Executing a multi-billion debt deal is always a daunting prospect, but when a country’s entire economic survival plan depends on it, the exercise can be hair-raising, as the seven lead-managers of Argentina’s voluntary debt exchange discovered in June.
If the bankers needed any more motivation to make every call, to consider every technical twist to make the deal work, they might have considered that the near-term prospects of the business in which they work – emerging-debt capital markets – also depended on the outcome.
The $29.5 billion deal, undertaken by CSFB and JPMorgan, was a tremendous success in its structure and execution. It achieved its prime objective of giving Argentine economy minister Domingo Cavallo some breathing space to concentrate on economic reform by staving off a meltdown in the sovereign’s bonds and an imminent liquidity crisis.
The deal was bigger than the $20 billion originally expected, and eventually involved replacing $29.5 billion of old dollar and peso debt with a new $11.5 billion 2008 global bond, a $931 million 2008 peso-denominated bond, a $2.03 billion local pagare or promissory note maturing in 2006, a $7.45 billion 2018 global and a $8.5 billion 2031 global.
Default fears overcome
By offering the new bonds, which featured either step-up coupons or interest capitalization in the early years, the deal deferred $16 billion of interest and principal payments over the next five years, $7.8 billion of which was to have fallen due in the next 18 months. With that sort of relief in sight, fear subsided that Argentina was hurtling towards default later this year, local interest rates came back down to more manageable levels and an emerging-market crisis on a scale not seen since Russia’s 1998 collapse was averted.
“This is about the best deal the market could do,” says Tulio Vera, debt strategist at Merrill Lynch. Investors piled into the new bonds and sent their prices soaring as much as 800 basis points in their first week of trading at the beginning of June.
But the joy was short-lived.
A day before the transaction’s June 19 settlement date, however, bankers involved in the deal stood by helplessly as Argentine bonds suffered their worst plunge in two months, taking the price of the new globals to below their re-offer levels.
“I felt sick to my stomach,” says one banker who had worked on the exchange. “When I left work on the Friday everything was fine and then as soon as I walk in on Monday someone tells me the 08s are down something like five points. I said, ‘What?'”
Surprising the leads as much as everyone else, Cavallo had announced a controversial exchange rate for trade that would fix the peso’s rate for importers and exporters at the mid-point between the US dollar and the euro. The move weakens the peso by about 8% for exporters and has prompted fears among international investors that it is the beginning of a creeping devaluation.
“It seems that the Cavallo economic team is testing the waters to see what would be the reaction to a possible devaluation,” says Walter Molano, debt strategist at BCP Securities.
The big, liquid 2008 bonds, which had substantially outperformed FRB Brady bonds in the first week of trading, were one of the hardest hit by the news. They had begun trading at 78.55 on June 4, soared to 84.5 by June 11 – during which time FRBS remained around the 88.00 level – and then plunged to 76.75 bid on June 18. FRBS dropped to 83.00 in the same period.
All Argentine bonds, including the 2008s, recovered a few days after the announcement as Cavallo did some heavy explaining to local business leaders to boost confidence in the plan.
Nonetheless, the violent reaction in the international capital markets underscored one of the unavoidable consequences of doing voluntary debt exchanges of this magnitude: No matter how well a deal is structured and distributed initially, its subsequent success is at the mercy of politicians battling to keep a country afloat. A large liquid deal is driven by euphoria at one moment, panic the next.
“The success or failure of this deal will ultimately be decided by the economic policy programme that Cavallo and his team implement,” says Cindy Powell, managing director and co-head of emerging market syndicate for JP Morgan.
Given the size of the new bonds, it is very difficult for the leads to control price movements after launch. The only practicable way to ensure good trading support is to structure the new bonds so that they will be technically stronger than the old ones. Often they take on a life of their own, soaring wildly on good news or strong technicals and plunging on what can often be a greater weight of bad news, given the precarious position the issuer had to be in to warrant the exchange in the first place.
Cavallo’s misperception
Cavallo should have been aware that the risk and expense of doing such a high-profile voluntary debt restructuring could only be justified if the market confidence it created were sustained by a consistent flow of positive economic initiatives. Apparently he thought the trade currency news would bolster confidence, not undermine it.
| Domingo Cavallo | ||||||
If Cavallo doesn’t get the economy going, and fast, the swap’s positive impact on the markets will be wiped out and the naysayers will once again question the wisdom of Wall Street-engineered debt exchanges that are done in desperation rather than from a position of strength.
“A lot of academics have been very critical of this transaction because they say it doesn’t make sense for an over-indebted country to increase its indebtedness,” says Mohamed El Erian, chief emerging-market debt portfolio manager at Pimco.
Bankers involved in the deal appear perplexed by criticism of the added burden on Argentina and their own profits on the trade. “It’s almost as if it’s a surprise to some people that voluntary debt exchanges don’t come for free,” says Powell. “This is a voluntary debt restructuring. That means you have to work within the constraints of a voluntary transaction and pay market rates. The only way to pay below market rates would be to force investors into an involuntary exchange.”
Fuelling the criticisms is the fact that the yields on the new bonds were 35 basis points wider than the average yield on the old paper.
Although 35bp isn’t so bad when you consider the swap extended the average life by 2.78 years and duration by 3.5 years, critics have focused on the fact that the deal increases Argentina’s already mountainous $130 billion stock of debt by another $2.3 billion and that the leads were paid $141 million in fees, an unheard of number in the emerging markets.
They argue that the deal averts default today only at the expense of increasing the risk of default further down the line.
But under the circumstances, what else is a country like Argentina to do? “It’s not as if Argentina had a whole lot of alternatives,” says a New York based emerging-market syndicate manager not involved in the deal. “It’s like, default now, or push it off and hope to avert it again later. I know what I would choose.”
Argentina presumably still has recourse to the multilaterals, but the IMF, Inter-American Development Bank and World Bank were behind a $40 billion package for the country last November and the IMF has been pressured by the G7 to encourage the private sector to shoulder more of the burden of sovereign debt workouts. The multilaterals won’t keep bailing it out again and again.
Both Moody’s and Standard&Poor’s also warned Argentina that the deal had to be a voluntary exercise or its ratings would suffer. To the rating agencies, it was important that the local investors, who held 60% of the old bonds eligible for the exchange, were not arm-twisted into the deal and that it included a reasonably broad participation from international investors.
“Default would have been a far costlier alternative to the debt exchange,” says Bruno Boccara, sovereign strategist at Standard&Poor’s. “Yes banks will make money out of such liability management transactions and yes it was in the banks’ interest to see calm return to the market, but I have two things to say about that: first, just because someone makes money out of something doesn’t necessarily make it wrong; in fact it can be an incentive for success. Secondly, this was a purely Argentine-driven solution.
Here is a country that chose long ago to deeply integrate itself with the capital markets. Argentina chose a strategy to borrow abroad and weave the capital markets into its policy measures, knowing that the risk was that once in a while there could be strong market pressure, so I don’t think there were any ethical issues involved here.”
Banks have been trying to convince various Argentine economy ministers for years to do a large debt exchange, long before it ever got to the point of a liquidity crisis.
JPMorgan first approached Argentina about a mega swap transaction two years ago, but then the country was in a much stronger position. The idea was to extend their amortisations as a way of getting improved credit ratings. They decided not to do it because they felt it was too risky. Too bad: it would have been cheaper to do it then.
The only way to make money
Such banks as JPMorgan, Goldman Sachs, Salomon Smith Barney and more recently CSFB have been aggressively pursuing liability-management transactions to prop up dwindling margins from emerging-debt underwriting.
“Frankly, if we are going to make any money, we have to be in this liability management stuff,” says a banker at one of the top firms. “Look at this year: liability-management transactions have dwarfed new issues in emerging markets. Look at the fees: Mexico did a $1.5 billion 10-year global earlier this year with 60c fees and paid the leads $9 million. They did a $3.3 billion exchange at 55c fees and so the leads on that deal got something like $16 million.”
By mid June there had been $36.5 billion of new global bonds created through liability-management transactions in Latin America this year, not including local bonds. That compares with $23.8 billion of conventional new international bond issues.
Liability-management transactions are attractive pieces of business because the issuers are receptive to the idea of improving their debt profile, especially when debt exchanges are done from a position of strength and lock in net present value savings. Investors usually like them because it gives them the chance to retire their old bonds in large chunks without there being a negative impact on the price and replace them with a more liquid new bond with better technicals.
“Liability management is a critical part of the business,” says Chris Gilfond, managing director, co-head Latin America capital markets, at Salomon Smith Barney, which was one of the seven lead managers on the Argentine deal. “It is a big part of the flows and understanding the opportunities that it will create in the cash market.”
When new-issue work is thin, liability-management transactions are also a good way of justifying large emerging-market sales, trading and research infrastructure.
“You will not be able to deliver these deals unless you have the capital markets, sales, trading, analytics and technical systems all up and running and on the same page,” says one emerging debt capital markets head.
Exchanges are generally far more labour-intensive and time-consuming than underwriting, so the banks need to generate a lot of liability-management business to make their efforts worthwhile. “It takes a real commitment of expertise, time and resources to generate these transactions, but that is well justified if you are successful in executing several transactions,” says Paul Tregidgo, managing director in charge of global emerging debt capital markets at CSFB.
JPMorgan/Chase, Goldman Sachs and Salomon Smith Barney have been the biggest managers of debt exchanges, but this year CSFB has come from nowhere to co-manage with SSB a $2.15 billion exchange for Brazil, Mexico’s $3.3 billion exchange and now the $29.5 billion Argentine deal.
CSFB rises from the ashes
CSFB’s meteoric rise follows a two-year effort on the part of the bank to rebuild its emerging markets group after the Russian debacle. Its group has been anxious to rid itself of its old reputation as a proprietary house and concentrate on building up its euro and dollar underwriting businesses, as well as break into liability management.
Those efforts have recently been complemented by some smart hires of old JPMorgan bankers.
In a happy coincidence, CSFB inherited both former JPMorgan New York syndicate manager Michael Schoen and top emerging-debt salesman Dan Jurkowitz, when it bought DLJ. Both have had extensive experience in exchange deals. Earlier this year Jim Healy, the global head of CSFB’s emerging-market group, moved quickly to make the most of the JPMorgan/Chase merger fallout by picking up Filippo Nencioni, one of JPMorgan’s best emerging-market debt and relative-value analysts and by poaching key members of JPMorgan’s local Buenos Aires sales and trading group, including Andrea Camp and Joaquin Eslava.
“The fact that liability management is a critical part of the emerging-market debt arena is no secret,” says Tregidgo. “It is vital to issuers and investors so if you are going to be a major force in the emerging-market debt business then you have to play in the liability-management sphere.”
Now Morgan Stanley has entered the fray by clinching the mandate with Deutsche Bank for Argentina’s euro exchange. For Deutsche, the mandate is a quick recovery effort from the embarrassment of being kicked off the $29.5 billion Argentine exchange along with ABN AMRO for distributing research during the marketing phase.
Rival bankers have had a field day with their misfortune: “Not issuing research during a marketing phase is capital markets 101,” says a US banker. “We live and breath SEC rules but here you have European banks that want to play in the US market that don’t understand something so basic.”
In truth, it was an unfortunate mistake by both firms and one not likely to damage their emerging-market businesses. “It’s not that big a deal,” acknowledges a head of emerging markets at a US bank. “I mean, the reaction of the Latin Americans to this whole thing was ‘oh, what a stupid rule’.”
| Bruno Boccara | ||||||
The demotion of the European banks merely added a sense of extra intrigue to an already dramatic transaction.
The race for the Argentine deal began in earnest in the fourth quarter last year after a political crisis put the spotlight on the fact that the ruling Alliance coalition government had not only failed to get the economy going but had in fact made the recession worse with a series of belt-tightening measures.
At that time banks in the liability-management business pitched a mega swap deal as a way of complementing the IMF-led $40 billion package Argentina had secured to calm international markets. But the then economy minister, José Luis Machinea, decided instead on a three-part debt restructuring process that involved a dollar exchange focused on the locals, a euro exchange and then a deal targeting the local pension funds that stripped out coupon payments in old global bonds and reinvested them in a new bond.
In early February Salomon Smith Barney and Goldman successfully executed the first part of that plan. The deal exchanged short-dated old dollar debt for a $2.6 billion five-year bonte and a $1.59 billion 11-year global bond, cutting amortizations by $3.6 billion over the next four years.
The confidence that deal bought was wiped out in a matter of weeks, however, when, among other things, it became clear that Argentina would be missing the first-quarter IMF deficit targets it had agreed to only a few months before.
JPMorgan, Salomon Smith Barney, CSFB and other banks quickly dusted off their mega swap proposals of the previous year and stood poised to jump. Their chance came in mid-March, after Argentina had burned through two economy ministers and appointed Cavallo just after the Inter-American Development Bank meeting in Chile. Fears of default were on the rise.
“The fact of the matter was that before the swap, Argentina was looking to have to raise $2 billion to $3 billion to meet debt payments coming due later this year and start pre-funding for next year,” says a banker. “Unless growth was going to get going they were never going to be able to do it.”
It took top emerging-market client managers David Mulford from CSFB and an Ernest Stern of JP Morgan to convince Cavallo that a voluntary debt restructuring on a massive scale was needed to make a defining statement to the market. “In a situation like this, you can’t just walk in and pitch this sort of transaction as a debt deal,” explains a banker. “You have to present it as something that resonates within the context of the country’s economic policies.”
Both Mulford, CSFB’s international chairman, and Stern, a managing director of JPMorgan, have a long working relationship with Cavallo that dates back to the first Bush administration and the development of the Brady bond plan. Back then Mulford was undersecretary for international affairs at the US Treasury, his friend Stern was the chief operating officer of the World Bank and Cavallo the economy minister in the Menem administration.
Mulford went straight from the late March Inter-American Development Bank meetings in Santiago to Buenos Aires and saw Cavallo in his second day in office, but came back empty-handed.
Cavallo liked the swap idea, but wanted to see if he could get the economy going first and bring spreads down before doing such a deal.
Little more than a fortnight later, Cavallo realized that if he didn’t do something about turning around short-term sentiment, there might not be a medium term to worry about.
Markets barely improved, despite his March 21 announcement of what has turned out to be a very powerful tax on financial transactions and other measures in his supply-side competitiveness plan. An unprecedented move on the part of congress to grant him emergency powers to improve economic growth didn’t help market sentiment much either.
Stern and Mulford separately cornered Cavallo at a lunch function in London in early April and once again pitched swap proposals. Cavallo, having the foresight to get the ball rolling at least, told the two to work together on the deal.
A few weeks later, and things began to spin out of control. FRBs, then the pricing benchmark, went into free fall again after Cavallo argued with then central bank president Pedro Pou over allowing local banks to use more government bonds as liquidity requirements. Then stress levels were raised further when he sent a bill to congress to change the peso/dollar currency peg to include the euro once the European currency reached parity with the dollar.
Cavallo lost his temper and wrote a caustic open letter to the markets, damning all those who had dared to mention Argentina and default in the same sentence. Investors lost their patience. “To be honest, I am a bit surprised by how little credit we have been given for getting the fiscal numbers back on track,” Cavallo complained in the letter. “I have thought a lot as to why honest people may dare write a recommendation as to how Argentina may default. Who could conceive such a destructive idea for a country and be bold enough to propose it?” He rounded it up with a final condescending blow: “The truth is that what is important is the final product, not the packaging. For your sake and that of your clients, keep your sight on the contents but let me choose the packaging.”
A stunned response
Market-makers were stunned.”He’s just not tuned in,” complains a sovereign strategist in New York at the time. “You can see it with his open letter, where in a patronizing manner he suggests analysts and investors should be happy enough knowing that he is going in the right direction.”
| Paul Tregidgo | ||||||
Just a few days later and investors’ worst fears started to come true: the government was forced to cancel a $700 million letes (treasury bill) auction because local banks were demanding at least 25% yields for three-month bills compared with 11% the previous month. Full-fledged panic set in. FRBs sank to 73.60 on April 23 from 82.25 the week before and the Argentine composite of the EMBI+ index gapped out to 1,284bp. “It was after the cancellation of the letes auction that panic really began to feed on itself,” says El Erian. “There was a basic drying up of liquidity and the Street did not want to take any inventory, so prices started gapping down. The concern at that point was that the risk of default was increasing.”
News of the swap was quickly leaked in the same week and had the desired shock effect. FRBs immediately stabilized and by the time the deal was officially announced on May 24, FRBs had rallied back to 88.5 and Argentina’s EMBI+ sub-index had tightened in to 921bp. Four days after the new globals were launched, the sub-index had come in to 880bp.
With the immediate fate of a country, not to mention an entire asset class, in their hands, the lead-managers were consumed by the deal. “I don’t care to speculate on what would have happened if this deal had failed,” says Tregidgo. “The success of this deal was monumentally important.”
With Argentina facing debt amortizations of between $10 billion and $15 billion every year for the next five years, size was paramount for the success of the deal. “Size mattered because Argentina’s borrowing requirements were sizeable,” says Powell. “You needed to do something that meant a meaningful reduction in their borrowing requirements over the next five years.”
The leads had to know well in advance of marketing the deal how much participation they could expect. That meant knowing exactly where the bonds were and how to entice bondholders to give them up.
“We would have never talked about this deal if we were not very very confident that we would be doing a $20 billion-plus deal, because there is so much reputational risk in doing this sort of transaction,” says Rachel Hines, managing director in charge of JP Morgan’s Latin American capital markets group.
| Chris Gilfond | ||||||
As one banker says: “What if this deal happened and it was just $12 billion? We would’ve looked like jerks.”
The syndicate structure played a key role in the swap’s success. About 60% of the estimated $65 billion of old bonds eligible for the debt exchange were held by local investors, made up of the banks, pension funds, mutual funds and retail buyers.
In Argentina, the top mutual funds and pension funds are directly owned or affiliated with the major market-makers, who also have their own portfolios of Argentine bonds.
JPMorgan and CSFB were quick to get the major local players on board. Salomon Smith Barney, Banco de Galicia, Banco Francés (owned by BBVA), Banco Santander (owner of Banco Rio) and HSBC were all invited to join them as joint lead-managers with an equal cut of the fees. The syndicate group consisted of all the other local market-makers.
BSCH itself estimates that it owns some 10% of Argentina’s local public debt. It had to become part of the solution, or it could have been a big part of the problem.”There was no question that we wanted the local banks on the right side of the table and that was an integral part of the equation,” says a banker. “For something this big you need to have the buy side and the sell side working towards the same conclusion.”
The new bonds were structured to attract specific sub-categories of investors and also to front-load debt relief so there was no question of them defaulting in 2001 and to give them at least a fighting chance to get through 2002.
The way to cut debt payments is to push out amortizations and cut interest payments, which was why the new global bonds either offered step-up coupons in the case of the 2008 or a five-year grace period with interest capitalization on the 2018s and 2031s.
The deal included a series of bonds, not only so they could be specifically tailored to different investor groups with different needs, but also to stagger the maturities and interest payment schedules on the new bonds so Argentina wasn’t hit with a huge bill in any one year.
“Argentina did not want a massive extension of duration at massive yields,” says Gilfond. “They wanted it to be a very measured exercise of pushing the very short term out to five years and then the fives out to seven years and then the intermediate and longer maturities out to 17 and 30 years.”
The pagare was tailored to entice local banks to give up their $4.25 billion of two- to three-year maturity notes by providing the same defensive interest rate mechanism as the old promissory notes. The peso-denominated 2008 was essentially a dollar bond denominated in pesos and designed to rid Argentina of expensive old peso debt but still satisfy those who needed peso assets.
The 2018 and 2031 globals were designed to get the longer-dated globals and Bradys out of the hands of international investors and local pension funds. Argentina included these bonds in the deal, even though their maturities don’t fall in the crucial 2001 to 2005 period when it has the greatest debt service burden, because of the interest relief it could get from retiring them, and also to boost the size of the overall transaction.
The 2008 global bond was the hardest, because it had to appeal to a very diverse group of investors holding the short-dated Argentine globals, Bradys and local bontes. The short-dated globals are largely tucked away in retail accounts, the bontes by local banks and mutual funds wanting interest income and the FRB Brady bonds by a broad group that includes dedicated emerging-market and global bond funds.
“One of the toughest maturities was the FRBs,” says one banker “They are short-term and liquid, so basically why would you want to sell them? FRB holders could argue that if the exchange did well, then FRBs would also do well.”
The carrot and the stick
It was the classic free-rider problem that often plagues exchange deals. There were certain FRB holders who could decide to stay out of the exchange because with such strong local participation the deal was sure to be a success. That would improve Argentina’s ability to pay back a reduced number of old bonds and there would probably be a short squeeze on FRBs to force the price up, so why go into the exchange at all?
“Liquidity became a very big issue in the 2008s,” says Michael Schoen, managing director and head of emerging-market syndicate in the US at CSFB. “We argued that the 2008s would outperform the FRBs because they were going to be huge, in the EMBI+, the new pricing benchmark in that part of the curve, and would offer greater duration and convexity than the FRBs. And that, in fact, has proven to be the case.”
With the longer-dated global bonds, the leads’ pitch to international investors was that they would outperform in a bull market for Argentina because the interest capitalization gave them greater convexity, and they would also outperform in a bear market because their prices were deeply discounted.
A very strong pension fund participation in the 2018s and 2031s was another carrot dangled in front of international bondholders.
“One enticement was that some of the bonds were very heavily held by pension funds, so if you were a non-pension fund holder of those bonds you risked de-indexation if the pension funds came into the deal in force,” says Gilfond. “So the question for the investor was ‘do you want to hold a bond that is no longer in the index compared with a bond that has better convexity, liquidity and with a very heavy weighting in the index and that will be well bid by the pension funds?’.”
Argentina has a reputation for being stingy on exchange deals, having set minimum prices on old bonds in some previous exchanges at below market levels. Compared with some previous exchanges it was actually seen as being generous this time around by setting minimum prices at mid-market levels. It paid those minimum prices for most of the bonds, the big exceptions being the Pars, Discounts and FRB Brady bonds. The government paid 1.1% over the market price for the FRBs in a bid to get as many tendered as possible. About $1.7 billion or 31% of total outstanding FRBs were tendered, for the most part by locals. The government paid 4.5% more than market levels for the Pars and 4.75% more for the Discounts in a bid to free up as much cash from the collateral of those bonds.
A measure of the deal’s success was the fact that two-thirds of all bonds were tendered on a non-competitive basis, at the minimum prices set by the government. It also attracted $9 billion of tenders from international investors, larger than the $5 billion to $7 billion initially expected.
The most contentious element of the deal was JPMorgan’s decision to change the bond inclusion rules on its EMBI+ index specifically so that the new global bonds could be included immediately at launch in early June rather than waiting until the end of the month. In doing so it significantly improved after-market performance of the new bonds.
JPMorgan changed the rule before setting the minimum prices on the old bonds because, with Argentina’s 20% weighting in the index, it didn’t want to expose dedicated emerging-market investors benchmarking their performance against the index to three weeks of tracking error.
A great support mechanism
There’s no question that immediate inclusion of the bonds in the EMBI+ turned out to be a great support mechanism for the deal. It helped smooth an initial attempt by dealers to short the new bonds in the grey market, based on the perception that some of the new globals, particularly the 2018, was priced tight to the Argentine yield curve and also because of basic concerns about how such a huge bond deal would trade on the break.
| Mohamed El Erian | ||||||
What happened, in fact, was that the larger than expected size of the swap was taken positively by the market, leaving dealers scrambling to cover shorts. Following on from that was a wave of dedicated emerging-market investors moving quickly to adjust their portfolios to the EMBI+ changes.
“The accelerated inclusion of the new bonds in the EMBI+ gave more of an incentive to international investors to reweight their Argentine components in a manner that mirrored the new index,” says Gilfond. “As a result we saw investors scrambling to buy the 2008s and 2031s in the secondary market immediately following the exchange.”
The change of the EMBI+ rules, however, has left some investors – most notably those underweight Argentina – fuming. “This is a disgraceful act,” says one dedicated bond investor. “The index is a public good and so it has to be predictable. If you are going to make this asset class serious it has to be based on a few principles.”
Just how huge Argentina’s debt needs are hits home when one realizes that even with $7.8 billion of the $16 billion of deferred debt payments falling due in the next 18 months, it still has an estimated $14.9 billion of uncommitted financing needs in 2002.
“The reality is that with the huge amount of financing Argentina has, it is very difficult to do any exchange that would alleviate this thing totally,” says Merrill Lynch’s Vera. “What a debt exchange can do for Argentina will always be somewhat at the margin, even one as big as this.”
With a financing gap that big, there’s no way around Argentina having to, at the very least, come back to the local markets.
According to CSFB, after the swap the government will have about $21.1 billion in total financing needs next year, which comes down to $14.9 billion given the $6.2 billion of IMF, World Bank and Inter-American Development Bank commitments already negotiated for 2002.
That $14.9 billion of uncommitted financing needs could be reduced by several other official and local financing sources to around $7.4 billion. Those official and local sources include deferring a $2.48 billion supplemental reserve facility payment to the IMF to 2003; getting the Inter-American Development Bank and World Bank to roll over $1.1 billion of amortizations due next year; assuming a $2 billion encaje bond held by the Argentine banks as part of their liquidity requirements will be rolled over and the issue of $2 billion of global bonds directed at the local pension funds.
Analysts argue that to a great extent the remaining $7.4 billion could be raised locally, leaving them with a significantly reduced dependence on the international markets compared with the usual $10 billion-plus yearly issue of dollar, euro and yen bonds in the past.
Whether it can avoid the international markets next year is beside the point. A heavy government reliance on the domestic market would mean it was still crowding out the private sector and therefore keeping local interest rates too high to get the economy growing.
Only a few months’ grace
Some analysts believe the government really needs to start announcing concrete signs of economic growth in Argentina before the end of the northern summer.
“Argentina has bought itself a few months, that’s all,” says Jaime Valdivia, chief emerging-market debt strategist at Morgan Stanley in New York. “Remember that there are senatorial elections in October, and if Cavallo wants to get votes for his own colleagues as well as political associates, he needs to have the economy up and running by August-September.”
Analysts expect Argentina to post a negative growth rate for the first half of this year, after having announced a first-quarter negative growth of minus 2.1%, meaning that a huge catch-up has to be made in the second half if it is to meet the IMF-imposed deficit target in the last six months.
By the end of June Argentine bonds were underperforming the market, with the Argentine sub-index of the EMBI+ languishing around the 1000bp mark on June 28, after tightening in to around 880bp immediately after the swap. FRBs were down to around 83.90 bid, 84.00 offered from 88.00 on June 12. The new 2018s and 2031s were trading above their re-offer levels but were off their highs. The most liquid 2008 global was trading around 77.25 bid, 77.75 offered from an issue price of 78.55. “People will be looking at all the GDP and tax collection numbers very very carefully in the next several months and the slightest sign of weakness could cause a big problem,” says one head of origination in New York.
The government has been doing its best to jolly everyone up by declaring it will get the economy growing by 5% in the second half, but at this point, with no resounding signs of economic improvement yet, it seems unlikely.
And what if the economy doesn’t grow? “If they don’t get the 3% to 3.5% growth by the end of the year that is needed in order to meet or come close to meeting the second-half deficit target in the IMF programme, then they could well be back in the same place they were in November 2000,” says Valdivia.
