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ARA Libertad has been detained in Ghana since October 2, 2012. (Photo: Martin Otero)
Monday, November 26, 2012
Special Reports

Argentina Debt Default?

Will a heated debt feud fuel another default in Argentina?

LATINVEX SPECIAL

Knowledge@Wharton  

In a scene straight out of a typical Hollywood action movie, crew members of an Argentine training frigate, the ARA Libertad, used arms to prevent the ship from being moved to a different berth in the Ghanaian port of Tema, where it has been detained since October 2 as a result of an embargo petition made by NML Capital, the Limassol, Cyprus-based subsidiary of New York-based Elliott Capital Management. The investment fund, which focuses primarily on distressed debt investing, has demanded more than $300 million from Argentina, since the country became famous for ceasing payments on foreign debt in late 2001 and early 2002.

The episode happened when port directors tried to comply with a local judicial order to move the frigate from its location in order to avoid congestion problems at the port, and economic damages that have amounted to $60,000 a day. The Argentine government, which cannot remove the boat from Ghana until it resolves its legal problems in that African country, has refused to relocate the vessel because there weren't enough crew members. Only the captain and 44 seamen are still on board after 281 crew members were evacuated more than 15 days ago. (...)

The frigate has been the victim of a media effort orchestrated on the part of the investment funds in order to attract international attention and threaten the Argentine government so that it repays debt on which it is already in default. In an even more serious incident, a U.S. Appeals Court has upheld the decision of federal judge Thomas Griesa to force Argentina to repay its debt to two funds, NML Capital and Elliott Capital Management, and 13 other bondholders. The decision of the U.S. court set off a wave of selling in Argentine bonds because of fears that the decision will affect the country's capacity to pay its debt holders.

"We will not pay any vulture fund," Argentine President Cristina Fernández de Kirchner told the media repeatedly. Doing so would mean repaying $1.4 billion to those investment funds. Fernández de Kirchner has resorted to the so-called "Cerrojo Law" (Latch Law) passed by the Argentine Congress in February 2004, which prevents the executive branch from re-opening the so-called 'canje' (exchange) process through which Argentina's creditors were compensated at a steep discount by the government.

In 2005 and again in 2010, Argentina offered debt holders two opportunities to exchange more than $90 billion in debt, paying bondholders off at a discount of 75 percent. Ninety-two percent of all creditors joined the program, while the remaining bondholders, including the investment funds involved in the current incident, rejected participation in the exchange process. The funds had acquired their bonds in the United States, under U.S. law.

Alberto Rubio, dean of the University of Belgrano's graduate business school, does not believe that Argentina should defer to the judgment of the U.S. Appeals Court. In his view, Argentina should appeal the decision to the U.S. Supreme Court. "This is a way of gaining more time until the decision becomes firm," he notes. "Perhaps it would take between eight months and a year."

Vicente Monteverde, a professor in the management sciences department at the University of Morón, also believes that Argentina could appeal to the U.S. Supreme Court. The problem, however, is that there are no precedents for doing so. "The government could invoke treaty equality under U.S. bankruptcy law, but this may not be applicable to a country such as Argentina, and this would also take time," he states.

Experts say that this situation jeopardizes Argentina's debt negotiation process with its creditors, which dates back to the 2001 economic crisis. There is even talk about a possible default or cessation of payments by the Argentine government. The dollar-denominated principal and interest of the bonds involved in these exchanges will mature in December, and the government has promised to make these payments in their entirety. Meanwhile, Argentine diplomats and their law firm in New York (Cleary, Gottlieb, Steen and Hamilton) are developing strategies to resolve the conflict with the investment funds. Judge Griesa has yet to determine how Argentina should pay those bondholders who remained outside the renegotiations.

On October 22, Guillermo Nielsen, Argentina's former Secretary of Finance, said during a Seminar organized by Argentina's Bank Magazine, "When countries issue foreign debt, they generally abdicate part of their commercial legal jurisdiction. If you issue [debt] in New York, the law that applies is the law in that location [New York], and we are telling investors that, given the discrepancies in business law, the right thing is for this case to be taken care of in the New York courts." Nielsen is an economist who was involved in engineering the debt exchange.

IN THE WORLD OUTSIDE

While its government tries to resolve its diplomatic problems, Argentina's image is suffering as a location for both foreign direct investment and international trade, experts note. In the World Economic Forum's latest report on financial development, Argentina once again declined in the rankings, and is now among the lowest on the list. Argentina dropped from the 53rd spot, a year ago to the 55th spot out of a total of 62 countries. The most negative data regarding Argentina cited by the report relate to financial indicators (business environment, institutional environment and financial stability) and the perception of corruption.

In addition, the country once again scored more than 1,100 points in J.P. Morgan's country risk index -- 16% higher than it scored a year ago, when President Fernández de Kirchner was reelected. Currently, those South American countries with the lowest risk are Colombia (207 points), Chile (159) and Peru (216). In contrast, Venezuela has the highest risk, with more than 1,200 points.

This situation prevents Argentina from raising debt abroad, where it would have to do so at much higher interest rates. When credibility is repeatedly damaged, such as by the questionable data offered by Indec, the government statistics office, and by constant changes in the rules of the game, "then markets withdraw," Rubio says. "There is always room for getting venture capital funding at the very high interest rates," he adds. "But given the current levels of international rates, it is a serious problem when you lose opportunities to access financing under normal conditions [i.e. lower rates]."

In that respect, Monteverde notes that Argentina "is already outside the international markets. Its [high] country risk of more than 1,100 points means that it has to pay an 11 percent surcharge abroad (each 100 points is equivalent to 1 percent). In those cases where the Argentine private sector needs financing, they also pay the same surcharge."

A collateral effect of uncertainty involves the rates for credit default swaps (insurance against the non-payment of debt). Given fears of a possible default, according to J.P Morgan, rates for credit default swaps on Argentina's sovereign debt now exceed 1,800 points, which is almost three times Venezuela's 758 points. In that respect, Argentina is exceeded only by Greece, with 7,300 points.

AN UNCERTAIN FUTURE

Given the court decision in the United States, this question is if Argentina will fall into a new default. "This decision updates and aggravates the degraded financial profile of the country in international markets," Rubio says. Moreover, "it complicates the access of government and private enterprises to external financing. The decision in the New York Appeals Court confirms the interpretation [in the earlier decision] of 'equalizing the conditions of all creditors.' Technically, the country [Argentina] is [already] in default. A default is not just a failure to pay [creditors], but non-compliance with contractual clauses."

A related problem is that, once the decision of the U.S. court goes into effect, other countries in similar condition could have a harder time refinancing their debt, including Spain and Greece, which are currently facing serious economic problems. These countries have also issued bonds in other legal jurisdictions and if those bonds go into default, these countries could use the Argentine case as a precedent, Rubio notes. "It is possible that the same thing could happen with other [sovereign] debt," he says. "Nevertheless, the Argentine case has the peculiarity of having been decided unilaterally, with bondholders taking a haircut when it was time to negotiate the exchange."

Nielsen said during the seminar that "[Judge] Griesa's decision isn't just media theatrics. It speaks to the essence of the U.S. financial markets. This is not a subject affecting only Argentina, since it transcends and jeopardizes all possible debt restructurings, such as those in Greece and Spain. This happened when [the U.S.] appeals court validated the decision of Griesa."

This much is certain: Argentina is guilty of "malpractice in its responses and its timing" over the ten years of legal disputes in New York, Monteverde says. He suggests that the U.S. judge's ruling in favor of the investment funds results from the fact that creditors wanted to validate their rights in an international court where they had better odds of fulfilling their objectives.

Experts note that there is a clause in the text of the exchange negotiations that stipulates that if Argentina repays or recognizes those creditors who remained outside the "exchange" process (i.e., the holdouts from the exchange deal), those creditors who accept the exchange can later make claims that they had previously renounced. As a result, Rubio notes, Argentina "runs the risk of facing new demands."

And what will happen with the ARA Libertad? To date, the Argentine government has spent more than $2.6 million on the repatriation of crew members, the daily costs involved with mooring in Tema, maintenance costs and crew salaries. Rubio says that the ship's fate "depends on Ghanaian justice, as well as on other non-financial factors that are too complicated to predict. These factors include the inconvenience caused for port operations [in Ghana] when the ship was delayed there; the costs involving in mooring the ship there; other expenses that the country [Ghana] is unlikely to pay for, and how much skill the investigators use in their negotiations" to resolve the case. Monteverde adds that, in reality "the frigate cannot be seized through international law, since you cannot seize ships of war. But the appeals process could take a long stretch of time to go through an African court."

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

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