Buenos Aires Province’s U.S. $500mn in securities, due in January 2021, tumbled 5.3 cents Wednesday to 64 cents on the U.S. dollar, their worst day in over four months as the government of the province, Argentina’s largest, plans to seek restructuring talks with creditors for “temporary financial relief” ahead of a $277mn debt payment due January 26. The talks will be seen as a gauge of how Argentina’s new government will handle its creditors, as the debt of Buenos Aires Province surpasses that of all the other provinces combined. The securities had returned 54% since the end of August, marking one of the world’s best bond rallies in emerging markets as investors bid up the debt since then on bets the payment would still be made. “Doubts persist over whether the Province will negotiate that payment within a broader restructuring or not,” according to Alejo Costa, chief strategist at BTG Pactual in Buenos Aires. “Bringing together the 2021 bondholders suggests they are going to try to rollover the payment or negotiate it within a more general agreement.”
Investors have been fretting over what the future holds for economically crippled Argentina more broadly since well before president Alberto Fernández assumed office on December 10. Markets have been pricing in Mr Fernández’s victory since his initial surprise but overwhelming win over his predecessor Mauricio Macri in a primary in August and then in the general election in October, but uncertainty surrounding how he would reverse the downward spiral of Argentina’s free-falling economy and restore investor confidence spiked further volatility in Argentina’s fragile capital markets. In addition, Mr Fernández campaigned on a rather vague economic platform, with plans only becoming clearer on the appointment of his new finance minister Martin Guzmán, a protégé of U.S. Nobel prize-winning economist Joseph Stiglitz, who moved swiftly to soothe investor concerns, prioritising a production-oriented agenda over more public spending cuts and saying the extremely fragile economy meant the country would have to “grow its way out of its virtual default”.
The Argentine government also announced at the end of 2019 that it would honour payments of $850mn, corresponding to two different sovereign bonds, Discount Bonds amounting to $752mn and the Centenary Maturing Bond issued in 2017 during Mr Macri’s administration, equivalent to $98mn coming as a relief to markets. The decision to honour the debt is intended to restore the country’s credibility, and, combined with a tax increase and a pension freeze, signals the government’s strategy to “continue honouring bonds, interest and capital, as long as Argentina can keep on with debt negotiations and avoid a default,” according to finance minister Guzmán.
A Sea of Economic Woe
Mr Fernández’s intentions on key indicators such as inflation, growth, the depleted reserve levels at Argentina’s central bank, and how he will repay the IMF (let alone local lenders) this year, remain unclear. Argentina’s bottomless well of financing requirements reaffirms the central necessity of a renegotiated deal with the IMF, which extended a $56bn bailout package to Argentina last year. This will require the restructuring of the high repayment schedule of the package and simultaneously the pay out of the $12bn remaining from that package. The task is not made easier by the fact that the majority of Mr Fernández’s supporters loathe the institution.
Forebodingly, Argentina has less than $10bn in net reserves, and the government owes the IMF roughly $22bn by 2022, and another $22bn in 2023. Even were the IMF to forgive half of the 2022 amount due, as is being touted in some circles, that is still $1bn more than the government has in reserves, which is not to overlook the billions it owes this year and next in both local currency and foreign, dollar denominated debt. Meanwhile, the country’s annual inflation rate stands at above 50%, and over a third of Argentina’s population lives below the poverty line. Unemployment is above 10% (officially) and the economy, which is largely dollarized (particularly in Buenos Aires), is in severe recession.
The central bank has room to cut interest rates, but with inflation hovering around 50%, even if the bank went to real rates of 0%, inflation would still devour everything. The indicators to watch, then, aren’t just the dwindling reserves at the central bank, but also monthly inflation data that will complicate economic policy and widen tensions between voters who put Mr Fernández in power who are exhausted by recession, and bond holders fatigued by defaults that want their money back. Argentina’s dollar-denominated bonds plummeted when Mr Fernández crushed Mr Macri in the presidential primary contest in August, with government bonds falling 25% on average and the price of the 100-year bond falling nearly 40% over a few days to roughly 45 cents on the dollar.
That turmoil cost, among others, the Franklin Templeton Emerging Markets Bond Fund run by star manager Michael Hasenstab dearly: the fund had loaded up on $7bn of Argentine bonds in the belief that Mr Macri would succeed in reforming Argentina. In the event, it lost $1.8bn on the day after the August election with total net assets dropping $3bn in a 9% decline in the three months following the primary election, causing Morningstar to lower the fund’s rating to neutral from bronze, its second-lowest rating. Mr Macri, for his part, was compelled to enact emergency measures, among them capital controls to stem the panic. He also announced Argentina would seek to postpone $7 billion of payments in short-term local bonds and $44bn in loans from the IMF, as well as push for a ‘voluntary reprofiling’ of $50bn of longer-dated debt mostly to foreign investors.
While these moves calmed investors, they don’t vitiate the question as to how Mr Fernández’s administration will tackle Argentina’s $330bn debt burden, and more immediately the $101bn due for imminent restructuring, raising urgent questions as to the kind of relationship Mr Fernández intends to have with bondholders and the IMF. Debt negotiations could become complicated by the capital controls and the re-emergence of the Mercado Azul, an unofficial exchange rate system that is probably not to the taste of IMF financial orthodoxy.
Not so Fast
Meanwhile, a central question revolves around a – hitherto untested – ‘uniformly applicable’ clause that comes into play in the event of a debt restructuring. A collective action clause (CACs) which has been part of most global bond sales since 2014 means that if a government signs a single accord with bondholders, all investors must be treated the same, whatever the bonds they hold and their current value. This option – the ‘single-limb’ vote – requires the backing of investors holding 75% of the outstanding value of bonds to be restructured., which for Argentina would mean investors holding a range of debt maturing from 2021 to 2117 are offered the same replacement asset or set of assets.
The alternative, a ‘two-limb’ option that would generate varying returns for those holding bonds maturing in between the next two or hundred years, and the certain sentiment of injustice that would accompany the ‘single-limb’ option could force Argentina’s government into a protracted restructuring process requiring it to negotiate with all bondholders. The ‘two-limb’ option requires the support of 66.7% of bondholders, by contrast, but also 50% of the holders of each note. Whatever bondholders vote for, then, will determine the difficulty and length of the debt restructuring.
Investors had been bullish until this week’s hedge from Buenos Aires Province on Mr Fernández’s comments about a restructuring that would entail bondholders giving the government more time to pay back debts without an explicit loss on investments. Sceptics, however, thought such terms would not deliver enough cash flow relief and are unlikely to win IMF support. Until some agreement is reached, Argentina’s dollar bonds are likely to remain under duress and there will be little appetite to buy debt aggressively until there is some indication of what a recovery price will look like.
Even if Mr Fernández and the IMF kiss and make up, the relief provided to bond buyers is likely to be short lived. Mr Fernández and his team will also have to find a way to pay the bills without reducing public employment payrolls and subsidies. If the bullish sentiment on bonds turns out to be correct, it might yet be prudent to get out as soon as a debt extension is made. Loans on the scale Argentina requires will not be made without extravagant interest rates that bond investors may love, but which Argentina’s voters loathe. And if Mr Fernández fails to provide a sustainable growth model, the burden of debt relief will likely nonetheless fall back onto bondholders. In the meanwhile, all eyes are peeled on what will happen in the Buenos Aires talks.
Image: Martin Guzman, Wikimedia Commons