After months of uncertainty, Argentina finally submitted its formal debt proposal to the Securities and Exchange Commission (SEC) on April 17— a little over two weeks past its self-imposed deadline.
The proposed debt restructuring of $66 billion worth of New York-based Argentine bonds would cut 62 percent off the net present value of assets. It also asks creditors for a moratorium on all interest and principal payments for three years. In an unexpectedly positive development, there is only a five percent cut to the principal. The government has given creditors until May 8 to consider the deal.
Compared to Argentina’s previous debt deals, this offer was better than expected—initially reflected in moderate improvements in the price of Argentine bonds and falling country risk. Yet, these gains quickly receded as creditors found cold comfort in the deal. So far, three groups of bondholders have already rejected the offer, demanding better terms.
The current offer by the Fernández administration would make this round of debt restructuring less aggressive than Argentina’s 2005 offer. However, it is much more punitive than what President Alberto Fernández’s alleged model, Uruguay, offered creditors in 2003.
D-day will ultimately be May 22, when Argentina either enters into a default or avoids the worst. On April 22, Argentine authorities failed to pay over $500 million in foreign law bonds, and although non-payment is a default, the country has a 30-day grace period before a formal default occurs. This is a risky gamble by the authorities, as it leaves them with a very short window of opportunity to negotiate with creditors.
“Vamos por todo”
As I have written here before, Argentina’s economy was in the lurch prior to the onset of the COVID-19 crisis. Fernández inherited two dire economic legacies: a debt overhang from President Mauricio Macri and a Jenga-styled economy from years of populist rule by the Kirchner couple.
The long and short of it is that Argentina has been unable to decrease public spending to levels that the country can finance with its own resources. Fernández’s heterodox team of economists and his own policy preferences toward subsidizing the middle class, largely through ill-targeted subsidies, has further increased the deficit.
Fernández’s unwillingness to consider unpopular structural or fiscal reforms means he sees increased public spending as part of the solution. Yet, Argentina’s long-run mismanagement of its debt and its penchant for money printing to cover its fiscal deficits has left the country resource poor and grappling with high inflation.
Aware that the country cannot access credit and money printing as it would lead to inflation, the government passed an emergency economy law that increased taxation on exports, foreign exchange and imposed a wealth tax. Yet, the increased rates of taxation failed to reverse the trend of lower revenue caused by the country’s three-year-old recession. Even before the onset of the pandemic, Minister of Economy Martín Guzman warned creditors that the country would not achieve a primary budget balance until 2023.
The outbreak of COVID-19 has substantially worsened the economic and fiscal outlook. According to the International Monetary Fund, Argentina will see an economic contraction of 5.7 percent—over a 10 percent reduction in the economy from the start of the recession in 2018. Notably, this is only an early estimate and does not include the potential effects of a default.
Mind the gap
Considering the economic crisis that confronts Argentina, the IMF deemed its debt as “unsustainable.” It determined that “the primary surplus that would be needed to reduce public debt…is not economically nor politically feasible.” In other words, creditors cannot expect full repayment with the debt’s current structure and timing.
This nod by the IMF to the Argentine government’s position strengthened the latter’s hand with creditors. In the context of the COVID-19 crisis and the IMF’s support, the offer presented by the authorities needs some work, but is not a deal breaker.
While some creditors are going so far as to call the proposal “garbage,” this is to be expected as they try to eke out a better deal. A more substantial criticism is “Argentina continues to seek maximum [debt] relief without articulating a credible plan for how the debt will be paid in the future.”
From the perspective of a creditor, the deal offered by Argentina is not coupled with a strategy to ensure repayment. The government has no path toward primary fiscal balance nor is it proposing any reforms to make the economy more competitive. Instead, the government holds that a deal must come first, as it would “open a window of opportunity to generate greater stability and speed up the recovery process,” said Minister Guzman.
This impasse is creating a serious misalignment of incentives for both sides.
With the government failing to provide a growth and repayment plan, creditors face high risk, leading them to demand higher interest rates. Pricing in the higher risk makes a deal harder to accomplish, as the authorities may recoil at the offer and prefer a default. If the authorities are more fearful of a default, they may agree to harsher terms that could make repayment harder to sustain. Without a clear path to repayment, creditors and Argentina may be back to square one.
Worse, any attempt at forecasting in the middle of an economic crisis, especially one that the IMF has deemed the worst since the Great Depression, may be nothing short of negotiating over fool’s gold.
Not cut from the same cloth
While Argentina struggles to get creditors to forgive large portions of its debt, other countries in Latin America are able to borrow at developed world rates.
Peru’s strong macroprudential approach over the past decade allowed the country to be a blockbuster in its latest debt issuance. As a result, the country is able to mount the largest injections of government money in the region to prop up the economy.
Another standout is Uruguay. The head of the World Bank’s Latin America and Caribbean division says Uruguay “is one of the countries that does best [in the region].” The IMF projects GDP to decline by 2.7 percent in 2020, but sees a strong rebound of five percent in 2021. In contrast to almost every other country, Uruguay’s central bank is raising interest rates to prevent inflation.
Should Argentina fall into default, it would be the ninth in its history and the third this century. A default would push the country into pariah status with creditors and raises the specter of another round of judicial challenges by holdouts (“vulture funds”). It is a situation not helped by its low level of policy continuity and questionable economic policies. It is not that Argentine policymakers don’t have examples to emulate, but even if they had the will to try, time appears to be running out.