Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AmericasJuly 1 2015

Argentina continues to walk a default tightrope

It is becoming less and less likely that Argentina will resolve its dispute with international investors over its 2002 default before its presidential election in October. The question is, will the country drift further apart from the international investor community, or will the next government bring about the structural reforms markets are impatient to see?
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Argentina continues to walk a default tightrope

By now, investors had expected that Argentina would have settled its long-running dispute with the hedge funds that had refused the sovereign’s debt restructuring terms following its 2002 default. When, in mid-2014, a US district court upheld a previous ruling siding with the funds, analysts forecast that president Cristina Fernandez’s administration would resolve the matter before the country's October 2015 general elections, and before payment on a dollar bond was due in the same month.

Argentina – according to its own official statements – is running out of foreign reserves and, officially at least, continues to be cut off from international markets. Yet, a settlement has still not materialised. Far from it, in fact. The country is being accused of favouring disingenuous schemes over international negotiation, and its already stagnant economy is at risk of being engulfed by further waves of litigation.

Bonar drama

The latest dispute is centred on the issuance of the so-called Bonar 24, in April 2015. These are dollar-denominated notes, governed by Argentine law, and which are exempt from the 2014 US court ruling, on the basis that they are offered to local investors only. According to New York judge Thomas Griesa’s interpretation of the pari passu clause, which was upheld by the district court, if one creditor is paid, all others must also be paid at the same time. This applies to sovereign debt that is considered external. The local-law Bonar 24, in theory, does not fall into this category, as it was meant for local investors only.

But, as often happens with large issuances – a total of $1.4bn was raised through the new notes – it appears that the offer crossed national borders. Investors believe that funds raised with the Bonar 24 will be used to repay notes due this October, the so-called Bonar 15, a dollar-denominated domestic bond. Aurelius Capital, one of the two activist hedge funds that won the New York case, promised action against any international parties that either bought or helped Argentina place the new notes abroad. The threat seemed to have triggered a response from Argentina’s economy minister, Axel Kicillof, which implied that international investors did buy the Bonar 24 – as followers of Mr Kicillof’s Twitter feeds may have noticed this April.

The holdout funds agree with Mr Kicillof that international investors were involved, and the funds now intend to block payments on the new debt, as any international offer would be considered as external indebtedness and ought to be captured under the New York ruling. Lawyers for NML Capital, which has led the law suit against Argentina along with Aurelius, have requested that the Bonar 24 be subject to Mr Griesa’s pari passu interpretation. Plaintiffs own a total of $1.7bn in debt claims – although overall legal claims are now a much higher $10bn.

One insider with direct knowledge of the legal dispute tells The Banker: “In May, there was a meeting with the [NML Capital lead] investor group that sued Argentina, in which it was asked ‘How many of you were offered the Bonar 24?’ and a few hands went up, so I guess it wasn’t a local offer only. This is what Argentina is attempting to issue now, instead of negotiating [with the holdouts].”

Yannis Manuelides, a partner at law firm Allen & Overy, says he had also received queries about Bonar 24-like debt. "There has been interest in the market in structures which, like Bonar 24, arguably fall outside the New York court ruling. Technically, this could be done by issuing under Argentinian law in non-Argentinean currency, but the bonds had to be genuinely offered exclusively within Argentina. Such a purely domestic offering would be very challenging for any big issue. The prudent advice [to clients] was therefore that such a structure would be seen as an obvious scheme to bypass the ruling and the investors could get entangled in litigation,” he says.  

The job ahead

Whoever is elected as Argentina’s new president in October will have a big task ahead. Gross domestic product (GDP) is expected to grow by only 0.5% or so this year, while next year’s forecast depends on a resolution with the holdouts but is unlikely to be much more than 2%, according to ratings agency Standard & Poor’s. Although helped by the Bonar 24 issuance, liquid foreign reserves will be $5bn by the end of December, according to local investment bank Puente – which will be sufficient to see the country through 2015, but not much beyond that, as the market for Argentine law, dollar-denominated debt is limited.

“Argentina needs to gather enough [international] resources for next year,” says Puente’s head strategist, Alejo Costa. “Our calculation is that by the end of this year, after the Bonar 15 payment, Argentina will have $5bn in liquid reserves – this means you take gross reserves, you net out any dollar liability, gold, anything that is not liquid, and then you have liquid reserves, the cash value.”

Argentina will therefore enter 2016 in a weak position, according to Mr Costa. “When you do the maths, the market for local-law issuances is not that deep," he says. "Argentina may issue maybe $4bn or $5bn in local law, but if it really wants to increase the depth of the market, it needs to issue debt in foreign law. The only way to have a natural buyer for Argentina, that can absorb $10bn or $20bn of new issuances, is to have real money funds from the US buying that debt. The way you do that is by increasing the weight of Argentina in different indices, and the way you increase the weight in the index is by increasing debt, but in foreign law – UK or New York law,” he says.

Going to give?

While reassured that Ms Fernandez, the feisty and popular current head of state in Argentina, will not be able to run again – the country's constitution does not allow more than two consecutive terms in a row – investors are planning for different scenarios, depending on which of the presidential hopefuls wins in October.

While front-runner Daniel Scioli, who is part of Ms Fernandez’s Justicialist party, has shied away from publicly tackling the holdout issue, pro-business candidate Mauricio Macri and third favourite Segio Massa have openly identified it as matter of priority. Former central bank governor Martin Redrado, now economic advisor to Mr Massa, says: “Argentina needs to resolve [the holdout] issue in a comprehensive way to put the default behind it. Our country would need significant inflows of dollars to regain economic confidence, credibility and growth.”

The next administration will also need to tackle a growing fiscal deficit – expected to reach 4.4% by the end of 2015; an inflation rate based on government statistics that are widely discredited and that the private sector puts at about 35%; and a multi-tiered foreign exchange system that investors believe gives a distorted and overvalued picture of the country.

Water Stoeppelwerth, advisor to the board of directors at Argentine fund manager Balanz Capital, says: “For investors who are used to looking at emerging markets, when you have a yawning fiscal deficit, a currency as overvalued as Argentina’s, you know that something is going to give.”

But Argentina’s exceptionally low debt-to-GDP ratio, less than 46% last year, and its abundance of natural resources, should make it an appealing proposition for investors. Stephen Fang, head of global restructuring and insolvency fixed income for Europe, the Middle East and Africa, at Aberdeen Asset Management, points to the country’s shale gas discoveries, which he describes as “one of the most promising shale developments outside of the US”, and to Argentina's oil reserves, which could turn it into the world’s fourth largest oil producer, as well as to its mining projects as factors that could lead to a brighter future.

No quick fix

As hopes that things will change under Argentina's next government – irrespective of its political convictions – rise across financial markets, some wonder whether investors are showing too much optimism over the country's immediate future. Delfina Cavanagh, the principal analyst on Argentina at Standard & Poor's, is one such person. “I get lots of calls about Argentina; investors are very enthusiastic. But changing things, making the necessary reforms, it won’t be fast or easy,” she says.

Such reforms need to pay particular attention to distortions in the market, such as controlled prices in certain sectors and on the currency. Liberalising the exchange rate is of particular importance, according to Mr Stoeppelwerth. “We think there’s a lot of money out[side] of Argentina that wants to come in but only when the exchange rate structure changes,” he says.

Mr Fang adds: “Fixing the inflation [problem] once and for all would also provide a needed boost to credibility and transparency – not to mention, help normalise relations with the International Monetary Fund, which could be useful down the line should Argentina require multilateral financing. [But], until the New York court saga is played out, we will continue to favour local-law performing debt.”

Holdout scenario

The saga now involves other holdouts, in possession of $5.4bn of New York-law Argentine bonds, which, in June this year, got the green light from the US district court to pursue payment under the pari passu clause. And it may also evolve into a holdout of holdouts scenario, where plaintiffs would opt out of any negotiations with Argentina to purse better terms.

Mr Manuelides believes that other holdouts with the same legal claim and, therefore, the same legal remedy as NML Capital and Aurelius may seek a better settlement – although this is unlikely given that most of the other holdouts do not have the capacity, funding and stamina that the principal activist holdouts have. Holdout investors of bonds governed by law of other jurisdictions may also purse Argentina, says Mr Manuelides, but the sovereign may well choose not to settle with this group, leaving the door open to further litigation. 

The conclusion of the Argentinean default saga may come in 2016, under a new leadership. However, this is far from certain, as market expectations have been unmet before in Argentina. Investors believe that a speedier resolution will be reached under the leadership of former businessman and mayor of Buenos Aires Mr Macri, who has been more vocal than others about the need to re-enter international markets and attract investment. He is considered as the best bet to dismantle Argentina’s currency and trade controls. If elected, however, he would very likely face tougher opposition from congress, where Ms Fernandez’s party and its Peronist views are strong.

This means, therefore, that Mr Scioli may be the man who could more easily bring about change. “[Mr] Scioli is busy trying to win the elections”, says one Argentina watcher, “and this may mean carrying over part of the current government’s lines.” The Justicialist candidate has already stated that he would welcome current economy minister and holdouts fighter Mr Kicillof in his team.

Late in June, Mr Scioli also announced Carlos Zannini, a close confidant of Ms Fernandez, as his running mate and possible future vice-president, which some see as an inexplicit endorsement by the current president. The Argentina expert says: “If Mr Kiciloff is named economy minister that would be a clear indication that Ms Fernandez will try to have a firm hand on things. [But Ms Fernandez] may also think that, because Argentina is a presidential system, where all powers are with the president, she won’t be able to really control Mr Scioli anyway, and so she may [prefer] to have her party in opposition for four years and then come back. It is all still very unclear.” 

Was this article helpful?

Thank you for your feedback!

Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
Read more articles from this author