Nick Phillips speaks to local experts about the Argentine government’s rapid accumulation of foreign debt in 2016, a trend that has some looking back to the country’s recent economic crises.
On Tuesday, 19th April 2016, sovereign debt traders saw an unfamiliar name in their order books. For the first time since its massive 2001 default, the Argentine government was offering bonds on the international market. Not content to slip back in quietly, Argentina made a splash by selling US$16.5bn in dollar-denominated bonds, with interest rates ranging from 6.25% (for 3-year notes) to 8% (30-year). It was the largest emerging market bond sale in at least 20 years. Three days later the government paid out more than half of the total sum, some US$9.3bn, to the final holders of defaulted 2001 debt.
The re-entry into international markets and subsequent payment marked the end of another chapter in the Argentine government’s troubled history with debt, which now includes eight credit defaults. The move would have been unthinkable under former President Cristina Fernández de Kirchner, but current President Mauricio Macri – a former business leader – was elected on a platform of cleaning up the economy and re-opening the country to international markets. The bond sale highlights part of this dramatic shift in approach to managing the country’s fiscal needs.
As the government continues to run a fiscal deficit—estimated to reach 5-6% of GDP in 2016—there are only two ways to make ends meet. Rafael Flores, President of the Argentine Association for Budget and Public Financial Administration (ASAP), explains, “The previous government financed a good part of the deficit by printing new currency… The current government is replacing [printing money] with external debt.”
Experts consulted by The Indy disagree on the merits of the new strategy. Flores stated that it “permits a more gradual reduction of the deficit that does not generate a recessive impact… In the context of very low international interest rates, it seems like a reasonable policy.” Economic historian Alejandro Olmos Gaona disagrees, saying, “When the country takes debt to cover its fiscal deficit and operating costs, as is happening now, the debt is not sustainable.”
The Legacy of 2001
The current situation traces its roots to Argentina’s devastating crisis that ultimately led to default in 2001. Throughout the 1990s, Argentina witnessed strong economic growth, fuelled in part by a steady influx of foreign capital. But by the late 90s the economy began to slow and eventually entered a recession. Debt rose sharply and the government was forced to take out more loans at higher rates just to pay interest on the existing debt. The peso-dollar convertibility system, which had once given confidence to skeptical foreign investors, made it impossible for the government to devalue its way out of recession. When Adolfo Rodríguez Saá finally announced a default in December 2001, it was too late to control the fallout.
In 2002 the Argentine economy slumped into its worst ever crisis. Productivity contracted and official unemployment numbers rose above 20%. Public debt reached 166% of GDP. In the political tumult of 2003, Néstor Kirchner took office as Argentina’s creditors began to sue the country in international court. In 2005, Nestor’s administration offered creditors a deal: the government would pay its overdue loans at a rate of 35 cents to the dollar. Three-quarters of bondholders accepted this offer. In 2010 a similar deal was offered and another 17% took the money. But the holders of the last 8% of Argentina’s defaulted credit did not want to settle for anything less than full payment.
A minority of creditors, led by Paul Singer’s vulture fund NML Capital, continued holding out for payment of the original value of their bonds, plus interest. They stepped up their claims in international courts, attempting to freeze government funds stored in foreign accounts and seize assets including. In 2012, they had an Argentine Navy ship briefly impounded in a Ghanaian port.
Ultimately, however, ex-President Fernández was able to continue to rebuff the holdouts, making debt reduction a signature part of her economic plan. This policy found some support from countries in the international community, but had the effect of restricting Argentina’s ability to borrow more foreign capital.
In the final years of Kirchnerism this began to pose a problem, manifest in a shortage of dollars (needed to pay for imports and service existing debt). Argentina’s economy relies heavily on commodity exports, so the worldwide slump in commodity prices drove down GDP sharply. Tax revenue went with it, but government spending did not, producing a widening fiscal deficit. The operating deficit in 2010 was 1.3% of GDP; by 2015 most economists agree that figure had grown to over 6% (there remain question marks over divergent methodologies). With limited access to credit, the government turned to the printing presses to cover its costs, contributing to years of punishing double-digit inflation.
A 180-degree turn
When Macri’s government took over in December 2015, the federal operating deficit had grown to worrisome levels and efforts to contain the supply of dollars (mainly via currency and trade controls) had damaging economic side effects. As the Cambiemos coalition has continually emphasised, the “inherited” economy was already struggling, with government officials suggested it was near collapse. That remains a subject of debate, but most analysts agree that at least it was not saddled by debt. “The best inheritance from the previous government, really one of the few redeeming qualities, is the low level of external debt,” says Flores.
The Macri administration achieved a political victory by settling with the holdouts and clearing the path to return to international markets. Investors took note of the new strategy – guided by upgrades from major credit rating agencies – and since the settlement was made in April the country has taken on a slew of new debt. The national state, provincial governments, and large corporations have issued over US$50bn from abroad in the first 11 months of the year.
With low interest rates worldwide, 2016 has been a boom year for debt in many emerging markets, but the historic sales have also raised eyebrows. The Financial Times’ John Plender wrote that perhaps a “investor amnesia” might have aided in the rapid sale of Argentina bonds.
Despite the markets’ clear appetite for Argentine debt, investors and analysts disagree over the real risk that the sale poses both to creditors and the government.
No Magic Number
Argentina’s international bond sales are part of the Macri government’s plan to stimulate economic growth, but the policies have yet to achieve their desired effects at home. Nearly one in three Argentines lives in poverty. The economy continues to shrink. Far from stopped in its tracks, inflation hit 40% this year. And now the government is responsible for a lengthy ledger of debt obligations in foreign currencies.
According to the Finance Ministry, the stock of public debt reached US$264.5bn by the end of September, which marks an increase of 4.1% since the start of 2016 and represents 53% of GDP. Debt-to-GDP ratio is a common way of measuring a country’s sovereign debt load, but it does not necessarily shed light on the sustainability of the debt.
For instance, Argentina’s debt-to-GDP ratio remains below that of many other Latin American nations. It is also within the 60% maximum established by the Maastricht treaty for Eurozone countries, which is widely viewed as an international benchmark. However, As Flores notes, there is no “magic number” for an acceptable level of debt, as it “depends on what it is used for.” Economists traditionally favor policies that use debt to finance stimulus plans and investment in the economy, such as infrastructure projects. Part of the current government’s economic plan does include major public works projects. As Olmos Gaona says, however, Argentina currently needs to borrow just to cover its operating costs, raising concerns from some that it will enter a vicious cycle similar to that in the run up to previous crises.
Ultimately, experts coincide that Argentina’s ability to maintain a healthy debt load depends largely on its ability to rein in the deficit. “I think that Argentina will be able to increase its debt without too many problems during this year and next. But, I think it needs to define a path for the reduction of the deficit,” says Flores. “It can be gradual, but it needs to be constant.” The government pledged to reduce the deficit to 4.8% of GDP in 2016, though most analysts expect the figure to come in around the same record level from last year, and there are creeping doubts about the 4.2% target for 2017.
Much depends on the health of the economy, which plays a major role in determining revenues. If the government can expand its tax base, a deficit reduction will become much more achievable. “If the economy grows by more than 3-3.5% annually and the government goes forward with a reduction of the fiscal deficit, the debt should not generate worries,” says Matías Carugati of Management & Fit consultancy.
The 2017 budget estimates annual growth of 3.5%, and inflation of up to 17%. Flores called those numbers “realistic, but optimistic… or optimistic but realistic.” Jorge Piedrahita, CEO of New York-based broker-dealer Torino Capital calls the estimate simply “optimistic.”
Hitting the 4.2% deficit target will require economic growth and also the political willpower to cut spending, which might be in short supply, particularly with crucial mid-term elections due in October. Some have expressed concern at the increase in state spending, especially in recent months. “Each time the Macri administration opens its mouth, they seem to be spending more money,” says Piedrahita, “it seems like it is very hard for them to say no to anyone.”
Given Argentina’s checkered track record with debt, it is particularly vulnerable to swings in market expectations that can dramatically influence the country’s economic stability. Even if Macri can get the economy on track, the government needs to inspire confidence in its commitment to pay in order to keep interest rates at a reasonable level; signs that it won’t can lead to a sudden downward spiral.
Olmos Gaona observed that the interest rates on Argentine debt compare unfavorably to other Latin American countries. This reflects the hesitation that investors still have towards the country, even with Macri’s government indicating a strong desire to improve its standing in the international markets. Until recently, the OECD had Argentina in its lowest credit classification—the same as Venezuela and North Korea.
One difficulty the country faces is that much of its debt is denominated in foreign currency (a proportion that has been rising rapidly since April), leaving the country exposed to exchange rate swings. The government officially estimates that by the end of 2017 the rate of exchange between the peso and US dollar will be 18-to-1, though some sectors are calling for a faster devaluation to compensate for a year of inflation near 40%. And external factors are again at play. The US Federal Reserve hiked interest rates this month, and said it planned up to three further increases during 2017. This will lead to a rise in global rates, and also encourage more investment in safer US dollar assets, like treasury bills, pushing the currency higher against emerging markets like Argentina.
Still, Piedrahita suggests that any rate increase would probably have a limited effect on emerging markets, adding that markets still have a favourable view of the new Argentine government. He added that the popularity of Cambiemos in polls next year is likely to affect interest rates well before the election happens. “Argentine assets, towards the middle of the year, will likely move at the rhythm of the polls. To the extent that the government is doing well at the polls, spreads could tighten… Anything that signals some shift could move the markets big time.”
Macri’s opponents already say his debt policy will lead the economy towards another crisis; he’ll be hoping this sense of déjà vu doesn’t spread to the investors he badly needs to make his plan work.