aranca views - argentina debt crisis

8/10/2019 Aranca Views - Argentina Debt Crisis

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s Argentina Debt SagaOctober 16, 2014

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Griefault: It s more technical than fundamental

Adverse US court ruling pushes Argentina into default once againOn July 30, 2014, Argentina defaulted on a payment to its restructured bondholders (USD539mn due on June 30) as its 30-day graceperiod ended. This is the eighth time the country has defaulted on debt repayment since it gained independence in 1816. Although

Argentina was willing and capable of making this payment, it was not allowed to. Thomas Griesa, a US district judge, had barred Argentina from making interest payments to owners of its restructured bonds until it pays the holdouts (Elliot Management and AureliusCapital) USD1.5bn. While the magnitude of default is not as alarming as in an earlier instance Argentina defaulted on nearly its wholeexternal debt of USD82bn in 2001 it casts a shadow on the countrys standing in the international community.

Argentinas 2001 sovereign debt default resulted in a ban on raising capital from international markets. With two successive exchangeoffers in 2005 and 2010, the government swapped its defaulted debt with 93% of their creditors, offering them a 67% haircut (33 centsto the dollar) on their bond holdings. However, a select group held out , seeking better terms; hedge funds Elliot Management and

Aurelius Capital f iled litigations for payment of full principal and interest. With US courts ruling in their favor, Argentina could not pay

their exchange bondholders without making a full payment to Elliot Management and Aurelius Capital.

Debt obligations if RUFO clause is triggered Central Bank foreign reserves

Source: Banco Central de la Repblica Argentina (The Central Bank of Argentina), Forbes

Argentina, however, is restricted by a Rights Upon Future Offers (RUFO) clause that is written into its restructured bonds. This clause,which expires on December 31, 2014, specifies that the country cannot voluntarily offer holdouts a better deal than its restructured debtholders. Doing so would trigger its RUFO clause, leading to full payment to all bondholders (shown in chart 1). Moreover, even after theexpiry of the clause, a payment to Elliot Management could trigger similar litigations and payment demands from other holdoutcreditors, which Argentina could ill afford amid depleting foreign reserves (shown in chart 2). The deadlock between Argentina and theholdouts could not be broken, leading to the country s second default in the last 13 years.

Aftermath of default: government measures amid depreciating peso and increasing cash concerns

Argentinas foreign exchange reserve plunged to USD27.9bn at the end of September 2014, the lowest since April. Analysts estimateforeign exchange reserve may drop to an eight-year low of about USD22bn by end-2014 if the issues persist. The peso was also hitafter people started converting it to dollar to protect their savings from an inflation of around 35%. The official peso has declined 23.0%since the beginning of the year and 3.2% since default. The black market peso has been hit worse, depreciating 32.1% against thegreenback since the starting of the year and 16.2% since default. The gap between the two rates has also been widening, rising to 74%

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Elliot Mangement and Aurelius Capital

Other HoldoutInvestors

Restructured BondHolders

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(currently) from around 50% at the beginning of the year. This suggests people believe the official peso would continue depreciating.On the day of default, Argentinas five-year CDS spread advanced 1,322bps to a record 2,966bps. The spread had eased in between,only to surge again to an alarming level.

Official Peso and Black Market Peso Argentinas 5 -year CDS spread

Source: Bloomberg, Thomson Reuters Eikon

Argentina is also on the verge of facing a serious cash crunch in 2015. According to the Bank of America estimates, the countrys netliquid reserves (portion of foreign exchange reserve readily available for paying debt) is expected to drop to USD8.8bn by end-2014.This is less than Argentinas debt payment liabilities of about USD13bn due in the next year. However, these liabilities include USD6bn

payments related to the Boden 2015 debt, governed by local law. The country has an option to roll over these debts in an extremesituation.

The government is taking several steps to tackle this adverse situation:

Argentinas Senate and Congress have passed a bill to make payment to the holders of restructured debt through an intermediarythat does no t fall under Griesas jurisdiction. Under the debt swap bill, holders of USD29 bn in bonds under foreign law would havean option to swap their debt for new securities governed under Argentine law. New payments would be made through state-ownedBanco Nacion instead of through current trustee, Bank of New York Mellon Corp. On September 30, 2014, Argentina depositedUSD161mn in bond interest payment with a newly appointed trustee.

After default, Argentina has restricted the number of people who can exchange the dollar for the peso. According to the new rule,for purchasing up to USD2,000 per month, a taxpayer must have a monthly salary of at least 8,800 peso (USD1,046), up fromprevious floor of USD7,200 peso.

Argentina and China agreed to swap yuan worth up to USD1bn by end-2014. It is a part of a USD11bn currency swap agreementsigned by both countries in July 2014. The move is expected to bolster Argentinas declining reserve. The yuan can also be used topay for Chinese imports.

Argentina is set to receive USD4.8bn (USD1.2 per year) in loans for social development from the World Bank through 2018. TheWorld Banks IFC would also invest $1.7 billion in export-oriented private companies in various sectors, ranging from agribusiness,energy, infrastructure, and financial institutions.

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Revisiting 2001: Exports helped revive economy post-default, but structural issues persisted

In December 2001, after three years of economic downturn caused by austerity measures to support its fixed exchange rate, Argentinadeclared one of the biggest sovereign-debt defaults in history. The following year, the government devalued the peso (USD/ArgentinePeso = 3.36) amid rising unemployment and civil unrest. By end-2002, 57.5% of Argentines were in poverty, inflation had risen to 41%,and GDP (for 1998 2002) shrank more than 20%.

Despite this, the economy recovered quickly. The currency devaluation increased the competitiveness of Argentine exports. Thecountry recorded a large trade surplus as Asias increasing food demand (led by China) pushed up the price of soy exports. Risingdemand for automobiles and other manufactured goods from Brazil provided further impetus to the countrys export s.

Argentina has largely been a resource-based economy: agricultural products account for almost 40% of exports. With the countryunable to finance imports or debt payments by borrowing from abroad, exports of soybean oil, wheat, corn, and soy complex(comprising beans, oils, and meals) products have been the main foreign exchange earner.

Argentinas trade data

Source: Bloomberg

As structural issues within the economy became apparent, the sustainability of this export-driven growth model became a concern.Populist measures have been an integral part of government policy, and huge subsidies are granted, mainly in the energy and transportsector. Much of the revenue earned from export taxes was spent on the governments social and welfare programs, leading to a spikein inflation. To control prices, the government imposed export restrictions and held the exchange rate at artificially strong levels,effectively making imports cheaper, but deterring manufacturers' ability to compete internationally and driving down private investment.The rise in energy imports (caused by falling oil production) and decline in soy prices began impacting the countrys favorabl e tradeposition.

Government actions involving seizure of private pension funds, nationalization of YPF (the countrys largest oil company), doctoring of

inflation numbers, and imposition of severe currency controls (restrictions on the purchase of dollars) also dented investor confidenceand increased capital flight from the country. Therefore , the country s foreign reserves dwindled.

Current situation not as grave as 2001

Argentina s current state is due to the same mistakes as in previous busts: uncontrolled government spending, heavy trade controls,and disincentives to foreign investors. However, the situation is not as grim as the 2001 default.

The countrys total debt under foreign law stands at USD29 mn, far lower than the USD82bn it owed in 2001. Moreover, the actualsize of its technical default is only USD0.5 bn, unlike 2001, when it reneged on payments on its entire foreign debt. Furthermore,in 2001, the country owed the IMF and Paris Club payments worth USD9.5bnn and USD6.3bn, respectively. Since then, the

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country has cleared its entire debt and accrued interest with the IMF (paying USD9.8bn in 2006) and agreed to settle its debtdisputes with the Paris Club (USD9.8bn).

2001 vs. 2014 Default Comparison Argentina Merval Index Performance

2001 2014

Foreign debt USD82 bn USD 29 bn

Default USD

82 bn USD

0.5 bn

Source: US Congressional Research Service, The Economist, Bloomberg

According to the IMF, amid falling foreign reserves and high inflation caused by loose macroeconomic policies, Argentinaseconomy is expected to contract 1.7% in 2014 (2.9% GDP growth in 2013). However, the situation is not as calamitous as 2002,when the countrys GDP shrank 10.9% (after fall ing 4.4% in 2001).

Argentinas foreign reserves at the time of the 2014 default stood at USD29bn, higher than USD15.3bn in 2001 (fell to USD 10.4bnby the end of 2002).

Argentinas benchmark stock market index Merval has nearly doubled since the beginning of 2014 as people are investing in themarket to protect themselves from a weakening peso and higher inflation. In 2001, the index fell 29%. Thus, overall sentiment inthe equity market is positive.

In 2001, the Argentine peso was tied to a fixed exchange rate (USD/Argentine Peso = 1). In 2014, the currency has been steadilydepreciating. With higher imports leading to a rising trade imbalance, the country needs to address structural issues within theeconomy to revive growth. On the exports front, while agreements with the sanction-hit Russian government are expected to boostfood exports, the increase may not be significant. Total trade between the two countries is expected to rise to USD3bn (1.6% of

Argentinas total trade) in 2015 from 2.0 billion in 2013.

This time, however, Argentina s energy dependence has been increasing. The country, from being a net exporter of oil (netpetroleum exports of 400,000 bbl/day in 2001), now imports around 20% of its energy needs (net petroleum imports of 50,000bbl/day in 2013). According to the US Energy Information Administration (EIA), Argentina has about 27 billion barrels of technicallyrecoverable oil and the worlds second largest recoverable shale gas reserve (802 trillion cubic feet). Despite this, Argentina haswitnessed a decline in oil production due to a lack of necessary investments. With the government in desperate need of reducingits energy bill, Argentina needs to ensure the flow of foreign capital is not impeded by debt defaults.

Research Note by:

Aniket Mittal and Sunny Agrawal

Analysts, Investment Research

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aranca views - argentina debt crisis

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