Cry for the bondholders – or for Argentina?

31st July 2014

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Argentina has defaulted on its sovereign debt for the second time in thirteen years.  But should investors be crying for a nation that was once in the world’s top ten for wealth or taking a well-flagged event in their stride?

The default occurred as markets opened this morning in Buenos Aires – late morning UK time – following the collapse of last ditch talks between the government and its creditors, dubbed by Axel Kicillof, minister of economy for the South American nation, as “vulture funds”.  These were demanding a full payment on some £770bn worth of bonds they had acquired even though Argentina does not appear to have the money to meet that debt . Yesterday Argentina missed a scheduled $539m (£320m) interest payment, triggering the failure. .

Kicillof is adamant that “the government would not sign any commitment to compromise the future of Argentina.”  But he added: “Argentina would respect the parameters of the law.”

But so far, reaction from investors has been muted despite Standard & Poor’s having already placed the country’s credit rating on “selective default” and other bondholders now having an automatic claim to the repayment of their outstanding loans – estimated to be around £12bn. It has so far been viewed as a domestic matter for Argentina with little potential for contagion.

The FTSE index of leading UK shares was unaffected with market participants arguing that Argentina is now such a minor player, responsible for just two per cent of emerging market debt and that, in any case, there are far bigger problems in handing the recovery from the developed world’s biggest financial crash for 80 years.  It is seen as small beer compared with managing eurozone problems or the far more substantial worries building up over Chinese debt. . Few UK funds have more than minor holdings in Argentina – because of a long history of previous problems – while the nation is seen as semi-detached from the world economic system. . And analysts stress that the default has been expected for some months so those affected will have had time to reconsider and rebuild positions.

Steve Ellis, portfolio manager for the Fidelity Emerging Market Debt fund, said: “We expect contagion to other markets to be fairly limited. This is a highly technical legal case and a selective default. However, there will be remaining risks around a longer term default which would have negative impacts on the Argentine economy.”

In any case, what is seen as a technical and highly legalistic dispute between bondholders and the Argentina government will not have any similar effects to the country’s economic meltdown in 2001-02, when savers’ accounts were frozen to stop a run on the banks and street demonstrations led to substantial loss of life.

But court appointed mediator Daniel Pollack said that default is “is not a mere ‘technical’ condition, but “rather a real and painful event that will hurt real people, including Argentine citizens, exchange bondholders and the oldout investors”. The “hold-outs” are US hedge funds which bought Argentinean debt for a few cents on the dollar in the wake of the last crisis in 2001. They “held out” against restructuring proposals that others accepted. But due to their legal action, other bondholders cannot be paid.

For the moment, bond insurance rates on Argentinean paper have eased after rising substantially while interest rates on long dated bonds remain well below their June highs when they hit 12 per cent.

Longer term, this could affect other emerging market bonds – the domino effect – or the crisis could drive a further nail into the rating agencies’  coffins.  Already under fire for their role (or non-role) in the 2008 crash, Kicillof now says:. “Who believes in the rating agencies? Why didn’t they warn the owners of mortgages in 2008 if they know so much about risk?”  If they turn out again to be merely messengers of news already disclosed, their own ratings could hit the slippery slope.

 

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