The economic figures are troubling - with private sector estimates deemed more reliable than official government stats. Investors are subscribing to the idea that President Cristina Fernandez de Kirchner is leading an irresponsible government. The nationalization of YPF because of its failure to produce enough domestic oil and gas amid price controls enforced by Kirchner herself, and placing a cap on the amount of personal finances that can leave the country as individuals attempt a desperate escape are some of the nonsensical decisions made. With the fluctuations in GDP (private estimate around 8% in 2010), the fundamentals point to slower growth. A combination of double digit inflation and high interest rates are eating away at productivity, forcing investors to hoard cash in US dollars and seek investments elsewhere across Latin America and the US. Meanwhile, neighboring countries such as Chile, Brazil, Columbia, and Peru are growing with higher levels of foreign direct investment and stronger export deals with China. Argentina is a Latin American outlier which must avoid making the same mistakes of the past.
Argentina: A country built on debt
Financing its survival through bond sales proved to be disastrous for one of Latin America's strongest economies. The 1999-2002 Peso Crisis caused high inflation and the country's poor and working class protested in anger and organized riots outside government buildings. Economists who look back will never forget the uproar as the dictatorship style government covered protesters in tear gas and worked to please bankers behind closed doors. In 2001, Argentina had a record $95B default as the country's 23 provinces financed their operations through bond sales. In 2002, the government defaulted on $100B in bonds and issued replacement bonds which resulted in steep losses for investors. Bondholders sued the federal government to recover full face value. At that time, President Nestor Kirchner was forced to freeze the country's assets in foreign banks. This was supposed to allow the country time to move back to domestic recovery, but the lure of international finances returned.
Newly elected President Cristina Kirchner (former first lady) is continuing this finance scheme. To return to the international debt market, Argentina must present itself as an attractive investment. To do so, the government must tackle the heavy $20B burden in defaulted debt, plus $9B in accumulated interest since 2005. Argentina has not participated in the international debt market since 2001, but they are returning to correct liquidity problems with more bond sales. Economy Minister, Amado Boudou, stated that Argentina will present a final offer to defaulted debt holders on April 14th. To prepare, President Cristina Kirchner has earmarked $6.6 Billion in Central Bank reserves for 2010 debt payments.
The idea is that Argentina will create a debt swap to repay investors from the $20B in defaulted debt. Large banks and hedge funds will receive cash payments at 1/3 value, and receive repayment of discount bonds with a 66.3% reduction. However, small investors such as pension funds in Italy might be left out.This coincides with the familiar structure of bonds - the highest contributors risk the most and therefore receive payments before the other holders.
The idea is that Argentina will create a debt swap to repay investors from the $20B in defaulted debt. Large banks and hedge funds will receive cash payments at 1/3 value, and receive repayment of discount bonds with a 66.3% reduction. However, small investors such as pension funds in Italy might be left out.This coincides with the familiar structure of bonds - the highest contributors risk the most and therefore receive payments before the other holders.
The problem is that Argentina is in a debt trap. By financing short term survival as a country, they are creating more debt through bond sales and relying on a mixture of government growth and external demand for exports (high commodity prices and a weaker currency) to provide hope for a return. The reality is that Argentina is digging a deep fiscal hole, which explains the yearly return to default repayments and bond sales. It's a never ending process of debt that can be reduced if the Argentine government returns to domestic fiscal sanity.
Governors speak out
Several governors realize the risk involved in entering the international debt market without a structural plan. Governor Ricardo Colombi proposed increasing his region's share of taxes on financial transactions. Current President Kirchner shut down this idea, and remained opposed to higher taxes and budget cuts. Cristina Kirchner leads in a socialistic style with rhetoric filled with care for the people, but others who sound the alarm know her true motives. To tell the people of Argentina that no burdens will be placed on them, but then return to destroy the dollars that they work so hard to obtain is quite deceitful. Again, the Peso crisis proved how shady government can be, and the unintended consequences on the poor and working class.
The Strategy
There is opportunity within the complex debt swap. A few years ago, many of these bondholders who will now - hopefully - receive their fair share through debt swaps financed by other countries, received one warrant tied to the official GDP figure for each defaulted bond. GDP warrants gross returns of about 24% yield, and are distributed in annual payments. If the official GDP increases at a higher rate than the government's base case scenario outlined in the warrant, investors will receive payments. These GDP warrants are the most attractive fixed income asset in Argentina. So long as the Argentine government continues spending and bond sales, the government's share of GDP will grow. Export growth should also push GDP higher for 2010.
Governors speak out
Several governors realize the risk involved in entering the international debt market without a structural plan. Governor Ricardo Colombi proposed increasing his region's share of taxes on financial transactions. Current President Kirchner shut down this idea, and remained opposed to higher taxes and budget cuts. Cristina Kirchner leads in a socialistic style with rhetoric filled with care for the people, but others who sound the alarm know her true motives. To tell the people of Argentina that no burdens will be placed on them, but then return to destroy the dollars that they work so hard to obtain is quite deceitful. Again, the Peso crisis proved how shady government can be, and the unintended consequences on the poor and working class.
The Strategy
There is opportunity within the complex debt swap. A few years ago, many of these bondholders who will now - hopefully - receive their fair share through debt swaps financed by other countries, received one warrant tied to the official GDP figure for each defaulted bond. GDP warrants gross returns of about 24% yield, and are distributed in annual payments. If the official GDP increases at a higher rate than the government's base case scenario outlined in the warrant, investors will receive payments. These GDP warrants are the most attractive fixed income asset in Argentina. So long as the Argentine government continues spending and bond sales, the government's share of GDP will grow. Export growth should also push GDP higher for 2010.
Argentina's GDP has experienced 3.37% annual growth, and the economy received a boost from higher commodity prices. From 1993 to present, government spending has accounted for about 20% of GDP. Also, more investment activity through these new bond programs will add to this positive growth. UBS Economist, Vivanco, projects an increase in 4.3% GDP growth in 2010. If this happens, the yield curve will grow, and the next warrant payment in December of 2011 will increase to 24%.
After 2010, expect a slowdown. At this time, private GDP estimates should decline and the government might come to realize that the problems are actually more severe than originally thought. Official estimates should decline to around 3-5% growth as commodity prices ease off its current peak. The lack of investment and inflation levels will surely work to stall significant growth. Letting go of that GDP warrant would be a wise idea at that later time.
For now, Cristina Kirchner and Economy Minister Amado Boudou will begin their roadshow to gain approval form the Security Commissions around the world for their debt swap. Amado expects 60% acceptance. Kirchner recently talked with the US Chamber of Commerce to strengthen investment ties with the US.
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