Imagine that you are one of the thousands of Italians, Japanese, Germans, Americans or Argentines who decided to invest in Argentine bonds during the 1990s. That makes you one of those people who loaned his savings to the Argentine government, so that Argentina could finance its public spending by paying interest to investors. Like Italians or Argentines, instead of putting your money into personal purchases or spending, you put it in bonds that offered advantageous interest rates; that is to say, rates that were much higher than those offered by other Latin American countries.
You would never have imagined that in 2001, Argentina’s worst social and economist crisis would take place, and that the government would wind up declaring default – that is, a total suspension of its payments of Argentine debt, including its obligations to international organizations, in particular to the IMF and the Inter-American Development Bank. Shortly before the default was declared, Domingo Cavallo, then minister of the economy, confiscated all bank deposits. (Cavallo is now a professor at HarvardUniversity.) That is to say, the government froze all current and fixed-term bank accounts of Argentine citizens in various banking institutions where people thought that the deposits were going to be guaranteed.
From December 2001 until today, Argentina has had five different presidents. It was only last month – more than 640 days after that event – that the Argentine government, under President Néstor Kirchner, came out with a proposed solution for restructuring part of the swollen Argentine debt, which has now reached $170 billion.
Unhappy Creditors
In September, the Argentine government managed to conclude a three-year agreement with the IMF after going through some difficult negotiations. It signed a letter of intent that provides the Kirchner administration with enough breathing room to launch a solution to a problem that has been delayed since December 2001 – the restructuring of the government’s debt with private creditors.
Roberto Lavagna, Argentina’s current minister of the economy, made the announcement during the annual meeting of the IMF, which took place recently in Dubai. The announcement was much tougher than international analysts had expected. To be specific, the government proposed to return money to its creditors but at an overall debt relief rate of 75%.
Although no one realizes it, this amounts to the largest debt relief in history. “The proposal was extremely tough, and apparently it is going to stay that way. It is the largest volume of debt – in terms of the quantity of bonds to restructure, the number of currencies involved in the restructuring, and the proposed [value of the] relief. That is to say, it is the toughest position of a country regarding its debt,” notes Cynthia Moskovits, economist at the Foundation of Latin American Economic Research (FIEL).
According to economist Marcos Ochoa, professor of postgraduate financial studies at the University of Belgrano, “If you look at earlier international parameters, Ecuador brought about a debt relief of 40%. Another example is Russia, which brought about an average reduction of 26%.”
As for why Argentina felt like cutting its debt to such a degree, “there is no concrete explanation,” says Gustavo Lázzari, director of public policy at the Atlas Foundation, and professor at ESEADE, a center for the advanced study of economics and business administration. Lázzari contends that the country is taking a hard line position because of the U.S. “The Bush administration is business-oriented, and it doesn’t have much sympathy for the IMF. In fact, the American president advised Kirchner to maintain a hard line position. Moreover, there aren’t many American creditors among those who would suffer this pruning of 75%.”
However, Italian, Japanese, Argentine and German bondholders – many of them retirees – are angry about the proposal because for each dollar they invested, they would be recouping barely 25 cents.
Kenneth Dart, a tycoon who manages a ‘vulture fund’ that has already managed to get a court ruling in New York, could before long win the right to recover $700 million. Vulture funds manage a lot of money and they invest it in bonds of emerging markets in order to earn interest.
The total value of private-sector bond debt to be restructured has reached $94.3 billion. Of that, $87.05 billion are in bonds and the rest in interest payments. The debt was issued during the 1990s through means of 152 different types of bonds (for example, the Global series, maturing in 2012 and 2015); in 14 different currencies (including the dollar, euro, yen, pound sterling, Swiss franc and Argentine pesos), and in eight jurisdictions.
“The ultimate goal of these negotiations is to lower Argentina’s indebtedness from 130% of its GDP to 80% by means of various relief measures. Some kinds of bonds remain outside the deal, such as the BODEN, which will be exchanged for other bonds,” explains Ochoa. Guillermo Nielsen, the minister of finance, says that the old bonds will be cashed in for three new bonds. Nevertheless, the government hasn’t offered details about payment periods and rates for these notes.
Until now, people have been talking about par value bonds that would maintain their value but have longer payment periods (about 30 years) and lower interest rates. The relief would amount to 75% but it would be recovered within 10 years at a much more attractive rate than par value. Finally, there is talk about “capitalizable” bonds, which would provide a discount at a fixed rate, plus some other rate that would vary along with the way Argentina’s economy progresses in the future.
According to Ochoa, “private Argentine bondholders would respond more positively to a proposal involving ‘capitalizable’ bonds because they are going to bet that the country’s economy will improve. That way, foreigners might prefer the discounted bonds so they could get out of Argentine debt faster, because they see it as a loss. In such a way, whatever funds foreigners could recover would seem better than waiting 30 years for a return equal to the par value of the bonds.”
Ochoa adds: “Perhaps those people who accept the bonds will be participants in the Argentine retirement fund [known as the AFJP]. That’s because they have more time to wait. The average person who contributes to the AFJP is between 30 and 45 years old. Anyone who is close to being in his 30s can wait another 30 years, which is what the law requires in order to contribute for retirement purposes.”
The government is also planning to reduce the number of currencies in which it issues bonds; this would be done only in dollars, euros and Argentine pesos. The government will even reduce the number of jurisdictions where the old bonds are registered.
A Long Negotiation with Creditors
This much is certain: The process of reengineering private-sector debt will be quite complex and take a long time. For example, Standard & Poor’s, the firm which grades risk, claims that the negotiations with creditors for the debt restructuring will perhaps take a considerable stretch of 2004.
The next step for the government will come in sometime this month when it chooses the banks that will place the new bonds in the marketplace, among them Deutsche Bank. To do this, the team at the ministry of the economy must establish assignments for the various banking institutions that will be involved. Economists believe that this process will be very expensive for the State, and it will have to be at least a bit tempting for the banks involved. Some sources believe that the cost could amount to $500 million.
In the case of Ecuador, for example, to restructure government debt the government had to offer banks a fixed sum, to which it added a percentage for those banking institutions that placed more than a fixed percentage of the bonds. Uruguay, in that regard, offered a commission of 0.4%.
Twelve banks will be involved in placing new Argentine bonds. They will be chosen for their importance in the marketplace, without resorting to any bidding process that might speed up the timing. Then, four Regional Organizing Banks will be chosen to focus on managing negotiations in Asia, North America, Europe and Argentina. In order to tone down the discussions and speak face to face with creditors, Lavagna and Nielsen traveled this week to New York, where they met with banks and creditors. In any case, other officials of the Argentine government will start the next round of negotiations on October 20. It will include visits to Tokyo,New York, Milan, Zurich and Buenos Aires.
Most bondholders are Italian (450,000), German (50,000) or Japanese (30,000). Add to this Argentine members of the AFJP, who amount to 9.3 million people, as well as those citizens who invested in bonds on their own initiative. Among those groups affected, Argentines are the most seriously damaged; they hold 39% of the $94 billion of debt. Of this percentage, 20% are members of the AFJP.
The AFJP case worries the Argentine government most because it involves contributions made by citizens over a period of nine years, ever since they set up this capitalization process. Why would AFJP members invest so much in state bonds? History tells us that, according to the law in effect during the 1990s, AFJP members could place up to 50% of their funds in public-sector bonds. But in 2001, Domingo Cavallo issued a decree that required people to place 100% of their money in public-sector bonds because of the government’s need to acquire fresh funding to finance spending. Later, Argentina went into default and a suspension of payments went into effect for 100% of AFJP funds.
The problem is, restructuring the debt could also shake up the system for forecasting contributions [to the AFJP system]. In that respect, there are various positions. Some people are betting on a “re-nationalization” of forecasting contributions so that only the state could take care of retirement and pensions. Others want to improve the current model, which has a mixed character – state plus private enterprise – while incorporating some changes.
Ever since the AFJP Union warned that it would not accept debt relief at such a high level as 75%, it has been working on its own plans for a law to reform the administration of retirement and pensions.
The International Financial Circuit
Because forecasts indicate that the negotiation process will continue until the end of next year, analysts are wondering if such a long wait will damage the image of Argentina and wind up making it harder for the country to get back on the world map. Ever since 2001, when the worst crisis in Argentina took place, a series of factors has kept the country outside global economic cycles. First, there was the social and economic crisis that provoked the resignation of Fernando de la Rua, then president. Next, the country went into default. That was followed by the confiscation and “peso-fication” of bank deposits. Among other factors, there was also the country’s high rate of unemployment.
If this is truly a sign that the current government is going to face the consequences, and propose a tough option for handling the country’s accumulated debt, economists wonder if all this will be enough to regain the trust of foreign investors and the rest of the world.
“Beyond the 75% relief figure established here, what you have to look at is how much support the government has for complying with this agreement,” notes Ochoa. “The team from the ministry of the economy has made certain assumptions: a growth rate of between 3 and 4%; and a fiscal effort to restrain spending to 3% of the GDP. Given these numbers, the government calculates that it needs to apply [debt] relief amounting to 75%. Where I have my doubts is with the other assumptions that the state has made – for example, the fact that it takes for granted future refinancing at upcoming expiration dates with international organizations such as the Inter-American Development Bank, the IMF or the World Bank. Another key assumption is that in the future, the State will be able to voluntarily capture 50% of the funds the AFJP collects between 2004 and 2018. If any of these assumptions winds up not being fulfilled, the entire scaffolding beneath this restructuring of debt could collapse.” If that happens, Ochoa believes that a long negotiation process could make it harder for Argentine companies to get financing outside the country, if they should need it.
In that sense, Lázzari believes that “the key thing for corporate financing is opportunity. Every small and midsize company, along with every large company, will have to find a way to get financing while getting rid of the bad image that we have as a result of the debt and our lengthy banking problem. And the country, at a governmental level, will have to support this. However, there is a shortage of signs that this is happening. We even see that Néstor Kirchner is not creating friends among business executives. Very much to the contrary, they attack him, and he is alienated from that sector.”
From another viewpoint, Moskovits believes that the setting in which the debt restructuring was planned looks quite good. “The Argentine economy is growing at a much higher rate than what the government expected. We [at the FIEL research center] announced that fact but not many believed us. Now, if we begin to negotiate the debt and we make certain price adjustments for public services that were postponed after privatization, and the economy continues to grow – then, we are going to enter a virtuous circle.”
Marcos Ochoa agrees with that viewpoint. “Today, in Argentina, they pay salaries of $100, which makes the country competitive. Once uncertainty about leading economic indicators goes away – and that is starting to happen – it is likely that the country will once again become a competitive place in which to invest, and it will grow again. I believe that this is going to happen, and that it is going to accelerate with time.”
However, no one dares to guarantee that, sometime in the future, when Argentina needs to borrow money again, savers from within the country and from abroad – whether Japanese or Russians – will once again have confidence in the country. “This [debt relief process] is just starting to happen,” says Lázzari. “We will see the consequences soon, when Argentina needs financing again, and it may be hard to obtain it. On the local level, they will also have to rearrange the AFJP system, so that people believe again that if they trust it with their savings, they will be able to retire in the future. Otherwise, people will be convinced that the best way to protect their money is to put it into bricks, into properties. That is to say, to live from rental income during retirement.”
