Over the past several months commentaries have repeatedly drawn comparisons between the current Greek situation and Argentina’s default. Some so-called “experts” have even urged the Greek government to follow Argentina’s model, defaulting on their obligations to creditors, breaking their peg to an external currency and then restructuring in a manner that relieves them of their burdens. These comparisons are both misinformed and dangerous.
I have spent much of the past year working on problems of peripheral European economies and, as part of my research of prior sovereign defaults, recognized a massive disconnect between Argentina’s fairly good fundamentals and the market pricing of their risks. Over the next few months I will be looking more closely at the opportunities, risks and likeliest path Argentina will take in the face of these rising macro-economic risks.
While the default is now a decade past, Argentina remains locked out of international capital markets, distrusted by neighboring governments and once again heading toward a narrowing and difficult set of choices that could impair their ability to best serve the needs of their domestic economy and their populations.
There are clear and obvious solutions to their problems, and a once in a generation opportunity to embrace a solution that could secure Argentina’s position as the next Latin American economic miracle, and an example to the troubled economies of peripheral Europe. Unfortunately, there is little evidence that the current government sees these opportunities or intends to embrace them.
When Argentina chose to default on $81 billion in bonds in 2001, its debt to GDP was relatively paltry – 62%, compared to Greece’s 150%. Since their default, the Argentines have entered into agreements to restructure more than 91% of their defaulted debt by haircutting those creditors by 70%. In the process the country has eliminated $57 billion of principal obligations and has avoided interest payments of almost $59 billion, after considering the $6.5 billion of interest payment on the exchange securities offered to those creditors in settlement. This is a spectacular success for Argentina’s debt negotiators. However, there remains a relatively small amount of defaulted debt still to be resolved: Paris Club arrears, outstanding ICSID awards, and some bonds in the hands of holdouts who do not appear to be going away anytime soon.
The government has been engaged in ongoing legal battles with remaining bond creditors that have resulted in the United States Federal Court, Southern District awarding over 100 judgments against the government for $7 billion. The government has chosen to ignore these judgments, and refused on principle to negotiate with its holdout creditors. It has adopted a similar attitude vis-à-vis the ICSID awards, and has dragged out its Paris Club negotiations, repeatedly submitting proposals that the bilateral creditors consider unserious.
By standing on principle, the government has locked itself out of the global capital markets, even though their debt level is far below their realistic borrowing capacity. Besides the fact that, because of their selective default rating, interest rates on Argentine bonds would be hugely expensive, any attempt to sell new debt into international markets would expose the bond proceeds to attachment by creditors. As long as the judgments against it remain unresolved, Argentina has little chance to access foreign capital and, instead, must rely on domestic funding for its economy.
Herein lies the real crisis that awaits Argentina and should be recognized as reason enough for Greece not to look to Argentina as an example. While Argentina’s economy is large, diversified and has per-capita gross domestic product that is more than twice that of its peers, it is over-reliant on domestic funding and a long-in-the-tooth commodity boom to support its economy.
As a result, the government has seized central bank reserves and nationalized pension fund assets to pay its performing debt, and, unlike virtually any other commodity-based economy in the world, Argentina has avoided using any of the funds generated by the commodity boom to create a countercyclical reserve fund. Even with the benefit of record exports of U.S. dollar-priced soybeans, central bank reserves have barely budged from their $50 billion level for several years. Where most of their neighbors have benefitted from foreign capital inflows, the Argentines have suffered from massive capital flight – US$10 billion, or about $100 million a day, during the first half of 2011 alone. In trying to address this capital flight, the government has harmed relations with both domestic and international businesses by requiring all domestic businesses that import foreign goods to become exporters as well. The results of these social policies are all manner of distortions: companies like BMW are exiting Argentina and domestic auto importers are being forced to enter unrelated businesses such as wine exporting.
The government’s unwillingness to resolve outstanding legal battles with remaining creditors and its reliance on expansive domestic measures have resulted in persistently high rates of inflation which continue to unnecessarily hollow out the economy. Thus, instead of capitalizing on a comparatively positive fundamental picture, Argentina is heading toward one of two dead ends: either draining the domestic economy to service debt and fund government spending, or defaulting on domestic and international debt once again. As in 2001, the ruinous consequences of this policy will impact the Argentine people first and foremost. With the monetary base increasing 41% y/y, inflation is hurting Argentina’s savers just as any future default would disproportionately harm domestic creditors.
In 2012, Argentina will be faced with almost $20 billion of debt service payments. The government has said that it expects to fund this through a primary surplus of about $5 billion, rolling over about $5 billion of multilateral and public sector organizations debt, further use of international reserves, new debt “sales” to domestic public sector agencies and cash advance from the central bank. But there are unacknowledged limits to such an approach. Public sector agencies, including the National Social Security Administration, already hold 46.8% of all Argentine government debt, and this portion of the debt grew by 9.5% in 2010. Meanwhile, with the expansion of the peso supply, the margin of central bank reserves available for external debt servicing is shrinking. In spite of its benign debt to GDP ratio, Argentina risks cannibalizing its economy if it does not re-enter international capital markets soon.
What’s a Government to do?
If the government is able to move past its ideological distaste for resolving disputes with the Paris Club, non-tendering bondholders and ICSID award holders, it would position the people of Argentina to finally put the entire default behind them and, given their relatively low debt/GDP, reap the benefits of a massive and well executed reentry into global capital markets.
If, rather than continuing to raid the domestic economy, the government chose to settle the $7 billion of outstanding creditor judgments, either by using some portion of reserves or by issuing new notes, the cost of settlement, even at the full nominal value of all claims, would be more than offset by savings within three years. This approach would allow the Argentine government to efficiently and effectively manage their economy without the risk of further hollowing it out through artificial interventions.
Moreover, with the threat of litigation and further attachments of bond proceeds behind it, the major rating agencies would be forced to recognize that Argentina’s fundamentals should merit a higher grade. Such a change in Argentina’s credit risk profile suggests that it could, in short order, achieve the Baa3/BBB ratings of its major peers.
On that basis, CDS spreads on Argentina would likely collapse by between 400 and 550 basis points, converging with the levels of its investment grade peers. The CDS spread compression that would accompany such settlements and the ensuing upgrades in ratings would net the federal government interest savings of between $15 and $22 billion over the next 8 or 9 years. The benefits would extend beyond the federal government and would result in a reduction of interest expenses on the billions of dollars of provincial debt by several hundred million dollars a year. The reductions in sovereign interest expense would, as a logical consequence, also reduce the cost of borrowing by private industry.
[Savings calculation assumes that $78bn of Argentine public debt (excluding bilateral and multilateral obligations) maturing through 2018 are refinanced at a credit spread of 1.40% (the average 10 year CDS spread among Brazil, Chile, Colombia, Mexico, Panama, and Peru) rather than a credit spread of 6.50% (the 10 year CDS spread for Argentina, as of 7/26/11)]
Moreover, and maybe more important a factor in driving growth and productive capital allocation, an accommodation with the Paris Club, and payment of outstanding ICSID awards would remove barriers to foreign direct investment, and Argentina could then join its Latin American peers in benefiting from recent capital inflows. As capital re-enters the country, the cost of borrowings by public companies would fall, public company equity multiples would increase and securities held on behalf of the Social Security Administration would reap the benefit of massive price appreciation.
When is a Default a Success?
To properly evaluate whether a default has been successful, the correct measure is not the nominal haircut to the amounts owed to foreign creditors, but, rather, the ne t present value of those savings weighed against costs, explicit and implicit, borne by the population. By that measure, Argentina’s 2001 default has not yet been anything close to a success, nor is it a model that Greece or any peripheral European economy should emulate. While a reduction in foreign debts provides some short-term benefit and may be a prerequisite to successful economic turnaround in the short-term, debt reduction alone cannot be judged a success until the government has restored broad access to international capital markets at rates that reflect the economy’s positive fundamentals. For Argentina, there is a clear path to such an outcome. Unfortunately, until the government takes the decision to travel down that path – a decision that is justified regardless of its antipathy toward its Paris Club, ICSID and “vulture” creditors – it will not have achieved a successful restructuring. In fact, Argentina is on the cusp of wiping out the benefit of the debt forgiveness that it has already forced on creditors in the 2005 and 2010 exchange. With dwindling reserves, a declining surplus, high inflation, and an eventual end to the commodity boom, there is an increasing risk that Argentina will hit the wall, again, and that Argentines will find that an ideologically driven economy promises much, but delivers little to the man in the street.
Joshua Rosner is Managing Director at independent research consultancy Graham Fisher & Co and advises regulators and institutional investors on housing and mortgage finance issues. Previously he was the Managing Director of financial services research for Medley Global Advisors and was an Executive Vice President at CIBC World Markets. Mr. Rosner was among the first analysts to identify operational and accounting problems at the Government Sponsored Enterprises and one of the earliest in identifying the peak in the housing market, the likelihood of contagion in credit markets and the weaknesses in the credit rating agencies CDO assumptions.
Disclaimer: The opinions expressed in “View from the Ground” columns do not necessarily reflect those of the FT Tilt editorial team. FT Tilt may edit the columns for clarity; any errors of fact or omission are the authors’ own.