May 05, 2020
For those following Argentina’s debt saga, the current situation might seem eerily familiar: after the implosion of an IMF program, Argentina finds itself at the brink of default, with a debt burden, denominated in foreign currencies, that it simply cannot pay. In contrast with Argentina’s default in 2001, when it reached agreements with most of its creditors years later, this time Argentina’s government is doing its best to avoid default by attempting to find agreement with its lenders for an orderly restructuring.
Argentina made its creditors an offer based on a sound framework that aims to restore debt sustainability. The offer proposed a three-year stay on all payments, followed by a gradual resumption in interest repayments as the economy recovers, along with a 0.4 percent write-off of the capital value of the bonds. Creditors now have a choice between accepting this offer or letting Argentina default as negotiations drag on.
To understand why this offer is the best Argentina can do, one needs to understand the dire situation its economy is in. Until Argentina can revive its economy, it truly does not have enough revenue to service its dollar-denominated debt. Negotiations or costly litigation might drag on. And even if creditors get a better deal on paper, it does not matter if Argentina cannot honor it.
Between 2017 and 2019, the ratio of external debt-to-GDP exploded: from 38.8 percent in 2017, to 69 percent in 2019. This was caused by a sharp depreciation of the peso, along with a contraction of the economy. These numbers will only get much worse this year as Argentina battles COVID-19. This additional shock is not only hurting Argentina’s domestic economy but has also caused a collapse in commodity prices, Argentina’s main source of exports.
It is clear that Argentina’s debt is unpayable and needs to be restructured. The IMF released its own debt sustainability analysis, which reached the same conclusion as the Argentine government: the debt is unsustainable and there is no scope for any foreign currency payments for at least the next three years. The most important implication of this assessment is that the IMF will no longer lend any funds to Argentina before a debt restructuring occurs, as its own rules forbid it from lending to countries with unsustainable debt.
Argentina’s private creditors need to accept that they will not receive their agreed-upon returns as there is currently no one left to bail them out. A restructuring could have taken place at more favorable terms if it had occurred before the IMF started its record $56 billion program in the summer of 2018. To most observers, it was already clear then that Argentina’s debt was unsustainable. Yet, the IMF bent its own rules and officially assessed Argentina’s debt to be “sustainable but not with a high probability.” This decision was made on political grounds, as the Trump administration was committed to the IMF supporting then president Mauricio Macri.
The roots of this crisis can be traced back to mistakes made by the Macri administration, in office from 2015 to 2019. Before Macri, Argentina was locked out of international credit markets due to a legal dispute with holdouts from its previous debt restructuring. The vulture funds — hedge funds that buy distressed debt and then take legal action to recover the full face value of the bonds — managed to hold Argentina hostage due to a 2014 ruling by a US court that Argentina could not repay any creditors until it paid the holdouts. Macri, who was elected on a “market-friendly” platform, was quick to settle the dispute and pay the vulture funds, with some making profits as high as 1200 percent.
Another step Macri took that would later prove disastrous was his immediate removal of all capital control measures. At first, markets cheered this, and Argentina issued over $40 billion in dollar-denominated bonds, mostly under US law. While markets lent him more dollars, Argentina continued to have limited sources of dollar revenue, and there were no significant investments in growing Argentina’s export base. Argentina’s macroeconomic imbalances were revealed when a brief rise in US interest rates precipitated capital outflows from emerging markets.
The large and sudden reversal in capital flows from Argentina caused a collapse of the peso, as the Central Bank stumbled to defend its currency, spending billions of dollars to no avail. It is then that the Macri administration approached the IMF, which ignored the debt sustainability issues and proceeded to sign an agreement of $56 billion, out of which about $44 billion was eventually disbursed. Most of the funds disbursed immediately left the country, enabling many investors to cash out of Argentina at little or no loss.
Meanwhile, Argentina was stuck with additional foreign exchange debt and an economic collapse exacerbated by IMF-imposed austerity. The cuts dictated by the IMF worsened the recession and failed to reduce Argentina’s deficit, as revenues collapsed along with the economy. The program also had enormous social costs, as poverty jumped from 27.3 percent in 2018 to over 35 percent at the end of 2019.
Argentina is entering its third year of recession as it now also battles the crisis triggered by COVID-19. In the last four years, Argentina reduced its primary expenditures by over 5 percent, negatively impacting its economy and thus failing to allow room to reduce the budget deficit. There is no more space for additional fiscal consolidation without deepening the economic crisis, and in the current context of a health emergency, without putting more lives at risk. For Argentina to generate revenue to repay its debt, it first needs the space for an economic recovery.
Given this national context, along with the unfavorable global economic situation, it is easy to conclude that Argentina is doing the best it can to do right by its people and by its creditors.