Daniel Lacalle

Argentina close to default… again

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Argentina will have to pay investment funds around USD1.3bn after the US Supreme Court’s ruling yesterday, which has rejected the country’s appeal against the funds. After this ruling Argentina’s country risk spiked 135bp to 866bp and the stock market fell 10%.

The Supreme Court rejected without comment the appeal in the Pari Passu case, leaving intact the lower court ruling that  Argentina must pay holdouts if they pay exchange bonds.

This is a victory for the holdouts that have been litigating against Argentina since the 2001 default.

In a national address Monday night, Cristina Fernandez repeatedly vowed not to submit to “extortion,” and said she had working on ways to keep Argentina’s commitments to other creditors despite the threat of losing use of the U.S. financial system.

The next step is for Argentina and the holdouts to go back to lower court to negotiate the payment plan. The risk is that if Argentina forced to pay all up front, all claims by holdouts could be near $15 billion, which is half of Argentine reserves. That means the risk of another default cannot be ruled out.

Argentina has more problems than just paying its debts, although that will be the most urgent problem for the country which has very low reserves (c. $28.0bn, 26% less than a year ago).

The problems of Argentina are well known: Excess public spending, depleting reserves, and massive deficits. Official surplus is accompanied by a fiscal deficit of almost $1 billion annually.

– Recession, with real GDP expected at -2.5% in the second quarter of 2014.

– Massive inflation from current 33% to 37.7% expected for the second quarter of 2014.

– Depletion of reserves.

– Primary deficit at -3% of GDP and negative trade account in 2013 and expected in 2014 and 2015.

Official figures hide an unemployment level that is estimated to be several times higher than the published data, and a heavily subsidized employment as well. According to a study by the Institute for Social Development of Argentina (Idesa), public employment in Argentina grew five times faster than the population in the last fifteen years. The average growth rate of public employment was 5% annually, while population grew at a rate of 1%. Public sector employees have more than doubled in the past ten years. Does that ring a bell? Greece, Spain, Portugal, etc…

The Campora (Kirchner and Kiciloff’s support group) is today the largest employment agency in Argentina.

Who pays for these public employees? Printing money (M2 +20% pa since 2006)… which creates massive inflation (average of 25% pa). A heavily subsidized economy. 5% of GDP are subsidies, a public spend that only goes to pay a hypertrophied political class and to mask the true cost of goods and services at unreasonably low prices without investing in infrastructure. These subsidies try to plug the hole made on citizen pockets by a currency in constant devaluation and by runaway inflation. Official inflation figures are estimated at 9.7% but international analysts, PriceStats, for example, estimate it at 30%.

I still remember a decade ago when I was stranded at the Hotel Alvear in Buenos Aires between mass protests, banking crises and monthly changes of government, a writer commented on the local television that “Argentina had the opportunity to choose between being and pretending, and decided to pretend”. And like all subsidized systems, currency devaluation and hiperinflation generates greater imbalances and ultimately bankrupcy.

The country is suffering from a recession combined with inflation and public spending that was growing at 44% at the beginning of the year, despite cutting social subsidies, which will not allow it to meet its most pressing debt obligations.

After 11 years of the populist Kirchner model, 50% of the labour force earn less than $400/month (according to INDEC)… in the middle of hiperinflation and close to default! 

In 2014 the Argentine public debt maturities total c. USD9.5bn, to which we must add the payment that the Supreme Court of the US has ruled, and an extra amount for the investors who accepted the debt exchange must be paid given that it would trigger a clause by which said holders will see their offers improved if it improves for the other investors, as is the case (according to Ahorro Corporacion).

Furthermore, the Supreme Court ruling stipulates that Argentina will not be able to continue paying most of the creditors if it does not settle up with the investment funds first. Argentina may file an appeal against this decision (it has 25 days to do so).

The Argentina authorities must embark on a sizable fiscal adjustment that takes the peso primary deficit to $10bn in 2014 (from $12bn in 2013) and to $6.4bn in 2015.

Peso debt payments of close to $12bn are assumed to be easily rolled over (held by local banks and public sector) and that the federal government issues peso domestic debt to local banks and Anses for about $2.6bn. In addition, the aggregate provincial financing needs are assumed to be $3bn. Assuming central bank profit transfers of $6.5bn (same as in 2013) and adelantos transitorios of about $4bn, this would mean that money printing to finance the treasury would amount to 2.8% of GDP and another massive 23% increase in base money in 2014 if it is not sterilized by the central bank, according to Barclays.

Argentina has three options:

– Agree on a support package by the IMF, which would unquestionnably stop the lunacy of the populist economic model implemented by Kirchner.

– Pay the bondholders and get support from the markets.

– Try to find US dollar financing outside of the US financial system. Impossible in my view.

The Economy Minister (Axel Kiciloff) speech in congress came as a negative surprise, announcing plans to swap exchange bonds into Argentine law to avoid paying holdouts and avoid the ruling of the US court.

According to Morgan Stanley:

A swap from international into Argentine law likely means  Argentina heading for default, since some may not swap.

The macro implications may be severe: a confidence crisis, fx crash, rising inflation and run on reserves.

Axel Kiciloff, the country’s economy minister wrote a book called “Bringing back Keynes”. He has done so with a vengeance, and destroyed competitiveness and public finances at the same time.

Krugman said in 2008 that Argentina was an “undeniable success”. It has become an undeniable nightmare.

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

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