Thoughts and lessons from Argentina's sovereign debt crisis

Recently, Argentina defaulted on its sovereign debt -- amidst possibly one of the worst times in the international economic history -- for the ninth time. Behind the shaky history of the country as a debtor, there are lessons to be learnt with regards to lending and creditor behavior.

We've always thought of national government as being the safest investment there can be, when it actually comes down to investment at a broad level. Over several years, the idea of a 'risk-free rate of return' has directly or indirectly referred to a rate of return offered on investments made in the safest instruments, backed by the most risk-free entity there can be - the sovereign government.

But there is definitely some misunderstanding in terms of the actual usage and interpretation of such a rate. After all, no investment can be completely risk-free, and even the safest investments carry a certain level of risk. Argentina's case sheds some light on this aspect. While it's certainly not fair to compare investments made by retail investors through instruments such as treasury bills to huge, billion-dollar investments made by large private funds, other national governments, or large quasi-national entities such as the IMF; it's interesting to see whether this perceived safety forms a part of what is hotly debated as a case of reckless lending vs plain fiscal mismanagement on part of the government.      

Argentina's case can be described as someone finally being able to climb a tall tree, only to end up falling down miserably into quicksand and being trapped for nearly 20 years. What started as a tremendous real GDP growth of ~10% on the back of deregulation and currency reform, quickly turned into recession characterized by a fall in GDP by ~28% in just 4 years, devaluation of currency, an inflation rate of 41%, a ~24% fall in wages, and a sharp rise in unemployment rate  and poverty rate to ~24% and ~58%, respectively.    

If we're trying to understand this debt trap (or pick a side in the aforementioned debate), it's pertinent to talk about how Argentina got into this mess in the first place. After the success of the reforms by the new president Carlos Menem, the growth leveled down slightly, and currency crises in other parts of the world (such as East Asia, Russia and Brazil) rapidly drove investment away from Argentina and slowly created an atmosphere of recession. Menem's successor, Fernando De la Rúa further introduced a series of tax increases with a view to reduce fiscal deficit. This killed whatever economic momentum was left and pushed the country deep into recession. Political turmoil mixed with even more key economic blunders in 2001 led to Argentina's entry into a debt trap. Increased tax rates and high interest rates made the country lose its creditworthiness and the country risk premium exceeded 20% by the end of October 2001. The creditors feared a default and that at such high borrowing costs, the debt would grow so fast as to exceed the ability of the government to repay it. The crisis spread fast and the government was unable to stop the problems reaching the private sector. With trouble refinancing their debt, the government froze bank deposits which ultimately brought the private sector activity to a halt. According to the Joint Economic Committee of the US Congress, this is when "the economy plunged from what still might arguably have been termed a very bad recession into a true depression."  

This more than proves that Argentina did not have the solid foundation required to escape a debt trap, let alone enjoy a consistent economic growth period. However, the years following the recession and leading up to the most recent default have been sufficient to observe the other side of the coin -- the creditor behavior, and raise concerns with regards to their involvement in furthering the economic crisis in Argentina.  

When Argentina negotiated with bondholders for the restructuring of ~76% of the ~US$82 billion worth of sovereign debt in 2005, it managed to do so, even though the terms were unfavorable to the creditors and they had to settle for repayment of around 30% of the face value. The remaining (~24%) were a diverse group of 'holdouts' who had refused to accept the offered terms and had chosen to litigate instead. This group was brought down to 7% in another round of restructuring efforts. This last holdout group was largely comprised of hedge funds and vulture funds, who eventually won their case in court. The result of the initial litigation was that it resulted in attachment orders against Argentine assets, leaving the country unable to access international credit markets. Even after these two restructuring efforts, in 2014 Argentina failed to honor the restructured bonds.

Therefore, even 12 years after the first default, and even despite two rounds of debt swaps and 93% of the bonds being restructured, Argentina had not been able to re-access the market. This was in sharp contrast to several OECD countries in Europe that gained access to international markets much faster after losing such access (such as Portugal, Ireland, Greece and Iceland). These countries were able to make significant economic policy adjustments, which helped them bolster their economy, and unlocked consistent GDP growth -- which is one of the strongest ways to emerge from the weight of debt in complicated cases such as that of Greece. For Argentina, however, this growth avenue seemed elusive.

Many fair market proponents were of the view that Argentina was essentially being bullied by vulture funds and irresponsible financiers who were intent on rejecting any reasonable restructure of debt . According to Sarah-Jayne Clifton, director of Jubilee Debt Campaign, "Reckless lending at high interest rates helped to create the current crisis, so lenders and speculators should share in the costs". She also emphasized that Argentina was right to demand a deep restructure of the debt and default if the lenders did not accept a deal. 

The above was said in context to the current global health crisis. A group of leading economists including Nobel Prize winner Joseph Stiglitz recently urged the holdout bondholders to take a constructive approach to restructuring and argued that debt relief for the country would be the only way to combat the pandemic and set the economy on a sustained path. Robert Johnson, an adviser to both Argentina and its creditors, recently wrote that it is important for financiers to recall the broader context, and that the ideology of shareholder maximization and deification of markets is under challenge due to unsustainable social outcomes.

Specifically, the creditors cannot just demand a restructuring that dooms the country to a horrific struggle, government collapse and the need for yet another round of restructuring, which keeps it away from international credit markets and disables its ability to restore the faith of its people in its economy. Also, economists have also argued that currently Argentina's top priority is to protect its citizens from a health crisis rather than paying back creditors who knew they were taking a big risk by buying high-yield Argentine bonds.

There have been dialogues among academicians and economists regarding the most suitable approach to make sure that this experience can be avoided going forward, for Argentina or for any other country who are likely to fall into a debt trap. Essentially, the argument boils down to either (1) structurally change the economy's borrowing procedure, and creation of a statutory mechanism, or (2) market based mechanism; an approach where the outcome is left to the market forces and decisions are based on such forces. 

In support of the first approach, even if the Argentina case was resolved, there needs to be a global statutory mechanism to avoid complex sovereign debt trap cases in emerging markets such as Argentina. The idea put forward by experts like Professor Francisco Panizza is that the problem is not that the countries default too early, but that they default too late -- due to the focus on holdout cases and so on. A delayed default combined with unsuccessful restructurings not only puts negative pressure on the economic climate of the country, but also blocks the government from accessing further credit (which is essential in a global crisis situation such as one currently), essentially amplifying the recession. This creates a lose-lose situation where everyone is worse off, including the debtors and creditors. Instead, an extensive insolvency framework  such as that created for corporate firms is needed so that government is not clueless about how to deal with a debt trap, and unreasonable debtors such as vulture funds do not take advantage of the economic crisis in the country. (Although it's certainly not fair to compare corporate firms with complex sovereign governments in this context, since a company can become bankrupt much more easily while it's nearly impossible for a country to be insolvent given that its assets are always going to be more than its liabilities i.e. a country can always raise taxes to cover any liability; but a similar mechanism can be used). The framework would also deal with key issues such as: ineffective and complex nature of re-negotiations, lack of interim financing for urgent situations, and the tendency to over-borrow instead of sourcing funds internally due to debt dilution.

The second approach which advocates continuation of the current system where market forces decide the outcome of the case. This was advocated by Professor Arturo Bris, who was of the opinion that there is a tendency to perceive market as 'better' and more open when it is favorable, and to seek for structural reform when it is unfavorable -- this tendency should be avoided and market forces should be allowed to decide the outcome of such a scenario without any external assistance. He added that statutory reforms are too inflexible which can create a problem in unique borrowing cases. In this approach, the mechanism suggested is more of an out-of-court settlement, where the borrowers and creditors can come together and reach an agreement. However, this may not be an effective mechanism for a lot of cases, especially when the creditors are unreasonable by nature and an agreement is hard to reach without involving complex litigation.

While the case of Argentina is not necessarily unique in the history, and debt restructuring is still a really long, complex process that causes significant harm to the general economy; it has brought forward some thoughts and lessons which need to be studied in order to avoid similar situations going forward. An ongoing, worsening 20 year long battle with economic instability largely fueled by a debt trap gave way to an economy unprepared to deal with a global healthcare crisis. Whether it was the incompetent government of the late 1990s and early 2000s or a group of difficult and predatory lenders looking to bleed the country for their share of the leftovers, the blame has become less important than to make sure this isn't repeated with another country who might not even be strong enough to battle it out for so long. A mechanism which ensures that this exact objective is achieved is required, and a global statutory, structural reform as advocated by Professor Panizza could be the ideal mechanism for this purpose.

Sources: 

1. IMD : 'Dialogues on Globalization series: Don't cry for me Argentina: Implications of unusual sovereign defaults'

2. US Congress Joint Economic Committee: 'Argentina's economic crisis: Causes and Cures'

3. Global Policy Forum: 'Billionaire Hedge Funds Snub 90% Returns'

4. J.F. Hornbeck: 'Argentina's Defaulted Sovereign Debt: Dealing with the "Holdouts"

5. Reuters: 'Nobelist Stiglitz, economists from 20 countries back Argentina in debt showdown'  - 27 May 2020

6. The Guardian: 'Argentina set for default as bondholders reject new terms' - 22 May 2020

7. Financial Times: Robert Johnson: 'There is a way forward for Argentina and its creditors' - 26 May 2020

8. The Wall Street Journal: 'Argentina Defaults on Sovereign Debt Amid Coronavirus Crisis' - 22 May 2020