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Argentina | Countdown to default

admin | May 15, 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 expiration of the grace period on Argentina’s missed $500 million in coupon payments is now just a week away. The countdown starts towards default with no obvious resolution in site. Argentina has asked for a counter proposal, although this does not necessarily imply the country will accept any bondholder suggestions. Argentine Economy Minister Martin Guzman continues to seek political validation for his rigid offer. Disagreements between bondholders may be reducing flexibility. And the public nature of negotiations has added to the risk of political interference.

The two sides are far apart and logistics are tight. It seems too late for a consent solicitation to seek payment deferral similar to Ecuador’s, and politics argue against making the coupon payment. There is also not much respect for tight deadlines and no apparent fear of default as demonstrated by the Province of Buenos Aires default on May 14. The sovereign default now seems inevitable without any last-minute intervention from Argentine President Alberto Fernandez. After default, there is no specific deadline to force a resolution. There is always the option to cure the default, but this will require motivation. The default has to be sufficiently inconvenient to force pragmatism over ideology and motivation for normalizing creditor relations. The market stress will also remain a function of whether there is goodwill from Argentina to reach a compromise solution.

The stigma of default apparently is not such a concern to the Fernandez administration; however the apparent bad faith in negotiations could become increasingly obvious once Ecuador presents a feasible restructuring offer to bondholders in June. It may explain why Minister Guzman wants to lock in low interest rates and avoid the difficulty and higher cost of future borrowing after a pattern of serial default and unwillingness to repay.

Minister Guzman is correct in qualifying Argentina in virtual default with restricted access to external capital. This doesn’t mean that a technical default could further restrict capital and further weigh on the economy at already a vulnerable moment. Argentina cannot fully embrace inward isolation given its high exposure to the IMF and its private sector integration with the rest of the world through trade, investment and financial flows. Default would be inconvenient if it further encourages US dollar demand and restricts private sector access to trade, bank or credit lines. This may result in more active lobbying from the private sector, especially in strategic areas. This is not the same situation as 2001 when a positive terms-of-trade shock allowed for much higher export earnings to compensate against net capital outflows. There is a high reliance upon exports to rebuild foreign exchange reserves and uncertainty about whether a default would undermine the effectiveness of capital controls or exports. There doesn’t seem to be active dialogue with the domestic private sector. Instead the government is actively lobbying to seek their political endorsement instead of starting a candid discussion about the pros and cons of default. This could easily change after default.

The financial markets have reacted with the blue chip foreign exchange rate now reaching its widest divergence with the official foreign exchange rate—worse than 2015. The domestic markets are particularly vulnerable after the central bank has allowed for overly easy monetary conditions and double-digit negative real interest rates. The recent foreign exchange restrictions may not prove effective to curb US dollar demand. There has been a consistent decline in US dollar bank deposits from $18.3 billion on April 17 to $17.3 billion on May 8 and subsequent declining deposit/reserve ratio at 155%. The low net foreign exchange reserves at $11.4 billion also do not provide much room for US dollar intervention while foreign exchange weakness only adds to the current stagflation. Perhaps the most important determinant is whether a technical default compromises domestic financing options.

The tight deadline on May 22 is already increasing the jitters for higher US dollar demand. The intensity of the financial market stress will depend upon whether there is goodwill to quickly cure the default. The political interference may slow but not completely obstruct a resolution with ideology potentially shifting to pragmatism under duress of economic contagion.

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jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

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