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may 17, 2014 vol xlIX no 20 EPW Economic & Political Weekly10

T Sabri Öncü (sabri.oncu@gmail.com) is an economist based in Geneva, Switzerland.

A Sovereign Debt StoryRepublic of Argentina vs NML Capital

T Sabri Öncü

A series of events since the early 1980s have pushed developing countries to restructure their economies and integrate themselves with global markets. These policy shifts have made them highly vulnerable to external changes. One such story is that of Argentina which from the mid-1970s has gone from crisis to crisis and is now facing legal pressure from US holders of old Argentine debt.

“A rgentina got a skeptical recep- tion at the United States (US) Supreme Court as the justices

considered whether two banks must turn over details about the country’s assets as part of a multibillion dollar fi ght over defaulted government bonds”, reported Bloomberg on 21 April 2014. On that day, the US Supreme Court justices heard the arguments of Argentina and owners of the defaulted bonds led by NML Capital − a Cayman Islands-based unit of billionaire hedge fund manager Paul Singer’s Elliott Management Cor-poration. The justices are expected to rule by late June or early July. This case is one of the many cases before the US Supreme Court in which Argentina is one of the parties. It is regarding the information NML is seeking from Bank of America and Banco de la Nacion Argentina about assets held by Argen-tina and its offi cials worldwide.

Although this case is about the his-toric Argentine default of 2001, the beginning of the debt accumulation that led to this default may be traced back to the “National Reorganization Process” (NRP) of the military dictatorship from 1976 to 1983. The NRP was the Argentine version of the familiar reorganisations of social life into a free market around the globe since the early 1970s and is similar in nature to the reorganisation of Chile from 1973 to 1990 or Turkey from 1980 to 1983 by their respective military dictatorships.

The two important policy changes the Argentine dictatorship made, in addition to opening the economy to the inter-national capital market, were: (a) dereg-ulation of the fi nancial sector, and (b) introduction of a crawling-peg of the peso to the dollar to bring the then run-away infl ation under control. While the fi rst of these meant the introduction of a

market-determined interest rate among other changes, the second required an exchange rate guarantee by the govern-ment. In addition, the government guar-anteed the deposits at the banks, effec-tively making much of the fi nancial sec-tor liabilities of the central bank in the event of a banking crisis.

The dictatorship borrowed heavily in the international capital market − mainly variable interest rate bank loans from the US and European banks that were lending recklessly in search of high yields − to fi nance government and cur-rent account defi cits. The private sector external debt also increased rapidly dur-ing this period. When record high inter-est rates of the early 1980s (induced by the US Federal Reserve to curb the oil-based infl ation of the 1970s) brought a global recession triggering the less developed country (LDC) debt crisis, Argentina was also hit.

Sovereign Debt, a History

First, a banking crisis developed, forcing the government to back a large portion of bank deposits. Second, a balance of payment crisis ensued, leading to a reversal of capital fl ows and severe cur-rency devaluation. This devaluation, coupled with an exchange rate guaran-tee, led to a state takeover of private debts, resulting in additional govern-ment debt. Indeed, with the encourage-ment of international banks in 1981-82, the public sector assumed a considerable portion of private sector foreign debt and the private sector’s share fell to about 30% in 1982. Lastly, the skyrock-eting interest rates in the US pulled up the variable interest rates on foreign bank loans, and the debt burden of the government increased further.

This fi rst period ended when Mexi-co’s default on its external debt in August 1982 triggered the LDC debt cri-sis, and Argentina followed suit in a matter of weeks. Argentina’s default lasted until an agreement with its cred-itors under the Brady Plan in 1992, envisioned fi rst in 1989 by the US Treas-ury Secretary Nicholas F Brady. It should be noted that there had been no

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Economic & Political Weekly EPW may 17, 2014 vol xlIX no 20 11

debt relief on the defaulted debt in 1982 until 1992, when the Brady agreement provided some relief. While in the beginning of the period − at the end of 1975 − Argentina’s external debt was about $4 billion, it was about $44 billion at the end of 1982.

The second period lasted from 1983, when Argentina returned to electoral democracy, and continued up to 1990. As with the rest of Latin America, those were painful years for Argentina. Wages dropped, unemployment rose, capital fl ed the country, economic growth slowed, external debt remained unserv-iceable, two hyperinfl ations and several balance of payments crises had occur-red. And Argentina’s access to the inter-national debt market had been cut off throughout the period. In spite of this, however, the external debt of Argentina continued to rise, albeit at a slower rate, mostly through capitalisation of interest on defaulted loans, and reached about $63 billion by the end of 1990. In addi-tion to fi nance government spending, Argentina issued domestic bonds denom-inated in US dollars because of a lack of confi dence in the domestic currency. Towards the end of this period, in June 1989, at the height of the hyperinfl ation of 1989-1990, the Carlos Menem govern-ment came to power.

The third period started in 1991 and ended with the debt default in 2001. In this period, the ongoing free market reorganisation was taken to its “natural” conclusion. In February 1991, the Har-vard trained economist Domingo Cavallo joined the Menem government as the economy minister until August 1996 and, in cooperation with the Inter-national Monetary Fund (IMF), started to implement one of the most radical struc-tural adjustment programmes in the history of the IMF. His programme included liberalisation of trade, liberali-sation of the capital account, privatisa-tion of state enterprises − including oil, natural gas, electricity, transportation, and other public utilities, even water − and draconian cuts in government spending, that is, austerity. Cavallo’s reform programme allowed large foreign ownership of banks, which led to a seemingly more stable banking system,

but one which failed to lend to small and medium enterprises.

At the heart of Cavallo’s reform pro-gramme was pegging the peso to the dollar one to one, which was encour-aged by the IMF. Although the peg ended the hyperinfl ation, after a period of rapid growth, the economy slowed, partly because fi rms could not get adequate funding. And, although other policy fail-ures occurred, the peg was the most important policy mistake. With the rest of the measures, it made the economy open to external shocks that were caused by the international fi nancial market volatility. In Stiglitz’s words, this was “a system doomed to failure”, not because of the mistakes made by Argentines, but because of its vulnerability to external shocks (Stiglitz 2002).

And the expected happened. First came the global bond crash of 1994 induced by interest rate hikes by the US Federal Reserve; then the 1995 Mexican peso crisis; then the 1997-98 south-east Asian and Russian crises; next the 1999 Brazilian crisis and last the 2000-01 global slowdown. Each event worsened Argentina’s situation in one way or another, leading to a major economic depression in the country from 1998 to 2002. The austerity measures encour-aged by the IMF and implemented by Cavallo after he was called by the then President De la Rua in March 2001 to lead the economy again increased the economic pain, and then led to social unrest and, eventually, to riots in December 2001. Finally, on 5 December 2001, the IMF refused to disburse a scheduled $1.3 billion loan because of Argentina’s budget defi cit and put a nail in the coffi n of the Argentine economy. When the riots of 20 December 2001 left several dead, the government fell, Cavallo and De la Rua resigned, and De la Rua fl ed the government building in a heli-copter on the same day. Four days later,

the then President Adolfo Rodríguez Saá halted payments on the $132 billion debt the country owed. The rest is history.

Debt Restructuring

Since this default, Argentina attempted to restructure its debt twice. First in 2005, and then again in 2010. In these restructurings, nearly 93% of the old debt was exchanged for new debt, leav-ing 7% as holdouts. It is some of these holdouts and others like NML Capital, who purchased the defaulted debt from other holdouts at a deep discount, who demand full payment. Indeed, led by NML Capital, they sued Argentina fi rst at the Southern District of New York District Court and won the case in Feb-ruary 2012. Then, the case moved to the Court of Appeals for the Second Cir-cuit in New York and in August 2013, Argentina lost again.

There are two reasons why holdouts could sue Argentina in US courts. The fi rst is that there has never been a global authority for effi cient and fair restruc-turing of sovereign debts. There have been talks of establishing one for many years but, despite the obvious need, there has been no progress. The second is Argentina’s mistake of restructuring the defaulted debt in New York under US law. Of course, it is anybody’s guess what percentage of the Argentine debt could have been restructured, had it been restructured in Buenos Aires under Argentine law. Now, the case is with the US Supreme Court and only time will tell the outcome.

Now, the moral of the story: a country needs to be very careful in reorganising its economy into a free market and inte-grating it with global fi nancial markets.

Reference

Stiglitz, Joseph E (2002): “Argentina’s Collapse Incited the Largest Default in History”, The Straits Times, 10 January.

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