Nova workboard

a blog from young economists at Nova SBE

The Argentina 8th Default

Having defaulted by the eighth time in July 30th, Argentina entered in the top ten countries that most defaulted. The previous default in 2001, where Argentina reneged $81 billion in debt, is the source of the last one. When the country defaulted in 2001, most part of its creditors exchanged their defaulted debt for new securities in two restructurings that happened in 2005 and 2010, but some creditors picked up cheap debt and has since litigated for payment of full principal plus interest in the New York courts, they were led by NML capital (a hedge fund).

In 2012 a ruling by the New York judge Thomas Griesa forbid Argentina from paying the creditors who held the exchanged bonds if they did not pay also NML, to ensure equal treatment to all creditors. In June, the Supreme Court of the USA refused to get involved in the case, in this way the judge’s rule still applied and Argentina needed to make difficult choices: pay NML $1.3 billion plus interest, negotiate a settlement with NML, or stop paying the exchange bondholders. The country ended up defaulting. Argentina government claimed that it could not pay the hold-outs without triggering a Rights Upon Future Offers clause (that expires at the end on this year) contained in the restructure bonds, meaning that the country could not offer a better deal than the one it gave in its 2005 and 2010 exchange without extending the same deal to all creditors.

Some hope still remains. Rumours say that a non-governmental settlement can be possible; a group of private Argentine banks might rally together to buy up NML’s claim and then negotiate with the government a deal that would involve payment after the expiry of the clause; in this way, Argentina would be pulled out of default.

Maximiliano Castillo of ACM Consultants claims that Argentina made the worst decision. The country has been locked out of international capital markets since 2001 meaning that has no access to external financing, its foreign-exchange reserves have been decreasing, and the economic boost it received in the 2000s from rising commodity prices probably will not happen again, the country needs to borrow to grow.  (i.)

The immediate impact of a default will be felt in the markets, with investors in credit default swaps seeking payment and rating agencies downgrading Argentine bonds. There are fears that the government prints money to finance its deficit, and consequently this will spur inflation, putting the exchange rate under devaluation pressure, it would be the second devaluation of the peso this year. A consultancy firm, Abeceb.com, predicted that Argentina will contract 3,5% in 2014, if it avoided the default it would contract just 1,5%. This new default is unlikely to have consequences across emerging markets. Unlike in 2001, Argentine debt is now held by a smaller pool of investors, such as hedge funds, who are accustomed to sharp price swings and greater volatility. Also, as Siobhan Mordan, head of Latin American strategy at Jefferies investment bank pointed out, the investors know that the situation in Argentina is unique and does not reflect what is going on in the rest of the region, so there are no fears of broad contagion.

The Argentine Central Bank clamped down on the foreign-exchange market last year in an effort to slow capital flight, its official policy has been that local issuers can only buy dollars to fund infrastructure projects.

Few believe that the consequences of the default will be as dire as in 2001, when unemployment reached nearly 25% and forced tens of thousands of Argentines on to the streets to scavenge for cardboard to sell to recycling plants. The economy is not in a deep crisis as in 2001, when Argentina had suffered from a four-year recession before defaulting. The size of the forgone debt is also smaller – $30bn compared with $80bn in 2001. (ii.)

Still, the IMF has been proposing new plans to make the modification of debt contracts more frequent. These plans consist in the change of two rules: first, it wants greater leeway to support the “reprofiling” of sovereign debt. Reprofiling is a relatively gentle form of restructuring, in which the maturity of bonds is extended but the amount owed and interest rate stay the same. Second, the fund also wants to limit the risk of being dragooned into lending huge amounts to stave off default in a country whose debts are unlikely to be sustainable by getting rid of a “systemic exemption” to its lending rules. (iii.)

Rather than Argentina sit down with their creditors just when debts get out of hand, it should take measures to avoid restructuring, such as issuing ruinously expensive short-term debt. The IMF implicitly supports this kind of behaviour.

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Author: studentnovasbe

Master student in Nova Sbe

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