Argentina: Why a new default is not same as 2001’s

31/7/2014

Last time, GDP fell 11 percent, peso’s value lost as much as 70%, inflation accelerated to 41%

Martin Cornejo shrugged his shoulders when he was asked if he was worried Argentina may be days away from defaulting for the second time in 13 years. No one expects a repeat of the last economic collapse, he says.

“This is very different to 2001,” when Argentina defaulted on a record US$95 billion of debt, said Cornejo, who works at a newspaper kiosk in central Buenos Aires. “People knew then it was going to happen. Now, they don’t pay attention.”

That’s bad news for hedge funds Elliott Management and Aurelius Capital Management, which used the threat of another default and economic crisis to pressure President Cristina Fernández de Kirchner to comply with Judge Thomas Griesa’s court ruling and pay them US$1.33 billion plus interest. The nation was widely considered to have entered default yesterday, as it was unable to reach a settlement with the funds, led by billionaire Paul Singer.

While a default will bring devaluation, a deeper recession, rising inflation and pressure on already dwindling reserves, it won’t have the same repercussions as 13 years ago, said Eduardo Levy-Yeyati, director of Buenos Aires-based research firm Elypsis. That time round 38 people were killed in protests and riots and the government was forced out of office after restricting bank deposit withdrawals amid 22 percent unemployment.

Fernández de Kirchner was concerned an accord with the hedge funds would trigger a clause in the bond contracts that prohibits Argentina from making a better offer to holdouts than it did to creditors who took losses of about 70 percent in restructurings in 2005 and 2010. The president and Economy Minister Axel Kicillof maintain that clause could lead to claims of US$500 billion, and asked for more time.

“Cristina must have advisers who aren’t entirely wrong when they say this isn’t 2001 and that at the end of the day it’s just a recession,” Levy-Yeyati said. “If the holdouts offer them a stay I think she’ll negotiate,” otherwise she’ll choose default, he accurrately predicted earlier this week.

The head of state on July 23 and Kicillof yesterday said the country wouldn’t sign any accord that might compromise the future of Argentines, pointing out that Argentina has tried to pay bondholders and was blocked by US courts.

“Those who don’t pay go into default and Argentina paid,” Fernández de Kirchner said on July 23 in a televised speech. “They’re going to have to invent a new term that reflects that a debtor paid and someone blocked and didn’t allow that money to arrive.”

Griesa blocked US$539 million of interest payments to bondholders last month until Argentina reaches an agreement with the holdouts and prohibited banks from distributing payments to foreign investors.

Alejandro Martínez, a black market currency trader, says he hadn’t see any of the panic dollar buying that accompanied the 2001 economic crisis. While the black market peso yesterday plunged well below the mark of 12.50 pesos per dollar, and part of its recent hike has been fuelled by Argentines seeking dollars for their winter holiday, he said.

Economic context

Argentina’s economy contracted 0.2 percent in the first quarter, the peso was devalued and interest rates raised to halt a slide in foreign reserves. The devaluation led inflation to quicken to 15 percent up to June.

While the economy is in stagflation, it’s still a far cry from 2002 when gross domestic product fell 11 percent, the peso lost as much as 70 percent of its value and inflation accelerated to 41 percent. In the crisis that began in 2001, the nation went through five presidents in two weeks, restricted bank withdrawals and converted dollar accounts into pesos.

While a default is likely to extend Argentina’s 13-year absence from capital markets, and could halve reserves from their current level of US$29 billion, the government may be able to access credit from other sources, said Levy-Yeyati. Argentina and China’s central banks agreed on July 18 to a currency swap equivalent to US$11 billion that Cabinet Chief Jorge Capitanich said could be used to stabilize reserves.

The president will probably have to respond to a default by devaluing a second time this year, raising interest rates and crimping imports to halt capital flight, said Marina Dal Poggetto, an economist at Estudio Bein, a Buenos Aires-based economic consultancy and research firm.

Economy Ministry spokeswoman Jesica Rey didn’t immediately reply to requests for comment on the impact of a possible default. Stephen Spruiell, a spokesman for Elliott, also declined to comment on how a default will affect its attempt to collect on the ruling.

While the cost to protect Argentina against non-payment with credit-default swaps is the highest in the world, the nation’s dollar bonds due 2033 have traded between 81 and 92 cents on the dollar this month on speculation the government will find a way to pay bondholders and skirt the ruling.

Argentine debt has returned 2.1 percent in July compared with an average return of 0.7 percent for emerging market debt, according to JPMorgan Chase & Co.

Diego Korenwaser, 30, said a default may even be beneficial for the store he runs in Buenos Aires with his mother selling leather coats and bags since a weaker peso would encourage more of the tourism upon which the business depends.

“I don’t think it will change much,” Korenwaser said. “There might be a few protests but I don’t think it will go beyond that.”

About 47 percent of Argentines supported the government’s stance on the holdout debt crisis in July, up from 38 percent the month before, according to a poll by Poliarquía. The survey of 1,400 people had a margin of error of 2.67 percent.

Fernando Koning, who owns a barbershop in Buenos Aires, said Argentines have seen it all before and have already taken measures to protect themselves against another debt crisis. The country has defaulted on its debt seven times since independence from Spain in 1816.

“People aren’t worried by a default — we’ve already seen this 50 times,” Koning said. “The dollars that I had in Buenos Aires, I already took them to Montevideo,” he said, referring to the Uruguayan capital. “I already had my money taken once so I learned the lesson that you have to take precautions.”

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