At the Museum of Foreign Debt in Buenos Aires, the message is clear: international capital markets can entrap borrowers. The exhibit chronicles Argentina’s debt from the 1800s to a reduction plan in the wake of a 2001 default on $100 billion, the largest in world history until a year ago, when Greece defaulted on more than 100 billion euros ($130 billion).
Reducing the debt isn’t proving easy. Argentina played hardball with creditors after ceasing payments and then blundered a restructuring of $81.8 billion of bonds. This has exposed Argentina to legal challenges from deft creditors seeking to collect face value on defaulted bonds they picked up in the secondary market at 20 cents on the dollar or less. Buyers like Paul Singer, an American billionaire hedge fund manager, have made three- to six-fold profits with the same strategy against Peru and other countries through legal challenges that force a country to negotiate or suffer a technical default.
The fight with Argentina has been playing out in US courts for the past decade, and a finale may be near. Two days after a February 27 courtroom hearing, the US Court of Appeals for the Second Circuit in New York ordered Argentina to spell out “precise terms” for any alternative payment formula for resolving litigation with creditors led by NML Capital, an affiliate of Singer’s Elliott Management, and Aurelius Capital Management. They want $1.33 billion for the defaulted bonds they hold. Argentina has until March 29 to submit the formula and a timetable for carrying it out.
The court order comes at a time when Argentina could use external financing to get through a rough patch of slow growth, rising inflation, stagnating international reserves and a widening fiscal deficit. “Argentina put itself in this awkward position,” says Rodrigo Olivares-Caminal, a reader in banking and finance at University of London. How it did this can be understood by comparing Argentina’s post-default decisions with Uruguay’s. The latter ran into financial problems after Argentina, its biggest trade partner, plunged into economic crisis in 2001. But instead of defaulting, Uruguay offered a voluntary debt exchange in 2003 to extend the maturity of its $5.4 billion debt by five years without writing any of it off. Uruguay got 93% creditor participation and was soon selling bonds again on capital markets.
Argentina wasn’t as efficient, friendly or meticulous. It told bondholders to take a 75% haircut – about 30 cents on the dollar – or forget getting anything. The offer got 76% acceptance in 2005 and another 17% in 2010 for a total of 93%. That’s not bad overall, but the country remained in default for 38 months before the first restructure, and took another five years to get to 93%. Argentina’s delay allowed Elliott and other creditors to organize a legal strategy and start litigation against the country before the 2005 restructure offer, Olivares-Caminal says. This prevented Argentina from using exit consent to sway creditors to participate. The technique allows the majority of creditors to encourage holdouts to participate in a restructure by making the old bonds virtually worthless. The holdouts beat Argentina to it by blocking holdings in some of the 152 series of defaulted bonds to prevent such a majority agreement.
That left the most favoured creditor clause. With this, Argentina reassured participants that if it were to give better treatment to another creditor then they would get the same until the clause expires on December 31, 2014. The government, however, left “settlement” out of the wording of the clause, Olivares-Caminal notes. This meant it would not protect the bondholders accepting the swap from a settlement deal with a holdout. To make amends, Argentina introduced a second assurance: the lock law. This prevents the government from reopening the exchange or making any sort of settlement with the defaulted bonds.
FISCAL MISMANAGEMENT
All told, the government can’t pay the holdouts in full, even if it wanted to “avert a technical default and get rid of the headache”, Esteban Fernández Medrano, an economist at MacroVision Consulting, says. That leaves one option: it must offer the same terms to the holdouts and hope they and others claiming a total of about $11 billion in pre-2005 debt accept.
Cristina Fernández de Kirchner, Argentina’s president, hadn’t exactly wanted this. Only late last year she vowed not to pay a penny to the holdouts, calling them vultures. Yet on March 1, she said, “We are willing to pay the vulture funds, but not in better conditions than the 93% who trusted in Argentina.”
Whether her offer is accepted or not, there is not much time. Argentina faces its next international bond payment on May 31. If the Second Circuit turns down its alternative for paying the holdouts, Argentina could face a technical default if it refuses to pay the holdouts at the same time as the holders of restructured bonds.
Whatever the outcome, the tussle with the holdouts has exposed a deeper problem that could lead Argentina to default for a fourth time since 1982: chronic mismanagement of public finances.
Things had improved. Nestor Kirchner, the president’s late husband, built a fiscal surplus after taking office in 2003 and widened it to 4% of GDP. This limited the country’s financing needs, allowing the central bank to increase reserves more than five-fold to $44 billion at the end of his term in 2007. The government even tapped the reserves to pay the country’s $9.81 billion debt in cash to the International Monetary Fund in 2006.
Kirchner and his wife, however, failed to sustain the fiscal surplus, even as the economy boomed by an average of 8% a year between 2003 and 2011. By 2007, spending was outpacing income. The response? The government raised withholding taxes on agriculture and oil exports, took the $30 billion private pension system under state control and wrested more access to central bank reserves. It needed more money to keep up with popular spending programmes – including on football broadcasting rights – and sustain low utility rates. The surplus slumped to a 2.5% GDP deficit in 2012.
And inflation rose. Cool the economy? No, the government started manipulating consumer price data in 2007 to show a steady 10% inflation even as private estimates calculate it at 25% for 2012 and closer to 30% now. The IMF cried foul and this year told the Fernández administration it had until September 29 to comply with the Fund’s rules for accurate statistics reporting or face a ban on borrowing from the Fund or expulsion.
Maybe worse, Argentina can’t borrow on global capital markets until it rectifies the data and settles about $10 billion in debt with the Paris Club of creditors. The latter may not accept a repayment plan until the former is settled.
Without access to capital markets, Argent-ina can’t take advantage of globally low interest rates, even as Bolivia, Guatemala and Paraguay sell bonds at yields of 5% or less. Fernández doesn’t want to anyway, saying this would return the country to escalating indebtedness like in the 1990s when public debt surged to 54% of GDP in 2001 from 30%.
Argentina has slashed its foreign debt – excluding that of the holdouts – to less than 13% of GDP, among the best ratios in the world. But the total debt has gone up to $183 billion from $125 billion in 2002 on rising transfers to the central bank, social welfare agency and state banks – now its chief sources of financing.
“By isolating itself financially, the government is exchanging capital markets for financing from the central bank,” Luciano Cohan, chief economist at Buenos Aires-based consultancy firm Elypsis, says. Central bank transfers to the government could reach 4–5% of GDP this year, up from 2–3% of GDP in the past few years, he says.
The government also started to print pesos to keep pace with 30–35% spending growth and safeguard hard-currency reserves as a cushion for paying debt. Lucas Llach, an economist, estimates the printing pace at 28% annually. Maximiliano Castillo Carrillo, who runs economic consulting firm ACM, doesn’t think this is sustainable. “A family can live for a year spending more than it earns, or two or three years, but not forever,” he says.
The consequence of staying out of voluntary credit markets and spending excessively is faster inflation, and this is irking people. Thousands hit the streets last November and December in protest, with one complaint clearly audible: that the government had removed people’s capacity to save. Bank deposit rates lag inflation by 10 percentage points or more. Buy hard currency? The government declared that illegal last year, which leaves the black market, where dollars cost 55% more than at the official exchange rate.
Adding salt to the wounds, this year the government wants to limit salary increases to 20–22%, or less than the 25–30% inflation, making it the first year real wages will decline since the Kirchners took power, says Rossi.
Another national protest is planned for March 21, and economic issues will be important in the mid-term congressional elections this October.
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