March 2004
Argentina: Economic Challenges in the Wake of Default
In December 2001, Argentina defaulted on the largest amount of sovereign debt in history. In the immediate aftermath of that default, the Argentine economy collapsed, and unemployment rose to high levels. Since December 2001, Argentina has made little progress in restructuring its private sector debt, although the Argentine economy does appear to have bottomed out. At a March 31 AEI conference, panelists took stock of Argentina's options for rescheduling its external debt and for designing economic policies to cope with its difficult economic situation.
Panel I: Restructuring Argentina's External Debt
Desmond Lachman
AEI
The seminar today not only revolves around potential Argentine actions in the wake of the 2001 default, but also how the relevance of this case resonates in other emerging markets. This is the largest sovereign debt default in history, as well as the largest depression that Argentina has suffered since the Great Depression. Despite the weighty consequences of these superlatives, it has been nearly two and a half years since the default, and no noticeable progress has been made in discussions with private-sector creditors. This leads one to wonder how the IMF, to whom Argentina has $15 billion outstanding, should handle future cases.
Charles Calomiris
AEI and Columbia University
There are five questions that I would like to pose to the panelists: How much of this debt can reasonably be repaid, and how much should be repaid? What is the possible efficacy of GDP-linked bonds (i.e. income bonds) in this situation? What role should the IMF play in this renegotiation between the government and creditors? Finally, if this debt is renegotiated, is there a way to protect creditors from future risk?
Randal Quarles
U.S. Treasury
The United States has been actively supporting the attempts to reestablish economic stability in Argentina through the effective restructuring of their debt. Taking into account not only the enormity of the debt--roughly $100 billion in private claims--but also the different currencies, legal jurisdictions, and types of bondholders involved means that satisfying this broad range of bondholders while preserving inter-creditor equity will be a major challenge.
The recent growth in Argentina is misleading. It was strong and will continue to be in the coming year. However, this represents a rebound from significant contraction over the past five years, and the country still has not returned to pre-contraction levels. In fact, this growth will not be sustainable without a significant infusion of foreign investment, a prerequisite of which is successful debt restructuring. The success of such restructuring relies, to a large extent, on the role the IMF is willing to take in supporting Argentina while renegotiations with its creditors take place.
The IMF must continue to provide financing for the duration of the program while concurrently helping Argentina prepare a strategy to promote growth and stability. The continued presence of such support would require good-faith negotiations between Argentina and its creditors. That is not to imply that the IMF should have a say in any terms of a deal; rather, they should ensure that a deal is actually in progress.
Recently, Argentina committed to hold negotiations with all representative creditor groups, including the Global Committee for Argentine Bondholders (GCAB), which marks a positive change in willingness to seek improvement. In yet another show of good faith, Argentina has retained the investment bank advisers that it hired throughout the restructuring process, seeking to finalize an appropriate minimum participation threshold that is mutually acceptable to both the debtor and creditors.
The specifics as to what Argentina should and could pay to its creditors are details that should be settled upon by Argentina and its creditors, with the IMF and the United States standing outside the renegotiations. As long as the deal results in a sustainable debt situation for Argentina while satisfying the bulk of the creditors, then there is no reason for the IMF or the United States to take an independent stance on the process.
Adam Lerrick
Argentine Bond Restructuring Agency
Carnegie Mellon University
I am here as the head of the negotiation team for the Argentine Bond Restructuring Agency, where I hold a seat on the Steering Committee on the GCAB. The GCAB is a practical solution to one of the major problems of the restructuring process in Argentina--coordination. With 150 bond issues and roughly half a million investors, Argentina would have a hard time meeting the needs of every foreign bondholder. The GCAB has solved that by appointing a handful of people to represent close to three-quarters of foreign investors.
Establishing sustainable debt restructuring requires a clear understanding of Argentina's debt payment capacity. In order to determine this, assumptions must be made about general macroeconomic performance of Argentina, the economy's growth rate, the exchange rate, and the availability of future funds with which to make payments. It is essential, however, that these assumptions are reasonable to all parties involved.
The good-faith efforts criteria imposed by the IMF is especially worthy of note in Argentina's case given the duration of time that has passed since its initial default. The only consequence imposed by the IMF is to stem the flow of money at an extremely low interest rate. As a rule, any country in default to private creditors is only eligible for IMF funds if it is making "good faith" efforts to resolve its debts. Therein lies the problem with this system: the IMF does not reward a defaulting government for a successful restructuring, only for the image of effort. Instead of rewarding the illusion of effort, the IMF should create a system of direct financial incentives, thereby encouraging a sense of purpose and urgency.
In response to the questions posed, the concept of GDP-linked bonds is interesting, albeit misleading. Bondholders are fixed-income investors. If they were attracted to Argentine equities, they would have purchased shares on the Buenos Aires Stock Exchange. Forcing an equity instrument on investors will lower its perceived value, solving nothing for the debtor.
As far as protecting creditors from future risk, given a successful renegotiation of Argentina's debt, there are certain provisions that can be put into bonds--debt capacity limits, debt borrowing limits--that have the ability to shield creditors from slipping into this situation again.
My feeling on the IMF is the same as the one expressed by my colleagues: enforce the rules, but do so from the sidelines. The problems between the private-sector borrower and private-sector creditors should be worked out among themselves.
Hans Humes
Global Committee of Argentine Bondholders
The key to restructuring Argentina's debt is to establish a process that is familiar to the creditors. Thus far, however, I think it is safe to say that there have been no negotiations. As the largest organized group of bondholders representing just about every class of creditor, we feel that our discussions will have a certain degree of import.
In terms of sustainability, we have our ideas, and the Argentines have theirs. As long as we can reach a reasonable settlement, I think both sides will be happy. No one wants to prolong this process. In fact, Argentina no longer has the luxury of time. The economy is too complicated, and it is integrated into the world market. It is in everyone's best interest to come together as soon as possible, and construct something that, while not exactly what everyone wants, is deemed satisfactory to all involved.
Vincent Truglia
Moody's Investor Service
As far as debt restructuring goes, we are simply observers. The rating system at Moody's varies from that of the S&P in that it combines default with severity of loss-a factor that becomes more and more evident towards the bottom of the scale. At the bottom, our ratings are almost entirely based on severity of loss. Argentina's old bonds are rated CA-consistent with a write-off of 50-85 percent of the debt. So anything that happens is consistent with that rating in net present-value terms.
The two problems that I can see are the dramatic decline of Argentina's investment and the government budget deficit. The decline in investment is the obvious result of the collapse in economic activity. Interestingly, when investment drops so quickly, it creates an account surplus, negating the immediate need for any net new money. That will change as imports rise and the economy improves, but Argentina can maintain its current path.
The government budget deficit is, again, a problem with a short-term solution. Because there is currently so much excess capacity in Argentina, there are virtually no inflationary pressures. Consequently, the government can finance their public sector debt through monetary emission with little concern for inflationary consequences.
Problems arise when it is no longer possible to finance their deficit in such a manner. Until the Argentine economy arrives at this point, however, it will be difficult to convince the Argentine public that the debt issue should be resolved. There are simply no immediate incentives, and that is probably why nothing has occurred. As a result, we are not optimistic about anything happening in the near future.
Panel II: Remaining Economic Challenges
Anne Krueger
International Monetary Fund
Argentina's macroeconomic performance over the past year or more has surpassed all expectations. Growth exceeded 8 percent last year and is predicted to be around 6 percent this year, with inflation remaining around 2.5-3 percent. Even so, much of what we have seen thus far is part of the recovery to pre-crisis levels of activity. In order to see significant progress in reducing unemployment and poverty, Argentina has to experience sustained expansion over the longer-term.
New investment will also soon be essential to ease bottlenecks forming as capacity utilization rises. This new investment will come partly from domestic savings, but new inflows of foreign capital will also be needed. Access to foreign capital will only come once Argentina regains access to international capital markets, and this will only happen if potential investors are convinced that Argentina's economic policies make for an attractive prospect over the long-term.
I believe that the fears of many emerging market governments--that too high a primary surplus can undermine recovery and efforts to reduce poverty--are misplaced. Prudent and sustainable fiscal policies do not hinder poverty reduction, nor do they slow growth. A stable macroeconomic framework, including a primary surplus consistent with debt servicing obligations, is an essential prerequisite for sustained, rapid growth, which is in turn the best way to reduce poverty. The experiences of Turkey after its crisis of 2001 and of Brazil show that sticking to a clearly stated macroeconomic strategy can bring considerable benefits. Argentina needs to press ahead with reforms as these countries and others have. If it does not do so, the prospects for sustainable growth are bleak.
Identifying what reforms are needed is far easier than implementing them. The most obvious problem is the need to replace the relationship between the center (the federal government) and the surrounding provinces, to give this relationship a stronger footing. Previous one-year agreements are being replaced by longer-term arrangements, and better incentives are being introduced on the provincial level on both sides of the balance sheet.
Given the present political situation, successfully resolving the problems of the energy sector will also be a major challenge for the government. A reliable, plentiful flow of energy is essential for any modern economy. This requires a pricing structure that takes into account the needs of consumers while making sure not to penalize the very poorest, all the while generating sufficient revenue for suppliers to undertake necessary investments. This has not been the case in Argentina, though. Investment in utilities has been greatly affected by the pesoization of utility contracts following the 2001 devaluation paired with inability of utility companies to adjust their tariff structures.
Throughout all this, the IMF's role is a supportive one. One of our primary tasks is crisis prevention. True, each crisis is a setback yet provides valuable insight into how we can improve our crisis-prevention framework.
Guillermo Mondino
Yale University
Looking into Argentina's economy over the past ten years, one has to ask if they were right to begin by reestablishing macroeconomic stability. I believe they were right. Even if they did it rather inelegantly, they established a base from which to move forward.
On the exchange rate regime, there seems to be a sense of progress, with an effective repesoification. Structurally speaking, while there has been some progress made in the banks, the system is fundamentally neither solvent nor profitable. This is compounded by public banks seeming to lack dedication to reform. The system was underdeveloped before the crisis, and there is little evidence that the system is developing even now.
Before the crisis, Argentina had a closed and over-regulated economy. Since the crisis, it has become even more so. The Argentine leaders appear to be among the least convinced of the benefits of globalization. If this continues to be the case, Argentina's future does not look bright. In the end, it is not the burden of the external debt that will determine Argentina's prosperity; the issue is going to be whether they are prepared to implement the economic reforms that are necessary to bring about sustained growth.
But what of nonpayment of the external debt? It is grounded upon one fact and one myth. The fact is that they cannot and should not pay on the original terms. The myth is that debt was somehow illegitimately forced on Argentina by rapacious lenders and foreigners. This myth, if perpetuated, will keep Argentina from achieving the prosperity that it deserves.
My bottom line is this: Argentina has bounced back and will continue to bounce back if it implements a required greater reform effort than currently shown. I therefore feel that there should be clearer markers about where the process should go forward on the debt. The issue has been reduced to one number, but economics consists of more than simply one number. The primary surplus is important, but I do not agree with simply stating what the primary surplus means for poverty. The IMF should not just put out a press release on what exactly should be done, but the path they are taking invites further delay for years. I believe they should lay out broad parameters to be met.
Nouriel Roubini
New York University's Stern School of Business
Looking into the past fifty years of Argentina's history, you see two kinds of features. On one side, you see a very dismal economic performance in terms of per-capita growth. On the other side, you see that Argentina has had a series of defaults on its sovereign debt throughout most of its history--about one every ten years.
Thus far, panelists have discussed how the external debt should be restructured and on what terms, but unless Argentina solves its problems--structural, fiscal, and otherwise--it is likely to be in default again by the end of this decade due in part to flaws in the restructuring process, the government's determination to keep their surplus to 3 percent, the method of compensating Argentine banks, and the ratio of public debt-to-GDP that the country would face.
What should be done to keep this from happening? There is a list of policy reforms that are necessary, some of which are quite clear, others which may not be politically feasible. A larger surplus, amounting to at least 4 percent of the GDP, is important. It is imperative to crack down on the widespread tax evasion while simplifying the tax system and making it fairer over time.
You will also need policies that will increase the trade openness of the country on a long-term basis. In the 1990s Argentina was very closed, and we saw that their debt-to-export ratio was very high by any standards. With the collapse of the peg, however, we saw significant changes; but now export taxes, while a necessary source of revenue for the government, are limiting the incentive to invest and produce in the tradable sector. Reducing these export taxes and moving more to direct/indirect taxes over a period of time makes sense. Argentina needs to be more open and integrated with the global economy.
There will need to be significant labor market reforms to increase flexibility; however, given the current political climate, this seems unlikely to occur. Recent news has shown that Argentina is moving in a direction that gives more power to unions and increases the rigidity of the labor market.
In regards to the banking system, there is a tradeoff to consider. The banks may require further compensation due to the asymmetric pesoification, but this will have further consequences in the form of the larger stock of government debt. The main objective of the policy should be to make sure the banks are liquid and earning enough on their investments to avoid cash flow losses. Present interest rates may need to be changed as they reduce the current cash flow for the banks and may constrain their ability to lend.
Finally, will these reforms be implemented? I have a mixed view. On one side, the government has so far followed more disciplined policies, but on the other side, the overall tone of the administration is a relatively populist one that does not seem to favor market-oriented reform.
Edwin M. Truman
Institute for International Economics
Generally, debt discussions look at payments on debt as residual. We look at what is left after paying for everything else in the budget, and what is left is then used to pay the debt. I think that this approach is fundamentally flawed. Residual can only be computed if one has a well-defined and exogenous level of output and of the deficit. However, a debt crisis like the one we see in Argentina operates as a tax on reform through the creation of all kinds of bad incentives, both in the public and private sector.
In addition, the debt default creates contempt due to the comfort of not paying the debt, as well as disregard for the importance of property rights. This creates what economists call a Laffler curve on the debt, which means basically that once the debt reaches a high enough level, payments actually turn negative. Argentina is definitely on the wrong side of that curve, having too much debt with very, very low payments.
Argentina needs to create a more stable and constructive overall environment. Today Argentina is a very closed economy. Trade openness is a fundamental feature for all reasons of efficiency. It is also critical in breaking the destabilizing political economy of the highly rent-seeking business community and social fabric of the country. Further, a critical benefit of increasing openness is the added degree of stability it brings. The more open an economy is, the less significant the movements in relative prices will have to be to adjust to sudden stops.
Argentina's government is not at present enacting any long-term solutions to their problems. One element, and possibly the most troubling, is that in the provinces, where debt servicing is the most difficult, Minister Lavagna is already talking about rollover of debt at concessional rates, leading to further debt relief and a greater burden on other creditors. In regards to their banks, in order to encourage lending, the government has softened regulations. While this may help in the short-run, a few years down the road the system will more than likely develop adjustment problems that will then be harder to resolve.
AEI interns Bo Harrison and Robert Jeffrey prepared this summary.
