For the second time in 13 years, Argentina defaulted last week, after not being able to reach an agreement with holdout investors which would have allowed debt-restructured creditors to be paid using funds already deposited by the Argentinean government in New York. This latest default is very different from the one in 2001 which was marked by a collapsing economy, unsustainable debt (about 150 percent of GDP) and, more importantly, by the inability of the government to keep making debt payments. As described in a previous article, this new de facto default is the result of a U.S. court ruling in favor of the holdout investors’ claim to be paid in full (i.e., without any “haircut”) and the inability of the Argentinean government to successfully negotiate with them.
But let’s step back a few months. Taking this U.S. court ruling as given, Argentina had three options:
1) Pay holdout investors (about 2 percent of Argentinean sovereign debt bondholders) the $1.5 billion that resulted from the U.S. court ruling. This would have triggered the so-called RUFO clause that aims to protect current debt-restructured bondholders by allowing them to demand the same treatment if other bondholders are offered a better deal. Given the debt burden this option would have imposed on Argentina, it was quickly disregarded by the government and most analysts.
The RUFO clause had been intended to accelerate the debt-restructuring process by guaranteeing that early entry into the process would not result in worse conditions than entering later. Some analysts calculate that the landslide of claims from the debt-restructured bondholders could amount to between $120bn and $500bn, which would have moved the debt-restructuring back to square one with very severe implications for the country’s payment capacity, not to mention significant economic and social costs. It is important to note that the RUFO clause expires in December 2014, after which debt-restructured bondholders will not have the right to claim equal treatment with any bondholders who receive more favorable conditions (e.g., less of a haircut);
2) Do not pay holdout investors, but negotiate so they might request a stay until early next year. This would have avoided triggering the RUFO clause, allowing the government to make regular payment to debt-restructured bondholders. Since this option would have severely reduced the negotiating power of holdout investors it would have required offering an important guarantee to convince lead holdouts of the country’s good faith, and convince Judge Griesa to re-establish the stay. This was what many analysts thought would happen given that it contained, in principle, strong incentives for both parties: holdout investors would be paid (at least in the near future), and it would have also allowed the government to keep paying the debt-restructured bondholders and, thus, to avoid another default. While this was, in the eyes of most analysts, the “win-win” solution, it would have come at a high domestic political price in Argentina, where the holdout investors would have been seen to have “won” the battle with the government. This would have been too heavy a political cost for the Kirchner administration to bear;
3) Do not pay holdout investors and do not negotiate, which would translate into a “de facto default.” I use the term de facto default because while the debt-restructured bondholders are not being paid, the government argues that they have deposit the necessary funds so they can be paid. Whether one wants to refer to this situation as default, de facto default, or debt-restructured bond holders lack of payment due to the U.S. court ruling, ultimately it means that the end of the Argentinean debt saga is further away from being solved than if option two would have been pursued.
As we now know, Argentina chose this third, less desirable option, and it will clearly have harmful economic and social implications. First, it will cut off the much needed financing of many provincial deficits and many private investors in Argentina. It is important to note that provincial spending represents more than 40 percent of total public spending and that in many provinces public employment represents more than 60 percent of total employment. Fiscal adjustments at the provincial level will most likely have severe economic and social costs. Even if the federal government decided to help these provinces with federal funds, it would incur high monetization of federal fiscal deficits and higher inflation (which is already about 40 percent annually). Second, it will further distance the country from being able to regain access to the global markets in their sovereign bonds. This is crucial, particularly now the region’s so-called bonanza times of cheap capital and high commodity prices has ended, and it now needs to refocus its attention on productivity issues including education and infrastructure investment. And last, but certainly not least, it will also complicate the short-term financing and interaction with the global markets needed to continue exporting main commodities.
All these issues will aggravate the already existing fiscal and external deficits, reduce foreign reserves and trigger further pressure towards currency depreciation and inflation, and reduce production and increase unemployment in an already weakened and deteriorating economy. One has to wonder why it is that the government did not attempt in a more aggressive manner to follow option two as opposed to “settle” for option three (ruling out option one, given the much higher costs associated with triggering the RUFO clause). Whereas the 2001 default was driven by economic forces (i.e., one may argue that there was a logic behind such a default), it is hard not to conclude that this new de facto default is driven by nothing more than shortsightedness in politics which will, all the same, have severe economic and social implications in the years to come.