Argentina and the International
Financial Architecture
LILIANA ROJAS-SUÁREZ
Center for Global Development
Washington, March 2005
Argentina’s saga has raised three fundamental
questions for the international financial
structure:
1. Has Argentina’s debt restructuring changed the
rules of the game in finance negotiations between
emerging market countries and their creditors?
2. What major problems in creditors’ behavior (IFIs
vs. Private sector) towards emerging markets can
be identified?
3. Can market-oriented solutions be designed and
implemented?
First, some stylized facts:
1. Among different classes of portfolio investment,
emerging market sovereign debt can be classified
as:
- high risk
- losing liquidity at first sign of problems
These two features are also present in so-called
“junk bonds”.
Not surprisingly, spreads of “junk bonds” and
emerging market sovereign debt move together
Spreads of Junk Bonds and EMBI+
1200
1000
800
EMBI+
600
Junk Bond
400
200
Source: IDB and Bloomberg
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
0
2. Features of emerging market sovereign bonds also
result in pro-cyclical capital flows
Latin America
Emerging Markets
120
6
6
100
5
4
3
2
Private capital flows, net
GDP Growth
Source: IMF, World Economic Outlook Database (September 2004)
1
Private capital flows, net
2003
2002
2001
2000
1999
-1
1998
0
1997
0
1996
0
1995
20
1994
1
1993
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
40
1992
50
2
1991
100
3
60
1990
150
4
80
Percent
5
Billions US Dollars
200
7
Percent
Billions US Dollars
250
gdp growth
Source: IMF, World Economic Outlook Database (September 2004)
Heightened risk, especially fears of “liquidity loss”,
induce private sector creditors to withdraw from the
markets when economic slowdowns occur.
Investors search for liquidity in Emerging Markets might, at
times, conflict with IFIs search for solvency
IFIs
• Assessment of debt solvency is based on intertemporal budget
constraints, largely assuming that “sudden stops” of capital
inflows will not occur during the period analyzed.
Markets:
• Rules regarding the adoption of Value at Risk Methodology which,
in general, assesses risks in terms of net risk, not gross risk
positions,
combined with:
• Traders’ reporting system of “end-of-day bottom line”
…induce a market focus on liquidity and might generate contagion.
Two very different examples of market
responses: Mexico after Russia and Argentina
Mexico:
• Attracted by high yield and expectations of IMF
support for financing needs, investors went long on
Russian securities.
• The need to “cover for liquidity risk” led investors
to also buy Mexican and other of the most liquid
emerging markets sovereign paper.
• When Russia defaulted, investors sold Mexican,
Brazilian and other liquid paper to minimize end-ofthe-day losses.
Argentina:
• The large stock of Argentina’s foreign exchange
reserves and long period of IFI support for the
country’s overall financing needs allowed major
investment firms to unload their holdings of
Argentina’s bonds before the bonds became
illiquid.
• This prevented contagion to other large
emerging markets.
• Because of the above, and in contrast to the
Russian default, Argentina’s default did not
create a systemic problem.
If liquidity is at center stage for market decisions on
sovereign bonds, then what affects liquidity?
Improves availability of Liquidity:
– Large foreign exchange reserves (even in flexible exchange
rate systems).
– IFIs liquidity support.
– Private sector contingent credit lines (less important).
Deteriorates availability of Liquidity:
- Large overall government financing needs.
- Large debt amortization and interest payments due in
the short run.
Going back to the original questions:
1. Has Argentina’s debt restructuring changed
the rules of the game in financing negotiations
between emerging market countries and their
creditors?
The short answer is NO.
–
Lack of G-7/IFIs financial support for debt
restructuring (or bail outs) is consistent with
Argentina not being a systemic problem. No major
difficulties developed in the international capital
markets following Argentina’s default.
–
A major lesson for emerging markets is not that it
is now “easier” to default and get a “good deal”
from their creditors. That conclusion would
ignore:
a) The favorable overall financial environment for
emerging markets over the last two years, including the
abundance of liquidity.
b) The painful default years for Argentina and the long
stream of failed negotiations.
c) The difficult problems lying ahead for Argentina now
that installed capacity is reaching its limits.
2. What is a major problem in creditors’ behavior
towards emerging markets?
•
•
In assessing countries’ performance and designing
“programs”, the IFIs’ methodology for estimating debt
sustainability does not differ from that used in industrial
countries, i.e., it is based on fiscal intertemporal analysis
without considering the likelihood of sudden liquidity
constraints.
In contrast, in market assessments, liquidity rules. This
partly reflects current rules and practices for the
functioning of markets.
These differences in approach can, and
certainly have, hurt emerging markets
3. Can market-oriented solutions be designed and
implemented?
YES. The solution lies in “aligning” market
objectives with IFIs’ / countries’ objectives.
And recommendations go to all parties involved:
– In assessing a country’s performance, IFIs need to “price
right” liquidity risks arising from market behavior.
– Countries need to be aware of the consequences of
having their debt being treated as junk bonds. For
example, has anybody examined the potential
consequences of Sarbanes-Oxley accounting reforms on
emerging market debt? These reforms are currently
affecting US junk bonds issuance.
– It is in the interest of policy makers in industrial
countries to revise the “undesired consequences”
of some financial regulations, as they might
contribute to, rather than prevent systemic
problems.
Two prominent examples of potentially
distortionary regulations are:
• Assessing market risk in net rather than gross
terms.
• Some components of Basel II that increase
incentives for short-term lending to emerging
markets.
Finally, reforms to the process of
restructuring international sovereign debt,
through “debt restructuring mechanisms” (à
la SDRM) and/or innovations in collective
action clauses (CACs), are essential.
However, they can only be effective if
measures to discourage countries from
overborrowing and creditors from
overlending are in place.
Pricing “liquidity risk” right can go a
long way towards that objective