from Follow the Money

It would be easier to take creditor complains about Argentina more seriously …

July 25, 2005

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if international investors -- not just local ones -- were not scrambling all over themselves to buy Argentina's most recent dollar-denominated bond issue.

Yes -- evey now and again, I do still intend to write about something other than China.

Argentina's bond issue was governed by Argentine law, not one governed by foreign law.  So technically, Argentina has not regained access to the international sovereign bond market.  Remember,  holders of around $20 billion (face value) of Argentina's "old" eurobonds did not  participate in its exchange - legally, Argentina has yet to fully put its default behind it.

But if you can sell local-law bonds to foreign investors, why bother with a Eurobond issue?

No one is forcing international investors to buy Argentine bonds.   Creditors are voluntarily opting to invest in a country that:

1) Defaulted at the end of 2001 -- not so long ago
2) Took its sweet time before it made an offer to its international bondholders
3) Did not "negotiate" with its bondholders, as they bondholders demanded.  Not that I particularly think Argentina should have sat down and negotiated, especially if that meant giving every member of the (not entirely representative) committee a veto over Argentina's ability to launch a deal.  Moreover, in a traded market, the "holders" of the old bonds of a distressed debtor may be very different from the likely market for the country's new bonds.  The notion that Argentina would negotiate an economic adjustment program with bondholders rather than the IMF was always rather far fetched. 
4) Sought and obtained more debt relief than has been the norm in previous emerging market sovereign debt restructurings. 

I think Argentina also needed substantial relief - more than other sovereigns -- to create a debt structure that offered a chance to escape from the cycle of restructuring and default that has marked Argentina's recent history.  Argentina's external sovereign debt to GDP ratio remains quite high even after its restructuring.  But Argentina still could have made a slightly better offer.   There was scope, for example, for more cash up front to compensate bondholders for an extended period of non-payment.   Even those who believe Argentina needed a fair amount of relief would agree that Argentina did not go out of its way to be nice to its creditors.

Yet today, despite its sins, Argentina is raising funds from international investors at an interest rate it could only dream of back in the late 1990s.  And at a rate not much above the rate of countries that have treated their creditors more nicely than Argentina, like Brazil and Uruguay.
The current market, with its focus on short-term positioning and trading gains, doesn't seem to worry too much about a sovereign reputation.   At least right now, it cares more about Argentina's strong current growth and manageable payment profile than its past behavior. 


Compare Argentina with Ecuador.  Both not only have large amounts of government debt, but have particularly large amounts of external sovereign debt.   Argentina sought a fair amount of debt relief, and is now raising new funds again.  Why?  Because it has a decent (not great) debt profile going forward, its payments profile is not so onerous as to suggest that it is politically unviable, and it arguably has a fairly strong incentive to pay its the debts it is now incurring to sustain its future market access.   That is particularly the case because Argentina opted to give priority to payments on its domestic law dollar debt during its crisis.  More and more of that debt is held abroad, but most of it is still held domestically.  That too has an impact on incentives for payment.  Creditors "buy" - literally in this case - Argentina's argument that it will give priority to domestic payments.  Remember, Argentina raised funds abroad last week by selling "domestic" dollar debt governed by Argentine law  -- not international bonds governed by New York or English law.

Ecuador offered its creditors a more generous deal than Argentina back in 2000 (it defaulted in 1999). 

Yet Ecuador has not been able to raise money from international investors since.  Why?  Above all because of Ecuador's own politics.  But its debt profile played a role too.  The restructuring provided Ecuador with temporary cash flow relief, but because the new debt carried a very high coupon after it fully stepped up (one bond pays 12%, the other steps up to 10%), no long term relief.   Interest payments in 2006 will be no lower than they would be on the original Brady bonds had LIBOR stayed at its 1999 levels.  Ecuador's continued political willingness to run large primary surpluses to make large interest payments to its existing external creditors is in doubt -- and that makes it difficult for Ecuadorto raise new money.  Ecuador would have been better served if it had put less emphasis on headline debt reduction in 2000 and more emphasis on its future payments profile.  In 2000, it traded face value debt reduction for a very high coupon on its external bonds after 2005.

My key points: 

Reputation trades off with a good debt profile looking forward.  

Incentives to pay are linked to the amount that you have to pay. 

Incentives to pay are also strengthened if the debtor expects payment to be rewarded with access to new financing, and right now, market access seems mostly to be a function of payments profile. 

Despite my carping about the speed of Argentina's return to the market, the fact that Argentina has regained access to the market supports its incentives to continue to pay its (restructured and newly issued) debt going forward.  It now has something to lose should it stop paying. 

But I also suspect the absence of a greater market penalty for "bad past behavior" also may make it harder to convince future borrowers to pay much attention to creditor proposals for good debtor conduct in default.   The market's willingness to forgive and forget may make it hard going forward to convince sovereign borrowers that they should care all that much about their reputation either. I suspect that means private creditors will look more and more to the IMF to try to enforce codes of good debtor conduct in default - and it is not clear to me that the IMF can or should try to do so.  The IMF's limited leverage might be best used if it focused exclusively on defining the macroeconomic adjustment path for the debtor, not judging the quality of its contacts with its creditors.

Don't get me wrong: default is still costly.   The question is not whether default is costly, but rather what strategy a country that already has incurred the upfront costs associated with default should pursue, i.e. how much should it offer to pay on its past debts and how should it go about treating its creditors during the restructuring.   And right now, it is kind of hard to make the case that creditors care quite as much about a debtor's past conduct as some of their rhetoric suggests --

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