Argentina flies in face of vulture funds 

October 2014  |  FEATURE  |  ECONOMIC TRENDS

Financier Worldwide Magazine

While Argentina may be the third-largest economy in Latin America, the past century has proved a rollercoaster of financial highs and lows. Once one of the richest countries in the world, the twentieth century saw the state slip into long term decline, punctuated occasionally by brief periods of growth. The new millennium has hardly been kinder, and since the country’s 2001 meltdown, real recovery has remained elusive.

Bad to worse

In July, the UN’s Economic Commission for Latin America and the Caribbean (ECLAC) lowered its gross domestic product growth forecast for Argentina to 0.2 percent from a previous forecast of 1.0 percent. This compares to predicted growth of 2.2 percent for the wider Latin American economy – down from 2.7 percent. The reduced outlook across the region can be blamed on weak external and domestic demand and a decrease in investment. However, Argentina’s state-controlled economy has exacerbated these issues, limiting foreign investment and the ability to buy US dollars. Many foreign companies have abandoned the country, unable to repatriate profits.

So far, so depressing, but things went from bad to worse when, at the stroke of midnight on 30 July, Argentina went into default for the second time in 12 years. This news – which made ECLAC’s previous report seem overly optimistic – forced the organisation to predict a contraction in 2014.

Argentina’s most recent default – the eighth in its history – has its roots in the 2001 crisis. Many of its creditors at that time exchanged their defaulted debt for new securities in restructurings that took place in 2005 and 2010. However, the default attracted the attention of so called ‘vulture funds’ including NML Capital and Elliott Management, which took the lucrative if risky path of buying up cheap defaulted debt with the aim of chasing payment in full plus interest in the New York courts – the governing law under which the original bonds were written.

In 2012, Judge Thomas Griesa of the New York district court banned Argentina from paying creditors who held exchanged bonds unless the country also paid NML according to its own terms. While Argentina has the funds to pay its bondholders, it cannot afford to pay off the vulture funds. In addition, if Argentina pays its holdout creditors in full it will trigger the so-called Rufo clause in the exchange bonds, requiring it to pay all creditors the same amount – a prohibitively expensive proposition that would negate the 2005 and 2010 debt restructurings.

The assumption has long been that some kind of settlement will be reached, however in July the US Supreme Court refused to get involved in the case, leaving Judge Griesa’s ruling intact and Argentina faced with three uncomfortable choices – pay its holdout creditors the $1.3bn plus interest awarded by the court; negotiate a settlement with the hedge funds; or stop paying the exchange bondholders. Argentina chose the nuclear option, and missed the payment deadline of 30 July.

Held to ransom

This came as little surprise to many. President Cristina Fernández de Kirchner has always opposed paying ‘holdout’ creditors, whom she accuses of holding the country to ransom. Indeed, the case has shined the light on the activities of ‘vulture’ investors who specialise in buying distressed bonds at cut price and suing for full repayment. Argentina has blamed foreign financiers for its economic ills, but given the options with which it was faced, in this case it may well be justified. And one can hardly blame Ms Kirchner for taking umbrage with what many now see as an aggressive and exploitative form of global finance. But who will this tactic hurt most?

Arguably, the country has faced more severe scenarios. Its current troubles are more containable than those of 2001 when the economy collapsed, resulting in millions unemployed. In 2001 the government was insolvent – today it has money in the bank. In addition, its current outstanding debt under foreign law amounts to only $29bn, much less than the $81bn on which it defaulted in 2001. Despite this, the consequences for the struggling economy are grim. Even if the default is a relatively short one, Argentina will see raised borrowing costs, further pressure on the peso, and a drain on foreign reserves. The default will also pour fuel on the country’s soaring inflation rates.

Contagion minimal

Argentina’s default is unlikely to have great impact on the global economy – the country has been isolated from global credit markets since its 2002 default on $100bn. However, the current situation has opened up old wounds, leading to political recrimination. On 7 August, Argentina asked the International Court of Justice (ICJ) in The Hague to launch proceedings against the US. In its application to the court, Argentina accused the US of committing “violations of Argentine sovereignty and immunities and other related violations as a result of judicial decisions adopted by US tribunals”. A statement issued by the ICJ confirmed it had transmitted this request, however as the US only accepts the court’s jurisdiction on a case-by-case basis, it seems unlikely that Argentina’s grievances will receive a great deal of attention.

At this point, it seems likely that Buenos Aires will have to strike a deal with the holdouts – for the good of its economy if nothing more. However, a successful deal would also benefit the US. New York’s standing as an international financial centre is at risk of damage if this decade-long conflict is not resolved, and the US needs to be seen able to enforce its rulings.

Ultimately, a resolution that favours Argentina may be the best long term outcome for the global economy. The ‘vultures’ have set a precedent in successfully suing for full repayment on the bonds issued under US law, and this will make it much easier for holdout creditors to disrupt sovereign debt workouts in future. Though this will prove profitable for some, it could be disruptive for all.

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Matt Atkins