In the end, Argentina did not swerve in its game of chicken with the vultures. On Wednesday night it failed to make a scheduled payment on its sovereign debts, despite the inordinate legal pressure brought to bear by a group of “vulture” American hedge funds that have snapped up a $1.5bn slice of the nation’s sovereign bonds.
Standard & Poor’s duly downgraded Argentina’s credit rating from triple C minus to “selective default”. The country has now failed to meet its sovereign liabilities for the second time in 13 years.
But what are the implications? The market price of long-term Argentinian bonds was not significantly moved by the default announcement. The yield, or effective interest rate, on a tranche that matures in 2033 steadied at around 9.6 per cent yesterday, suggesting that the impact of the default was priced in by the market.
However, yields could rise rapidly if Argentina’s bondholders lose their patience and demand full and immediate payment of the $29bn (£17bn) or so that they are owed, as is their right. That sum is roughly equal to Argentina’s foreign exchange reserves, which could mean an intense squeeze on the domestic economy.
In any case, the borrowing costs of Argentinian households and major companies are likely to rise as a result of the default. That will not help Argentina’s economy, which was already contracting before this week’s default.
Annualised real GDP growth turned negative in the first quarter of the year, according to the country’s official statistics agency. In its most recent forecast, the International Monetary Fund expected growth of just 0.5 per cent in 2014 for South America’s second-largest economy after Brazil. That is now very likely to be downgraded.
Inflation is also already relatively high at 12 per cent (40 per cent according to some unofficial measures), and the cost of living is likely to rise still higher. The Argentinian peso instantly fell 4.4 per cent against the US dollar on the unofficial “blue” market yesterday, and a second full-scale devaluation in a year could be on the cards. Unemployment, currently 7.1 per cent, could easily jump.
Yet analysts are not expecting a repeat of the chaos in 2001-02 when the country defaulted on $95bn of debts. At that time, domestic savers’ accounts were frozen to stop bank runs. Inflation went through the roof as the peg with the dollar was broken. Street protests saw scores of deaths. GDP contracted by 10 per cent.
Another fear before the latest default was the possibility of contagion in other emerging market countries. But though global equity markets were down yesterday, there was no panic. There was no repeat of last year’s sudden outflows of hot capital from emerging markets when traders and investors believed that the US Federal Reserve was on the verge of ending its monetary stimulus.
One possible reason for this is a belief among investors that, despite Argentina’s default, a deal with the vultures will still come. The country, after all, is not insolvent this time. The government of President Cristina Fernandez de Kirchner is willing and able to pay those creditors who have agreed to a restructuring.
It was blocked from doing so by an American court when Thomas Griesa, in a momentous judgment, ruled that Argentina cannot make interest payments to the majority of bondholders who have accepted a restructuring in the wake of the last default, unless it first pays out in full to the hedge funds – including Paul Singer’s Elliott Management and Mark Brodsky’s Aurelius Capital Management – that refused to participate in the swap.
There have been suggestions that US investment banks or Argentinian local banks might offer to buy the bonds from the hedge funds. Standard & Poor’s has said it will revise the “default” rating if an agreement can be reached.
However, the basic impasse remains, despite this week’s drama. Argentina claims that if it gives the vultures what they are demanding, it will need to pay all bondholders the original amount, so unravelling the restructuring deal and sending the country’s total bill up to $200bn – a sum equal to 40 per cent of Argentina’s annual GDP. The hedge funds dispute that the law requires this. Yet that Buenos Aires was willing to accept the risk of default – after taking significant steps over the past year to restore its standing with the world capital markets – implies this concern is more than just a negotiating tactic.
The simple passage of time may help in producing a resolution. A key clause in the bonds expires at the end of the year, which may be when a deal is done, according to some analysts. “This probably will be fixed in the next six months,” said Alberto Bernal of Bulltick Capital Markets. “Argentinians need the money, they need to come back to the market, and the holdouts want to get paid.”
The wider legal implications of this high-stakes stand-off are also unclear. Some argue that Judge Griesa’s ruling sets a dangerous precedent, making it impossible for sovereign nations to negotiate necessary restructuring deals with bondholders. The IMF itself has raised this concern.
Others counter that, on the contrary, this legal battle will accelerate reforms of the sovereign debt markets, ultimately making it impossible for bondholders, like the vulture funds, to hold out on these kind of swap deals in future.
So will the case of Argentina and the vultures make global financial markets more, or less, stable? It is difficult at this early stage to say. But the dice has now been rolled.