Will global markets continue to be jittery about Argentina’s latest sovereign default?
Negotiations in New York on July 30 failed to resolve differences with a group of bondholders — some in speculative funds derided by Argentina as “vulture funds” — demanding full payment on the $1.3 billion in bonds they own. A New York court overseeing the case then declared Argentina in default by missing interest payments on bonds due that week. New York-based hedge funds have been demanding full-value payments on the bonds they bought at steeply discounted prices following Argentina’s economic crash in 2002.
Immediately after the news, Argentina’s Merval Stock index fell more than 8%, and equity markets in Mexico, Brazil and other regional markets suffered declines. But prices steadied with news on August 6 that the creditors were considering an offer from Citigroup, JP Morgan, HSBC and Deutsche Bank of 80 cents on the dollar for their roughly $1.66 billion in Argentine debt, a development that potentially could resolve the issue, which the global banks would like to help along.
According to Bloomberg, “At stake for the banks, which include Citigroup Inc., is an opportunity to help Argentina resume payment on its bonds and regain access to overseas markets, bolstering the value of the debt and earning goodwill that could lead to underwriting business when the country starts issuing notes again.”
Repercussions for the U.S. and Argentina
The latest default is important “because it sets a precedent,” says Wharton finance professor Franklin Allen. “Going forward, sovereign default on bonds issued under New York law will be much more difficult. One likely response is that many countries will switch to other kinds of debt and avoid issuing these bonds. More generally, this development plus other recent events — such as the BNP Paribas fine — will lead countries to avoid the United States for financial clearing and settlement.”
There is also a danger of further contagion. Already, Latin American equities have taken a hit, notes Mauro Guillen, a Wharton management professor and director of The Lauder Institute. He calls that “unfair — whatever happens in [the financial markets] of Brazil, Chile, Mexico and Peru should have nothing to do with Argentina, but somehow the market associates Argentina with the region.”
More broadly, this nervousness comes at a time “when there is a lot of turmoil in global markets” given recent events in Ukraine, the Middle East and elsewhere, Guillen adds. Nevertheless, “it is discouraging to see that markets don’t discriminate in a better way” between Argentina and the other countries of the region. “The markets are jittery and they see this thing going on in Argentina, and they say, ‘Maybe we should get out of Argentina and Latin America as well.'”
“The markets are jittery and they see this thing going on in Argentina, and they say, ‘Maybe we should get out of Argentina and Latin America as well.'” –Mauro Guillen
Allen agrees that some markets have overreacted. “In the medium run it is unlikely that this will have a large effect. If I was advising Argentina, I would suggest they restructure and provide bondholders with fully equivalent value in Argentinian issued bonds indexed to the dollar. Another possibility is to give them bonds issued in China or Hong Kong. I doubt if in the long run the bondholders that are the subject of the current default will suffer much, if any, of a loss.”
Setting a Precedent
Despite the headlines, Guillen says the current crisis is not technically a default. “This is different in many ways” from Argentina’s sovereign default in 2001, when the devaluation of the Argentine peso left creditors with a great deal of debt that they had to pay back in dollars,” Guillen notes. That “was a complete sovereign debt default of $105 billion. It was the largest sovereign debt default in history — only surpassed by Greece more recently.” Guillen recalls that in 2001, Argentina had to go to the International Monetary Fund for support. “For four or five years [after that], Argentina was shut off totally from international capital markets.”
A few years after the government defaulted on the $105 billion in bonds back in the early 2000s, it reached settlements with 93% of the bondholders, who accepted deep discounts of 33 cents on the dollar to settle the issue. (Investors were likely to receive nothing if they did not accept this deal.)
However, the balance of the creditors — so-called holdouts — refused the deal, and eventually resold those bonds, to a U.S. hedge fund among others, for a small fraction of the already deeply discounted price. One hedge fund group involved in the most recent developments paid $48 million for bonds nominally worth about $1.3 billion, hoping to win full payment eventually with the help of courts battles that would take years.
Argentina has steadfastly refused to pay the full face value to the holdouts. Yet, even if the government wanted to settle the issue today, it has a big problem: The negotiated settlement states that, should the government provide payments to holdouts that are higher than the amounts paid to the 93%, then Argentina must pay all creditors at an equivalent level. The 33-cents on the dollar deal would no longer apply.
Then, a U.S. judge ruled that Argentina could not make any of the regularly scheduled interest payments due to the 93% of creditors who had accepted the negotiated deal unless the Argentine government first paid the holdouts the full value of their bond holdings. Despite the ruling, Argentina attempted to make the interest payments — as it has been doing for years — of more than $500 million to a group of creditors last week but was blocked from doing so by the U.S. courts, and thus entered default. Argentina wanted to take the issue to the International Court of Justice at the U.N., but the Obama Administration refused the request.
“In general, I think this, plus various other events, such as the BNP Paribas fine, will lead countries to avoid the United States for financial clearing and settlement.” –Franklin Allen
The government of Argentina, meanwhile, “claims that it is not in default because it has transferred a $563 million interest payment due to the group of bondholders who agreed to take less than full payment on its debts in negotiations that took place in 2005 and 2010,” explains Barbara Kotschwar, a research associate at Peterson Institute for International Economics. However, ratings agencies have reacted by downgrading Argentina’s bonds to default grade, and the cost of insurance on Argentine bonds has risen. Thus, “these latest developments are widely expected to damage Argentina’s economy and complicate future debt restructurings of problem countries.”
Kotschwar says the character and the magnitude of the two episodes (2001 and 2014) are quite different. “In 2001, Argentina was unable to pay its $81 billion debt. This time the level of debt is much less — Argentina owes $29 billion to the exchange bondholders — and Argentina has the ability to pay that amount. In 2001, its reserves were only around $14.5 billion. Today, while the level of reserves has been falling, Argentina has about $29.7 billion in foreign reserves.”
Argentina’s economic condition also is much brighter today than in 2001, when the country was experiencing its third consecutive year of negative GDP. While the country’s growth estimates for 2014 “range from anemic to negative,” over the past decade GDP growth has been “relatively robust,” notes Kotschwar — over 8% a year for most of the 2003-2011 period. Unemployment in 2001 was about 20%, now it has dropped to 7%. Moreover, “the political situation is also more stable. In 2001, two presidents had been forced to leave office.” Today, President Cristina Fernandez de Kirchner is in her second term.
Nevertheless, while Argentina is “still solvent,” this technical default “could have some negative consequences,” says Kotschwar. The controversial U.S. court ruling case could “exacerbate Argentina’s economic pressures” as well as “wipe out the policy space that government officials had started to open with a number of steps that demonstrated a willingness to adjust course.”
At present, Argentina faces several “economic pressure points: low — some estimate negative — economic growth, falling reserves, and the second- or third-highest inflation rate in the world” behind Venezuela and maybe Iran, she adds. “One could envision pressure on the peso and the already large gap between the official and [black market] rate, which might lead to another devaluation. This could lead to more protests and pressure to raise wages, which could have even more upward pressure on inflation.”
Consistent Underperformance
Financial analysts and Latin American specialists agree that Argentina’s most recent crisis is symptomatic of the country’s unique history, not a model likely to be repeated by other nations in the region or elsewhere in the developing world.
“These latest developments are widely expected to damage Argentina’s economy and complicate future debt restructurings of problem countries.” –Barbara Kotschwar
Guillen notes “Argentina is by far the country that has gone through the most sovereign defaults — 13 or 14. Every 10 years or so, they get into trouble. So [for Argentina] this is something that is not very unusual.”
Argentina’s political system is driven by a very populist political party — the Justicialistas — that “is not interested in setting Argentina on a path toward sustainable economic growth,” Guillen adds. “What they constantly do is make certain promises in order to gain votes. They use the government budget to try to buy votes.” In 2008, the party even nationalized $30 billion in private pension funds. “There are almost no checks and balances in the system. The executive branch has lots of power,” Guillen states.
Although Argentina has a relatively well-educated population, it “consistently under-performs,” Guillen points out. Argentina “is in a class by itself, but these days Venezuela is probably even worse.” On the other hand, Colombia has never defaulted on its debt — not even in 1982, when almost every country in the region did so. “The Argentine economy remains highly distorted,” adds Kotschwar. “The government has announced the reduction of some subsidies on water and electricity, but price controls and various subsidies remain, putting pressure on the government budget.”
Will the current crisis have any sustained impact on financial markets in Latin America or elsewhere? Unlike 2001, when there was a clear contagion in financial markets, knowledgeable “investors seem to consider Argentina a specific, sui generis case,” says Kotschwar. However, “contagion may occur if there is no quick resolution. If Argentina’s economy starts to be affected, it will very likely affect the Southern Common Market [Mercosur] countries, particularly Brazil, which is the most closely tied to Argentina” when it comes to trade in goods.
So long as international investors are jittery, adds Guillen, they will “tend to overreact to some of these things.” And even if the damage from Argentina’s latest sovereign debt crisis is quickly contained, Argentina “will have a lot of trouble” in the future unless they get out of the cycle of populism, Guillen notes.
“Until [Argentina] changes in a major way, it will continue to be a very risky place to invest,” he adds. What are the prospects of that happening soon? “They haven’t changed in 60 years, so I don’t know how likely that is.”
