Tuesday, June 17, 2014

Argentina: Update--After Monday's High Court Decision, Standard and Poor's Declares Argentina CCC-, Potentially "Selective Default"

According to The Latin American Tribune, after the US Supreme Court declined to hear an appeal by the Government of the Republic of Argentina of a lower court decision that ruled in favor of plaintiffs against Argentina, the High Court's decision raises the risk of payment interruptions on the foreign currency debt Argentina owes to bondholders under New York law. 

Subsequently, today (June 17), Standard and Poor's credit rating agency lowered Argentina's to CCC-.

The outlook on the long-term ratings is negative based on the potential for a payment interruption or a distressed debt exchange.

Accordingly, the downgrade reflects the heightened risk of default on foreign currency debt following a recent decision by the US Supreme Court not to hear the Argentine government's appeal against a previous decision by the US Second Circuit Court of Appeals in favor of plaintiffs against the sovereign. 

On Aug. 23, 2013, the US Second Circuit Court of Appeals upheld the ruling of a district court in New York in favor of the plaintiffs against Argentina. 

COMMENT: In particular, the High Court said in its 7-1 decision..."we think that the Argentine government has limited capacity to pay the plaintiff creditors while servicing its current debt."

The true reality is that under President Fernández and formerly her husband, Nestor Kirchner, Argentina has spent money like water with few restraints.

I hate to say it, but the High Court's ruling may well force Fernández to budget for national expenditures. 

Under the High Court's order, Argentina must hand over $907 million to the plaintiffs before June 30, 2014, or lose the ability to use the US financial system to pay an equal amount to holders of other Argentine bonds. 

President Fernández said the total owed, including interest, would be US$1.5 billion. 

Paying the US court could mean defaulting on the vast majority of the country's performing debts, which are held by bondholders who agreed previously to provide debt relief that enabled Argentina to rebound from its economic crisis of 2001.

Fernández said she has experts working on ways to avoid such a default and keep Argentina's promises to pay those bondholders. Yet, she added, her government will not make the court-ordered payments to NML Capital Ltd. and other investors she characterized as "vulture funds."

Although the Argentine President's rhetoric may amount to "saber-rattling," she may have no other option but to make court-ordered payments to NML Capital, regardless of how repugnant she finds doing so. 

The markets had expected Fernández to take a very hard stance, which could be brutal on the internal Argentine That being said, the real repercussions is on the country's being able to function internationally, particularly in the US marketplace.

Argentine stocks plunged as economists, analysts and opposition politicians practically begged her to comply.

The justices not only rejected Argentina's appeal without comment--they also ruled 7-1 that bondholders could force Argentina to reveal where it owns property worldwide. That could make it easier to collect on other debts that have gone unpaid since Argentina's economy collapsed.

Justice Antonin Scalia wrote that US federal law offers no shield to Argentina's assets. Justice Ruth Bader Ginsburg worried that this could expose even its embassies and military ships to being subject to seizure if the government doesn't pay. 

Bowing to the US courts would force Fernández to betray a pillar of the government that she and her late husband and predecessor, Nestor Kirchner, have led since he won the presidency in 2003: That Argentina must maintain its sovereignty and economic independence at any cost. 

Paying off the lawsuit winners in the way the courts have ordered also would encourage a long line of other creditors to seek similar recourse. Fernández said Monday night those creditors together hold $15 billion in defaulted debt or more than half the Central Bank's remaining foreign reserves, and that paying it all immediately in cash "is not only absurd, but impossible."

Nevertheless, unless Argentina begins to function as if it were a banana republic, it may be forced to play ball with Washington. 

Refusing to comply could win applause from her core supporters, because paying the plaintiffs 100% plus interest in cash would mean sacrificing the subsidies and populist programs that enabled her to win re-election by a landslide.

Argentina's Merval stock index dropped 11% after the court decision, its largest one-day loss in more than six months.   

Share prices for the state-run YPF energy company fell nearly 13% while the Edenor electricity utility plummeted 20%. The cost of insuring Argentine bonds against default soared, and the value of Argentina's currency plunged to 12 pesos to the dollar on the black market, implying a 33% loss to anyone needing to buy foreign currency legally.

Argentine analysts warned about the consequences of not complying with the US courts.

Fernández will pay a steep political price by paying off the winners, but doing so will lower Argentina's country risk, restore foreign reserves and prevent the recession from worsening, said Miguel Kiguel, a former deputy finance minister and World Bank economist in the 1990s who now runs the Econviews consulting firm.

"The Argentine government could attempt to maintain payments on its currently performing debt through a mooted debt exchange, it could possibly tender for the 2005 and 2010 restructured bonds in an exchange that could replicate tenor, amount, and coupon but change the governing law and jurisdiction of payment to Argentina."

The government already uses a variety of exchange controls, and there is a disparity between the official and parallel market exchange rates. 

Standard and Poor's CCC- assessment reflects the risk that the government could further tighten its exchange control regime to the extent that it impairs the ability of the private sector to service its foreign currency debt.

The negative outlook reflects the likelihood of a further downgrade based on possible payment interruptions or the announcement of what they could consider a distressed debt exchange. 

"Either a payment interruption or a distressed debt exchange would lead us to lower our rating on Argentina to SD, indicating "selective default," Standard and Poor's said.