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Argentina's last debt card is a doomsday scenario

Published June 19, 2014 10:00 am

Repayments • Analysts doubt country will succeed in avoiding debts to U.S. hedge funds.
This is an archived article that was published on sltrib.com in 2014, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

Buenos Aires, Argentina • Argentina's government is finally preparing to negotiate a payment plan for the $1.5 billion in bad debts and interest it owes to the U.S. hedge funds it demonizes as "vultures."

But before both sides sit down for talks, President Cristina Fernandez wants everyone to know she still has some cards to play.

Despite the U.S. Supreme Court's decision to turn away Argentina's last appeal, Fernandez has promoted the idea that her government can ignore its rulings and meanwhile keep its promises to a much larger group of bondholders. Her ministers say she can avoid defaulting on another $24 billion in debt by paying them outside the U.S. financial system.

Most analysts say this scenario will never work. Meanwhile, Fernandez's Cabinet chief, Jorge Capitanich, denied on Thursday that an Argentine team would go to New York for talks with creditors next week — backtracking on a promise the government's attorney made to a judge the day before.

"There's no mission or committee prepared for a trip to the United States," Capitanich said. He did not provide any details about next steps, but said, "We're going to utilize all the strategies that could be convenient to defend the national interest."

New York billionaire Paul Singer, whose hedge fund NML Capital Ltd. won the case, will have to decide whether Fernandez is bluffing. The stakes couldn't be higher for Argentina's fragile economy.

Here are some ways it could play out:

"Plan A"

— Argentina complies with the orders of U.S. District Judge Thomas P. Griesa.

It pays the plaintiffs 100 percent in cash, plus interest, on debt that went into default a dozen years ago, starting with $907 million by June 30. That's when another $907 million is due on the $24 billion in "exchange bonds" owned by the 92 percent of investors who agreed to swap defaulted debt for new bonds worth a third of their original face value. The holdout plaintiffs own about 1 percent of the original defaulted debt, and sued rather than agree to provide Argentina debt relief. The judge says exchange bondholders can't be paid unless the holdouts get an equal amount.

The pros of this approach? With nearly $29 billion in foreign reserves left and very low indebtedness relative to the size of its economy, Argentina can afford to make this month's payments, at least. And if it is willing to follow New York law and borrow again, it can meet future bond quotas without abandoning its populist programs.

In fact, bond analyst Josh Rosner says Wall Street firms are eager to lend Argentina whatever it needs to pay off all its remaining defaulted debt, which Fernandez said totals $15 billion.

"If the government chose to raise capital as a means of resolving this impasse, it would normalize its relations with the international capital markets, reduce its cost of funds going forward and immediately begin to attract the foreign investment necessary to develop key industries, including its energy sector and the broader economy," said Rosner, the managing director at Graham Fisher in New York.

The main con for Fernandez? Most Argentines blame international debt for causing the very crisis that led to the default, and are fearful of taking on major new loans.

The official story of Fernandez's "victorious decade" is that she and her late husband, President Nestor Kirchner, restored Argentina's economic sovereignty after foreign banks brought the nation to its knees. They paid down international debts, even at a huge cost.

But without affordable access to foreign credit, the government has already spent much of the Central Bank's reserves on energy subsidies and social programs, weakening its ability to control inflation and manage the money supply. Fernandez is correct when she says "it would not only be absurd but impossible" to use half the remaining reserves to pay court judgments in cash, as the judge has ordered.

"Plan B"

— Argentina defies the judge, forcing U.S. banks to stop processing its payments to the 92 percent of bondholders who have been getting paid. Argentina then offers to swap these freshly defaulted New York bonds with new bonds paid from Buenos Aires and guaranteed by Argentine law.

Cabinet chief Jorge Capitanich said Thursday that this remains Argentina's plan, and blamed the judge for making it impossible to meet its June 30 responsibilities in New York.

Fernandez controls Argentina's Congress, so she could get this plan approved locally, but organizing a debt swap can't be done in little over a week, meaning missed payments are inevitable. And because Argentina has the capacity — but not the will — to pay the court judgment, this would be more than a "technical default," as Argentine authorities have described it.

The missed payments would likely trigger a cascade of bad outcomes and threaten to unravel many other debt accords, including Argentina's recent deal to repay $9.7 billion to the Paris Club of lending nations, which includes the United States.

The main pro of this approach is that defying the so-called "vulture funds" is a highly popular idea among Argentines.

Argentina's law firm advised Fernandez that her best option for leverage was to default first and negotiate later. So even if it doesn't work, it could give a president intent on showing the global financial system who's boss in Argentina a short-term boost as she begins the last 500 days of her eight years in office.

And if Singer believes she's not bluffing, he might just offer a face-saving deal she can carry back from the edge of the abyss.

The main con? Few people who understand bond markets think it has any chance of success.

About 85 percent of the creditors would have to approve it, said Matias Carugati, an economist for Buenos Aires-based consultancy, Management & Fit, and many investment funds are barred from making such a change. Others would be wary of relying on Argentine law.

Consequences:

Argentina is already suffering through a recession, rising poverty and crime, reflecting an economy that has stopped growing. Its consumers are already spooked by currency controls, lack of credit, spiraling inflation and other results of the government's refusal to settle accounts with foreign lenders.

A disorderly default would be dire, making credit disappear and costing jobs, said Fausto Spotorno, an economist with Orlando Ferreres & Asociados.

"I'm not so much worried for me as for my kids. I'm going to be dead already and Argentina will still be paying what it has owed for years," said Umma Sanchez, a 37-year-old psychologist. "We will never be a normal country, and that we owe to the people who govern us."