on July 11, and is up 61 percent from a year ago. The country's daily production in the second quarter reached its highest level since the March 2003 U.S. invasion, the U.S. Defense Department said July 30.
Roadside bomb attacks dropped to 14 in June from 76 in the same month last year as a result of the U.S. troop increase and support of local Sunni Muslims battling al-Qaeda fighters, Army Lt. Gen. Thomas F. Metz told reporters Aug. 6, according to the Pentagon's news service. American soldiers would withdraw from cities and towns to nearby bases by next summer under a proposed agreement announced on Aug. 21 between the U.S. and Iraq.
Oil Field Dispute
``The political situation has improved substantially,'' said Jonathan Binder, who began buying Iraqi bonds for the more than $2 billion of emerging-market assets he manages at INTL Consilium LLC in Fort Lauderdale, Florida.
Gains may be tempered should a dispute between Kurds and Arabs for control of oil fields in Kirkuk trigger a resurgence in violence, said Ward Brown, who manages more than $3 billion in emerging-market debt, including Iraqi bonds, at Massachusetts Financial Services in Boston. The disagreement has prevented the Iraqi parliament from reaching a consensus on a law that would provide for elections this year.
Iraq's bonds, which don't have a credit rating, rallied even as more than $500 billion of credit market losses and writedowns drove investors away from all but the safest government securities.
National City and KeyCorp, based in Cleveland, have debt ratings of A and spreads of 9.81 percentage points and 7.48 percentage points. The banks are two of the more than 70 firms worldwide that have recorded about $512 billion in losses and writedowns since the start of 2007 amid the collapse of the subprime mortgage market.
Emerging-market premiums widened 64 basis points, or 0.64 percentage point, from a year ago to an average of 3.05 percentage points, according to New York-based JPMorgan Chase & Co. Iraq's yield spread is smaller than Argentina, Ecuador, Ukraine and Venezuela, JPMorgan indexes show.
``Iraq provides some insulation from the market,'' Brown said. ``The risks are so idiosyncratic that it trades on its own drivers.''
To contact the reporter on this story: Lester Pimentel in New York atlpimentel1@bloomberg.net
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