A Sensible Path for Avoiding an Argentine Default.
With a July 30 deadline looming, Kirchner must tone down the rhetoric and strike a deal with 'holdout' creditors.
By RICHARD DEITZ - July 27, 2014
True leadership requires clear thinking and the dispassionate assessment of risks and rewards. Argentina's President Cristina Kirchner has until July 30 to decide whether to lead her country into renewed default or reach a settlement with "holdout" creditors. There is a sensible path forward, but it would require setting aside heated rhetoric in favor of wisdom and measured leadership.
Argentina defaulted on its debts in December 2001, amid a prolonged economic recession. In 2005 the country made a take-it-or-leave-it debt restructuring proposal to its creditors. Bondholders were asked to accept new instruments with a significant reduction in face value. To put teeth into the proposal, Argentina's legislature passed a "lock law" that forbade the country from offering anything in the future to creditors who did not participate.
Roughly 75% of Argentina's creditors participated in this 2005 debt exchange. When the legislature voted in 2010 to reopen the exchange temporarily, most of the remaining bondholders, presumably discouraged by Argentina's intransigent posture, tendered their bonds. A small group of holdout creditors, however, pressed on with litigation in the U.S. federal court in New York.
Argentina's Finance Secretary Pablo Lopez in New York for mediation talks, July 24. AFP/Getty Images
Whether through poor legal advice or bad political judgment, Argentina never made efforts to settle this litigation and instead bet all on its case. In 2011, District Court Judge Thomas Griesa ruled in NML Capital Ltd. v. Republic of Argentina that the equal-treatment provisions in Argentina's defaulted debt meant that Argentina could no longer service its debt issued under the exchange offers unless it simultaneously made payment in full on the bonds held by the litigating holdout creditors. The final word came on June 16 when the U.S. Supreme Court declined to take the case, exhausting Argentina's avenues for appeal. The only decision that remains is whether to resolve the litigation or lead the country into a new default.
What are the stakes? According to Argentina, paying all remaining holdout creditors would cost $15 billion. In mid-July Mrs. Kirchner said in Brazil that Argentina was ready to provide the holdout creditors with the same conditions as creditors who entered the 2005 exchange. By rough calculation that would cost $6 billion. So the amount in dispute is about $9 billion. Not a small sum, but $9 billion is a mere 2% of Argentine GDP.
A wise leader would consider the consequences of leading her country into default. Capital flows to Argentina would be severely reduced, borrowing costs would rise, economic growth would slow and government finances would become constrained. For the population, this would mean fewer jobs, higher inflation and fewer government services. Default would almost certainly cost the country more than 2% of GDP and its effects would last more than one year.
But complying with the New York judgment presents two problems. First, $15 billion represents more than half of Argentina's foreign-exchange reserves. Second, the rights-upon-future-offers clause—known as the Rufo clause—in the 2005 and 2010 debt exchanges essentially gave a money-back promise to participants that Argentina would not make a superior offer to holdout creditors before Dec. 31, 2014. Neither of these problems, however, is insurmountable.
Holdout creditors have expressed a willingness to accept bonds rather than cash as a currency of settlement. The amount of bonds necessary would not place any particular burden on debt sustainability, as Argentina's debt levels are modest. The rights-upon-future-offers clause could be addressed by soliciting the consent of holders of Argentina's exchange debt to waive the provision. Given that the clause expires on Dec. 31 and that its existence essentially heightens the risk of default, it should be straightforward to gain the requisite supermajority approval from bondholders to waive the clause.
And so a path to settlement becomes clear. Argentina's holdout creditors could agree to a three-month extension of the stay on execution of their judgment. This would allow Argentina to continue servicing its performing debt and avoid renewed default. In return, Argentina would agree to settle with its holdout creditors by payment in newly issued bonds. Such an agreement would be expressly subject to Argentina achieving a waiver of the rights-upon-future-offers clause and a commitment to launch immediately a consent solicitation for such purpose. If the solicitation failed, the clause would lapse at the end of the year and the parties would have the unfettered ability to complete the settlement in January 2015.
When hopes of a solution were raised earlier this month, yields on Argentine bonds reached multiyear lows and its equity markets rallied. This is a sign that the markets would reward a settlement with renewed investments that would promote growth and jobs. There is little sense in trading this outcome for a new default. Grasping that plain wisdom is the challenge for Argentina's leaders.
Mr. Deitz is founder and president of VR Capital Group Ltd., an alternative asset manager specializing in distressed sovereign and corporate debt in emerging and developed markets.