Ten years since suffering the largest sovereign default in history, Argentina has – at least on the surface – defied critics by posting robust growth, reducing poverty and decreasing its enormous debt.
Even US secretary of state Hilary Clinton acknowledged this in a visit to Buenos Aires last year, noting that Argentina’s debt-to-GDP ratio is lower than that of the US. “However Argentina is doing it, it’s working,” she said at the time.
But any closer scrutiny shows that Argentina has paid a significant price for its go-it-alone approach to economic and financial management. The country has yet to return to the international capital markets and is starved for private investment. Capital flight increased by 47% in the first half of 2011 (to $9.8 billion) compared to the previous year, according to Argentine central bank data.
While Argentina’s financial meltdown played out for a global audience, at roughly the same time just across the narrow River Plate, Uruguay, its much smaller neighbour, also faced a financial crisis – but one mostly without the accompanying global fanfare.
Montevideo chose a different tack to Buenos Aires and negotiated an orderly restructuring of its debt – thanks largely to strong US backing.
A decade later, Uruguay is reaping the benefits of its actions. The country’s six-year average growth rate (per capita GDP) to 2010 was even higher than that of Brazil, Colombia and Panama. Its S&P sovereign rating is four notches ahead of Argentina’s and just a step away from investment grade. Moreover, it retains the sympathy of financial markets and has open access to international capital.
Claudio Loser, director of the Western Hemisphere Department at the IMF until 2002, tells Emerging Markets that in contrast to Argentina, “Uruguay was very smart in how it dealt with the IMF. It was a costly process for them, but they came out of it with their reputation intact and great respect in the capital markets.”
Edwin Gutierrez, portfolio manager at Aberdeen Asset Management, who manages $140 million in Uruguayan bonds, says that Uruguay’s economic success today is because “Uruguay has always had a philosophy of reaching out to the markets, unlike the Argentines.”
He says the 2002 crisis and 2003 debt restructuring made a great impact on the international investment community as it showed that, “through thick and thin, Uruguay has always had market-friendly proposals”.
Today the financial world appears to have turned on its head, with advanced economies, and not emerging markets, the locus of financial crises. Discussions abound on the lessons for today of past emerging markets crises, as Europe and the US struggle with hefty debt burdens and are forced to take the bitter pill of austerity.
But the divergent experiences of Argentina and Uruguay – two countries similar in so many ways, sharing tango, yerba maté, an all-meat diet and separated only by a narrow river – show that managing sovereign crises and weighing up whether or not to default is never easy.
Uruguay was perhaps fortunate in that the focus of IMF and market attention had been mostly spent on Argentina, given the size of its economy and the turbulence its crisis caused in emerging markets.
Carlos Steneri, the Uruguayan official primarily in charge of debt negotiations, tells Emerging Markets that the IMF had suffered from “Argentina fatigue’, and it thought that: “Uruguay was the same as Argentina so did not want to fund more programmes that, they thought, would ultimately fail.”
One observer said that Uruguay had also battled with the IMF – though its main challenge, according to officials involved at the time, was simply getting the fund’s attention.
For all the effort the IMF put into its decade-long experiment in Argentina, it is Uruguay – the South American country many claim the fund ignored – that emerged, at least in the eyes of foreign investors, as more successful. It did so according to analysts due to its handling of 2002/03, but also because of its subsequent macroeconomic policy choices.
SHORT-TERM BENEFIT
By contrast, Argentina opted for default, devaluation, and then disengagement which, to this day, has had serious consequences. A decade on, the country has yet to issue new debt in the international capital markets, amid increasing funding pressure on the government.
“Argentina’s strategy of using reserves to pay back debt is a finite strategy,” says Alberto Bernal, head of research at Bulltick Capital. It’s a strategy that will have to change, he says. “I expect Argentina to acknowledge that fact by issuing debt in 2012 to finance a portion of the shortfall.”
The country has been highly dependent on keeping fiscal and trade surpluses for financing, the latter mainly from agricultural commodity exports to China. One consequence of this is an erosion of leverage in trade negotiations with the Chinese.
Imports have risen to 15% of GDP, according to Maria Dal Poggetto, director of Estudio Bein & Asociados, a Buenos Aires economic consultancy. This is 50% higher than their previous peak in 1998 of 10.5% of GDP during the era of convertibility. This has had a debilitating impact on local manufacturing.
Argentina is also highly dependent on tax from agricultural commodity exports, creating greater potential for conflict with the country’s large and powerful farm groups. They have already clashed repeatedly: a 2008 strike paralyzed the country and inflicted more economic damage domestically than the subsequent global financial crisis.
The financing constraints Argentina regularly faces are perhaps the most acute contrast between the two nations.
“Argentina prefers to issue debt to its state pension system rather than issue Eurobonds to international investors given the uncertain status regarding lawsuits and threatened efforts to attach payments,” Gutierrez says.
In the long run, this is unlikely to benefit the economy. Gutierrez says Argentina’s way is “more costly than issuing standard Eurobonds. And the yield on outstanding debt is much cheaper in Uruguay than it is in Argentina.”
Argentina’s situation is different from Uruguay’s. Guillermo Nielsen, former Argentine finance secretary from 2002 to 2005, says that “the Argentine crisis was distinct due to the level of political interference from the IMF.”
He says that the fund prevented them from launching a debt swap in 2002 as they had wanted and instead chose to wait for the election of Néstor Kirchner as president. He says this produced trauma. “The IMF did not understand that Eduardo Duhalde was a constitutional president. They kept moving the goalposts on us.”
Taking advantage of having some independence from the IMF, Uruguay, in contrast to Argentina, took a different path in the grip of financial crisis, and today has few problems with its credibility.
HISTORY OF A COLLAPSE
For Uruguay the crisis started accelerating in 2002 as its GDP plummeted and unemployment soared. At the time Uruguayan banks held substantial amounts of Argentine dollar savings; these accounts were rapidly depleted after Argentine banks started freezing accounts, in the midst of its own financial crisis.
Because the IMF required Uruguay to publish daily reserve numbers to receive an initial assistance package, Uruguayan citizens began to fear the central bank and government were running out of money. The result was they copied the Argentines, and the bank runs worsened. In February 2002, 80% of withdrawals were by non-residents. By May, that 80% came from Uruguayans.
The country also faced IMF demands to tighten the fiscal purse strings. Steneri says he spent eight months trying to convince the IMF that drastic austerity measures and subsequent haircuts to creditors – another IMF recommendation – were wrong-headed.
Uruguay’s situation was distinct from that of Argentina – mostly, it was a question of size. “A very small country does not have the luxury of committing errors. If Uruguay had gone bankrupt, who’d care?” says Steneri.
“The struggle was to preserve the viability of the country just to survive in a world of giants. That meant that first we had to comply with the law. In addition to being a moral matter for us, it was an issue of survival.”
With little help from the IMF, Uruguay decided to appeal directly to the US, the fund’s largest shareholder, where it found a sympathetic ear in John Taylor, at the time US Treasury undersecretary for international affairs.
The US then convinced the IMF to agree to a plan to back dollar deposits in Uruguay, at a cost of $1.5 billion and to relent on pushing through an aggressive debt restructuring. Taylor says this was the first and only use of the Exchange Stabilization Fund – an emergency reserve fund of the US Treasury normally used for foreign exchange intervention – during the administration of George W. Bush.
Uruguay technically defaulted but through an orderly re-profiling of its debt. S&P rated it a ‘selective default’.
Taylor says, however, that the Uruguayans “worked cooperatively with creditors”, and led a voluntary debt exchange in which “payments were stretched out over five years without a change in net present value”. This was different from the aggressive exchange that the IMF had recommended.
And it paid off in other ways too. Gutierrez says that, “while Uruguay did technically default, it did not trigger a CDS [credit default swap] event. Most investors gave them the benefit of the doubt ... Uruguayans worked on a market-friendly proposal that also met Uruguay’s needs, and it has worked out for investors through to today.”
Another positive spin-off was a procedural one. Uruguay also incorporated Collective Action Clauses (CACs), considered relatively novel at the time. CACs make legally binding a decision by a supermajority of bondholders on all of them. This set a precedent for future debt exchanges. Taylor says that Mexican officials asked him about the Uruguayan experience and then started using them.
Indicative of the market’s praise for Uruguay’s restructuring, the country went back to the credit markets in 2003 itself, the same year of the debt re-structuring – by contrast, almost a decade later Argentina has yet to return to international capital markets.
REVERSAL OF FORTUNES
Almost a decade later, it is widely thought that the way Uruguay handled its crisis and led a relatively clean and orderly debt exchange paved the way for its subsequent success.
Alberto Ramos, a senior Latin American economist at Goldman Sachs, tells Emerging Markets that today “market sentiment differentiates the two realities – Uruguay versus Argentina – in a very significant way, and that can be traced to the way the countries dealt with this issue 10 years ago.”
Put simply, Uruguay is less constrained in its financing options.
Ramos says indicators of its better standing with investors include better credit default swap spreads, or fees on insurance for loan defaults, greater access to capital and higher sovereign ratings from credit agencies.
Indeed, Uruguay is booming: GDP has averaged 6.3% annually between 2005 and 2011, according to Standard & Poor’s. The ratings agency’s August report on Uruguay also gives growth estimates for the country for 2011 and 2012, 5.8% and 4.8% respectively, higher than that of Brazil, Colombia and Panama.
Though its fiscal deficit is increasing this year due to higher energy costs – according to JP Morgan 1.6% of GDP in 2011, up from 1.1% last year – its public debt has fallen from 114.5% of GDP in 2005 to 41.6% in 2010. S&P forecasts this to continue to decrease to 34.1% this year and 29.6% in 2012.
And although there is some concern over a bump in inflation – estimated to be 7.5% in 2011 – these are numbers Argentina could only wish for.
While Argentina’s macroeconomic performance has been more mixed, it has also been losing competitiveness. In the World Economic Forum 2011/12 Global Competitiveness report, Argentina ranks 85th, a drop of 15 from 2006/07. By contrast Uruguay ranks 63rd in the current report, a climb of 16 from that year. (Argentina’s first debt restructuring concluded in 2005.)
Loser says that Uruguay’s ascension and strength in competitiveness versus Argentina’s stems largely from “how Uruguay handled 2002 and 2003 – the crisis and debt restructuring – and also how Argentina did not pay attention to the international consequences of their actions which continue today.”
The decisions Uruguay has made since 2003 have also been important. “The government has been consistent in macroeconomic policy. Obtaining investment grade is a top priority for them,” says Franco Uccelli, an authority on Uruguay’s economy at JP Morgan Chase.
And no matter that the country has another leftist president and ex-guerrilla, José Mujica. Since his inauguration Mujica has stressed the need for sound economic management, and appointed Danilo Astori, an economist and former economy minister, as vice-president.
Astori says that the country’s funding needs are covered for two years. The government has sent a filing to the Securities and Exchange Commission to issue $560 million in bonds, but he says that no decision has been made on whether that will take place.
ENVIABLE
Uruguay also finds itself in an enviable position with the credit ratings agencies. It has received upgrades from all three major firms, most recently from Standard & Poor’s in July. Moody’s and Fitch also upgraded the country in the past six months. And it looks set to continue its ascent towards investment grade, just one notch away.
Uccelli estimates this to happen in the next 12 months although he says it could happen in six since “things have been moving so quickly.”
Sebastian Briozzo, a director in Standard and Poor’s Sovereign Group, says that while Uruguay has made good in both reducing its debt burden and the percentage in foreign currency, it needs to do more.
Uruguay’s economy has the largest dollarization in Latin America in terms of deposits. S&P notes 75% of deposits and 55% of its loans are still in foreign currency and expects the reduction to be gradual. Briozzo also says that Uruguay’s close economic links with Argentina pose a risk, given the latter’s increasingly precarious economic position.
But officials in Montevideo say the agencies are behind the times. Mario Bergara, the country’s central bank governor, says: “From our perspective Uruguay already deserves investment grade. The private market confirms this.”
As evidence he cites the country’s favourable bond spreads, comparing them to Brazil and Peru. Astori, who like Bergara meets regularly with officials from the agencies, contends that “the rating agencies are moving very slowly. The market has moved much faster.”