Publish in Perspectives - Wednesday, March 18, 2020
Argentina -- here represented by capital Buenos Aires -- has no choice but to return to the capital markets, the author argues. (Photo: CESBA)
Argentina does not have a solvency problem and won’t get any sympathy in debt talks.
BY WALTER T. MOLANO
As Argentina lurches towards restructuring, it is clear that it has been the recipient of very bad advice. From the IMF to Nobel Prize winners in economics, the country has been urged to default on its debt, and apply a large haircut on bondholders. This is the only way that the country will return to sustainability, or so they say. Hence, Argentina will again walk away from its obligations and live up to its reputation, as a serial defaulter.
In order to ensure sustainability, Economy Minister Martin Guzman argues that the country cannot pay coupon rates above 3 percent. However, what he does not understand is that the more adverse the restructuring, the higher the exit yield. The government’s objective should principally be the exit yield. One of the reasons why the country has been a serial defaulter is because it has always had to pay exorbitant rates for fresh capital. During the last 13 years, the average EMBI spread for Argentina was 811 bps. With an average 10-year Treasury yield of about 2.5 percent, the average cost of capital for Argentina has been north of 10 percent. No country can sustain that type of interest costs, particularly when they are periodically shut out of the international capital markets.
PRIVATE PENSION FUNDS
This was a problem that was supposed to be solved by the introduction of the private pension fund system. It created a domestic pool of savings that would have taken care of the country’s financing needs, while access to the international capital markets were closed. It worked wonders in Chile, Bolivia, Peru, Colombia, Uruguay and Mexico.
However, the Argentine private pension fund system was nationalized by the very same government that is now bemoaning its lack of access to capital. Moreover, the spasmodic access to capital is one of the several reasons why the country’s cost of funding is so high. The problem is that the people making recommendations to the Argentine government probably never heard of the rule of 72. One of the rules of thumb presented in Finance 101, it states that dividing 72 by the rate of return indicates how many years it will take for an investment to double, Therefore, using a yield of 10 percent, the country’s debt obligation double in 7.2 years. This is the reason why Argentina is a serial defaulter. Its huge reputational problems force it to pay dearly for capital, and it is always expanding its debt load geometrically. The interesting thing is that it now has the opportunity to turn around its reputation.
NOT SOLVENCY PROBLEM
Argentina does not have a solvency problem. A year ago, when the IMF came to the country’s rescue, it said that the country did not have a solvency problem. So why does it have a solvency problem, now? What changed? Did it embark on a borrowing binge? No. It did go through a democratic electoral process, where there were no accusations of irregularities. Democracy is one of the tenets of a modern capitalist system. The two go hand in hand, right? The currency did devalue in the aftermath of the electoral results, but isn’t that one of the possibilities that can occur in the floating exchange rate regime that was mandated by the IMF? Furthermore, the country’s dollar GDP shrank after the devaluation. Again, this is a normal outcome, given that GDPs are calculated in local currency units and converted into dollars. However, the effects of devaluations are transitory and GDPs normally return to their steady state soon afterwards.
Prior to the PASO, Argentina’s dollar GDP was $490 billion, and it fell to $411 billion by the end of the year. This pushed the gross debt-to GDP ratio to 101 percent from 81 percent, and the external debt to GDP to 57 percent from 40 percent. Moreover, the average size of the Argentine economy for the last five years has been $561 billion, which means that the debt to GDP ratios will fall substantially once the economy returns to its steady state level of output.
This is not to say that the country does not have a liquidity problem. No modern country, company or individual can survive without access to external capital, unless they reduce themselves to bare bones subsistence. Therefore, what the country needs to do is to hammer out a plan that will accelerate its return to the capital markets. This will only happen if it does the right thing, by trying to make good on its external obligations.
These are the reasons why Argentina will not get any sympathy from creditors. Economy Minister Guzman may try to intimidate as much as he wants, but he knows that if he wants to avoid the prolonged restructuring nightmare that the Kirchner’s endured, he will need to propose something that is palatable to investors. The difference with the last restructuring is that the country was enjoying the bonanza of a commodity boom and a quiver full of liquid assets, such as YPF and the private pension fund system. Now, the state’s cupboards are bare and commodity prices are plunging. Therefore, it is time for Buenos Aires to tune out the sweet siren’s song, because it will only lead to the rocky shoals of perdition.
Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development.