Argentina: Argentina’s Impressive Economic Recovery And The Debt Swap

The Government of Argentina and particularly its Ministry of Economy could not be happier with not only the result of the debt swap of the Argentine debt but with the overall state of the economy. The bondholders that did not participate of the exchange could not be more disappointed.

But a long legal battle is awaiting them and Argentina. Likewise, the raise of the Federal Reserve interest rate in the United States is threatening emerging markets.

Nevertheless, for a country that only two years ago defaulted and fell into one of the most difficult crisis of its history the overall economic situation looks promising. Today, the situation has changed 180 degrees: a) the value of assets (real estate, industrial, farms, etc.) is higher than during the convertibility law in dollar terms; b) bank deposits are at record levels, c) vacation occupancy has been over the limit, d) consumption is booming, e) production is back to the best years during the economic growth in the 90’s, f) revenues from exports increased. By word of mouth Argentina has also become one of the most popular tourist points of destination in the world. Those that have visited the country in 2004 did not return disappointed, much to the contrary they came back impressed by the quality and pace of living that the country is presently offering, a quality of life that the Argentineans are also enjoying.

The pessimists and almost all analysts predicted that the offer that the Ministry of Economy of Argentina presented at the meeting of the IMF in Dubai more than a year ago was going to fail. The end result: 76.15 % of the bondholders accepted the largest discount exchange proposal ever in modern history. We may not like what happened or the Government’s attitude but it has been an impressive success.

Of course, there are many other issues that Argentina will have to resolve in addition to the debt. Those with experience in Argentine history know that crisis have been recurrent in the country every 10-12 years. But things may be different today.

The pessimists still have hopes that their predictions will come true. They argue that:

1. consumption will slow down because the 2003 and 2004 recovery was not more than a revamp due to more than five years of recession,
2. that Kirchner will fight with other leaders of the peronist party (particularly Duhalde) and will loose power with the unavoidable consequence of becoming a lame duck by the end of its third year as President,
3. that Argentina still needs massive inflow of foreign capital and fresh money from the multilateral organizations to sustain growth, and that such money will not be available,
4. that there are structural reforms very much needed to convert any plan in a sustainable program,
5. the arrogant attitude of the Government will isolate Argentina from the IMF and the G7 and,
6. inflow of genuine foreign capital necessary to sustain growth will not come.

Now, what will happen if they are wrong? Which will be the situation if: a) the IMF becomes more flexible and extend the payment terms of the debt to make it feasible for Argentina to meet its commitments, b) local credit becomes available at normal rates, c) consumption continues to grow as well as production, d) the value of the peso follows the fall of the dollar and therefore Argentine exports continue to benefit of its competitive advantage, e) commodities prices start rising again and f) by comparison the conditions of the financial world markets make of Argentina an attractive place for investments?

I believe that there are clear probabilities that Argentina will resolve successfully some of the pending issues that critics have enumerated as cornerstones for a true recovery because precisely international political and market conditions will favor Argentina.

Let me describe some of the structural issues that Argentina has to resolve and which are still pending:

The Government has already changed the composition of the Supreme Court. In general terms we may say that the new members are individuals with considerable judicial experience and honest track record, though certainly with a more liberal center left ideology than before.

The new composition of the Supreme Court will also play an important role in the Government objective of impeding the enforcement of potential negative awards in the International Center for Settlement of Investment Disputes (ICSID). See article published in Mondaq.com on 21 December, 2004, titled: "Argentina: ICSID Arbitration and BITs Challenged By the Argentine Government", by Carlos E. Alfaro.

Notwithstanding corruption at lower court level is still an issue, public scrutiny has become more intense and as a result several judges have been impeached. As to security issues public pressure has also triggered a profound reform in the police force and therefore a remarkable improvement in security.

The main structural problem in Argentina is that the Peronist Party by far controls the political agenda and has no credible opposition. This outright control of the politics of the country by only one party is not healthy and is part of the structural problems for the future.

In the House of Representatives they control 129 seats out of 257. The second majority party, the Radical Party only has 44 seats followed by a new party ARI (center left) that has 10 seats.

In the Senate the Peronist Party has 41 seats out of 71 followed by the Radical Party with a distant 14 seats. The rest of the seats are divided among primarily 12 provincial parties. ARI has no representatives in the Senate.

These numbers reveal that with the exception of the Peronist and the Radical Party, there are no other parties with national presence, with an organization or credible leaders in the Provinces.

In October there will be elections for the renewal of one third of the House of Representatives and the seats in the Senate of eight provinces. Unfortunately, the political battle will be centered only within the peronist party which is divided among many sectors.

The election is crucial for President Kirchner and his followers because it will determine if he becomes a prisoner of his own party or succeed in placing his candidates in the ballots. The most likely move for the President will be to reach an agreement with the opposition within his party and avoid dividing the votes. As far as today he has tried to ally members of other political parties with his followers but has failed. If the peronist party presents a united list of candidates they will win most of the elections. Kirchner buoyant with the success of the debt swap will make of these elections a referendum of its policies.

3. Payment of the new debt and holdouts:

Argentina closed its $103 billion Private Debt restructuring offer on Feb. 25 and announced a final acceptance rate of 76.15% on March 18.

Argentina's $103 billion debt has been converted into $35.251 billion of restructured debt. Of that amount, $15 billion will be issued in par bonds, $11.909 billion in discount bonds and $8.342 billion in quasi-par bonds. Argentina will issue the new securities on April 1.

Another positive aspect is that the debt has been extended until the year 2046 at a lower interest rate and part of it in pesos. According to government figures, 37% of the country's total debt load will be in pesos after the new bonds are issued, compared with 3% in December 2001.

At the time of the restructuring, the Argentine government took actions to convince creditors that its offer was the final one, including passing a law prohibiting the re-opening of the deal. The closer we get to the October elections more difficult it will become for the Government to surrender to the pressure of reopening the swap opportunity.

Some of the funds with bond positions are seeking to attach the old bonds exchanged deposited with Bank of New York, the institution that acted as a trustee. Technically the bonds still belong to the private individuals or institutions that enter into the exchange. The trustee has immunity. But even if such a judicial action is not likely to proceeding it produces uncertainties and may be used to negotiate other judicial decisions.

The Government still has to make payments this year of 12 billion in principal and interest to international financial institutions and between 2005 and 2010 it will have to pay from $70 to 80 billions dollars.

Argentina must then renegotiate with the multilaterals its payment obligations and obtain better financial terms. The IMF in order to renegotiate has demanded:

1. a higher fiscal surplus,
2. closing of negotiations of the Concessions,
3. the enactment of certain federal laws, such as the Federal Tax Co-participation, and other measures called "Structural Political Reforms".

Though some people predict tough negotiations Argentina is in a more solid position than it was a few years ago, after all, it has paid 100% of its debt with the IMF and it is not in an urgent need of fresh money.

Likewise, after the restructuring the World Bank has liberated substantial amounts of money for infrastructure development (roads, water sewage, etc.) that were suspended during the crisis. This is a sign that pessimists are ignoring.

The Government has to renegotiate 49 agreements. Some of them are already in advanced negotiations and it is expected that 35 will be concluded by the end of this year. The Government has required the concessionaires to withdraw their claims before ICSID as a condition for the renegotiation. Gas Natural Ban has already announced that as a result of the negotiations with the Government is withdrawing their claim before ICSID.

Tariffs, committed investments, debts, and judicial suits are all pending issues that must be renegotiated. In the already closed negotiations -about 12- the government has already authorized tariff increases, i.e.: in Gas, the Government offered a 15% increase, in Water between 16 and 20%. The impact of these increases in the inflation rate and salary adjustments remains to be seen.

6. Exchange rate and the dollar:

The exchange rate is a critical variable for the competitiveness of Argentine products but the Central Bank must print money to absorb the excess of dollars in the market and keep its value high. The Government wants -no matter what- a competitive low peso, and will intervene as necessary through institutions like Banco Nacion (a national owned bank) to maintain the present rate.

The inflationary effect of buying dollars with new printed money can be compensated with operations in the open market like the offering of new treasury bills (Lebacs) to withdraw pesos from the market creating an opportunity for the inflow of speculative short term investments.

Notwithstanding the low value of the peso, it is estimated that exports will grow only 4% and imports 20% as a result of the increase in consumption and in industrial activity.

7. Inflation:

Inflation will not only be closely associated with the increase in the M1 (by the printing of new money by the Central Bank) but also by:

1. the increase in tariffs to be renegotiated with the Concessionaires,
2. the salary pressures in an election year,
3. the increase of prices as an undesired effect of tourism,
4. It is also observed a strong pressure from the public service sector and the producers of consumer products to revalue its prices, which will take them to higher levels than those in the years 2003/04.

President Kirchner has adopted a tough stance against companies increasing prices (i.e. outright boycott against Shell gas stations) but on the other hand his Government has reached an agreement with meat producers and supermarkets to reduce prices. Other similar agreements will follow. These measures of course have only a temporary effect and have generally failed in the past but it will defuse a sudden spiral effect during 2005 and allow the Government time to study other measures.

Some specialists says that the increase in real salary will come in hand with domestic productivity and internal economic activity, others, say that the salaries will revalue with investments that generate employment. This is the position adopted by the Ministry of Economy who has said that he opposes a system of adjustment of salaries by inflation rates proposed by the unions.

It remains to be seen if the Government resists the pressure of the unions in an election year.

A sustainable recovery requires a tax reform to eliminate distortion in the tax system, increase Compliance and eliminate tax evasion as well as "employment not registered".

Argentina has a withholding tax on exports that ranges from 25% to 45% and an income tax of 35%. There is no withholding on the payment of dividends.

It is very unlikely that the Government will eliminate or reduce for example the withholding taxes on exports. A low peso value and the withholding go hand by hand. It is the corner stone of this economic program. The Government with the withholding is at the same time protecting the internal market and compensating the benefits of a low peso for the exporting sector, a benefit that other sectors of the society do not receive.

The withholding is also an important / crucial source of revenue for the Federal Government – The funds collected do not have to be shared with the Provinces, like the income tax.

Certainly the President of Argentina has a controversial style and its Ministry of Economy is a tough negotiator. But perhaps the circumstances in which Argentina is involved require this kind of leadership. Once the main issues have been resolved certainly such style will be counterproductive. But while the main political and economic issues are still unresolved, like the renegotiation of the concessions contracts, the medicine applied may prove to be successful. Likewise, Government revenues are at its highest level which will allow it to develop infrastructure projects and further reduce unemployment. Consumption will continue to grow as a result of this factor as well as the level of economic activity (GDP growth in January was of 9.1% and it is estimated to be above 7% in the whole year).

The success in the debt swap has consolidated the power of the President and has triggered a stabilizing effect on the economic program. The speculative changes in the bond market as a result of the Federal Reserve rate increases will not slow down this process.