Argentina has defaulted again. But a deal with its creditors is not out of the question

2/8/2014

Disappointment, melodrama, and a faint glimmer of hope. The ingredients of the latest instalment of Argentina’s legal stand-off with its “hold-out” bondholders were painfully familiar. The disappointment came late on July 30th, when Argentina entered into default for the eighth time in its history (see chart). The melodrama came courtesy of Axel Kicillof, the economy minister, railing against Thomas Griesa, the New York court judge whose ruling precipitated this moment. And the hope is that a settlement remains possible.

The country’s previous default, when it reneged on $81 billion in debt in 2001, is the source of its latest one. Most of its creditors exchanged their defaulted debt for new securities in two restructurings that took place in 2005 and 2010. But a few creditors took a different path. They scooped up the cheap defaulted debt in order to chase payment of full principal plus interest in the New York courts, under whose law the original bonds were written.

Led by NML Capital, a hedge fund, a group of these hold-outs—Mr Kicillof and his boss, President Cristina Fernández de Kirchner, prefer the term “vulture” funds—won an order barring Argentina from paying its exchange bondholders unless it also coughed up the $1.3 billion plus interest they wanted. That meant Argentina either had to deal with the hold-outs or stop paying the exchange bondholders, and thereby tip into default again.

The Argentine government refused even to meet the hold-outs in person until July 29th, the day before a grace period on a payment to exchange bondholders expired. The government claimed it could not pay the hold-outs without triggering a Rights Upon Future Offers (RUFO) clause contained in the restructured bonds. This clause, which expires at the end of the year, states that the country cannot voluntarily offer a better deal than the one it gave in its 2005 and 2010 exchanges without extending the same deal to all creditors. Not true, responded the hold-outs, who argued no judge would interpret a court-ordered payment as voluntary.

In the event, face-to-face negotiations, held in New York, yielded no breakthrough. The language afterwards was harsh. Mr Kicillof held to the official line that Argentina cannot be in default if it is willing to pay its obligations to the exchange bondholders. In a belligerent press conference, he cast doubt on the mental state of Judge Griesa; the integrity of the mediator appointed to oversee negotiations; and the objectivity of international credit-ratings agencies (one of whom, Standard & Poor’s, has downgraded Argentina’s foreign-currency debt). NML, for its part, said that the mediator had proposed many creative solutions and that Argentina had chosen to default.

And yet hope remains. As the two sides were meeting, rumours swirled that a group of private Argentine banks might rally together to buy up NML’s claim and then negotiate a deal with the government that would involve payment after the expiry of the RUFO clause. Tantalisingly, Mr Kicillof said that, although the government had not reached an accord with the hold-outs, a non-governmental settlement remained possible. “A solution between private actors wouldn’t be weird to me,” he said. Some speculated that it suited Mr Kicillof to be seen not to have any part in a third-party deal, in order not to trigger the RUFO clause. Daniel Pollack, the court-appointed mediator, said that he would remain on hand to help reach a deal.

If an accord is made and Argentina is quickly pulled out of default, the effects may be muted. Standard & Poor’s decision could easily be undone, for example. That might also help avert the possibility of claims for immediate payment, triggered by “cross-default” clauses, from all the country’s foreign-law bondholders, not just the ones governed by New York law.

The international ramifications of default are also expected to be slight. Argentina has been locked out of international capital markets for 13 years; its debt under foreign law amounts to a bit over one-third of what it was in 2001.

But the costs to the country will rise the longer it remains in default. “The situation might not be cataclysmic, but defaulting was still the worst decision the government could have made,” says Maximiliano Castillo of ACM Consultants. The country may have got used to doing without access to external financing, but its foreign-exchange reserves have been shrinking, and the economic boost it received in the 2000s from rising commodity prices will not be repeated. It needs to borrow to grow.

The government is aware of this. In the past few months it has scrambled to resolve disputes with the International Centre for the Settlement of Investment Disputes (ICSID); the Paris Club, an informal group of government creditors; and Repsol, a Spanish oil firm whose stake in YPF, the state oil firm, it expropriated in 2012. A default will undo this progress.

The fear now is that the need to print money to finance its deficits will further spur inflation, putting the exchange rate under renewed pressure. Add in the likely jolt to consumption from default, and the recession that the country entered earlier this year will only deepen. Abeceb.com, a consultancy, is predicting that Argentina will contract by 3.5% in 2014; if the country had avoided default the projection was of a milder tightening of 1.5%.

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