Friday, June 23, 2006

Bonding, Buenos Aires-Style


June 23, 2006

Argentine President Néstor Kirchner today concludes his four-day visit to Madrid, where he hopes to finish his country's dangerous tango with delinquent debt of over $1 billion owed to Spanish investors. The rest of the world, however, remains a wallflower. What about the $5 billion owed to Italian pensioners, the $5 billion owed to German and Dutch investors, or the well over $10 billion owed to Americans?

Still, Mr. Kirchner's Madrid visit signals an about-face in Argentine debt politics. With the largest debt default in history -- $143 billion -- on his hands, suddenly he is willing to deal with investors who refused to accept the meager terms of his country's 2001 restructuring. Speaking with Spanish Prime Minister José Luis Rodríguez Zapatero yesterday, Mr. Kirchner said Spain's debts will be honored "because it is our economic and moral obligation." The rest of the world must wonder, to paraphrase Napoleon, if Argentine morality ends at the Pyrenees.

In the 1990s, Argentina saw a period of dramatic growth after years of political and financial turmoil. This renaissance was not fueled by domestic investment; sufficient funds simply did not exist. Nor would enough funding have come in from the IMF or World Bank. Rather, Buenos Aires looked outside its borders for sources of hard currency. Given its penchant for not honoring its debts, Argentina was forced to offer high-interest bonds to lure new investors -- even with the guarantee of a government-issued bond.

The Argentines found takers primarily in their European brethren -- hundreds of thousands of Italian, Spanish, German and Dutch pensioners and individual investors. All told, Europeans bought more than $28 billion worth of the bonds, fueling Argentina's wild ride.

Sadly, history tends to repeat itself. Reserves rapidly diminished as Argentina's foreign debts matured. Instead of difficult but necessary belt-tightening, Argentina's political leaders refused to slow the train down. Instead of honoring its international obligations, Buenos Aires chose to give its debt a "haircut" by offering its creditors an unprecedented 70% reduction in face value -- the largest such default in history.

In typical bond-default restructurings, nine in 10 bondholders are willing to accept a new deal. But only three-quarters took Argentina's offer of a paltry 30 cents on the dollar.

Not surprisingly, Spaniards aren't the only ones demanding that Buenos Aires honor their debts. Earlier this week Italians protested in front of the Argentine Embassy in Rome, calling on new Prime Minister Romano Prodi to demand repayment of their investments. An estimated 450,000 Italian families, investors and pensioners bought into the promise of billions in Argentine bonds offering relatively large returns for a seemingly safe investment in government-issued debt.

With a new government in Italy, President Kirchner has an opportunity to heal the wounds of having defaulted on the savings of thousands of Italians. Mr. Prodi won with such a small margin that he cannot afford to avoid any issue affecting Italian voters. And with Italians holding some $5 billion in Argentine debt, much is at stake.

Actually gaining access to these funds is not going to be an easy task for Mr. Prodi's fledgling Italian majority. It will not be easy for Mr. Kirchner either. When the Argentine Congress approved the debt renegotiation package in 2005, it strictly forbade any new opening of the process. The idea was to encourage as many bondholders as possible to participate, avoiding future speculation. In order to reopen the deal the Argentina Congress would have to repeal this "padlock" bill.

Buenos Aires may not have a choice. Even though the Argentine economy has shown a steady budget surplus of around 3.5% of GDP over the last three years, this growth is not enough to service all of the debt payments currently due. This is true despite the fact that the Argentine government was able to cancel all of the debt it owed the IMF.

The Kirchner administration plays to the masses as well as any government. But the Casa Rosada must understand that the Argentine economy is reaching ominous capacity constraints. Further growth -- and political success -- will require new foreign direct investment. And once-bitten investors will think twice about pouring money into Argentina again unless the government takes positive, market-friendly action to soothe its existing, disgruntled bondholders. For starters, Mr. Kirchner could abandon the reckless market interventionism that has led his government to impose price controls on utilities, tax exports and sometimes suspend beef exports to the U.S.

Savers around the world have one good reason to hope for economic sanity in Argentina: political self-preservation. Mr. Kirchner has a keen eye on how his policies will affect both his re-election prospects in next year's polls, as well as his legacy. Barnstorming foreign capitals proves that Mr. Kirchner is seeking investment to keep his economy growing. With foreign investment lagging, he surely knows that he must eventually return to the bond markets he burned in 2001.


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