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Argentina | Game theory

| February 14, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The price of Argentina’s debt has dropped in recent days just as the IMF has arrived to talk debt restructuring and as the country’s lead negotiator has sharpened his rhetoric. The calendar still assumes 10 days of meetings with bondholders during the last half of February. The meetings should give the market its first view of Argentina’s offer. The ambitious March deadline for a resolution looks realistic only if Argentina offers friendly terms and if a majority of bondholders accept.  It seems logical that the recent rhetoric would shift towards a more threatening approach to discourage holdouts.  Tension usually runs high for any debt restructuring. A compromise solution, however, is a better alternative than a prolonged default for either debtor or creditors.

It stands to reason that Argentina wants a quick fix.  Argentina appointed Minister Guzman for his expertise in debt restructuring. The country needs to quickly normalize creditor relations to avoid contagion to the real economy and re-access local capital markets.  The accelerated March restructuring deadline requires not only friendly terms but also maybe a coercive or aggressive negotiating approach. The recent Guzman comments may reflect a strategy of talking down prices to make the offer more attractive, or perhaps a strategy of first presenting an unfriendly offer that improves through a negotiation process. The hawkish rhetoric may also reflect a political strategy to vilify bondholders for the economic crisis when speaking directly to the legislature, but it may not rule out a pragmatic approach with bondholders.

Argentina also has to worry about holdout risks that may also explain the hawkish rhetoric. The recent warnings from Argentina stress insufficient resources to pay debt service through a lengthy debt restructuring process.  This seems intended to coerce participation and reduce holdout risk after the eleventh hour BUENOS payment.  The hard default risk increases after the March deadline. That could coerce maximum participation. Tense headlines should continue through the next phase of bondholder talks.

The recent shift in rhetoric logically would represent this strategy. It seems illogical for Argentina to demand a large haircut in capital that would prolong difficult creditor negotiations and destabilize the fragile economy. This worst case scenario will also probably force a turnover in the economic team with no obvious alternative for a resolution.  The prolonged default under a harsh restructuring offer would also represent a worst case for real money bondholders worried about forfeited coupon payments and expensive litigation.

However, the deal risk is now higher on weak repayment scenario. It’s difficult for creditors to accept increasingly unrealistic restructuring terms as uncertainty about debt repayment capacity grows.  Minister Guzman made a mistake of outlining only a slow path towards primary fiscal surplus that contradicts the previous strategy of seeking liquidity relief.  It would have been easier with creditors, including the IMF, to sketch a quicker path to a primary fiscal surplus.  Guzman outlined a primary fiscal deficit in 2020 and only slow convergence to a primary balance in 2022-2023 and then even slower path towards a 1% of GDP primary surplus in 2026. There was a purposeful de-emphasis of detailed economic scenarios – shrugging off long term forecasts as unreliable.  It would have been just as easy to show a faster convergence to a primary fiscal surplus so as to not complicate creditor negotiations. The market cannot ignore the deal risk of an ideologically biased economic team under the domestic political constraints that suggests antagonistic market relations. The market communication has been less than ideal on the bungled restructuring of the ARGDUO’20.

If the economic team insists on solvency relief then the debt restructuring will become increasingly complicated and quickly revert to worst case scenarios of recovery value of 25% to 30%.  The market reaction was to increase the probability of downside risk: a subjective range of, say, 25% to 30% on solvency relief instead of a 55% to 60% on liquidity relief. It’s still high deal risk for the liquidity relief scenario on now less realistic fiscal targets and coercive tactics on threatening default to discourage holdouts or initial low-ball offers. The markets will quickly know whether the first offer is friendly or unfriendly with the next phase on bondholder later this month.  The latest hawkish rhetoric suggests a pickup in volatility and tense negotiations as meeting start next week with prices vulnerable on if Argentina’s first offer disappoints.

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