Argentina: Avoiding Another Default

Can President Cristina Kirchner end her mandate without a debt default?

LATINVEX SPECIAL
Knowledge@Wharton

Anger and denial were the first emotions that registered from Argentine president Cristina Fernández de Kirchner on June 17 when the United States Supreme Court rejected intervention in the ongoing legal battle between the country and the group of bondholders to whom Argentina owes $1.33 billion from bonds that it defaulted on during the country’s economic crisis of 2001.

The position of Fernández de Kirchner was spelled out in a recorded message in which she said, “You have to distinguish between negotiation and extortion.” The Argentine president let it be known that she was not going to accept the judgment of the Supreme Court, which left standing the court order of Federal Judge Thomas Griesa, who had mandated that Argentina must make payments to the 7 percent of the nation’s creditors who had not entered into the debt swap arrangements made available to them in 2005 and 2010. These bondholders included investment funds Aurelius Capital Management and NML Capital, and a group of 13 others, whose aggregate claims amounted to $1.33 billion plus interest.

However, the government then took a subsequent step in the opposite direction. Ultimately, the president and her team of advisors decided at the last minute to negotiate in order to end what has become a dangerous situation for Argentina. The country’s failure to accept the judgment could mean entering into default once again, thus rendering useless the payments that Argentina had agreed to pay the other 93 percent of its creditors, and sending the country into bankruptcy.

This change of strategy was captured later in an advertisement taken out by the government of Argentina in The Wall Street Journal, in which officials confirmed the country’s willingness to “continue paying its debts” and claimed that the U.S. federal judge “promotes conditions for negotiating a resolution” of the dispute with the plaintiff bondholders. During a public meeting held on June 20, Argentina’s Flag Day, Fernandez Kirchner said, “We want to comply with 100 percent of the creditors.”

Subsequently, after Griesa blocked Argentina from making $539 million in interest payments due on some of its bonds, Argentina announced that it would send a delegation to meet with a court-appointed lawyer on July 7. Observers believe that Argentina will likely default if it cannot get that money to bondholders before a 30-day grace period. The judge has ruled that Argentina must pay the hedge funds that are suing to collect on their defaulted bonds at the same time it pays those investors who own bonds the country issued after its 2001 default.

According to Wharton management professor Mauro Guillen, the government must learn that it “has to play cleanly, both with respect to its citizens and the international community.” Over the short term, the new, cooperative attitude of the Argentine government had a positive reaction in the marketplace, where bond prices rose by 9 percent in Buenos Aires, and by between 13 percent to 18 percent on dollar-denominated bonds and coupons linked to Argentina’s gross domestic product (GDP). That derivative investment takes into account the growth rate of the Argentine GDP, as well as changes in the real exchange rate and the volatility of the growth rate of GDP in 30 years. In addition, the government began to lower the value of the “blue dollar” (the dollar exchange rate on the black or parallel market), by raising its value against the peso, from 12.45 pesos per dollar to 11.90 pesos per dollar.

A LONG HISTORY

Argentina’s current predicament began when then-President Nestor Kirchner assumed the job in 2004, during the aftermath of the social and economic crisis that battered the country at the end of 2001. To provide a solution to the $102 billion debt that the country maintained with its domestic and foreign creditors, the government opened two debt exchanges in 2005 and 2010, through which it managed to get support from 93 percent of the investors by providing them with a settlement at a 65 percent discount on the dollar.

The other 7 percent of bondholders did not accept this settlement process, and continued their legal action in the United States, where the bonds had jurisdiction. Among them were two investment funds that buy low-priced bonds — otherwise known as “junk bonds.” The two so-called “vulture funds” — Aurelius and NML — had paid $48 million to acquire Argentine bonds, whose market prices had collapsed because they were considered highly risky. In the wake of the legal judgment in the U.S., these funders were due to receive a stunning $900 million dollars — that is to say, 100 percent of the bonds’ face value, plus interest. In denouncing the latest judgment against Argentina, President Fernandez de Kirchner said, “I believe that in all of organized crime, there has never been a case of a profit of 1,608 percent in such a short time."

The country’s debt problems don’t stop there: An additional $15 billion dollars from other creditors remains in limbo, and thanks to the decision of Judge Griesa, these bondholders now have a legal precedent to validate their claims.

Meanwhile, the government of Fernández de Kirchner has tried to relieve itself of two other important debt burdens — its debt to Repsol, the Spanish oil company, and to the Club of Paris, an informal forum of official creditors and debtor nations. At the end of April, Argentina agreed to pay Repsol $5 billion in bonds for the 51 percent of Repsol’s shares that the government had expropriated. Moreover, on May 28, the Argentine government agreed to pay the Club of Paris the sum of $10 billion over five years, with an initial capital payment of $650 million.