NEARLY THREE YEARS after Argentina declared a moratorium on its foreign debt, the country finally looks as if it is going to launch a bond exchange in an attempt to cure the default.
Most people involved now expect some kind of offer before the end of the year, although few observers are confident that it will achieve much success.
Part of the reason is that most of Argentina's bondholders seem determined to reject the country's offer out of hand. The Global Committee of Argentina Bondholders (GCAB), which claims to represent more than 500,000 retail investors and 100 institutions holding some $37 billion in Argentine debt, says that there's virtually no chance they will recommend that the offer be accepted.
The stage is being set for what could be a worst-case outcome: Argentina finally trying to resolve its debt situation, and then finding itself rebuffed by its unimpressed creditors.
Argentina, after initially accepting a lowest-offer bid from Lazard to act as its financial adviser, in February mandated Merrill Lynch, UBS and Barclays Capital to lead manage what they hope will be the largest bond exchange ever seen.
Since then, teams at the banks have been working hard on getting the deal structured – no easy matter, with bonds issued in seven currencies and eight jurisdictions – and backing it up with debt-sustainability analyses. Cleary, Gottlieb, Steen & Hamilton is providing legal advice and invaluable experience: it has worked on all the distressed sovereign bond exchanges so far.
Reputations on the line
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Rato: under his leadership,
the IMF is taking a much
harder line on Argentina
than previously |
The banks involved, which are not able to talk on the record, know that they're putting their reputations on the line. They certainly want the exchange to be accepted by 67% of bondholders: that's the level at which their fees go up. Base fees are 27.5 basis points, rising to 35bp once two-thirds of bondholders accept the deal. If they do, the banks will share more than $170 million in total fees.
Meanwhile, for the first time, there seems to be a strong political desire in Argentina for a deal to go ahead. The cyclical rebound – which contributed to 8.8% growth in 2003 – is slowing down, president Nestor Kirchner's (pictured) popularity is waning, and 2005 is the year in which the government's debt amortizations really start to kick in. Kirchner has probably gained as much political capital from rhetorical creditor-bashing as he ever will.
At this point, it's becoming increasingly important for Argentina to start reintegrating itself into the international markets once again, opening itself up to much-needed capital inflows.
Both Argentina and its creditors are hopeful that a successful exchange would prompt a large influx of capital. Argentines alone hold between $150 billion and $200 billion offshore; if Argentina regains financial stability, a lot of that money could find its way back home. That's what happened in Russia. Once it restructured its defaulted bonds, tens of billions of dollars of Russian flight capital returned to the country as new investment.
"When you leave default behind, you have a very important change of expectations: there is a psychological bonus," says Angel Gurria, the former finance minister of Mexico (and Euromoney's finance minister of the year in 1999), who now represents European retail holders of Argentina's debt. "That's what happened in Mexico: once we removed the uncertainty, it was another story."
Peter Hakim, president of the Inter-American Dialogue, says: "I'm not getting a sense of 'come invest in Argentina, we're a strong, growing, powerful economy'. And they can't do that until they solve the debt problem."
What Kirchner needs if he is to win re-election in 2007 is a sharp uptick in economic activity, something that virtually every country that has concluded a debt restructuring has enjoyed as soon as the deal is done.
He also needs the money that a restructuring would make available. "Starting next year, capital payments and amortizations on performing debt pick up quite nicely," says Alfonso Prat-Gay, governor of the Argentine central bank. "If you don't have a deal with private creditors, the chances of being able to roll over all of it are rather slim."
The performing debt mainly dates back to the aftermath of Argentina's devaluation, when depositors and financial institutions were given government paper to compensate them for their losses.
It might seem counterintuitive that Argentina paying international bondholders is going to make it more likely that it will be able to roll over domestic debt. In fact it does make some sense.
If Argentina successfully restructures its debt this year, the coupon payments on its international bonds are likely to be very small, at least to start with, because all the bonds are going to have step-up coupons, and maturities will be pushed out at least 20 years. But international investors are going to be much happier looking at Argentina again, which means that more money will start flowing to the domestic markets.
Elusive returns
Argentina, if it does manage to do a deal, will immediately find itself with a large weighting in all the emerging-market bond indices. Most important, it will figure more prominently in JPMorgan's EMBI Global, a standard benchmark for fund managers.
At the moment, only eight Argentine bonds, with a face value of less than $10 billion, are in the EMBI Global, which means that Argentina has a weighting of less than 1.8%.
Post-swap, all the new dollar-denominated bonds will be eligible, which means that even without a price increase, Argentina's weighting could easily surpass the 10% level.
Institutional investors will stay away from Argentina at their peril. It will almost certainly be one of the highest-yielding countries in the index and, so long as it doesn't default all over again, will provide bondholders with the kind of returns that have been increasingly elusive in emerging markets of late.
"I will invest in Argentina again when, firstly, there's clarity as to Argentina's contractual obligations in terms of debt servicing, and, secondly, there's clarity as to the risk of diversion of funds," says Mohamed El-Erian of Pimco, the world's largest emerging-market fund manager, with $14 billion in assets under management.