Does Another Debt Crisis Await Argentina

8/9/2019 Does Another Debt Crisis Await Argentina

http://slidepdf.com/reader/full/does-another-debt-crisis-await-argentina 1/6

This report is available on wellsfargo.com/research and on Bloomberg WFEC

April 06, 2010

Economics Group

Executive Summary Argentina has been in the news lately, and when this happens, it is normally not for good reasons.Once again, investors are worried that Argentina may default on its external debt. Thisspeculation is a repeat of what happened during 2008 and 2009, and it seems to be more related

to internal political fights than to the current condition of government finances, even thoughgovernment finances have continued to deteriorate. This speculation is also related to the fact that Argentina is still negotiating with holdout bondholders from the 2005 restructuring of itsdefaulted external debt. Argentina’s access to the international financing markets has been closedsince it defaulted on its debt in 2001, and some investors holding about $20 billion in defaulteddebt did not accept the government’s debt renegotiation in 2005.

While we do not expect Argentina to default during the next several years, the seeds of a potentialdefault are being planted today. First, the administration is using stocks to pay for what it owesinstead of relying on its cash flow. Second, the government is tampering with inflation numbers inorder to pay less in interest on some part of its current debt. Third, government expenditures aregrowing too fast for fiscal sustainability, especially if the economy does not make a strongrecovery.

Trying to Find Who Is Going to Pay The country seems to have been pushing hard to finalize its negotiation with the 2005 debtrenegotiation holdouts in order to be able to count on the international capital markets in thefuture and lower the cost of financing. Meanwhile, the Fernández-Kirchner administration has

been very active in securing other domestic “sources” of government financing over the pastseveral years. And so far, it has been successful in achieving those objectives, even as the differentsectors affected by those measures have been up in arms over the government’s advance into theeconomy and firms’ hard-earned revenues.

The administration has not stopped at anything to get away with what it wants. The latest episode was the creation of the Fondo del Bicentenario (Bicentennial Fund, BF) set up to use $6.6 billionin central bank reserves to help pay for this year’s financing needs. However, the BF started onthe wrong foot, as the central bank president at that time, Martín Redrado, immediately opposedthe transfer of reserves to the government while the political opposition sent the matter to the

courts and several judges intervened by freezing any use of reserves until the judicial processended.

The administration won a partial battle against the central bank president and pushed him out of office, naming a “friendlier” central bank president, Ms. Mercedes Marcó del Pont, who is still in aprecarious position because she has not been confirmed by Congress and concerns are increasingthat she may never be confirmed. At the same time, the administration cancelled the original BFdecree and issued two new ones: one called the Fondo del Desendeudamiento (DeleveragingFund, DF), which affects $4.382 billion in reserves for the payment to private lenders, andanother one that is less conflictive that will affect $2.187 billion in reserves for payments to twointernational organizations, the World Bank and the Inter-American Development Bank.

Special Commentary

Eugenio J. Aleman, Senior [email protected]! 1-612-667-0168

Does Another Debt Crisis Await Argentina?

The government has been successfin securing sourcof financing.



Will Argentina Default Again? WELLS FARGO SECURITIE April 06, 2010 ECONOMICS GROUP

The Argentine Congress finally declared the original Bicentennial Fund null and said that anyother decree that tried to use reserves to pay for debts in the future would also become null.However, on March 30, 2010 two intermediate courts (appellate courts) freed the reservesarguing that the lower courts were incorrect in freezing them, and thus the administration seemsto have the upper hand at the time of writing this report. At this point, it seems that the Argentinepolitical opposition will not try to stop the government through court actions. This means that the

government will probably be able to use the $4.382 billion central bank reserves to pay privatelenders.

The payment of the debt with central bank reserves is the first red flag as the government hascontinued to use stocks to pay for government debt instead of using its cash flow. This action runsthe risk of depleting the country’s resources and makes the future financing path unsustainableThus, it is clear that the administration is “selling the Queen’s jewelry” to pay for its everincreasing government needs.

This is not the first time the government has used stocks to pay for its debts. The problems for theadministration started to become self-evident in 2008 when it decided to take over the privatepension fund system. While the administration argued that it was doing just that to “protect” thefuture of Argentina’s pensioners, the real reason was that the administration was starting to beconcerned with either its ability to finance its deficit and/or the cost of financing government

needs without access to international capital markets. At this time, the administration has takenover almost $24 billion from the private fund system and has been using that money to pay forincrease government expenditures. This was the second time the administration used a “stock” topay for its financing needs. The first time was in 2005 when the administration also used central

bank reserves to pay down its debt with the IMF in an action that was deemed to have been a cryfor the country’s independence from the IMF, which this administration has blamed for all of thecountry’s problems during the past 50 years or so.

The government has used stocks of assets to pay for some of itsspending rather

than using cash flow.

Figure 1

Argentina Foreign DebtPercent of Nominal GDP

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

1993 1995 1997 1999 2001 2003 2005 2007 2009

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Foreign Debt (Percent of Nominal GDP): 2009 @ 47.9%

Figure 2

Argentina Nominal GDP GrowthYear-over-Year Percent Change

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

1994 1996 1998 2000 2002 2004 2006 2008

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Nominal GDP: 2009 @ 10.9%

Source: Argentine Ministry of Economics & Public Finance, IHS Global Insight, and Wells FargoSecurities, LLC

A Look at the Numbers: Comparison to 2001 Although we do not expect a default on the country’s debt anytime soon, the seeds of such anevent are being planted today. As we said before, the Fernández-Kirchner administration has

been very resourceful in financing its debt payments during the past several years. It is truehowever, that the administration has had a very large primary fiscal surplus that has allowed it topay its debts easily. However, this is changing at a very fast pace due to the weakness in economicactivity and the strong pace of government expenditures.

The seeds of potential default are being planted today.

While there are many that say that Argentina’s debt situation today is more manageable than when it defaulted on its debt, this should not be an argument to dismiss the problems thadministration is facing to finance it.

2



Does Another Debt Crisis Await Argentina? WELLS FARGO SECURITIES, LLC April 06, 2010 ECONOMICS GROUP

3

Let’s look at some statistics comparing today’s situation with that of the pre-default. Argentina’sforeign debt in 2001 was $144 billion, or 54 percent of GDP. Today’s debt is $147 billion, or48 percent of GDP. However, there is a caveat with these numbers, because they do not includethe money owed to the holdouts of the 2005 debt restructuring program. If we assume that theseholdouts get 30 cents on the dollar, today’s debt will increase to $156 billion and about 51 percent

of GDP, which puts it close to what it was in 2001. However, at that time, the Argentine peso wasestimated to have been overvalued by approximately 40 percent and the economy had been inrecession for several years, with falling tax revenues. Thus, when the government allowed thepeso to depreciate, debt as a percentage of GDP surged to 152 percent in 2002. Today, the peso isnot overvalued by any standard, and while a relatively large devaluation is not out of the question,the situation is highly manageable and will probably not deteriorate as it did during the 2001-2002 crisis.

Figure 3

Argentina Tax ReceiptsYear-over-Year Percent Change

-10%

0%

10%

20%

30%

40%

50%

1993 1995 1997 1999 2001 2003 2005 2007 2009

-10%

0%

10%

20%

30%

40%

50%

Tax Revenue: 2009 @ 13.2%

Figure 4

Argentine Consumer Price IndexYear-over-Year Percent Change

0%

2%

4%

6%

8%

10%

12%

14%

2004 2005 2006 2007 2008 2009 2010

0%

2%

4%

6%

8%

10%

12%

14%

Consumer Price Index: Feb @ 9.1%

Source: IHS Global Insight and Wells Fargo Securities, LLC

Furthermore, today’s debt has a very different structure than that of 2001. Back then, 72 percentof the debt was denominated in U.S. dollars while 19 percent was denominated in euros and only

3 percent was denominated in the local currency. Thus, the devaluation that occurred in 2001produced a surge in the debt as a percentage of GDP and of interest payments as a percentage of GDP that pushed the country into default. Today’s debt profile is a bit better, with 41 percentdenominated in U.S. dollars, 24 percent denominated in euros and 28 percent denominated in

Argentine pesos. Furthermore, 55 percent of the debt denominated in Argentine pesos is indexedto the CER (Coeficiente de Estabilización de Referencia), a measure based on the consumer priceindex. And because the government has been underestimating the consumer price index for morethan two years, the cost to the government of this debt has been kept low.

Thus, the tampering with the inflation numbers is the second problem we see creating issues forthe government and for the country going forward. While it is very difficult to gauge what has

been the “real” level of inflation over the last several years, it is worth noting that labor unions, which are normally pro-government, have been asking for increases in salaries that are close to 25to 30 percent, arguing that workers’ purchasing power has been severely affected by inflation.

This is just a confirmation that the numbers amassed by the statistical institute are way off. Butthis is not the worst problem faced by the current administration. The mistrust this tampering hasproduced is such that nothing the administration does or publishes is credible. This is taking a bigtoll on the economy’s performance, as firms don’t want to invest if they are not going to be able torecover these investments by selling goods and services at the prices they need to sell them. Andmany firms are facing severe pressure from the administration to keep prices of goods andservices sold by those firms down.

This has been all too common for this country since the middle of the last century, with thegovernment stepping into firms’ territory and disrupting their ability to price their goods. It has

The foreign debt-GDP ratio today similar to what iwas before the ladefault.

The government has been tamperiwith the inflationnumbers.



Will Argentina Default Again? WELLS FARGO SECURITIE April 06, 2010 ECONOMICS GROUP

4

happened to the energy sector with price controls and all types of limitations to free enterprise; ithas happened in the agricultural and cattle sector, with all sorts of constraints and regulationsthat have distorted the allocation of resources within those sectors; it has happened to the privateeducation sector; it has happened to media outlets, with the breaching of contracts between theprivate sector and the government, etc. But the worst part of this story is that this is a road thathas already been traveled—a sort of déjà-vu—several times in the past. Large devaluation of the

currency, debt default, high inflation, hyperinflation, balance of payments crises or a combinationof many of these ailments has plagued this country over the centuries. Thus, while the country

will continue to grow as long as commodity prices remain high and Brazil and China continue togrow at a fast pace, we are not positive on the prospects for the Argentine economy in the long runif the administration continues down this destructive path.

At the same time, while interest payments on the debt represented 3.8 percent of GDP before thecrisis, today’s interest payments as a percentage of GDP are close to 1.8 percent. Meanwhile,interest payments were 21.9 percent of total tax receipts in 2001, whereas they are only 6.5percent of total tax receipts today.

All of these statistics point in the same direction: while the government’s situation hadeteriorated, the possibility of a default during the next couple of years is very low. The biggestproblem the government is facing today is its reliance on trade taxes and on the inflation tax.

Value-added taxes increased 28 percent on average between 2002 and 2008 while they onlyincreased 9 percent during 2009. Meanwhile, taxes on trade have grown by 75 percent during the2002-2008 period but dropped 12 percent during 2009. Thus, it is clear that the revenue side ofgovernment accounts has deteriorated considerably. However, there are signs that this situationis on the mend, which will help the administration as the year progresses.

While value-added taxes grew by only 9 percent during 2009, they have increased by 22 percent between December 2009 and February 2010. Meanwhile, taxes on trade dropped 12 percenduring 2009 but increased by 18 percent from December 2009 to February 2010. However, theproblems for the administration are basically related to expenditures and the way it has tried tosettle social issues since coming into power. This is not going to change as long as the PeronistParty, which is the party of the president, is in power.

Peronist Economics 101The third problem we see going forward is the surge in government expenditures, which has beenoutpacing government revenues and is on an unsustainable path.

The Peronists are known for their populist rhetoric and economic policies and for giving-in toselected social groups like labor unions, the “piqueteros”1 movement, etc., in order to keep thesesectors in check. However, the situation is becoming unbearable and too costly for theadministration at a time when fiscal revenues are weak. Thus, we should expect social discontentto increase during the next several years if the administration cannot get alternative financing forits debt payments and decides to finally lower government expenditures.

This is the root of the administration’s current funding or financing problems. As an example, wecan refer to the release of the fiscal results for the second month of this year. In that release, theminister of economics, Amado Boudou, said that the government’s primary fiscal results, that isthe fiscal results without taking into account the payment of interest on its debt, recorded asurplus of 1.2 billion pesos for a cumulative 2010 result of 2.241 billion pesos. The February

primary fiscal surplus result was 24 percent lower than the one recorded during the secondmonth of 2009. However, the minister indicated that “had the administration not ‘given’ 410million pesos from soybean exports tax receipts (what they call “retenciones” or retentions) to the

1 The “piqueteros movement” is a group of out-of-work individuals that have been supported by the Peronistadministration through subsidies and are at the beck-and-call of government officials and used to threaten businesses and other private institutions in the country. They normally form pickets outside antigovernment institutions, block roads or threaten businesses as their form of protest. While some of thesegroups have become independent from the government, the large majority of them are pro-government.

Government spending is on anunsustainable

path.



Does Another Debt Crisis Await Argentina? WELLS FARGO SECURITIES, LLC April 06, 2010 ECONOMICS GROUP

5

provinces plus 700 million pesos in money spent on subsidies to the poor,” then the surplus would have been larger than the 1.6 billion surplus recorded in February 2009.

Argentina’s nominal government expenditures have grown by an average of 24 percent since2003, while nominal GDP grew by an average of 21 percent. In 2009, nominal governmentexpenditures grew 25 percent, while nominal GDP grew only 11 percent. Meanwhile, real

government expenditures have also grown at a high rate. Real government expenditures grew atan average of 5.3 percent since 2003, while real GDP grew 7.4 percent during the same period. In2009, real government expenditures grew 7.2 percent, while the economy grew by only 0.9percent in real terms. Thus, not only is the government spending as if there was no tomorrow, it isalso spending very inefficiently. This is clear when looking at the prices paid by the governmentcompared to the prices paid by the rest of the economy.

Conclusion: When to Default? That is the Correct Question.Even as the administration has been trying to find different ways to pay for this year’s financingneeds, we estimate that the risks for a default are very low in the short to medium term. This isespecially true as the administration has been moving forward to make a final offer to the 2005holdouts from the 2001 debt default. With the recent SEC approval of the terms of the offer, theadministration can now proceed to try to convince these holdouts to join the club of those thatalready took a large haircut. According to the Argentine minister of economics, Amado Boudou,the holdouts should expect no more than 35 cents on the dollar, that is, a haircut of 65 percent ontheir holdings of Argentine debt.

If the holdouts accept this offer from the government, the country will be able to access theinternational capital markets once again and the expectation is that it is going to be able to findfinancing rates that are close to the single digits, much better than today’s rates of 15 percent to20 percent. If the administration is able to access international capital markets at lower rates,then they will be able to extend the day of reckoning to at least as long as the Kirchners remain inpower, which ex-President Nestor Kirchner has indicated to be close to 2020.

After that, the opposition or the right wing of the Peronists will take over and will try to figure outhow to keep the government expenditure party going. If they try to lower governmentexpenditures, then the social situation will deteriorate very fast and another crisis will ensue. Wedo not see this happening in the short run, but it will become a risk especially if strong economic

growth does not resume.

What is difficult to understand is that the Argentine economy has grown by leaps and boundssince the 2001-2002 crisis, and the government continues to spend as if the crisis continues. The

Argentine economy has grown by a cumulative 52 percent since 2002 and is today much largerthan it was during the days when the Convertibility Law was the law of the land. However, socialand economic marginalization continues to be a serious problem that seems to have no feasiblesolution but for the government to continue to spend as if there was no tomorrow.

If the government cannot find more sources of financing in the short- to medium-run, and if it isnot successful in accessing the international capital markets, then we should expect theadministration to recourse to higher inflation tax, devaluation and more confiscatory measuresagainst different productive sectors of the economy. The outcome of these measures willdetermine how close or how far away another debt default may be.



Wells Fargo Securities, LLC Economics Group

Diane Schumaker-Krieg Global Head of Research& Economics

(704) 715-8437(212) 214-5070

[email protected]

John E. Silvia, Ph.D. Chief Economist (704) 374-7034 [email protected]

Mark Vitner Senior Economist (704) 383-5635 [email protected]

Jay Bryson, Ph.D. Global Economist (704) 383-3518 [email protected]

Scott Anderson, Ph.D. Senior Economist (612) 667-9281 [email protected]

Eugenio Aleman, Ph.D. Senior Economist (612) 667-0168 [email protected]

Sam Bullard Economist (704) 383-7372 [email protected]

Anika Khan Economist (704) 715-0575 [email protected]

Azhar Iqbal Econometrician (704) 383-6805 [email protected]

Adam G. York Economist (704) 715-9660 [email protected]

Ed Kashmarek Economist (612) 667-0479 [email protected]

Tim Quinlan Economist (704) 374-4407 [email protected]

Kim Whelan Economic Analyst (704) 715-8457 [email protected]

Yasmine Kamaruddin Economic Analyst (704) 374-2992 [email protected]

Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer

registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and theSecurities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and throughsubsidiaries including, but not limited to, Wells Fargo & Company, Wachovia Bank N.A., Wells Fargo Bank N.A,

Wells Fargo Advisors, LLC, and Wells Fargo Securities International Limited. The information and opinions herein arefor general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nordoes Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person uponany such information or opinions. Such information and opinions are subject to change without notice, are for generalinformation only and are not intended as an offer or solicitation with respect to the purchase or sales of any security oras personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated

banks and is a wholly owned subsidiary of Wells Fargo & Company © 2010 Wells Fargo Securities, LLC.

SECURITIES: NOT FDIC-INSURED NOT BANK-GUARANTEED MAY LOSE VALUE

Does Another Debt Crisis Await Argentina

Documents

Transcript of Does Another Debt Crisis Await Argentina