Assignment 2
Write a 1600-1900 word paper (with a much more strictly enforced word limit this
time!), due electronically by 12:00 PM Friday the 14th, responding to the following
statement:
“Of the IMF, the international financial market, and the Argentine government, the
Argentine government was least responsible for its default, and should not offer
bondholders more than 30 cents on the dollar.”
When responding to this remark, notice that it has two components: 1) it says that
Argentina was not to blame for its economic crisis, and 2) it says that it should not offer
more than 30 cents on the dollar. You have the benefit of hindsight, but I’d still like you
to analyze both components of this comment.
Keep in mind that when assessing who is to blame, I want you to focus on the economics
that caused the default, not moral culpability or anything like that. For example, you
might focus on the government’s dollar peg, the deficit spending, the continued loans by
the IMF, the speculation of the bond market, the type of reforms pushed by the IMF, etc.
You may also wish to consider whether a large haircut is in Argentina’s best long-term
interest, and if a country cannot have exchange rate stability, monetary autonomy, and
capital mobility simultaneously, which two they should prioritize.
Once again, include an abstract (which will not count against your word limit), and
focus on making your arguments as clear and concise as possible, because I anticipate
that the word limit will be a real cap. Finally, focus on improving the errors that I
commented on in your first paper, because that is where I will be focusing most of my
attention when grading this paper. Good luck!
The following articles recount the debt-restructuring plan that was recently accepted by
the majority of Argentine bondholders and give an update on how Argentina is doing
now.
Short haircuts all round
Nov 2nd 2004
From The Economist Global Agenda
Argentina has unveiled a new offer to the creditors it stopped paying almost
three years ago. Will this end the largest sovereign default in history?
A HAIRCUT or a scalping? That is what Argentina’s disgruntled
creditors are asking themselves after the country’s economy
minister, Roberto Lavagna, unveiled his latest plan, on Monday
November 1st, to restructure the $100 billion of sovereign bonds
it no longer honours. Without an army to back them up, private
lenders can never hope to make a sovereign defaulter repay in
full. But the proportion of debt write-off, or “haircut”, they will
grudgingly accept varies widely. Whether Argentina’s
bondholders settle for Mr Lavagna’s latest scissor work may
depend on who they are. Some are hardened Wall Street moneymovers who professed to know what they were doing when they
bought in to Argentina’s supposed economic miracle in the
1990s. Others are Argentine pension funds trapped in the
subsequent financial meltdown. Still others are retail investors—
little guys in Japan, Germany and especially Italy—who believed
what unscrupulous banks and brokers told them about where to
put their nest-eggs.
Mr Lavagna is hoping to divide and conquer his country’s
assorted creditors by offering to swap their bonds for not one but
three different types of securities. Small investors, whose plight
attracts the most sympathy in Rome, Berlin and Tokyo, will be
offered “par” bonds. Denominated in dollars, these will carry the
same face value as the bad debts they replace, but will not
mature until 2038, paying a miserable rate of interest in the
meantime. Domestic pension funds and their ilk will swap their
defunct dollar IOUs for a limited number of peso bonds, worth
30.1% less at face value, paying 3.31% interest, and maturing
four decades hence. And Argentina’s biggest foreign creditors, for
whom no one cries, will get so-called “discount” bonds. Discount
is the operative word here: they will knock a whopping 66.3% off
the face value of the bonds they replace, and will not mature for
almost 30 years.
To sweeten the deal, Mr Lavagna will acknowledge the $2.1
billion in interest that went unpaid before December 2001—but
not the more than $20 billion of interest that has accumulated
since. He will also backdate the new bonds to December 31st
2003, so that an interest payment of about $475m will fall due
immediately. Mr Lavagna will also set aside extra money for
bondholders if Argentina grows faster than 3% per year from
now on. The true extent of the haircut may not be clear until the
new bonds first come on the market. But they are unlikely to be
worth much more than 30% of the original value of the bonds
they replace. By comparison, Ecuador offered creditors between
33% and 62% after its default in October 1999. Even Russia
offered 35% after its 1998 default.
Could Argentina afford to pay more? J.P. Morgan, an investment
bank, predicts that its economy will grow by 8% this year. The
federal budget surplus, excluding interest payments, is likely to
be 4.6% of GDP, and the central bank has accumulated more
than $18 billion of foreign reserves. But almost half the
population remains beneath the poverty line. The Global
Committee of Argentina Bondholders, which claims to represent
holders of a large chunk of Argentina’s outstanding debt, is
convinced it could pay more. The deal is “far below the general
consensus of what Argentina has the capacity to pay,” said Hans
Humes, the committee's co-chairman.
Disappointing these creditors remains politically popular in
Argentina. But it is losing Argentina sympathy in the
International Monetary Fund. Argentina owes the IMF $14.4
billion and is expected to repay it $5.5 billion (including interest)
next year. In the past, the Fund has rolled over this debt, coming
up with fresh loans with which Argentina can repay older ones.
But, by its own rules, it can only lend to a country in default to
other creditors if that country is renegotiating its debts in “good
faith”.
The Fund has refused to define what constitutes good faith. But
Argentina has stretched the concept about as far as it can. In
August, the Fund felt unable to approve a further loan to the
country until it made better progress with its creditors. Any offer
that remains unacceptable to more than, say, 30% of
bondholders would surely also be unacceptable to the IMF. Thus
Mr Lavagna will hope to win over as many creditors as he can, as
cheaply as he can.
He has found some canny ways to tempt them to settle. The
more who accept, the more new securities he will issue, he says.
In addition, he has cunningly blunted the incentive to hold out for
a better deal in the courts, whether in the United States (where
the new bonds will be issued), Italy (where seven lawsuits are
currently underway), Germany (where 100 are) or Argentina
itself. If a recalcitrant creditor wins a better deal in the courts, he
says, Argentina will also offer a better deal to the bondholders
who agree to his swap. This “favoured creditor clause”, as he
calls it, creates a monumental free-rider problem for the
bondholders. Those who accept Mr Lavagna’s debt swap will be
spared the costs and risks of a court case, while still reaping the
benefits of any successful legal challenge. But given that this is
true, why should any bondholder bother to mount one?
Could Mr Lavagna’s toughness and trickery set a precedent for
other countries tempted to default on their debts? The markets
thus far seem to be discounting the possibility, demanding only
the narrowest of “spreads” (interest-rate premiums compared
with the return on American Treasuries) on the bonds they buy
from Argentina’s neighbours and peers. As commodity prices
peak and interest rates rise, their complacency may be tested.
Until then, Argentina’s example does not seem to have deterred
new fools from rushing in.
Besides, Argentina is a past master at bilking its creditors. In a
recent IMF study, Kenneth Rogoff, Carmen Reinhart and Miguel
Savastano estimate that it has spent more than a quarter of its
history since 1824 either defaulting on its debt or restructuring it.
The default at the end of 2001 followed those of 1989, 1982,
1890 and 1828. Each time investors returned, albeit at a price.
Mr Lavagna will hope they display a similarly short memory this
time. The world’s capital markets can be bitten more than once,
it seems, before they turn shy.
S&P raises debt rating as economy
rebounds
Strong economic growth and the elimination of international
debt in Argentina prompted S&P to raise the nation's credit
rating to five levels below investment grade.
BY DANIEL HELFT AND ELIANA RASZEWSKI
Bloomberg News
Argentina's credit rating was raised for the second time in a year by Standard & Poor's,
which cited falling debt levels and increased investment.
New York-based S&P lifted the nation's long-term foreign currency debt rating to B, the
same level as Uruguay and one step above Bolivia, from B- with a stable outlook. The
rating is five levels below investment grade.
The upgrade reinforces many investors' view that the economy has recovered in
Argentina five years after the government defaulted on $95 billion of bonds, said Vitali
Meschoulam, a fixed-income strategist at HSBC Securities USA in New York. On
Wednesday Argentina sold dollar-denominated bonds to international banks for the
second time since the default.
The rating change is ''further confirmation that Argentina's economy is on the right
track,'' Meschoulam said.
Higher ratings in Argentina are emblematic of improved credit quality across Latin
America as interest rates fall and international reserves climb on the back of record
exports of such commodities as oil, copper and soybeans.
Moody's Investors Service said this week it may lift the credit rating for Chile, ranked
along with Mexico the highest in the region at Baa1. Last month, S&P raised Brazil's
credit rating to BB, two levels below investment grade, from BB-.
''We have been watching a very positive economic cycle in the past two years and LatinAmerican countries have benefited from it,'' said Rafael Guedes, managing director of
Fitch Ratings' Brazilian unit, in an interview in Sao Paulo. ``The countries took
advantage of the increase in international trade with very adequate economic and fiscal
policies.''
Brazil, where the inflation rate was as high as 4,900 percent in June 1994, may achieve
investment grade by the middle of next year, Nelson Rocha Augusto, president of Rio de
Janeiro-based BB DTVM, Latin America's largest asset manager, said in an interview.
Brazil's annual inflation rate was 5.5 percent in February.
Other investors and economists including Cristina Panait, an emerging-markets analyst at
Los Angeles-based Payden & Rygel, say an investment grade rating for Brazil in the next
two years is likely.
Guedes said such predictions are optimistic.
''Brazil needs to grow and learn how to spend in a better way,'' he said. ``It's a dream to
think about an investment grade without that.''
Argentina's credit ratings have climbed since the government completed a restructuring
of defaulted debt in June last year. The country, whose 2001 debt default was the biggest
ever by a sovereign borrower, recorded 9.1 percent economic growth last year. The
economy has expanded more than 25 percent in the past three years.
The country in December used about one third of its central bank reserves to pay off its
entire debt with the International Monetary Fund, reducing its need to tap international
credit markets.
The extra yield investors demand to hold Argentina's dollar-denominated bond due 2033
instead of a comparable maturity U.S. Treasury has fallen to about 3.7 percentage points
from 5.3 percentage points in December last year.
Argentina on Wednesday priced $500 million of bonds to yield 8.36 percent, or 3.7
percentage points more than a U.S. Treasury of similar maturity. Brazil's 10 percent bond
due 2011 yields 1.49 percentage points more than a U.S. Treasury of comparable
maturity.
S&P lifted Argentina's credit rating from selective default in June last year, when the
government persuaded creditors holding $62.3 billion of defaulted bonds, or 76 percent
of the country's $81.8 billion of defaulted principal, to accept new securities worth about
30 cents on the dollar.
S&P said its decision to raise the rating was a result of the economic expansion and a
reduction in government debt.