Argentina finds itself in the second default of the 2000s following the refusal by holdout creditors to opt for a last-ditch debt restructuring deal.
All About the Default
In late 2001, Latin America's third-biggest economy suffered the largest sovereign default in history at the time. The amount was close to $100 billion and the situation was resolved only through large-scale debt restructuring.
The majority of bondholders accepted a government offer to exchange older bonds for newer issues, worth only a fraction of those issued earlier. However, a small fraction of bondholders – around 8% – refused to accept the terms of the two bond swap transactions of 2005 and 2010.
These ‘holdout’ investors or ‘vulture funds’ – led by NML Capital, a subsidiary of Paul Singer-led Elliot Management Corp. – continued to retain the older bonds and took Argentina to court to obtain the full value of the securities. A protracted legal battle followed and the holdouts managed to win judgments against the State, demanding as much as $1.5 billion in unpaid debts, plus interest.
In the meantime, Argentina had until Jun 30 – with a 30-day grace period – to disburse an initial coupon payment of $539 million to the exchange bondholders. The country deposited the money with The Bank of New York Mellon Corp. (BK), Argentina’s trustee bank for its disputed bonds, in Jun.
However, a U.S. judge ruled that Argentina cannot make the $539 million payment until it first settled with the dissident creditors by shelling out the principle amount of $1.33 billion. Argentina refused to follow the order and the situation hit a stalemate. Despite intense negotiations between the parties, they failed to strike an agreement before the lapse of the 30-day grace period on Wednesday midnight.
This put the country into a technical default since Thursday morning.
Consequences of the Default
The situation is quite extraordinary in the sense that there is no solvency problem unlike in 2001-2002 when the economy crashed and the government went bankrupt. In fact, Argentina can easily pay its current bondholders. However, as per the U.S. ruling, it cannot do so before striking a deal with the old lenders.
Already in recession, the latest setback is bound to inflict more pain on Argentina. The country’s economy contracted 0.2% in the first quarter of 2014 following a 1.4% expansion in the previous quarter. Inflation is rising and a default could only weaken a beleaguered economy even more. To make matters worse, the ratings agencies have sprung into action and revised their outlook on the country to negative, apprehending pressures on the peso and dwindling foreign reserves in the face of high inflation.
Focus on Argentine Stocks
With the South American nation missing on its deadline for a debt payment, stock and bond prices were set for a freefall. That is exactly what happened. The country’s benchmark Merval stock index lost more than 8% after jumping the previous day on hopes of a last minute compromise. The default woes were also felt by Argentine shares that trade in the U.S. to the tune of YPF S.A. (YPF), BBVA Banco Frances S.A. (BFR), Pampa Energia S.A. (PAM), Telecom Argentina S.A. (TEO), Transportadora de Gas Del Sur S.A. (TGS) and Grupo Financiero Galicia S.A. (GGAL). Even a short default will complicate their life, raising the cost of external borrowing.
State-owned integrated oil and gas company YPF – whose fortunes are tied closely to that of the nation itself – led the group, sinking 9.1%. Banking giant BBVA Banco Frances, which is more prone to a systemic shock such as a credit default, was down 7.4%, while financial services holding company Grupo Financiero Galicia fell 5%. Electric utility Pampa Energia, Telecom Argentina and natural gas transporter Transportadora de Gas Del Sur were off 8.8%, 8.3% and 8%, respectively.
Conclusion
Unless Argentina can free itself from the obligations, it seems the market has to contend with the dreaded U-word: Uncertainty. Is an Argentine default here to stay? Or can the situation still be saved by some sort of compromise? Let's wait and watch.
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