Default or not default? That is the (Argentine) question...

Argentina's president, Cristina Kirchner, refuses to accept that the country has defaulted on its debts. But her denial can only make things worse.

Celia Szusterman
5 August 2014

D-Day in Argentina, 30 July 2014,  came and went. And nothing has changed. The president, Cristina Kirchner, and her economy minister Axel Kicillof  are not tired of repeating that life goes on. Indeed. Yet, is it true that nothing has changed - default or not default?

On 31 July, the day after entering (or not) into default, Mrs Kirchner  broadcast to the nation: “They will have to invent another name. Because we have paid.” Once again, she seems to be in a state of denial. Instead of recognising reality, having a good analysis and devising a strategy to reach a solution, she offers - amid the usual sea of white-and-blue flags - an epic narrative.

This time the enemies are not the farmers nor Clarín, the multimedia group, but the “vulture funds” (the ubiquitous name for the hated hedge funds). Buenos Aires had woken on the morning of 29 July with hoardings offering a stark option: “Patria o Buitres” (Motherland or Vultures). The chief of cabinet, Jorge Capitanich, blamed not just the hedge funds but the United States, and threatened to take the case to the International Court of Justice in The Hague. Axel Kicillof himself accused Judge Griesa of being at the service of the “vultures”, then accused the judge-appointed mediator, Dan Pollack, of incompetence. Even Joseph Stiglitz, the Nobel economics laureate, reportedly said that Griesa’s decision was paramount to throwing a bomb not just at Argentina but at the whole global financial system.

Amidst so much hyperbole, one fact remains. On 31 July, Argentina fell into a default - variously described in the rest of the world as “selective”, “partial” or “technical” (see, for example, the reaction of the rating agencies Standard & Poor’s, Fitch, or China's Dagong Global Credit Rating, as well as the advice of Russ Dallen: “In this game, it is best to refer to the rulebook, which in this case is the Prospectus for the 2005 and/or 2010 Restructured Bonds). Until somebody comes up with a new word (“neo-defaultism”?) this is the reality. Yet for Kicillof, the use of the word default is an “atomic nonsense”.

A medley of failure

The sooner the situation is reversed, the sooner the default label will be removed.  But if the Argentine government does not recognise the severity of the situation, what are the chances that it will be in a rush to negotiate a solution to a problem it regards as non-existent? Yet until it does, the reputational damage will continue unabated. The consequences will be grave: among them a lack of investment, a drop in economic activity, a rise in unemployment, inflation, and pressures on foreign-exchange reserves. 

On 27 June, the economic analyst Enrique Szewach wrote that Argentina (or “the Republic” as it is referred to in Griesa’s judgment) had two alternatives: either to negotiate a long-term payment for “holdouts” and all other bondholders under litigation, or “blame Griesa, the US government, [and others] for ‘preventing us from paying’. It would then engage in a new epic battle in The Hague, and go into default”. Szewach concluded: “clearly, this second option is mere fantasy, since the consequences of a default would deepen the existing recession”. Guess which option Mrs Kirchner and her “genius” (her words) economy minister have chosen?

The explanations are to be found in a medley of words starting with “i”. They start with incompetence. Mrs Kirchner has known for at least two years - since Judge Griesa’s first verdict in favour of the “holdouts”and against the Republic - that there was a need for a "Plan B". At that point ideology, and the destructive capacity of populism, led her to choose the nationalist option. The “vultures” were “coming after our resources” - a repetition of the argument against the UK in the case of the Falklands/Malvinas. In various assemblies, she tried to regionalise the latter conflict, saying that the UK was coming not just after Argentina’s resources, but those of the whole region. When the assets of the local subsidiary of the Spanish energy giant Repsol were confiscated, there was much talk of “recovering our natural resources”. Vladimir Putin, during his visit to Argentina in mid-July, expressed an interest in the shale deposits of Vaca Muerta. It is not clear why the country’s natural resources should be so much worse off in Spanish hands than in Russian.

Perhaps Mrs Kirchner was impressed by the adoration in which some Venezuelans still hold the late Hugo Chávez, proclaimed by his successor Nicolás Maduro as the country's “eternal leader”. If the destruction of the Venezuelan economy has failed to dent the love of (some) Venezuelans, this may give Argentina's president hope for a similar reward after 2015 - in a battle framed as one of populism vs. the hedge funds (and vs. belief in the rule of law, free markets, and free societies). Of course these funds are “motivated by a desire to make money”. Surely only those who think making money is despicable can be surprised by this.

What Mrs Kirchner and Kicillof ignore is that the debt (“incurred by other governments, not ours”) is the result of excessive public spending. This irresponsibility has led her government since 2009 to “borrow” $40 billion from central-bank reserves, filling its vaults with “bits of paper”. The fiscal deficit has prevented the government from buying back from the central bank about $3-3.5 billion per year to restore its finances. The result is that the foreign debt, both old and new, is unpayable: it would mean allocating $10 billion per year to service the debt. Madness. Even without the default Argentina’s economy was facing meltdown (see Roberto Cachanosky in La Nación [29 July 2014] and Szewachnomics [31 July 2014]).

This explains the need to borrow from financial markets. To do so without being charged usury levels of interest, it was necessary to settle all outstanding debt: with Repsol (Kicillof said at the moment of confiscation that Repsol would have to pay billions to Argentina), with the Paris Club (Argentina did not even try to negotiate a reduction in punitive back-interest payments), with the verdicts of the World Bank’s International Center for Settlement of Investment Disputes (ICSID), and with the “holdouts” which had refused the terms of the 2005 and 2010 restructurings.

A president, alone

Is there a way out of this (in Mrs Kirchner's view) victorious decade, which in fact can only be described - and that generously - as a wasted one? In contrast with other Latin American countries, Argentina since 2003 has returned to high levels of inflation, unsustainable debt, growing poverty and recession. Yet there is hope. A new government will be elected in October 2015. Mrs Kirchner is not allowed to run for a third term. Thus by 2016, if another “model” is put in place, fiscal equilibrium is achieved, the central bank is excused from financing the public deficit and trust is restored, a reasonable long-term agreement with creditors would mean that the debt, in the long run (and yes, when we are all dead) is payable. Lessons to be learned?  Szewach has it right: the best way of coming out of default is…never to go into one.

As Russ Dallen has written: “In the end, the worst thing about all of this is it could have been easily avoided”. If Argentina's private-banks' association ADEBA had just stepped up and bought the bonds, paying the $1.6 billion to NML and Aurelius, the problem could have dissolved and Argentina begun re-accessing international capital markets. A deal around those parameters is still being talked about and may even yet happen. (The first time Argentina defaulted, in 1828, it took the country twenty-nine years to start to cure the default.)

The sad thing is that the last decade, which saw the recovery of economic activity after the 2001-02 crisis, produced unprecedented levels of fiscal income. Yet since 2007 the fiscal deficit has kept expanding. Ignorance of Economics 1.01? Irresponsibility? Incompetence of a president and an economy minister with little knowledge and less experience? Ideology?  There is a further explanatory element. Isolation - mental, physical and geographical. Every weekend Mrs Kirchner flies 2,500 kilometres to Santa Cruz, where she is in the almost exclusive company of her son. When she is in Government House - usually four days a week, and never starting the day before noon - she does not hold cabinet meetings (there have been none since 2003). She listens to no one, other than Kicillof. Her isolation is complete. When someone told one of her collaborators what the consequences of falling into default would be and asked that she be told, the reply was: “There is no way I can tell her that”.

Kicillof’s atomic nonsense may turn out to be an atomic irresponsibility. Default - technical, partial or selective - is default. In 2005 and 2010, first Néstor Kirchner and then Cristina chose New York as the jurisdiction overseeing the new bonds in order to persuade bondholders to accept the new terms. Not to have anticipated the consequences of the whatever-you-want-to-call-it may well turn out to be an atomic idiocy.

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