Back in the days…
On April 1st 1991, Carlos Menem (President of Argentina) and his Economic Minister Domingo Carvallo adopted the ‘Convertibility Plan’. The goal of this plan was to bring to an end four decades of inflation (especially after the 1989-1990 hyperinflation the country suffered from with annual rates of 3070% and 2313% respectively), therefore Argentina relied on a fixed convertible exchange rate (1ARS = 1 USD), limiting the printing of pesos only to a amount necessary to purchase dollars in the FX market. Immediately, it attracted foreign investments and the cost of borrowing plummeted (spread Argentina vs US bonds narrowed to almost zero). Standard of living increased (wages went up) and, as a matter of fact, the inhabitants of Argentina were pretty much satisfied to have a strong currency.
However, it didn’t take so long to the Argentine economy to show trade deficits as a strong currency impacted their exports. Many local businesses closed during the mid 90s and unemployment rate started to soar. Therefore, in order to keep the economy growing, government started to intervene and the debt ballooned.
However, Argentina had to ‘swallow’ several shocks:
– The Tequila crisis and Mexico’s December 1994 peso devaluation, which scared international investors and capital started to flow out of Emerging Markets.
– The Fed starting to raise its benchmark rate from 3.0% in early 1994 to 6.0% in 1995.
– A US Dollar prolonged period of appreciation, resulting in a strengthening Argentine peso and therefore a loss of competitiveness against its main trading partners
– The rise of the East Asian financial crisis in 1997
– The Russian default of 1998
– The Brazilian devaluation of 1999
If we have a look that at the tables below, which shows the main macro figures of Argentina during the second half of 1990s, we can see that it became clear that the Convertibility Plan was unsustainable for the Argentine economy. The ‘recovery’ of 1996-1997 with GDP picking up and unemployment rate declining wasn’t enough to hide the ‘twin deficit’ as current account deficits and debt measures worsened in the same period.
(Source: Trading Economics)
As we learned from the previous crisis, if an economy is showing negative figures for a few consecutive years, fear of an eventual default is rising and investors start to withdraw all their investments and place them into ‘safe-haven’ assets. At that time (late 90s), there was a massive capital flight from Argentina to US, spreads between the 10-year yields hit 2000 bps and Argentina was not able to borrow in the market anymore.
After serving 10 years as the President of Argentina, Menem’s attempt to run a third term was ruled to be unconstitutional and opposition candidate Fernando de la Rua took office on December 10, 1999. He immediately turned to the IMF for help, and on March 10 (2000) Argentina received a first $7.2bn bailout conditioned on a strict fiscal adjustment. It was followed by a second assistance package of $40bn a few months later, raising concern over the effects on the credibility of the Convertibility Plan. By the end of 2001, Argentina defaulted and walked away from more than $80bn in international debt by conducting a debt swap (for instance, on November 6 2001, Argentina exchanged $60bn of bonds with an average rate of 11-12% for extended maturity notes carrying 7% interest rate). Eventually, President Duhalde (who replaced interim President Adolfo Rodriguez Saa after de la Rua resigned on December 21, 2001) announced the end of the currency board on January 6 and a plan to devalue the ARS.
Since then, the ARS has constantly been depreciating against the greenback and is now trading at 8.20 against the greenback. However, as you can see it below, the on-shore rate (Dollar official) is still trading well below the off-shore rate (dollar blue or black-market rate) which is now flirting with the 13.00 level.
However, in most cases, restructurings occur after a default and restructuring the debt doesn’t mean making the debt vanish, but working on a some negotiations with international creditors in order to get a bit of time while the country itself starts to recover. Therefore, since 2003 the government has implemented a successful debt management strategy, and during two restructurings in 2005 and 2010, holders of about 93% of Argentina’s debt agreed to swap their bonds in deals that initially paid around 30 cents on the dollar.
But a few creditors (hedge funds such as NML and Aurelius Capital) refused to swap and instead went to court in New York (under whose law the original bonds were written) and sued for a repaid 100% of face value for bonds purchased on the secondary market for cents after Argentina’s financial crisis (when the market price of the bonds plummeted). After years of fighting, the holdouts’ strategy paid off as a 2012 New York Second Circuit Court ruled in favour of the holdouts and required that Argentina pay full value plus interest on the outstanding bonds. US District Judge Thomas Griesa has ruled that Argentina can’t pay holders of its restructured debt without also paying the $1.3bn plus interest to the holdouts (pari passu clause). He declared illegal any further payment on restructured debt which excludes the ‘holdouts’ .
On June 30th, as Argentina couldn’t legally pay only the restructured debt, the country missed a crucial $539 million bond payment to US creditors as it couldn’t pay the extra $1.3bn (plus interest, total of $1.5bn approximately) to the holdouts. The country has now entered into a 30-day grace period which matures tonight and Abeda (members of Argentina’s banking association) is still working on a last-minute plan in order to help the country avoid default.
The question that you may ask yourself is ‘why not pay the holdouts?’
Negotiating with the holdouts bondholders could trigger the Rights Upon Future Offers (RUFO) clause and would open up to $30bn (equivalent to the nation’s foreign exchange reserves) worth of claims from other creditors holding the same bonds, which until December 31 this year ‘prohibits Argentina from voluntarily offering a better deal to the holdouts without also extending it to the exchange bondholders’.
In addition, it would decrease the standing of Argentina’s current President, Cristina Fernandez de Kirchner, in the eyes of the Argentine people (‘It’s our obligation to take responsibility for paying our creditors, but not become the victims of extortion by speculators’, Kirchner said in her national TV last June).
Looks like no default based on market speculation…
The solution indeed would be to work out a deal where Argentina would pay the holdouts in the form of new bonds, therefore avoiding a default and not triggering RUFO clauses.
If we have a look at the market, Argentine bonds are surging to a new three year high on speculation that government officials and holdouts will reach an agreement. As you can see it on the graph below, the 2033 bonds soared 17 cents on the dollar to 98 cents today…