Argentina: A cautionary tale for borrowers and lenders alike (Feature)

By Veronica Sardon Apr 20, 2010, 6:06 GMT

Buenos Aires - Foreign debt is a household concept in Argentina, but it comes coupled with terms like country risk and default.

The South American country's latest crisis, in 2001-2, involved all three.

Argentina had suffered from a severe recession since 1998, and it needed to keep borrowing. It had both trade and budget deficits, and it needed to honour interest on its outstanding debt.

Since the country was believed to be in major financial trouble, its risk premium was massive.

'Argentine bonds offered higher yields than American Treasuries precisely because their promise to repay was not as secure,' The Economist said as a reminder to disappointed investors in 2005.

And such a risk premium was not only defined in financial terms: global lending institutions like the International Monetary Fund (IMF) and the World Bank imposed conditions on Buenos Aires, basically in the form of a demand for cuts in government spending.

These conditions soon proved to be too much. Government spending was by then the pillar of a crumbling economy, and, with a fixed exchange rate in place at the time, Buenos Aires was not supposed to simply print more money to deal with the absence of fresh funds.

But local governments did just that, issuing IOUs that changed hands as money at the height of the crisis.

'To right itself, the Argentine economy needed to regain competitiveness. Since the exchange rate could not fall, prices and wages had to instead. As recession took hold, peso prices edged downwards, tax revenues faltered and Argentina's dollar debts grew harder to repay,' as The Economist would later put it.

The government tried to do as it was told and implemented unpopular measures, including cuts in the salaries of pensioners and public servants. Eventually, it even froze deposits held in private bank accounts.

There were riots in the streets, president Fernando de la Rua resigned, flying from the presidential palace in a helicopter while the country's institutions collapsed into chaos. For weeks, there was a series revolving-door presidencies.

Adolfo Rodriguez Saa held the presidency for exactly one week, going down in history as the man who declared that Argentina would not honour its pending debt payments.

Within days, in early 2002, president Eduardo Duhalde made it even clearer.

'It is time to tell the truth. Argentina is bankrupt. Argentina is broke,' he said.

At about 93 billion dollars, it was considered the largest default in history. This despite earlier praise that Argentina had been 'doing the right thing' economically.

'Argentina opened itself enthusiastically to world financial markets, which backed the country with significant resources. The risks involved were minimized by all these institutions and agents until very late in the process,' Jose Antonio Ocampo, then head of the Economic Commission for Latin America and the Caribbean (ECLAC), wrote in 2003.

Many financial brokers played down the risk as they sold Argentine titles to their clients, and reaped generous profit in doing so. But there was a multiplier effect to the harm this could do.

'The longer Argentina was kept going with infusions of cash, and the more the country delayed facing unpleasant realities about its plight, the more cataclysmic a crash it would suffer,' said expert Paul Blustein of The Washington Post.

But defaulting on foreign debt is not easy. Subsequent governments let the peso float, allowing some economic growth, but the problem remained: how to regain trust and access to global financial markets.

Argentina has been partially successful in reshaping its defaulted debt. In 2005, some defaulted debt was reprogrammed, with investors getting about 35 per cent of what they were formally entitled to.

But holdouts who want more of a return remain and Argentina remains 20 billion dollars in debt, despite making it clear that investors cannot expect to get back more than a third of what they lent. Buenos Aires is set to make a new offer later this month.

The default has been expensive in terms of a lack of access to cheap international loans, and both the public and the private sector have suffered as a consequence. A plan to use the Central Bank's reserves to pay up has lately met with great opposition at home.

'We decided to use a portion of those reserves to avoid having to go out on the capital markets where, as a result of this default by Argentina, we would surely be on (interest) rates of 12-15 per cent,' Argentine President Cristina Fernandez de Kirchner said this month.