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Español Argentina’s default saga, with the nation and her bondholders in bitter confrontation, has begun a new chapter. US Judge Griesa ruled in favor of some holdouts — known as the “vulture funds” — and continues to hope Argentina will make the corresponding payment for the full value of the debts, US$1.7 billion.
That would free up $539 million for the bondholders who entered new agreements in 2005 and 2010. Prior to the ruling, the Argentinean government was paying these parties on time and in accordance with restructuring.
Since the Griesa ruling, payments to these restructured bondholders have remained stalled, and they will remain on ice until the select holdouts receive what is owed to them. Argentinean officials, however, have decided not to pay the holdouts, and credit-rating companies have characterized the current situation as a “selective default.”
Uncertainty among Argentineans, consequently, has ballooned. Many ask themselves how the “selective default” will affect the economy; others wonder whether this default will be similar to and as severe as that of 2001.
This article endeavors to clarify the steps that led to Argentina’s cessation of payments and subsequent default (again); identify the underlying causes that have brought the nation to this debacle; and the impact of the default on a nation already in recession, set to continue in 2015.
How Did Argentina Get Here?
Argentina’s international debt has been growing since the military dictatorship of the 1970s, when it reached $41 billion. Every central government since then has contributed to a rapidly increasing debt, and at the end of 2001 it reached $144 billion.
At that time, President Adolfo Rodríguez Saá announced that the nation would stop paying beyond $102 billion. It is difficult to say what was worse, that the executive branch decided to default on its record debt, or that the Congress fervently supported the decision.
Sadly for Argentineans, such decisions come at a hefty price, and our international credit has suffered since.
Sadly for Argentineans, such decisions come at a hefty price, and our international credit has suffered since.
In 2003, when Néstor Kirchner became president, he worked with that year’s minister of the economy, Roberto Lavagna, to come up with a way to restructure the debt. In March 2005, they negotiated to discount 65 percent of the debt, and 76 percent of the bondholders agreed to receive less money. Five years later, Argentinean officials managed to extend the discount to 92 percent of the bondholders. The current president, Cristina Kirchner, thought the battle was won.
That couldn’t be further from the truth. The creditors that did not enter the exchange, the holdouts, sued Argentina. At the beginning of 2012, US Judge Thomas Griesa ruled that the creditors that did not agree to the restructuring offered — those that brought their case to him — must still receive at least the amount of those that did (pari passu clause). At the end of 2012, Judge Griesa also ruled in favor of the select holdouts and ordered Argentina to pay $1.3 billion (now almost $1.7 billion).
Argentina did not accept this ruling, and in June 2013 the country appealed to the US Supreme Court against Judge Griesa’s ruling. Two months later, the Supreme Court upheld Griesa’s decision. Argentina was required to pay the holdouts within a year — that is, by June 30 of this year, with a 30-day grace period through to to the end of July 2014.
Argentina Shields Itself with RUFO Clause
The Argentinean strategy, instead of simply paying these dues, has been childish throughout — relying more on cheap insults than meaningful dialogue.
The official position is that if the nation were to comply and make this payment, she would have to pay the remainder of the holdouts, caught up in other court cases. This would translate to a $15 billion payment.
Economic Minister Axel Kicillof has complained that this amounts to half of the nation’s reserves. It would be wise for the minister to recall that between 2011 and June 2014, the nation bled $22.5 billion of its reserves, an amount far higher than the $15 billion that the holdouts demand.
Second, the Kirchner administration maintains that it cannot negotiate with the holdouts, because if it did, it would trigger the RUFO (Rights Upon Future Offers) clause. This implies that the bondholders that entered the restructuring, the “hold-ins,” could demand payment for the total, original amount. This would cost the Argentinean government another $120 billion, while its reserves are only $29 billion. In other words, it would mean outright insolvency.
With the presence of the RUFO, opinions abound for and against the activation of such a clause. The critical element states the following:
[If] Argentina voluntarily makes an offer to purchase or exchange or solicits consents to amend any Eligible Securities not tendered or accepted pursuant to the Offer, Argentina has agreed that it will take all steps necessary so that each holder … will have the right … to exchange … [for] terms substantially the same as those resulting from such amendment process.
In this clause, one must highlight the word “voluntarily,” which is the key to this issue. In other words, the bondholders that entered the exchange are able to demand the entire debt, but only if Argentina voluntarily offers it to other bondholders.
In this case, the nation would be implementing the judge’s order, and the payment would not be voluntary. If the payment, however, were realized through renegotiated bonds, that would complicate the situation.
Regardless, what the government has forgotten to say is that this clause does not prohibit payment in cash. Through this manner, the government could have resolved the holdout situation without risk of triggering the RUFO. This insight suggests the Kirchner administration has no intention of paying off its debt.
This insight suggests the Kirchner administration has no intention of paying off its debt.
Still, there was other ways to avoid the RUFO. The Kirchner administration could, for example, open a bank account in New York in US dollars and allow Judge Griesa to use the account to pay the holdouts. This would not be a negotiation, because there would be an embargo in effect. This adds more weight to the view that the government will still not be interested in paying the holdout debt in 2015, even though the RUFO clause will have expired.
On the other hand, the administration was near to an agreement with private banks and Argentinean business-owners that were open to buying the bonds from the holdouts. But the frigid tone of the finance minister muffed this opportunity.
Now, such a solution is in the hands of international banks. Perhaps, via further bureaucracy, they will attempt to buy the debt to avoid a broader default from Argentina.
The Official Response, the Real Problem
President Kirchner has begun to say in her speeches that Argentina will not declare a default, because the country paid. The funds simply got stuck in New York on account of Griesa’s order. Because of this, her thinking goes, the bondholders cannot charge them. With this technical yet polemical stance, she has repeated over and over that a nation in default doesn’t pay, but Argentina has paid.
Again, this argument is childish. Kirchner may be able to avoid saying the word “default,” but she can’t avoid the consequences of it. She can repeat her mantra as many times as she wants, but the reality is that international investors are taking their money out of the country, and Argentineans are seeking refuge in the US dollar.
Investors are taking their money out of the country, and Argentineans are seeking refuge in the US dollar.
The insurance companies that issued Credit Default Swaps (CDS), which offer a backup payment if the nation enters default, have admitted that Argentina is in this very situation. They have notified their customers that they will be paying the CDS to the holders. In other words, even those who are suffering from the default have admitted the country is in one.
The default, however, is distinct from that of 2001 — mainly because banks remain solvent. However, from another point of view, this default has worse ethical consequences, because it could have been easily avoided, and the Kirchner administration simply chose to cease making payments. This is doubly so, given that various banks offered a solution, which was soon scrapped after the unfortunate and damaging comments by Minister Kicillof.
Consequences of the Selective Default
The impact to the domestic economy will not be a rapid shock. Markets have yet to react fully, because of two possible outcomes: (1) the international banks will come to an agreement, and (2) there may well be a political sea change with elections in 2015.
Nonetheless, if the default situation remains unresolved, the pressure generated in the currency market will accentuate, as will inflation. This implies a reduction in consumption and, eventually, more unemployment.
Economic activity will also contract further than if there had been no default, amid a more volatile, risky environment. In short, if the default continues, Argentina’s recession will worsen. On the other hand, if the country exits from the default, the recession will decrease. Unfortunately, it is very unlikely that Argentina will escape her recession.
Unfortunately, it is very unlikely that Argentina will escape her recession.
Finally, as a nation, we cannot avoid the blame by pointing at the morality of the vulture funds. Leaving ethical discussions aside, the fact is that the high-risk investment funds exist because of the presence of national debts. These debts enter the equation on the back of fiscal deficits, which in turn have their origin in excessive government spending. In other words, the problem arises from the financial irresponsibility of Argentinean officials over the last few decades.
The vulture funds were always there; the government knew this the whole time. The question we should reflect on as Argentineans is, why does this happen to us? And the answer will be found in the recognition of irresponsible government spending.
