Buenos Aires banks on a cure from Dr Frenkel

Click to follow
The Independent Online

But for the West's spot of bother in Afghanistan and the deepening economic gloom in both the US and Europe, the Argentinian debt crisis would be playing as a much bigger story than it is. Before you fall off your chair laughing, take note. Argentina is the biggest sovereign debt crisis ever, and what is being threatened is also potentially the biggest bond default in history.

Argentina has some £90bn of external debt, of which the great bulk is in government bonds. This in turn is mainly held by non-residents, so what is happening is much more than a localised economic crisis in a far away place. At one stage, the Russian debt crisis of late 1998 threatened a global recession. This one is much bigger, and what's more, it finds the world economy in much more fragile condition.

The news yesterday was that President Fernando de la Rua has brought in the big guns of Merrill Lynch to help sort out the economic mess he finds himself in. Even by Latin standards, the welcome given to Merrill, and the London-based head of its Sovereign Advisory Group, Dr Jacob Frenkel, was somewhat over the top. According to "Presidential Decree No 1375", published yesterday, Dr Frenkel is "the world's most technically qualified individual" and "the only person who combines all the technical conditions, prestige and personal recognition needed to develop the delicate tasks required by the present situation". Investment bankers tend not to be shy about their talents, but even they would surely struggle to keep a straight face through that one.

In London, Dr Frenkel is perhaps as well known for his abilities as a standup comic as an international financier and policy maker. He is one of the funniest after dinner speakers around. As a former governor of the Bank of Israel, and the man often credited with having cured Israel's long standing inflation problem, he is also a good deal better qualified to find solutions than most.

Well, he's going to need all his skills and some to pick his way through this particular minefield. Quite apart from the specifics of the Argentinian situation, there is a real danger of contagion – that investors will start scrambling out of emerging market debt more generally, thus setting off a chain reaction of economic crises across the developing world.

Last time this happened – in the emerging market crisis of 1996-98 – the economic consequences for the West were not as bad as they might have been, but only because the flight of capital away from high risk emerging markets ended up getting reinvested in the perceived safe haven markets of the US and Europe. In the short term at least, the crisis was a boon for the West.

What goes round comes round and the excess of capital that then built up arguably helped prompt and sustain the technology bubble, the adverse consequences of which are still with us today. It just goes to show, there is no such thing as a risk-free investment, whichever geographic location is chosen.

In any case, in order to avoid a repeat of the 1996-98 contagion, it is important that solutions are found. It is quite a problem, as Fitch, the ratings agency, demonstrates in a recent paper, Argentina Debt Restructuring Scenario.

The Argentinian government proposes to swap existing bonds for new ones carrying a much lower, 7 per cent, coupon. But details are thin on the ground, and although the government says it will specifically tie a part of the country's taxation revenues to servicing the new bonds, investors would undoubtedly want more in order voluntarily to accept such a proposal.

As things stand, the cost to Argentina of servicing its debt mountain next year will be in the order of $28bn, which it cannot afford, hence the risk of default. According to Fitch, Argentina needs to get that down to $14bn to $20bn, or 5 to 7 per cent of GDP, to be sustainable. It is this gap that the proposed reduction in coupon is intended to bridge. Obviously it would come at quite a cost to bondholders, who on Fitch's numbers would face an implied loss of $10bn to $26bn, or 18 to 47 per cent of the net present value of the bonds. Any loss born by bondholders would in legal terms constitute a default event. Bondholders are therefore going to have to be compensated if they are to be persuaded to accept. There are precedents. During the Mexican debt crisis of the early 1990s, banks were eventually persuaded to take US zero coupon bonds as collateral against loss, paid for by the IMF. However, the Argentinian crisis is of a different order of magnitude, requiring more substantial international support. There are also thousands, possibly tens of thousands, of bondholders involved, which makes the problem infinitely more complex.

In the end, Argentina may be forced into default regardless. As Russia has proved, it does not have to be the end of the world, and for Argentina at least, debt default is probably preferable to devaluation, which would do even more damage to its international credibility. But if Argentina does go that route, it will be a huge blow to already deflated global capital markets. Who knows what the consequences might be?

It's a major problem for these countries. In the West, the textbook response to an economic downturn is to slash interest rates, cut taxes and pile on the public spending. In Argentina, now in its third year of recession, the Western prescription is by contrast that they should raise taxes and cut spending until the budget is returned to surplus and the debt paid off. Poor countries are expected to do the exact opposite of what rich countries do. The short to medium term social and economic pain is usually extreme. Over to you, Dr Frenkel.

BAA conundrum

When the Tories privatised the British Airports Authority in 1987, a trick was missed in not breaking it up and allowing Heathrow and Gatwick to compete with one another for traffic. The result is the privatised monopoly known as BAA, which merrily coins it at both airports, and then uses the profits to subsidise Stansted to the disadvantage of rivals such as Luton.

It is left to the regulator, in this case the Civil Aviation Authority, to make the best of a bad job by trying to curb BAA's worst excesses. The instinct of most regulators when confronted with a monopoly is to force down its prices, thus protecting the consumer in the same way that healthy competition normally would.

However, airport capacity in South-east England does not conform to these rules. Demand outstrips supply by such a huge margin that the only sane solution is to charge more, thus making sure that the best use is made of scarce runway slots. Unfortunately that would simply have the effect of inflating BAA's monopoly profits even further. Landing charges at Heathrow would need to rise from around £5 a head at present to perhaps £50 before demand was choked off.

The pricing proposals announced by the CAA yesterday do not begin to resolve this mess. The CAA has decided to end the "single till" approach whereby BAA's vast retail income is used to subsidise landing charges. This will at least require airlines to pay a charge which reflects the cost of providing the infrastructure. But it will not result in market rates being charged.

The 11 September effect will not last forever, and the long-term solution is more runway capacity in the South-east. Given the acute environmental sensitivity of expanding Heathrow any further, the brave move would be to build a new airport in the Thames estuary or offshore as others such as the Japanese have done. Don't hold your breath.

j.warner@independent.co.uk

Comments