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Has Argentina changed the rules of the sovereign debt game?

by Brad Setser
February 26, 2005

Argentina is on the verge of completing one of the largest sovereign debt restructurings in history. Argentina is seeking to restructure about $82 billion in bonds, plus $21 billion or so in past due interest. The biggest preceding bond restructurings were Ecuador ($6.5 billion) and Uruguay ($4 billion of international bonds) — so Argentina’s restructuring is absolutely massive. It dwarfs Russia’s 2000 restructuring of about $30 billion in international sovereign debt. (technically, Russia restructured syndicated bank loans, not bonds, but since lots of the loans had been sold into the market, the difference between bank loans and bonds was bit blurred).

Investors had until Friday to tender their bonds in the exchange. The final results will be announced next week. Recent estimates suggest that 75%, maybe more, of all eligible debt participated in the exchange.

Investors who participate in the exchange are giving up their legal right to full payment of principal and all past due interest. But since the legal right to full payment is nearly impossible to enforce, investors effectively are giving up an old bond that won’t be paid for a new bond that Argentina should pay. The catch? Argentina offered a maximum of $42 billion in new bonds in exchange for roughly $82 billion in old bonds. Or, to think of it a bit differently, the market value of the old bonds was about $26 billion ($82 billion face worth roughly 32 cents on the dollar). If all holders of old bonds swap into new bonds, the new bonds will also be worth about $26 billion ($42 billion face, and an average price of 62 cents on the dollar), and probably a bit more if there is a post-restructuring rally. So investors are recovering only a bit more than 30 cents on their original dollar, assuming they initially bought the bonds at par.

Argentina, consequently, is about to carry off not just a big restructuring, but also to get substantially more relief from its creditors than debtors have gotten in previous debt restructurings — something that Argentina’s President, Nestor Kirchner, never hesitates to point out.

Kirchner clearly thinks the deal is a good thing for him.

But is it a good thing, or a bad thing, for the broader international financial system?Some — and not just creditors with skin in the game — argue that Argentina’s exchange is nothing more than a mugging of creditors. Walter Molano, quoted in this Reuters story, is typical of those who worry that Argentina is setting a terrible precedent:

“There are a host of countries waiting in the wings to see what happens with the Argentine restructuring, before deciding how to proceed,” wrote Walter Molano.

According to this argument, by letting Argentina get away with this exchange, the IMF and the G-7 are undermining the sovereign debt market.

Of course, the creditors who opted to participate in the exchange are at least as responsible for the outcome as the IMF and the G-7 (Argentina has not exactly been following all of the IMF’s advice for the past few years). It is interesting that private creditors, who often argued that the IMF should stay out of sovereign debt restructurings, have been desperate to get the IMF to weigh in on their side over the past few weeks. The creditors discovered that they had far less leverage than they initially thought …

Others — and I clearly am in this camp — say that Argentina sought more debt relief than other debtors because it ended up in a worse position than other debtors after its default. It went into its crisis with substantial debts generally, and an unusually large amount of external sovereign debt in particular. It experienced an unusually deep crisis — in part because it went through an exchange rate crisis, a sovereign debt crisis, a banking crisis and a corporate crisis all at once.

Argentina’s pre-crisis public debt to GDP ratio of a bit over 50% was a bit deceptive. Argentina’s GDP was valued at a massively overvalued exchange rate before its crisis; at realistic exchange rates, the government’s debt to GDP ratio was more like 80% or even a 100%

Consequently, Argentina needed more debt relief than other debtors. This is not to say Argentina could not have made a slightly more generous offer — I previously have argued that Argentina should have tried to sweeten its offer by putting a bit more cash on the table. That might have increased participation and reduced Argentina’s future legal troubles without risking its future solvency. But while Argentina had room to adjust its offer at the margins, it could not have made a substantially more generous offer without putting its ability to emerge from its cycle of debt and default at risk.

Even if all creditors agree to Argentina’s proposed terms, its overall debt levels will remain very high. Its debt to GDP ratio will remain around 80%. Servicing that debt will require that Argentina sustain a primary surplus — revenues in excess of non-interest expenditures — of around 4% of GDP.

Overall debt levels don’t tell the entire the story. There is a difference between the debt a sovereign government owes to its own people, and the debt it owes to external creditors. Defaulting on domestic debt is defaulting on yourself — it reduces domestic wealth, and usually devastates the domestic banking system. That is hardly a recipe for domestic political success. Countries with large amounts of domestic debt — notably Brazil and Turkey — have made major fiscal adjustments to avoid a domestic default.

High levels of external sovereign debt are another thing. External debt implies an ongoing net transfer out of the country: sustaining the political support for that transfer in the face of adverse shocks is hard. According to JP Morgan data, Argentina’s “external sovereign debt to GDP ratio” will remain unusually high even after its restructuring, at 50% of Argentina’s current GDP. That ratio is comparable to countries like Ecuador (35% of GDP) and Pakistan (49% of GDP). It is well above the levels of Mexico (12%), Russia (13%) and Brazil (18%).

In my view, high levels of external sovereign debt are sustainable only if the coupon on the debt is low and the debt does not need to be refinanced frequently (as will be case with Argentina), or if the debt is owed to unusually generous creditors, like the Paris Club, who tolerate frequent arrears (see Pakistan) …

Will Argentina’s restructuring set a bad precedent and undermine the broader market. Paul Blustein says no.

I just don’t buy the argument that this will set a precedent for Brazil or Turkey or any other country,” said Paul Blustein, author of ‘And the Money Kept Rolling In (and Out)’, a new book on Argentina’s economic collapse. “This country went through hell,” he said. “Any country that thinks this is a good way to reduce your debt burden is nuts.”

I tend to agree. More importantly, the evidence suggests that the market also agrees with Blustein.

Argentina’s desire for a major debt relief are hardly a surprise. It has been known for some time. If creditors were really worried that Argentina’s restructuring made default and deep debt relief an attractive option, they would either raise their estimate of the probability an emerging market will default or reduce the amount they expect to recover on a defaulted bond. Both would tend to reduce a bond’s value. What actually has happened? The value of almost all emerging market bonds has gone up over the past two years … hmm.

Obviously, this has something to do a global surplus of liquidity, which is leading investors to bid up the price of all fixed income assets. But it is more than that too. PIMCO holds more emerging market bonds than anyone I know of, around $20 billion. Even though they were smart enough to get out of Argentina well before it defaulted, they certainly would worry if Argentina’s default and subsequent restructuring radically changed other sovereign government’s incentives to pay.

However, PIMCO looked around the world and did not see emerging markets acting like they wanted to follow in Argentina’s footsteps. Rather, they saw most emerging markets, most notably Brazil, taking steps to enhance their creditworthiness after Argentina’s default. Look at Brazil’s primary surplus, Turkey’s primary surplus, even Ecuador’s primary surplus. Look at the current account surpluses and reserves of most emerging economies, not just Asian economies.

This is not to say that Argentina’s restructuring will have no impact. Argentina did not show that default is painless, but it did show that the costs of external default are heavily frontloaded. Heavily indebted countries that have already incurred the upfront costs of default are likely to look at Argentina’s example and be less inclined to rush to do a quick deal with their creditors. But that does not mean all countries in difficulty will emulate Argentina. Some are likely to emulate Uruguay instead, and seek to restructure their bonds on terms that are (comparatively) favorable to creditors to try to buy the time they need to avoid an Argentine style meltdown.

Argentina does set a precedent. But it is not the only precedent out there, and it is a precedent that most countries won’t find all that appealing.

Be wary of over-generalizing based on a single example.

Russia had the biggest sovereign default and restructuring before Argentine. In 1998, Russia defaulted on its domestic treasury bills — the famous GKOs. Incidentally, international investors held lots of these treasury bills, so it does not contradict my earlier argument about the importance of looking at the share of debt held externally. It defaulted on Soviet era syndicated bank loans. It restructured its debts to the Paris Club. But it did not restructure its international sovereign bonds.

Anyone who concluded, based on Russia, that international bonds would be exempt from future restructurings, or would be restructured on better terms than other debt, ended up making a big mistake. Look at Argentina.

One interesting point: Even if 80% of all creditors participate in the deal, the holdouts will hold more international sovereign bonds ($16 billion face, over $20 billion including past due interest) than had been restructured prior to Argentina (I am starting the clock for bond restructurings with the Brady plan, which created the modern international sovereign bond market). Argentina’s default is still not entirely behind it. Its lawyers will be in court fighting off legal challenges for a long-time.

38 Comments

  • Posted by p

    Brad,
    I think you are right that the Argentina deal will mot likely spill over to other nations. You rightly point out that the real debt levels were approaching 100%. In addition, bankers are pretty good at figuring out when to cry uncle and they have not been that loud on Argentina. Third, the bankers know how to manage leverage. Forth, this is a multiperiod game and the cost of defaulting are material.

  • Posted by anne

    What has put Argentina in a position where it can force creditors to accept 32 cents on the dollar for its debt? I have watched Argentina play tough, and I sympathize with Argentina, but I am surprised at how strong a bargaining position they have gained and can only vaguely guess at why their position has so improved. What is your sense?

  • Posted by Jesse

    Anne is asking exactly the essential question here: “What has put Argentina in a position where it can force creditors to accept xx cents on the dollar for its debt?”

    Once that question is answered, the answers to the other questions not only flow from it, but we might also learn something about the transition of Bretton Woods II from metastability to sustainable equilibrium.

  • Posted by anne

    Jesse

    We must read and think this through carefully. Thank you.

  • Posted by anne

    http://www.nytimes.com/2004/12/26/international/americas/26argent.html?ei=5090&en=0d564b5c6c92f384&ex=1261717200&partner=rssuserland&pagewanted=all&position=

    Argentina’s Economic Rally Defies Forecasts
    By LARRY ROHTER

    BUENOS AIRES – When the Argentine economy collapsed in December 2001, doomsday predictions abounded. Unless it adopted orthodox economic policies and quickly cut a deal with its foreign creditors, hyperinflation would surely follow, the peso would become worthless, investment and foreign reserves would vanish and any prospect of growth would be strangled.

    But three years after Argentina declared a record debt default of more than $100 billion, the largest in history, the apocalypse has not arrived. Instead, the economy has grown by 8 percent for two consecutive years, exports have zoomed, the currency is stable, investors are gradually returning and unemployment has eased from record highs – all without a debt settlement or the standard measures required by the International Monetary Fund for its approval.

    Argentina’s recovery has been undeniable, and it has been achieved at least in part by ignoring and even defying economic and political orthodoxy. Rather than moving to immediately satisfy bondholders, private banks and the I.M.F., as other developing countries have done in less severe crises, the Peronist-led government chose to stimulate internal consumption first and told creditors to get in line with everyone else.

    “This is a remarkable historical event, one that challenges 25 years of failed policies,” said Mark Weisbrot, an economist at the Center for Economic and Policy Research, a liberal research group in Washington. “While other countries are just limping along, Argentina is experiencing very healthy growth with no sign that it is unsustainable, and they’ve done it without having to make any concessions to get foreign capital inflows.”

    The consequences of that decision can be seen in government statistics and in stores, where consumers once again were spending robustly before Christmas. More than two million jobs have been created since the depths of the crisis early in 2002, and according to official figures, inflation-adjusted income has also bounced back, returning almost to the level of the late 1990′s….

  • Posted by anne

    http://www.nytimes.com/2004/12/26/international/americas/26argent.html?ei=5090&en=0d564b5c6c92f384&ex=1261717200&partner=rssuserland&pagewanted=all&position=

    Because of the absence of a debt accord and a stalemate over utility tariffs, some investors, mainly European, continue to shun Argentina, citing what they call the lack of “judicial security.” But others, mainly Latin Americans used to operating in unstable environments or themselves survivors of similar crises, have increased their presence here amid expanding opportunities.

    “These are slogans that people repeat without thinking, as if they were parrots,” Roberto Lavagna, the minister of the economy, said when asked about the predictions that investment would disappear. “In 2001 and the beginning of 2002, all kinds of contracts were destroyed,” he said. “So why are they investing? Because today clearly they can get a very good rate of return.”

    The Brazilian oil company Petrobras bought a stake in a leading energy company. Another Brazilian company, AmBev, has acquired a large interest in Quilmes, Argentina’s leading beer brand, and a Mexican company has bought up control of a leading bread and cake maker.

    Asian countries, with China and South Korea in the lead, have begun to move in. During a state visit last month, the Chinese president, Hu Jintao, announced that his country plans to invest $20 billion in Argentina over the next decade.

    But the bulk of the new investment comes from Argentines who are beginning to spend their money at home, either bringing their savings back from abroad or from under their mattresses. For the first time in three years, more money is coming into the country than is leaving it.

    That has given Mr. Kirchner the luxury of taking a hard line with the monetary fund and with foreign creditors clamoring for repayment.

    “The thing is that Argentina has a current account surplus, so they don’t really need so much foreign investment,” said Claudio Loser, an Argentine economist and the former Western Hemisphere director for the I.M.F. “Domestic investment is taking place because there are opportunities in agriculture, oil and gas.”

  • Posted by anne

    Brad argues persuasively with this perspective, but I am not so sure.

  • Posted by steve kyle

    I think it is more of a precedent than you do. If what you mean is that nobody is going to wake up tomorrow and try to “pull an Argentina” well then OK. But the next time a country finds itself in a serious bind they are going to look for terms like Argentina got. Not only that, but they arent going to want to go through the pain Argentina did before looking for the deal. After all, knowing what we know now, wouldnt it have been better for Argentina and all concerned to have come to this deal earlier than they did? And if another country looks like it is on this same path wouldnt we in fact come to it sooner?

    Basically, what I am saying is this: It is a mistake to say “this is not a precedent” because no other country is immediately lining up and trying to write off the same percentage of their debt as Argentina did. It WILL be a precendent when the next large debtor gets into serious trouble.

    And as for restructuring bonds, it is about time. In the old days (before WW2) there werent any syndicated loans and all defaults (pretty much) were defaults on bonds. That meant that returning to international K markets meant making nice with those bondholders. Back then they got a mere pittance but there are plenty of (kind of ancient) precedents for coming to terms with international bondholders. And as for those domestic bondholders, they vote. The only way I can imagine a default on domestic bondholders is if the Bushies could figure out which of those holding the debt live in blue states.

  • Posted by P O'Neill

    There’s still the question of whether Argentina sets a precedent for its own future behaviour. I hadn’t realised till reading this post that even post-restructuring they’ll have a 50% external public debt ratio — way above the thresholds that Reinhart & Rogoff find for serial bad boy defaulters. Is it rational for any foreign lender to provide any new funds against this backdrop?

  • Posted by Jesse

    Well, of course Argentina is setting a precedent, as an analogy to a precedent in law. The key question is also that which is an in law, what makes this precedent apply to any future case?

    Is it the size? Yes partly. Is it the fact that Argentina is not necessarily and immediately dependent on its creditors? Does Argentina have alternatives? Why? Is the current power base of dollar creditors shifting to something else, some new ‘monetary order?’

    Argentina is not powerless in this negotiation. So, is it because they are strong, or because their counterparties are weak? Or a little of both.

  • Posted by anne

    There seems little doubt that Argentina feels it is acting from strength, and my guess is that she feels she is drawing closer to South American neighbors and Asian countries in trade and investment relations. This new closeness may be the source of felt strength. Argentina may be growing less dependent on Europe, save for Spain, and America.

  • Posted by dsquared

    There’s still the question of whether Argentina sets a precedent for its own future behaviour

    That precedent was already there; since the First Baring Crisis, Argentina has defaulted on its external debt once every twenty to thirty years.

    I would be in the “precedent” camp, but that’s possibly because I’ve just finished reading some of Ricardo Hausmann’s stuff. I think that there’s a new development model coming down the track, and that large-scale debt default will be a part of it.

  • Posted by anne

    Argentina may well be fairly modeling China with a tough trade and investment and debt negotiation stance, especially so if trade and investment relations are changing.

  • Posted by anne

    DSquared

    “I think that there’s a new development model coming down the track, and that large-scale debt default will be a part of it.”

    Please explain your interesting comment further.

  • Posted by DF

    I think Brad already posted on what gives Argentina its strength. Basically they are running a surplus budget. And they are planning to run them for a long time.
    Therefore they don’t need the investors money. They don’t need the bankers.

    If the USA could manage to run a surplus budget they could default on all of their debt. Not just 2/3 of it.
    The UdSSR did that before.

    Argentina borrowed in dollars at a time when its peg was clearly overvalued. This is what justifies the default.

    If you think the dollar is undervalued compared to the Euro (power of purchase parity) and if in the deflation ahead, the dollar was to rise (because of the credit shrunk destroying liquidity at a huge pace) … Then a similar case could be made by the USA towards europe.
    Why would the european bankers get all the profit from the dollar reevaluation ?

    Of course it does not work between the USA and asia, the asian currency being undervalued.

  • Posted by brad

    Paul O’Neill,

    I agree: It would not be rational to provide large amounts of new external financing to argentina now, both because of its current high levels of debt and because it needs to demonstrate its commitment to pay its new debt out of its own resources, not borrowed resources. Similarly, the scale of Argentina’s default and restructuring dictated that it assume that it would have market access (external market access) for some time, which constrained its restructuring offer.

    Anne — DF more or less gets my argument for Argentina’s (relatively) strong bargaining position right. They have a primary budget surplus, and a current account surplus (tho the current account surplus is shrinking) so they don’t need access to markets — the interest payments on their debt can be paid out of tax revenues. (They will need domestic market access soon though, as the domestic debt Argentina restructured after its default is starting to amortize).

    I would note two other things as well:

    1) The costs of default itself are frontloaded. Default = absolutely no market access. Spending then has to match revenues (unless you run domestic arrears — but remember, Argentina was running domestic arrears before its external default/ devaluation; after its default, it more or less stopped running domestic arrears — that was an important step toward stabilization). Argentina’s external accounts moved from a significant external (current account) deficit to a major surplus. The transition from deficits to surpluses, and the renegotiation (or forced restructuring of domestic dollar contracts) was painful. But after the transition happened, there was little ongoing pain from continuing to be in default.

    2) Argentina was able to unfreeze domestic bank deposits during 02/03 and, over time, the deposits, more or less, stayed in the system (dollar deposits had been turned into peso deposits). That meant that Argentina’s banking system functioned at some basic level — people had access to their “money” even if they did not have as much money as before, and they could use the banking system to make payments, etc. Argentina’s government was also paying the domestic debt that had been pesified, and lots of new debts that had been issued during the crisis for one reason or another — that provided the banking system with a performing asset, and some other domestic assets also continued to perform during the crisis. Argentina’s ability to get its own banking system up and running even while in default on its external debt made it a lot easier to stay in default (I have an article forthcoming in a law journal with anna gelpern on this).

    3) Politics. There was a sea change inside Argentina. Argentina’s previous development/ growth model had been based heavily on access to the external sovereign bond market (and convertibility); it was pretty clear Argentina was going to find a new model going forward. Kirchner felt very little domestic pressure to be nice toward external bond holders (or for that matter, to be nice to domestic residents holding Argentina’s international bonds; 40% or so of the bond in the restructuring were held by Argentines, largely the pension funds). There were voices demanding an even tougher line.

    If any Argentines read this blog, do weigh in as well –

  • Posted by anne

    http://www.nytimes.com/2004/12/26/international/americas/26argent.html?ei=1&en=01eea19f9c912ab3&ex=1110609058&pagewanted=all&position=

    “The thing is that Argentina has a current account surplus, so they don’t really need so much foreign investment,” said Claudio Loser, an Argentine economist and the former Western Hemisphere director for the I.M.F. “Domestic investment is taking place because there are opportunities in agriculture, oil and gas.”

    Just this week, the government announced that reserves of foreign currency have climbed back to $19.5 billion, their highest level since the crash and more than double the low recorded in the middle of 2002, a year with a net outflow of $12.7 billion.

    “The peak of investment in the 1990′s was 19.9 percent” of gross domestic product annually “and today it is at 19.1 percent, having risen from a low of 10 percent,” Economic Minister Roberto Lavagna said.

  • Posted by Jesse

    The rubber will meet the road in Argentina when and if the currrency controls come off, and money can flow out if it wishes.

    I am watching to see how China moves to create a sphere of influence in South America. One of the base assumptions that is common is that the current dollar reserve structure with the multinational banks and IMF is the only game in town.

  • Posted by gd_2005

    The issue of precedent: is there is one and of what kind, I believe is contingent on a perhaps more theoretical question (yet based on empirics): what is the impact of this restructuring to notions of reputation and sovereign punishments (especially in the form of a credit crunch that is kept even after the swap?)?
    Brad mentioned PIMCO selling their Argentine bonds before default. Would they not be willing to buy them now that ratings went up?! What is the empirical basis TODAY of theories of reputation and credit crunch punishment to defaulters given the market incentives for funds etc to invest in high yield debt (especially since it is unlikely that Argentina would default on these restr. bonds in the near future). Any ideas?

  • Posted by gd_2005

    Brad: interesting your take on the POLIICAL side of this story — you would be impressed (or not) to know that there are papers linking default to leadership turnover, stating that when it is easy to remove a pres. he will not default because otherwise he will be punished in elections (i.e., thrown out). Could something be more off tune with the reality we see?
    The issue of Kirchner having domestic support even despite the default on pension funds merits att. My take on it (written somewhere) is that (1) those are all (with the exception of Nacion) privately owned and it is easy to shift the blame of losses then to the private sector, (2) since these are long term investment, the common folk’s understanding of time horizons plays in favor of the government in accountability matters in the short run.

    PS: forgive the double posting please

  • Posted by anne

    http://www.nytimes.com/2004/11/20/international/asia/20china.html?ei=1&en=e28f762250887887&ex=1110617291&pagewanted=all&position=

    China Widens Economic Role in Latin America
    By LARRY ROHTER

    Suddenly, the presence of China can be felt everywhere, from the backwaters of the Amazon to mining camps in the Andes….

    “I am watching to see how China moves to create a sphere of influence in South America.”

  • Posted by brad

    Jesse — my general sense is that most controls are now off. there have been some external inflows linked to foreign purchases of the boden ($ debt issued post default, which argentina has been paying) linked to the general search for yield. there also may be some Argentine money returning home (hence the reserve increase), in part because the peso looks comparatively undervalued, so there is an incentive to shift from dollars to pesos at the margin. I need to look into the magnitude of these flows.

  • Posted by brad

    gd –

    no need to apologize for the double post; both raise important points. I agree with your take on the pension funds. Kirchner, from what I understand, has made their support of the previous government/ their purchase of gov. bonds the issue, so the debate is more about “accountability” than “future returns” — and I think the evidence is pretty good that devaluation and/ or default generally is not good (politically) for the government in power at the time of the default/ devaluation, which can lead governments to wait to long to initiate a needed restructuring (my take on argentina).

    re: reputation. The markets don’t seem to consider it much of an issue, the bond market prefers to look forward not backward. Look at where Russia trades at now! But maybe that can be nuanced a bit, since countries that have defaulted generally have shied away from the bond market as well, and built up massive reserve war chests, and the combination of limited new sovereign issuance/ massive reserves is good for the market. If Argentina moves forward in a similar way, sustains large primaries, and makes clear its ongoing commitment to pay the new debt (and finds a legal solution for the old debt that is out of the exchange), I suspect the market will look forward not backward.

    One test: look at how does Argentina’s long bonds trades relative to Brazil’s long bonds. Both will have relatively high debts. Both need to sustain large primary surpluses going forward. Brazil faces more interest rate risk, particularly on its domestic debt, than Argentina, but it should have a better reputation than Argentina ..

  • Posted by gillies

    crash early, crash often, and tell the wimpish creditors to stop worrying about the past and get a slice of the future?

    good one if you can pull it off.

    now for 64 000 dollars – where would argentina stand now if a greenspan had ‘saved’ it, or if a japanese style consensus had avoided all that pain? capitalism got going with the concept of limited liability companies. are we seeing the rise of limited liability countries?

    and your debtor countries paying up 30c in the dollar – how does that precedent look from south korea?

  • Posted by gd_2005

    Brad, many thanks. The test you suggest is interesting, and we (all) should carry it on — maybe report here. In the Argentine case, it is worth mentioning, and as Roubini predicted, there was much money to be made by those funds who bought the bonds from the “retired Italians et. al.” and got into the swap — more than 50% returns probably! Debt restructurings are profitable for some, let’s not forget (who are not exactly Kirchner’s-political associates). Much more could be said if we knew more about the market for distressed sovereign debt (as opposed to the knowledge we have for the corporate sector from Altman), and had access to this data of WHO did in fact trade the Argentine bonds. Argentine media says we will know “the numbers” on Thursday. But will we know the “whos” behind those numbers. Did we ever for the case of Russia?!
    Best.

  • Posted by brad

    50% returns seems high, unless someone was snapping up bonds in the low 20s, which is hard to believe. Though no doubt some retail investors sold when they should have held, participated in the exchange and sold afterwords (assuming there is the typical post exchange rally — a bit of an if in this case, for lots of reasons).

    one interesting point: apparently, lots of hedge funds/ prop desks were buying euro denominated bonds from retail investors with the intention of taking up the option of swapping into peso debt.

    That is a classic arbitrage. Retail investors lack the knowledge and skill to manage a peso portfolio, but the peso option appears to be the most valuable of all the options available. If hedge funds bought bonds from retail at the price of the new euro bond, and then exercised that bond’s embedded option to switch into pesos, the retail investor did not lose while both the hedge funds and I would argue argentina gained (Argentina gets peso debt which matches it peso economy — no currency mismatch).

    This is a bit technical, but to a sovereign debt wonk, it is interesting, since a local currency option/ and in particular a VERY popular local currency option is something that is rather new and different.

  • Posted by Yusef Hydrogaster

    If I remember correctly, the Peoples’ Republic of China deliberately defaulted on its foreign debt after the revolution in 1949 – now it has “favored trading nation” status with the US.

    “Precedent” isn’t all that important in these matters, in my opinion.

    What matters is what is convenient in the here and now.

    I don’t think “punishment” makes sense if the cost of punishment is seen to be as expensive for the punisher as for the punished.

    However, I have wondered what would happen if the US defaulted on China and said, ” There. Payback for 1949.” I hope nothing like that happens, though.

  • Posted by Francisco

    Talking about precedents:
    US defaulted its debt in golden terms in 1971, when the Bretton Woods system was finished.
    Nixon made a swap more or less like Argentina is doing right now. He told his creditors: In exchange for your golden denominated assets, I’ll give you dollar denominated assets. The reason?: US couldnĀ“t service its debt in the original conditions (same reason as Argentina today).

  • Posted by Paul

    In case anyone cares, maybe a fund manager can add a point on a couple of interesting issues thrown up by the restructuring:

    The big move of the last few weeks was heavy selling by Italian retail investors and buying by hedge funds (like the one I work for). The retail sellers finally got the message that there would be no real attempt to make them good. In fact the Argentine haircut was not extraordinarily large, what was extraordinary was that foreign bondholders took nearly all the hit. This was the first time that the debtor country was heavily in hock to the IFIs – and the IMF doesn’t “do” write-offs. Italian retail should bear grudges – but against the banks who missold them the bonds, against the IMF which refused to write off any of its debt and against GCAB which scandalously peddled fairy-tale hopes of legally extracting money from Argentina.

    Interestingly – and certainly to the surprise of the Argentines themselves – there has been huge interest in swapping Euro-denominated debt into peso-denominated debt. This might well produce an large overhang of peso assets – around US$5bn+ of peso-denominated debt is created with no matching inflows or build of reserves. But the willingness of foreigners to extend credibility to a country that has just effectively faced down its creditors (and the gloating approach of the Argentines during the roadshow must have been hard to take for the small investors) is surely surprising.

  • Posted by gd_20025

    Brad, Paul: what is the logic behind the switching to peso debt.

    Paul: You mention the willingness of foreigners to extend credibility, but we can also remember that S&P signaled an upgrade of Argentine bonds even before the swap had been completed. Does that play any role in the seemingly successful outcome of the restructuring? Or just (as seem to be usually the case) the rating agency does not antecipate action but goes with the perceive flow of things?!

  • Posted by anne

    Paul

    Interesting comments; please do continue.

  • Posted by dsquared

    “One test: look at how does Argentina’s long bonds trades relative to Brazil’s long bonds. Both will have relatively high debts. Both need to sustain large primary surpluses going forward. Brazil faces more interest rate risk, particularly on its domestic debt, than Argentina, but it should have a better reputation than Argentina .. ”

    Surely the verdict is in on this one; look at where the Kingdom of Thailand trades, despite having never, ever defaulted on any external debt.

  • Posted by anne

    gd

    Thank you so much for the caution. Showing us how to read on South America critically is worth much, and I always take note of such advice :)

  • Posted by anne

    gd

    Well, you have a clear sense of social history. Please continue the conversation, for I need to sharpen my reading. What I might spot about southern Africa becomes quite a different matter when I read about South America. Nice :)

  • Posted by Paul

    The logic behind choosing peso debt is that the peso is cheap on most metrics (large trade, current account surpluses, PPP, terms of trade); the peso debt is inflation linked, hence bondholders profit from any real appreciation in the peso whilst also enjoying a higher numerical (I’m trying not to write “nominal” yield). This is part of a general trend in emerging markets, where local markets are the new “hot item”.

    I think the S&P signal is important for a couple of reasons, not least by making the new debt eligible for a number of mandates and indices and thus providing potential demand for the new bonds.

    There is a lot more to spreads than the credit quality or even default history. Regressions of components of credit spreads (I’m quoting from memory here, will try and find references) generally find the coefficient of a good default history to be negative (ie lower spreads) but barely significant, while share of the EMBI+ and EMBIG indices strongly negative. Small markets enjoy a “rarity premium” in a market desperate to diversify. Finally, on default history it is clearly important how thoroughly the country has changed. Poland and Croatia’s communist-era defaults are not held against them, whereas it seems unlikely that Argentina’s basically unchanged Peronist regime will enjoy the benefit of the doubt.

  • Posted by gd_2005

    Paul, interesting. Thanks for the info.
    Seems first effect sov rating is actually credit to the private sector — since sov is a reference is this sense. Should be interesting to see interest for the sov. bonds from now on especially given this “perception of change” you cite. Peronist or not, it is a somewhat different approach to economic management what Argentina has so far presented (if for no better reason, because it had no choice of external credit) — exchange rate at the level it is surely shows more realism and export possibilities (even as the deficit vis a vis Brazil remains significant)… But latest news shows Kirchner, Lula, Chavez, etc are now “budies”. We will see if this will be a new “circus in town” or some sort of a new regional approach of substance.
    Best!

  • Posted by gd_2005

    Anne: indeed, we are all trying to figure stuff out.
    Ironic that the vastness of news outlets does not make us substantially “less lost” sometimes.

    Take care.

  • Posted by Paul

    D’oh sorry…should have read (two posts higher)

    share of the EMBI+ and EMBIG indices strongly positive (ie countries with small amounts of debt outstanding pay less).