April 06, 2010

Economics Group

Special Commentary

Eugenio J. Aleman, Senior Economist

Eugenio.J.Aleman@wellsfargo.com ! 1-612-667-0168

Does Another Debt Crisis Await Argentina?

Executive Summary
Argentina has been in the news lately, and when this happens, it is normally not for good reasons.
Once again, investors are worried that Argentina may default on its external debt. This
speculation is a repeat of what happened during 2008 and 2009, and it seems to be more related
to internal political fights than to the current condition of government finances, even though
government finances have continued to deteriorate. This speculation is also related to the fact that
Argentina is still negotiating with holdout bondholders from the 2005 restructuring of its
defaulted external debt. Argentina’s access to the international financing markets has been closed
since it defaulted on its debt in 2001, and some investors holding about $20 billion in defaulted
debt did not accept the government’s debt renegotiation in 2005.
While we do not expect Argentina to default during the next several years, the seeds of a potential
default are being planted today. First, the administration is using stocks to pay for what it owes
instead of relying on its cash flow. Second, the government is tampering with inflation numbers in
order to pay less in interest on some part of its current debt. Third, government expenditures are
growing too fast for fiscal sustainability, especially if the economy does not make a strong
recovery.
Trying to Find Who Is Going to Pay
The country seems to have been pushing hard to finalize its negotiation with the 2005 debt The government
renegotiation holdouts in order to be able to count on the international capital markets in the has been successful
future and lower the cost of financing. Meanwhile, the Fernández-Kirchner administration has in securing sources
been very active in securing other domestic “sources” of government financing over the past of financing.
several years. And so far, it has been successful in achieving those objectives, even as the different
sectors affected by those measures have been up in arms over the government’s advance into the
economy and firms’ hard-earned revenues.
The administration has not stopped at anything to get away with what it wants. The latest episode
was the creation of the Fondo del Bicentenario (Bicentennial Fund, BF) set up to use $6.6 billion
in central bank reserves to help pay for this year’s financing needs. However, the BF started on
the wrong foot, as the central bank president at that time, Martín Redrado, immediately opposed
the transfer of reserves to the government while the political opposition sent the matter to the
courts and several judges intervened by freezing any use of reserves until the judicial process
ended.
The administration won a partial battle against the central bank president and pushed him out of
office, naming a “friendlier” central bank president, Ms. Mercedes Marcó del Pont, who is still in a
precarious position because she has not been confirmed by Congress and concerns are increasing
that she may never be confirmed. At the same time, the administration cancelled the original BF
decree and issued two new ones: one called the Fondo del Desendeudamiento (Deleveraging
Fund, DF), which affects $4.382 billion in reserves for the payment to private lenders, and
another one that is less conflictive that will affect $2.187 billion in reserves for payments to two
international organizations, the World Bank and the Inter-American Development Bank.

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The Argentine Congress finally declared the original Bicentennial Fund null and said that any
other decree that tried to use reserves to pay for debts in the future would also become null.
However, on March 30, 2010 two intermediate courts (appellate courts) freed the reserves
arguing that the lower courts were incorrect in freezing them, and thus the administration seems
to have the upper hand at the time of writing this report. At this point, it seems that the Argentine
political opposition will not try to stop the government through court actions. This means that the
government will probably be able to use the $4.382 billion central bank reserves to pay private
lenders.
The payment of the debt with central bank reserves is the first red flag as the government has
continued to use stocks to pay for government debt instead of using its cash flow. This action runs
the risk of depleting the country’s resources and makes the future financing path unsustainable.
Thus, it is clear that the administration is “selling the Queen’s jewelry” to pay for its ever
increasing government needs.
The government This is not the first time the government has used stocks to pay for its debts. The problems for the
has used stocks of administration started to become self-evident in 2008 when it decided to take over the private
assets to pay for pension fund system. While the administration argued that it was doing just that to “protect” the
some of its future of Argentina’s pensioners, the real reason was that the administration was starting to be
spending rather concerned with either its ability to finance its deficit and/or the cost of financing government
than using cash needs without access to international capital markets. At this time, the administration has taken
flow. over almost $24 billion from the private fund system and has been using that money to pay for
increase government expenditures. This was the second time the administration used a “stock” to
pay for its financing needs. The first time was in 2005 when the administration also used central
bank reserves to pay down its debt with the IMF in an action that was deemed to have been a cry
for the country’s independence from the IMF, which this administration has blamed for all of the
country’s problems during the past 50 years or so.
Figure 1 Figure 2
Argentina Foreign Debt Argentina Nominal GDP Growth
Percent of Nominal GDP Year-over-Year Percent Change
180% 180% 30% 30%
Foreign Debt (Percent of Nominal GDP): 2009 @ 47.9%
160% 160% 25% 25%

140% 140%
20% 20%

120% 120%
15% 15%
100% 100%
10% 10%
80% 80%
5% 5%
60% 60%

0% 0%
40% 40%

20% 20% -5% -5%

Nominal GDP: 2009 @ 10.9%
0% 0% -10% -10%
1993 1995 1997 1999 2001 2003 2005 2007 2009 1994 1996 1998 2000 2002 2004 2006 2008

Source: Argentine Ministry of Economics & Public Finance, IHS Global Insight, and Wells Fargo
Securities, LLC

A Look at the Numbers: Comparison to 2001

The seeds of Although we do not expect a default on the country’s debt anytime soon, the seeds of such an
potential default event are being planted today. As we said before, the Fernández-Kirchner administration has
are being planted been very resourceful in financing its debt payments during the past several years. It is true,
today. however, that the administration has had a very large primary fiscal surplus that has allowed it to
pay its debts easily. However, this is changing at a very fast pace due to the weakness in economic
activity and the strong pace of government expenditures.
While there are many that say that Argentina’s debt situation today is more manageable than
when it defaulted on its debt, this should not be an argument to dismiss the problems the
administration is facing to finance it.

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April 06, 2010 ECONOMICS GROUP

Let’s look at some statistics comparing today’s situation with that of the pre-default. Argentina’s The foreign debt-to-
foreign debt in 2001 was $144 billion, or 54 percent of GDP. Today’s debt is $147 billion, or GDP ratio today is
48 percent of GDP. However, there is a caveat with these numbers, because they do not include similar to what it
the money owed to the holdouts of the 2005 debt restructuring program. If we assume that these was before the last
holdouts get 30 cents on the dollar, today’s debt will increase to $156 billion and about 51 percent default.
of GDP, which puts it close to what it was in 2001. However, at that time, the Argentine peso was
estimated to have been overvalued by approximately 40 percent and the economy had been in
recession for several years, with falling tax revenues. Thus, when the government allowed the
peso to depreciate, debt as a percentage of GDP surged to 152 percent in 2002. Today, the peso is
not overvalued by any standard, and while a relatively large devaluation is not out of the question,
the situation is highly manageable and will probably not deteriorate as it did during the 2001-
2002 crisis.
Figure 3 Figure 4
Argentina Tax Receipts Argentine Consumer Price Index
Year-over-Year Percent Change Year-over-Year Percent Change
50% 50% 14% 14%
Tax Revenue: 2009 @ 13.2%

12% 12%
40% 40%

10% 10%
30% 30%

8% 8%
20% 20%
6% 6%

10% 10%
4% 4%

0% 0%
2% 2%

Consumer Price Index: Feb @ 9.1%

-10% -10% 0% 0%
1993 1995 1997 1999 2001 2003 2005 2007 2009 2004 2005 2006 2007 2008 2009 2010

Source: IHS Global Insight and Wells Fargo Securities, LLC

Furthermore, today’s debt has a very different structure than that of 2001. Back then, 72 percent
of the debt was denominated in U.S. dollars while 19 percent was denominated in euros and only
3 percent was denominated in the local currency. Thus, the devaluation that occurred in 2001
produced a surge in the debt as a percentage of GDP and of interest payments as a percentage of
GDP that pushed the country into default. Today’s debt profile is a bit better, with 41 percent
denominated in U.S. dollars, 24 percent denominated in euros and 28 percent denominated in
Argentine pesos. Furthermore, 55 percent of the debt denominated in Argentine pesos is indexed
to the CER (Coeficiente de Estabilización de Referencia), a measure based on the consumer price
index. And because the government has been underestimating the consumer price index for more
than two years, the cost to the government of this debt has been kept low.
Thus, the tampering with the inflation numbers is the second problem we see creating issues for The government
the government and for the country going forward. While it is very difficult to gauge what has has been tampering
been the “real” level of inflation over the last several years, it is worth noting that labor unions, with the inflation
which are normally pro-government, have been asking for increases in salaries that are close to 25 numbers.
to 30 percent, arguing that workers’ purchasing power has been severely affected by inflation.
This is just a confirmation that the numbers amassed by the statistical institute are way off. But
this is not the worst problem faced by the current administration. The mistrust this tampering has
produced is such that nothing the administration does or publishes is credible. This is taking a big
toll on the economy’s performance, as firms don’t want to invest if they are not going to be able to
recover these investments by selling goods and services at the prices they need to sell them. And
many firms are facing severe pressure from the administration to keep prices of goods and
services sold by those firms down.
This has been all too common for this country since the middle of the last century, with the
government stepping into firms’ territory and disrupting their ability to price their goods. It has

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 Will Argentina Default Again? WELLS FARGO SECURITIES, LLC
April 06, 2010 ECONOMICS GROUP

happened to the energy sector with price controls and all types of limitations to free enterprise; it
has happened in the agricultural and cattle sector, with all sorts of constraints and regulations
that have distorted the allocation of resources within those sectors; it has happened to the private
education sector; it has happened to media outlets, with the breaching of contracts between the
private sector and the government, etc. But the worst part of this story is that this is a road that
has already been traveled—a sort of déjà-vu—several times in the past. Large devaluation of the
currency, debt default, high inflation, hyperinflation, balance of payments crises or a combination
of many of these ailments has plagued this country over the centuries. Thus, while the country
will continue to grow as long as commodity prices remain high and Brazil and China continue to
grow at a fast pace, we are not positive on the prospects for the Argentine economy in the long run
if the administration continues down this destructive path.
At the same time, while interest payments on the debt represented 3.8 percent of GDP before the
crisis, today’s interest payments as a percentage of GDP are close to 1.8 percent. Meanwhile,
interest payments were 21.9 percent of total tax receipts in 2001, whereas they are only 6.5
percent of total tax receipts today.
All of these statistics point in the same direction: while the government’s situation has
deteriorated, the possibility of a default during the next couple of years is very low. The biggest
problem the government is facing today is its reliance on trade taxes and on the inflation tax.
Value-added taxes increased 28 percent on average between 2002 and 2008 while they only
increased 9 percent during 2009. Meanwhile, taxes on trade have grown by 75 percent during the
2002-2008 period but dropped 12 percent during 2009. Thus, it is clear that the revenue side of
government accounts has deteriorated considerably. However, there are signs that this situation
is on the mend, which will help the administration as the year progresses.
While value-added taxes grew by only 9 percent during 2009, they have increased by 22 percent
between December 2009 and February 2010. Meanwhile, taxes on trade dropped 12 percent
during 2009 but increased by 18 percent from December 2009 to February 2010. However, the
problems for the administration are basically related to expenditures and the way it has tried to
settle social issues since coming into power. This is not going to change as long as the Peronist
Party, which is the party of the president, is in power.
Peronist Economics 101
The third problem we see going forward is the surge in government expenditures, which has been
outpacing government revenues and is on an unsustainable path.
The Peronists are known for their populist rhetoric and economic policies and for giving-in to
selected social groups like labor unions, the “piqueteros” 1 movement, etc., in order to keep these
sectors in check. However, the situation is becoming unbearable and too costly for the
administration at a time when fiscal revenues are weak. Thus, we should expect social discontent
to increase during the next several years if the administration cannot get alternative financing for
its debt payments and decides to finally lower government expenditures.
Government This is the root of the administration’s current funding or financing problems. As an example, we
spending is on an can refer to the release of the fiscal results for the second month of this year. In that release, the
unsustainable minister of economics, Amado Boudou, said that the government’s primary fiscal results, that is,
path. the fiscal results without taking into account the payment of interest on its debt, recorded a
surplus of 1.2 billion pesos for a cumulative 2010 result of 2.241 billion pesos. The February
primary fiscal surplus result was 24 percent lower than the one recorded during the second
month of 2009. However, the minister indicated that “had the administration not ‘given’ 410
million pesos from soybean exports tax receipts (what they call “retenciones” or retentions) to the

1The “piqueteros movement” is a group of out-of-work individuals that have been supported by the Peronist
administration through subsidies and are at the beck-and-call of government officials and used to threaten
businesses and other private institutions in the country. They normally form pickets outside anti-
government institutions, block roads or threaten businesses as their form of protest. While some of these
groups have become independent from the government, the large majority of them are pro-government.

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Does Another Debt Crisis Await Argentina? WELLS FARGO SECURITIES, LLC
April 06, 2010 ECONOMICS GROUP

provinces plus 700 million pesos in money spent on subsidies to the poor,” then the surplus
would have been larger than the 1.6 billion surplus recorded in February 2009.
Argentina’s nominal government expenditures have grown by an average of 24 percent since
2003, while nominal GDP grew by an average of 21 percent. In 2009, nominal government
expenditures grew 25 percent, while nominal GDP grew only 11 percent. Meanwhile, real
government expenditures have also grown at a high rate. Real government expenditures grew at
an average of 5.3 percent since 2003, while real GDP grew 7.4 percent during the same period. In
2009, real government expenditures grew 7.2 percent, while the economy grew by only 0.9
percent in real terms. Thus, not only is the government spending as if there was no tomorrow, it is
also spending very inefficiently. This is clear when looking at the prices paid by the government
compared to the prices paid by the rest of the economy.
Conclusion: When to Default? That is the Correct Question.
Even as the administration has been trying to find different ways to pay for this year’s financing
needs, we estimate that the risks for a default are very low in the short to medium term. This is
especially true as the administration has been moving forward to make a final offer to the 2005
holdouts from the 2001 debt default. With the recent SEC approval of the terms of the offer, the
administration can now proceed to try to convince these holdouts to join the club of those that
already took a large haircut. According to the Argentine minister of economics, Amado Boudou,
the holdouts should expect no more than 35 cents on the dollar, that is, a haircut of 65 percent on
their holdings of Argentine debt.
If the holdouts accept this offer from the government, the country will be able to access the
international capital markets once again and the expectation is that it is going to be able to find
financing rates that are close to the single digits, much better than today’s rates of 15 percent to
20 percent. If the administration is able to access international capital markets at lower rates,
then they will be able to extend the day of reckoning to at least as long as the Kirchners remain in
power, which ex-President Nestor Kirchner has indicated to be close to 2020.
After that, the opposition or the right wing of the Peronists will take over and will try to figure out
how to keep the government expenditure party going. If they try to lower government
expenditures, then the social situation will deteriorate very fast and another crisis will ensue. We
do not see this happening in the short run, but it will become a risk especially if strong economic
growth does not resume.
What is difficult to understand is that the Argentine economy has grown by leaps and bounds
since the 2001-2002 crisis, and the government continues to spend as if the crisis continues. The
Argentine economy has grown by a cumulative 52 percent since 2002 and is today much larger
than it was during the days when the Convertibility Law was the law of the land. However, social
and economic marginalization continues to be a serious problem that seems to have no feasible
solution but for the government to continue to spend as if there was no tomorrow.
If the government cannot find more sources of financing in the short- to medium-run, and if it is
not successful in accessing the international capital markets, then we should expect the
administration to recourse to higher inflation tax, devaluation and more confiscatory measures
against different productive sectors of the economy. The outcome of these measures will
determine how close or how far away another debt default may be.

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Wells Fargo Securities, LLC Economics Group

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