The consequences of Argentina’s selective default

12th September 2019

By Ignacio Portes

The consequences of Argentina’s selective default

The fact that Argentina was at high risk of defaulting was no secret to anyone paying attention. But the manner in which the country’s debts are being postponed and re-negotiated has still baffled almost every analyst; even those who foresaw a debt crisis looming.

Argentina has not really defaulted on its mid- and long-term bonds yet. So far, it is only in the beginning of discussions with creditors to try to reach a more realistic payment schedule agreed by both parts, with no payments unilaterally missed. Instead, it was the short-term bonds, many of them denominated in pesos — a currency that the country can freely print — that went unpaid.

As a consequence, Argentine firms and local governments were thrown into all kinds of trouble. Their short-term working capital was invested in this type of bonds, which they assumed to be the safest. Now, they are struggling to pay salaries and other basic maintenance costs on time, setting off a series of chain reactions that we are only starting to witness.

</p> <h2><strong>Some precedents exist</strong></h2> <p>“How many governments have defaulted debt issued by themselves within the same presidential period? How many governments have defaulted bonds issued in their own currencies? Where did this idea to default peso-denominated bonds come from? It’s all a big joke,” heterodox economist Eduardo Crespo said, criticizing the Macri administration after hearing the news.</p> <p>Indeed, the decision to default home currency bonds was outside expectations, but some <a href="">precedents do exist</a>. The most prominent in Argentina’s history was that of the Plan Bonex, a compulsory swap forced on fixed-term peso depositors on December 1989 to stop that year’s crippling hyperinflation.</p> <p>But when the Plan Bonex was mentioned in economic circles critical of Macri’s administration over the last few years, it was as a potential end-game scenario to the Central Bank’s snowballing 7-day <a href="">Leliq notes</a>. Far fewer analysts thought about default or forced restructurings as a possible government response to short-term Treasury debt, which is also smaller.</p> <p>Other precedents of <a href="">local currency defaults</a> include Russia after the dissolution of the Soviet Union and Venezuela, but the fact that such extreme cases need to be used as comparisons says a lot about the current situation in Argentina.</p> <h2><strong>The consequences</strong></h2> <p>Just like the 1989 Plan Bonex led to a few disastrous bankruptcies, the decision to postpone Lecap, Lelink, Lecer and other notes’ payments for 90 to 180 days is also causing widespread economic disruption.</p> <p>In an inflationary economy sustained through government debt, private and public institutions often appeal to these bonds to protect their working capital from the effects of the local currency&#8217;s depreciation.</p> <p>Holding US dollars would arguably be a safer bet, but the amount of government manipulation in currency markets means that option also has its downside risks. (Indeed, a few days after the default on short-term notes, the government also banned companies in Argentina from purchasing foreign currency)</p> <p>Now, the holders of those notes are cursing the moment in which they bought them, or raging against the government’s decision, as they scrap to keep up with their most basic bills.</p> <p>In response to firms’ complaints, the government <a href="">said last week</a> that it would accept its own defaulted bonds as compensation for social security liabilities. This will undoubtedly bring some relief to companies, but it will come at the cost of hurting the balance sheet of the ANSES social security agency even further.</p> <p>ANSES already holds a lot of Argentine stocks and bonds in its portfolio, whose value has been plunging since early 2018. ANSES has already been under scrutiny for how unsustainable the country’s pension system currently looks.</p> <p>The Central Bank has <a href="">also bought a small amount of the notes</a> in secondary markets in order to help with firms&#8217; liquidity issues, but that will also come at the cost of further deterioration of its <a href="">balance sheet</a>.</p> <h2><strong>Provincial defaults next?</strong></h2> <p>The default has also put provincial governments on the brink of failure. <a href="">According to Clarín</a>, 10 out of the country’s 24 governorships held a majority of their resources in these short-term instruments.</p> <p>Incredibly, the newspaper reports, “the most hurt is Buenos Aires province, which has 500 million dollars invested in these notes.” That means that the country’s newly-sworn Economy Minister Hernán Lacunza defaulted on the bonds he had just recently invested in as minister for the province.</p> <p>Also affected were San Juan (US$234 million), Mendoza (US$ 205 million), Buenos Aires city (US$ 123 million), Río Negro (US$ 83 million), Salta (US$ 35 million), Formosa (US$ 20 million), Santa Fe (US$ 20 million), Catamarca (US$ 15 million) and La Rioja (US$ 13 million).</p> <p>As the default also included the short-term dollar-denominated Lete notes, which the provinces used to save up for their own provincial bonds maturities, governors now fear those payments might also be at risk.</p> <p>This brings back memories of the early-2000s Argentina, when large provincial debts proved to be one of the weakest links that led to the economic crisis.</p> <h2><strong>The reasons</strong></h2> <p>So with this costly domino effect set into motion after such an unorthodox measure, why did the government undertake it?</p> <p>According to <a href="">Martín Guzmán</a>, an economist seen as increasingly influential in Peronist/progressive circles, “the goal was to bring some short-term calm to the exchange rate. The selective default to local-currency bonds under local jurisdiction was the alternative to printing pesos, which would have eventually added more pressure to the peso-dollar rate.”</p> <p>Even among market-friendly economists, the decision was seen as a strange mixture of dogmatism (due to the government’s insistence in keeping pesos away from circulation) and short-term, emergency thinking.</p> <p>Although the default was only described as “selective” by <a href="">international ratings agencies</a>, Guzmán believes this approach will bring new problems to the rest of the country’s debt, as bond values drop even further in secondary markets, making them more attractive to so-called “vulture” funds which might end up suing the country for full payment and boycotting a more peaceful restructuring process.</p> <p>In any case, Argentina’s current credit health is already close to non-existent, with the <a href="">International Monetary Fund</a> and hardly anyone else seen as potential future creditors. Some in Fernández’s team believe China might still be an option. But the range of possibilities has done nothing but shrink since early 2018. Even if Fernández’s advisers are keen to find alternatives to a full-on default, the will to pay is often not enough to deal with insolvency issues.</p> <p>

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Ignacio Portes

Ignacio Portes is The Essential's General Editor. Former Economy editor at the Buenos Aires Herald, he has also written for publications such as Naked Capitalism, NSFWCorp and Revista Debate.