EM: How did the new approaches to restructuring introduced by you and your team effect the outcome of the debt swap?
RL: I believe that the most important idea was the most obvious one, and that is that the viability of fulfilling foreign debt obligations is tied to economic growth. Put another way: if there is no growth, there's no ability to pay. That is not how the markets have seen the issue.
Up to now, the idea was that as long as there is voluntary financing, there is sustainability, or as long as the financial system keeps lending, the scheme can maintain itself. The Argentine case proved that isn't so. When debt accumulates in the proportions that it did in Argentina – especially in the last 12 years, up to 2001 – inevitably at some moment a crisis will arrive. So, the simple idea is that it isn't the markets that decide.
Since the markets, with the support of international financial organizations, continued believing for much more time and debt kept piling up, the process lasted so long and was, therefore, so deep.
EM: Could you comment on the concept of 'good faith efforts' in debt negotiations?
RL: Look, in Roman law as in Germanic law there is a very clear standard and that is that the best proof of good faith is not to promise what can't be fulfilled. That is what Argentina did. Many times it was suggested to us – and this would have been very comfortable for the economic team – to offer a very quick restructuring with a reduced discount.
But that is what Argentina had been doing since 1994. We said, "No." Even though it would be much more complicated, much more difficult, we were not going to promise what we couldn't deliver and then in a year-and-a-half, in 18 months, we would again be in a crisis situation. That is the best proof of good faith.
I would also add that good faith shouldn't be exclusively proffered by debtors. It should also be offered by creditors. For example, it has been proven that there wasn't good faith on the part of Italian financial institutions which, having received placements meant exclusively for institutional investors – and the Argentine prospectus said this very clearly – ended up selling them to retail clients. So I am convinced that creditors also should be judged in terms of good faith.
EM: A 3% fiscal surplus has proved too ambitious a target for Argentina for the past 50 years. What has changed to make this surplus now?
RL: It's possible – if there is growth. This means that the interests of Argentina and the interest of its creditors are shared in the sense of not imposing recessive policies as occurred during the better part of the 1990s. If Argentina doesn't grow it won't meet this target, which is only possible under the assumption that there is stable growth of 3% on average.
Now, if reasonable policies are put in place, Argentina has the conditions to achieve a 3% rate. Only the application of very mistaken policies over the last 30 years can explain Argentina's low growth and permanent indebtedness. In the 27 years up to 2002, Argentina had 17 years of exchange rate lags. This was the most serious of the mistaken macroeconomic policies committed. That means that during 80% of those 27 years we suffered from inadequate macroeconomic policies or were in crisis trying only to recover, not grow.
EM: You have said no government would want to go through what Argentina has during these past three years. Still, are there any precedents that may have been set that concern you?
RL: Argentina's situation was exceptional and its solution was also exceptional. The truth is, there aren't many countries in the world that have, for example, committed a mistake like convertibility. For convertibility to have worked, three issues had to be resolved: the fiscal surplus, world-wide exchange rate stability and a successful Uruguay Round in opening agricultural markets.
Convertibility was adopted in 1991. In 1994 not one of these three – not a single one – was accomplished. The UK devalued in 1992, and with that began a process – not only in the developing world but also among developed economies – to adopt flexible exchange rates. From the point of view of agricultural opening, the Uruguay Round failed. And in this country, far from building a fiscal surplus, we were accumulating a growing deficit.
Nonetheless, the markets – greedy for their commissions – as well as the multilateral agencies, sustained this programme until September 2001 when there were only weeks left before the social, political and economic collapse.
EM: Do you think that the Argentine case makes it more or less likely that there will be changes in how future defaults and restructurings are handled?
RL: I share the view of the Republican administration [in the US]. And the President has done no more than remain consistent with what he said during his campaign. I believe that moral hazard exists. The financial markets, believing that in the case of conflict, they are going to be saved by multilateral institutions, commit very big errors. I believe Argentina is an example of this.
What I say is that one has to be coherent. If there is no assistance package there can't be rules of judgment as if there had been. For example, the IMF insisted on a restructuring with a certain [participation] percentage – and although we didn't know it, we were very close to it. The reasoning was that this percentage was obtained in other restructurings.
But the others – Russia, Mexico, Brazil and Argentina itself in the past – were accompanied by assistance packages. This is the first restructuring done without an assistance package and, moreover, with net payments to the multilaterals. Since April 2002, Argentina has paid $10.5 billion to three institutions – above all the Fund, the World Bank and somewhat less to the IDB.
What one cannot be is incoherent. If we are going to maintain the policy of not having assistance packages – and in order to avoid moral hazard, I'm in favour of this – we have to adjust the evaluation standards for restructurings.
EM: Have any other governments contacted you with queries about the Argentine restructuring strategy?
RL: No. But we have already expressed some ideas because we see these ideas within the area of the behaviour of the international public sector. We have also expressed some ideas about the behaviour of the private sector. For example, we say that it is unjust to treat equally those who have asymmetric information.
We, in the G20, have proposed a more favourable treatment for small investors and, second, for those who bought bonds at their original value. Third, we propose less favourable treatment for those who bought bonds after the default, generally vulture funds. We believe that differentiating creditors by very objective criteria is most fair and that this will help financial markets – above all, the most efficient financial markets – and will protect the smallest investors.
EM: Some analysts have credited external conditions – even pure luck – as being a primary reason behind the swap's success. What is your opinion?
RL: I don't share that view at all. These people think that if the interest rate had been higher, Argentina would have changed its offer. And it wouldn't. Why? Because our proposal is based on the capacity to pay, not on the situation in financial markets at a given moment.
Consider this: two months before the swap, the whole world said, "It won't work." Now they say, "It worked because they were lucky." This is absurd. This is to go back to thinking in terms of moods or the frame of mind of the analysts, the rating agencies – and those, too, are very fickle. Their understanding tends to arrive late. The rating agencies, for example, reduce a country's qualification once it's gone into default.
This isn't very useful. It might have been before but not after. And that doesn't happen only with countries but also with companies. Enron's rating was lowered after it was in bankruptcy. So, since they think in this way, they think a higher interest rate would have meant a different offer. In fact, it would have been exactly the same.
EM: Was there ever a moment when you felt that the whole process could unravel?
RL: Well, those thoughts exist. But, look at it the other way. If one says I am offering with good faith the maximum that the country can pay, then if it doesn't work, what then? Argentina was not going to change its offer. But what might have happened was a postponement, a continuation of the default. Today the numbers have openly allowed us to end this episode.
If you put in the centre of all of this – not the way markets reason – but taking into account not only foreign obligations but our obligations to our own population, you acquire a different sense of security about what you're doing. That is what the analysts, who are very short-term thinkers, have difficulty understanding.
Look, four weeks before the swap, the analysts unanimously said it was necessary for the success of the operation to offer more Par bonds which have no discount. In fact, the Par bond was the one that attracted the least interest. A country cannot manage according to the changing whims of a few financial operators.
EM: What is your evaluation of the role of the IDB during Argentina's crisis?
RL: Clearly, the IDB and President Enrique Iglesias understood best the reasoning that I have expressed. As a consequence, while not making new net credits, our total existing loan portfolio was restructured – and with the right timing, because not only do you have to manage a restructuring, you have to arrive on time. The IDB did that and understood that we were not asking for fresh money or net credits but time to move forward with the restructuring. The IDB did this better than any other organization.
EM: What are your concerns, going forward, about the Argentine economy?
RL: The greatest risk following the swap is the idea that there is a 'before' and 'after' the swap. Why? Because curiously those that support this idea are the two political-economic extremes in Argentina. On the one hand is what one might call a form of 1970s populism that says 'good, now the moment has arrived to distribute, to grant credits with much more ease and so on.' And we all know that this is not the way to go, that this runs the risk of inflation.
On the other end of the political spectrum are those right-wing conservatives from the 1990s who say, 'great, now that we've resolved the problem of the debt, we have to begin the financial deals again.' We have said to both, 'No' – no to populism and no to the conservative right. If you look at the country, you see that it was not only concerned with the debt.
GDP has grown 26% since April 2002 and 2.5 million real jobs have been created. Poverty has been reduced. The rate of investment is the highest it's been in 15 years, and I assure you this is not transitory but is looking toward the future. So what should be changed? The fiscal surplus is the highest in 50 years. So why should we change? What I would say is that there is now more time to strengthen those tendencies that deal with questions like productivity. But this is about reinforcement, not about change. It's about consolidating the economic programme not changing it.
Opinions
Mario Brodersohn, economic advisor to the Radical Party
Favourable external conditions are an insufficient explanation for the success of the debt exchange. It is also important to take into account the structural characteristics of the debt in default. Since almost all of the bonds were undesignated paper, there was a huge obstacle the formation of a "creditor club".
This made Argentina's default and restructuring much more comparable to those of the 1930s than to the 1980s. In the earlier crises, it was 10 years before any negotiations were concluded. Mexico, for example, got an 80% write-down only in 1942 while Brazil also got very favourable terms the following year.
In addition to the weakness of the creditors and the government's hardline stance, the passage, late in the game, of the law that prohibited any modifications in the offer was fundamental.
Paying only part of the interests due and capitalizing the rest means the total debt will increase. However, since this is included in the contractual conditions of the swap, it won't necessitate going to the international capital markets. Moreover, the extended grace periods for amortization and the structure of indebtedness is reasonable. In fact, given the low interest rates, both in relation to GDP and to exports, you have to wonder why Argentina's country risk is higher than Brazil's.
Miguel Kiguel, former finance secretary
The negotiation was so one-sided that, essentially, there was no negotiation. Argentina managed to set its terms single-handedly on creditors without any discussion with them. This indicates that there has been a major underestimation of the power of the sovereign. It also should make abundantly clear the reality of the bond markets in the international market context.
Many issues now need to be addressed. Just to name a few, the inability of foreign courts to impose pro-creditor decisions raised the question of the usefulness of having foreign law clauses in bonds. If you don't have the Marines, there doesn't seem to be much that foreign government agencies can do. Another discussion that will come back to life concerns the exclusion of multilateral lending from the consequences of default. Should they also take a hit? After all, literally everyone else was harmed so why shouldn't the IMF take on the risk of its own lending? That might make lending more difficult but it would also force it to be involved in restructuring processes on a pari passu basis with the private sector.
There are important changes in Argentina, in fact in the region. The possibility of fiscal discipline is here to stay. The context is more like Asia in the 1970s. That should make it possible to turn policy thinking toward other long pending economic issues. With surpluses, there is room for trial and error. If you have money, you can afford to make mistakes.
Desmond Lachman, resident fellow, American Enterprise Institute
The fact that Argentina got such good terms will, in the long run, be bad for emerging markets and bad for the IMF. It's true that Kirchner's dogged patience paid off and the country got terms that are almost twice as favourable as any other recent restructuring. But there will be costs to pay.
First of all, does anyone believe that other countries, if forced to default, won't, for domestic political reasons, feel forced to be as hard nosed and tight fisted with foreign credits as Argentina was? And is it credible to think that lenders won't factor in the real possibility of protracted negotiations and ruinous settlements into the cost of loans? Emerging market economies will find that it is they who will be footing the bill for Argentina's spectacular triumph over the IMF.
The Fund didn't show up and one has to be concerned about the precedent that's been set. With regard to Argentina, the Fund continues to not respect its own rules, mainly by lending into arrears without verification that a country is negotiating in good faith.
Still, one needn't worry about the Fund. It remains far too useful to the G-7 countries, which can use it without the nuisance of parliamentary sanctions. No US government in its right mind is ever going to close down the IMF.
Daniel Marx, former finance secretary
What made the greatest difference was the shift in bondholder perceptions as the February 25 deadline bore down. The "grab this or you end up with nothing" message worked for many. But there were other equally propelling dynamics. Most creditors perceived that they had no effective protection. The courts proved resistant to enforcing rulings favouring creditor arguments and the Fund decided to keep collecting from Argentina and to stay out of the picture.
Reaching a new agreement with the IMF is not necessarily going to be as simple as understood by some observers. Eventually there will be a meeting of the minds but disbursements will be reduced relative to payments made to them.
The lessons are many, beginning with the enormous cost to the people and to the economy. I have no doubt that there will be changes in how default processes are handled in the future. There are going to be new pressures for developing mechanisms that allow for more orderly resolutions, which would become a positive development. It's obvious to all parties, one has to believe, that the social traumas as well as the value destruction embedded in the current process are not in the majorities' interest.
Guillermo Mondino, former advisor to Domingo Cavallo
The Argentine authorities started with a weak hand and ended with a weak hand. External conditions were exceptionally favourable. Basically, they just got lucky and, as the saying goes, it's better to be lucky than smart. That was 100% true in their case.
Also, they were very harsh and their apparent willingness to commit suicide worked in their favour. It was a game of chicken and the markets came to believe that they were willing to see the exchange fail. This weakened the hands of creditors who were fractured and divided.
Completing the debt swap was important but it isn't over by any means. They will not be able, in the end, to repudiate the 25% who stayed out. They will have to deal with that.
Going forward, the model for dealing with default will change but only in part. The idea that defaults will be more likely is overdone as other emerging markets governments recognize the costs. Remember, no leader who was in power at the time of a default has completed his term in recent years; that's a lesson politicians take to heart.
The Argentine circumstances were very particular and very peculiar. However, that said, we now see that lawsuits have proven to be inconsequential and that recovery levels are lower and not necessarily related to capacity to pay.
Federico Thomsen, former chief economist, ING Barings Argentina
The offer is sensible. The fiscal surplus target – and, therefore, the haircut – is a reasonable if not an easy objective for Argentina. The economic team did well in not making the offer more generous and in sticking to their guns. With the restructuring, public finances are sustainable, assuming, of course, sufficient discipline. It's an opportunity and, hopefully, not another one that will be lost.
Post default and restructuring, Argentina raises many concerns. Not the least of them is how President Kirchner will react to the "success" of the swap. To say the very least, the signs are not encouraging. Most important will be his approach to a new agreement with the IMF. Despite the high cost of giving up an agreement with the Fund, it's a move that can't be ruled out.
With recent legislative approval for delegating more power to the executive, he is the most powerful president in many years and may see breaking with the IMF as a major achievement. Certainly, he may believe that it will assure him of a personal victory in the October elections and may even "have legs" in a bid for re-election in 2007.
One of the objective problems in coming to an agreement with the IMF is that its list of reforms is so poor. Argentina doesn't comply with a number of them because, quite simply, the votes aren't there. The political costs are so huge and the benefits are so small that they are non-starters and simply keep alive a needless tension.
Holding Court
HOLDING COURT
In the US, a famously litigious society, a much-used expression promises everyone "a day in court" – and that's supposed to be a good thing. Argentine economic officials may disagree. Traipsing through the Southern District Court of New York could become way too much of a good thing as bondholders sue and vulture funds attempt embargoes. And that's only one venue.
The International Center for the Settlement of Investment Disputes (ICSID), hardly a household name even among followers of the multilateral community, now has before it between $16 billion and $38 billion in claims by over 30 multinational firms, mostly in the energy sector, growing out of the devaluation and price freezes following the 2001-2002 financial crisis.
An independent agency within the World Bank, ICSID was established in 1966 to mediate between countries and investors in cases such as nationalizations, access to justice and prejudicial treatment. As of the end of 2004, 154 nations had signed the ICSID convention, Argentina among them.
Since its operations began, ICSID has successfully adjudicated 89 disputes, but it has certainly never received an avalanche of claims like the one it now faces with Argentina. Nor does the information posted on its website indicate that it has ever encountered a body of settlement demands approaching such an enormous amount of money.
Leonardo Madcur, secretary of technical coordination in the economy ministry, is one of the two officials in charge of handling Argentina's representation before ICSID. "It wouldn't be constructive to assign blame," Madcur told Emerging Markets, "and these issues will be resolved through renegotiating the contracts – and not just the tariffs – with each of the companies."
This, he explains, may involve delaying contractually agreed upon investment targets and re-programming expansion plans. He insists, however, that the traditional areas of focus between ICSID and its claimants do not apply in the case of Argentina as the negative impact took place on an "equal opportunity" basis. Moreover, Madcur stresses, if utility costs had remained in dollars, "Argentina would have had 3 million more poverty- stricken citizens."