Argentina Debt Default Decoded

What is Argentine debt crisis?

Argentina has a dubious history of failing to repay the foreign exchange debt and bonds and had defaulted for 7 times in history. After missing an interest payment on its bonds on June 30, the country had a 30 day grace period to reach a settlement with its holdout creditors — mostly the hedge fund Elliott Management — in order to avoid default. That grace period was up on Wednesday and Argentina defaulted for eighth time on Thursday, 31^st July 2014.

 

How did it happen?

The root of this crisis lies in the previous default and the worst economic recession of Argentine history, the great recession of 1998-2002. Argentine economy was fighting depression and was in heavy debt. It defaulted in the last week of 2001 on public debt totalling 81 billion US dollars. Following the default, foreign investment stopped and capital flow ceased almost completely. The Argentine government faced severe challenges trying to restructure its debt.

Debt restructuring is done by a sovereign entity to avoid bankruptcy in situation of a debt default. It involves reduction and renegotiation of the existing debts and an extension of the payment terms.

Argentina started its debt restructuring in 2005. It succeeded in exchanging 76.2% of the defaulted bonds and brought them out of default by offering mostly longer term discount bonds (around 30% of the nominal value). In 2010, another 16.4% bonds were exchanged bringing the total to 92.6% and leaving about 7% debtors as ‘holdouts’.
 

These 'holdouts' were the ones who had brought the defaulted debt at a highly discounted rate during 2001 and then refused to accept the restructuring and filed lawsuits against the Argentine government to pay them in full and also block their payments to the other 93% of the bondholders who accepted the restructured bonds. The bonds were issued under the New York law because lenders trusted US laws more than those of politically volatile and economically weak Argentina.



How Vulture Funds/holdouts make money



 

This June, the Argentina government lost the lawsuit against the holdouts in a US Court and was prohibited by the court to make payments on the restructured bonds and also to pay the ‘holdouts’ in full, mainly Elliott Management, a hedge fund.

 

Argentina had 3 options left, to pay, to settle or to default.

They couldn’t pay the holdouts in full because Argentina currently doesn’t have the money to cover its outstanding bonds in the event of a default, largely because of the Rights Upon Future Offers (RUFO) clause on its bonds. RUFO clause prohibits it from voluntarily paying the holdouts, who are demanding full payment on their bonds, better terms than the 25 to 29 cents on the dollar the other investors accepted.

They said they wanted to settle with the so called ‘vulture funds’ but offered them nothing more than the previous restructuring terms and not surprisingly, the talks failed.

As a result, Argentina wasn’t allowed to pay interest of $539 million on the restructured bonds and its economy defaulted for the 8^th time despite having the money.

What are the consequences?

The default has helped no one. The restructured bondholders didn’t get the interest. The holdouts/vulture funds didn’t get paid at all. And most importantly, Argentina’s credit rating has plunged and it looks like a pariah again, and its economy will remain starved of loans and investment. This might deepen the recession Argentina is facing since the start of the year.

 

What are the solutions?

Since Argentina has money to make the interest payments on the 93% restructured bonds and it hasn’t really gone rogue financially, there are a number of solutions to resolve this legal deadlock between Argentina and ‘holdouts’. I have listed a few below.

1.    Argentina convinces Elliott to ask the judge to allow the payment of interest on restructured bonds.

2.    The RUFO clause expires at the end of this year, so Argentina could try to persuade its bondholders that the default is temporary.

3.    Argentina convinces the restructured bondholders to waive the RUFO clause and allow them to pay the holdouts in full. Should RUFO be waived it would be easier for Argentina to settle with the holdouts before the end of the year.

4.    A third party such as an international bank takes the burden off the Argentine government. It buys the debt from the holdouts and gets paid by Argentina in 2015.

 

Who is the villain?

1.    The holdouts/vulture funds: They are hedge funds and their aim is to make money. They are just asking for the repayment of the money they invested with the Argentina government in 2001. They can be called unsporting for being so adamant but they are definitely not doing anything illegal.

2.    The US Court: How would you feel if you lent someone money and the court said you can’t have it back in full? This would just discourage you from lending money to anybody ever again. A decision against the ‘holdouts’ would have made the hedge funds skeptical about lending to sovereigns. However, blocking the payment of interest on the restructured bonds was unnecessary and easily avoidable. The court should rather have encouraged both parties to reach a settlement.

3.    Argentina Government: When you face a debt default situation, you settle. You settle for less but you settle. On the contrary, the government remained stiff and reportedly didn’t even have serious settlement talks with Elliott Management till 29^th July. The default will lead to inflation, higher interest rates, weaker foreign exchange rate, other economy disruptions and most importantly, pains for the Argentine people. I believe the government should have made sincere efforts to settle rather than going into a voluntary default.