Another week, another proposal to deal with Argentina’s debt. The latest one, by the Argentine president, Cristina Fernández de Kirchner, is to launch a voluntary debt swap where investors holding defaulted bonds exchange them for new debt governed by Argentine law.
So Bank of New York Mellon would cease to be the trustee and would be replaced by Banco de la Nación in Buenos Aires and this would enable Argentina to pay the interest owed to the majority of bondholders who agreed to a restructuring deal.
While the proposal may resolve the current technical default, it does not represent a viable solution to the problem of the hold-outs, who have little incentive to enter this voluntary arrangement. Whether or not this particular deal will work, it is imperative that some sort of deal is struck: not just for Argentina, but as a precedent for the way that international debt is managed.
In an era of increasingly integrated capital markets the ability for a state to wind down and restructure defaulted debt obligations is imperative.
Vultures circling
The current situation in Argentina is but the latest development in a saga that started in January 2002 when the country defaulted on US$95 billion in outstanding debt. Despite two rounds of restructuring – one in 2005 and one in 2010 – there are still a number of “hold-outs” or “vulture funds”, that refuse to accept the reduced repayment terms. They won a court order in the US (where the bonds were issued) this year saying that, contrary to the majority of Argentina’s creditors who accepted reduced payouts, they can hold out to be paid in full, including all past due interest.
This led to a very curious situation where Argentina had the money to pay its bondholders and was willing to pay them, but was prevented from doing so by its trustee BNY Mellon for fear of breaking US law. Such unusual circumstances prompted rating agencies to declare the country in default.
There are fears of how the market will react and Argentine bond prices are falling – trading at around 80 cents on the dollar. But this is no way near the levels of the 2002 aftermath, which saw prices plummet as low as 15 cents on the dollar. This seems to indicate that the markets have confidence that a deal will eventually be reached.
Striking a deal
Striking a deal is in the interests of everyone. The vultures themselves want a return on their investment – not just in terms of what they paid for the defaulted debt in the first place but also subsequently the blood and treasure spent on several years of protracted legal battles.
The returns they stand to gain may be morally dubious because of their aggressive tactics of pursuing countries that can least afford to repay defaulted debt that was accumulated during military dictatorships, but they will be real enough. Even without a deal – instead accepting the terms of the original deals made in 2005 and 2010 – the vultures still stand to gain enormous dividends of more than 300% from their original investment.
A deal is also in the interests of Argentina itself, which needs access to international credit markets. The economy did incredibly well in the years after 2002; pursuing a model of development both different and more successful to the neoliberalism of the 1990s under the Presidency of Carlos Menem. However, this occurred during a period consisting of a stable and benign international economic environment and buoyant international commodity prices. In their absence the model has begun to demonstrate some areas of tension, exposing some underlying flaws in the model.
One of these tensions is persistently high inflation. Investment strikes by international energy companies since 2002 have led to a number of key bottlenecks in the Argentine economy, which domestic savings are insufficient to deal with. For example, the Vaca Muerta, a region in the west of the country with the world’s second largest shale gas deposit, would receive a boost from international capital.
While international capital (in the form of Chevron, Petrobras, ExxonMobil and others) has already shown an interest, this will only get easier once a debt deal has been struck. This would help re-ignite GDP and help ease inflation. It would also take pressure off the federal government’s fiscal accounts and so allow it to continue plans to alleviate poverty – still a significant problem in Argentina.
While there is an argument that Kirchner can gain short-term political capital in not reaching a deal – her intransigence has clearly helped her flagging domestic popularity – the long term economic interests should outweigh this calculation. It is also clearly in the interests of international capital that a resolution is found.
The legal precedent that this case produces is too difficult to discern at this stage, but there is a very real danger that it will seriously impact on the ability of other countries to deal with default in the future.
While eurozone nations have introduced collective action clauses into their newly issued debt, this practice has not spread to the developing world. “Pari-passu” clauses that demand all creditors be treated equally remain for vultures to capitalise on, and they give little incentive for creditors to agree to restructuring deals in the future – in Argentina or anywhere else.
This has clear implications for the smooth functioning of international debt markets and the international economy by extension. Without the ability to engage in an orderly default everyone loses; with those who lose most often being those who can least afford it – the poor.