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Does Another Debt Crisis Await Argentina

Does Another Debt Crisis Await Argentina

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This report is available on wellsfargo.com/research and on Bloomberg WFEC
 April 06, 2010
 Economics Group
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. Thisspeculation is a repeat of what happened during 2008 and 2009, and it seems to be more relatedto internal political fights than to the current condition of government finances, even thoughgovernment 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 itsdefaulted external debt. Argentina’s access to the international financing markets has been closedsince it defaulted on its debt in 2001, and some investors holding about $20 billion in defaulteddebt 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 potentialdefault are being planted today. First, the administration is using stocks to pay for what it owesinstead of relying on its cash flow. Second, the government is tampering with inflation numbers inorder to pay less in interest on some part of its current debt. Third, government expenditures aregrowing too fast for fiscal sustainability, especially if the economy does not make a strongrecovery.
Trying to Find Who Is Going to Pay 
The country seems to have been pushing hard to finalize its negotiation with the 2005 debtrenegotiation holdouts in order to be able to count on the international capital markets in thefuture and lower the cost of financing. Meanwhile, the Fernández-Kirchner administration has been very active in securing other domestic “sources” of government financing over the pastseveral years. And so far, it has been successful in achieving those objectives, even as the differentsectors affected by those measures have been up in arms over the government’s advance into theeconomy 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 billionin central bank reserves to help pay for this year’s financing needs. However, the BF started onthe wrong foot, as the central bank president at that time, Martín Redrado, immediately opposedthe transfer of reserves to the government while the political opposition sent the matter to thecourts and several judges intervened by freezing any use of reserves until the judicial processended.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 aprecarious position because she has not been confirmed by Congress and concerns are increasingthat she may never be confirmed. At the same time, the administration cancelled the original BFdecree and issued two new ones: one called the Fondo del Desendeudamiento (DeleveragingFund, DF), which affects $4.382 billion in reserves for the payment to private lenders, andanother one that is less conflictive that will affect $2.187 billion in reserves for payments to twointernational organizations, the World Bank and the Inter-American Development Bank.
Special Commentary 
Eugenio J. Aleman, Senior Economist
Eugenio.J.Aleman@wellsfargo.com
!
1-612-667-0168
Does Another Debt Crisis Await Argentina?
The government has been successful in securing sourcesof financing.
 
 Will Argentina Default Again? WELLS FARGO SECURITIES, LLC April 06, 2010
 
ECONOMICS GROUP
 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 reservesarguing that the lower courts were incorrect in freezing them, and thus the administration seemsto have the upper hand at the time of writing this report. At this point, it seems that the Argentinepolitical opposition will not try to stop the government through court actions. This means that thegovernment will probably be able to use the $4.382 billion central bank reserves to pay privatelenders.The payment of the debt with central bank reserves is the first red flag as the government hascontinued to use stocks to pay for government debt instead of using its cash flow. This action runsthe 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 everincreasing government needs.This is not the first time the government has used stocks to pay for its debts. The problems for theadministration started to become self-evident in 2008 when it decided to take over the privatepension fund system. While the administration argued that it was doing just that to “protect” thefuture of Argentina’s pensioners, the real reason was that the administration was starting to beconcerned with either its ability to finance its deficit and/or the cost of financing governmentneeds without access to international capital markets. At this time, the administration has takenover almost $24 billion from the private fund system and has been using that money to pay forincrease government expenditures. This was the second time the administration used a “stock” topay 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 thecountry’s problems during the past 50 years or so.
The government  has used stocks of assets to pay for some of itsspending rather than using cash flow.
Figure 1
Argentina Foreign Debt
Percent of Nominal GDP0%20%40%60%80%100%120%140%160%180%1993199519971999200120032005200720090%20%40%60%80%100%120%140%160%180%Foreign Debt (Percent of Nominal GDP): 2009 @ 47.9%
Figure 2
Argentina Nominal GDP Growth
Year-over-Year Percent Change-10%-5%0%5%10%15%20%25%30%19941996199820002002200420062008-10%-5%0%5%10%15%20%25%30%Nominal GDP: 2009 @ 10.9%
Source: Argentine Ministry of Economics & Public Finance, IHS Global Insight, and Wells FargoSecurities, LLC
 A Look at the Numbers: Comparison to 2001
 Although we do not expect a default on the country’s debt anytime soon, the seeds of such anevent are being planted today. As we said before, the Fernández-Kirchner administration has been very resourceful in financing its debt payments during the past several years. It is true,however, that the administration has had a very large primary fiscal surplus that has allowed it topay its debts easily. However, this is changing at a very fast pace due to the weakness in economicactivity and the strong pace of government expenditures.
The seeds of  potential default are being planted today.
 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 theadministration is facing to finance it.2
 
Does Another Debt Crisis Await Argentina?
 
 WELLS FARGO SECURITIES, LLC April 06, 2010
 
ECONOMICS GROUP
 3Let’s look at some statistics comparing today’s situation with that of the pre-default. Argentina’sforeign debt in 2001 was $144 billion, or 54 percent of GDP. Today’s debt is $147 billion, or48 percent of GDP. However, there is a caveat with these numbers, because they do not includethe money owed to the holdouts of the 2005 debt restructuring program. If we assume that theseholdouts get 30 cents on the dollar, today’s debt will increase to $156 billion and about 51 percentof GDP, which puts it close to what it was in 2001. However, at that time, the Argentine peso wasestimated to have been overvalued by approximately 40 percent and the economy had been inrecession for several years, with falling tax revenues. Thus, when the government allowed thepeso to depreciate, debt as a percentage of GDP surged to 152 percent in 2002. Today, the peso isnot 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
Argentina Tax Receipts
Year-over-Year Percent Change-10%0%10%20%30%40%50%199319951997199920012003200520072009-10%0%10%20%30%40%50%Tax Revenue: 2009 @ 13.2%
Figure 4
Argentine Consumer Price Index
Year-over-Year Percent Change0%2%4%6%8%10%12%14%20042005200620072008200920100%2%4%6%8%10%12%14%Consumer Price Index: Feb @ 9.1%
 
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 percentof 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 2001produced 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 percentdenominated 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 indexedto the CER (Coeficiente de Estabilización de Referencia), a measure based on the consumer priceindex. And because the government has been underestimating the consumer price index for morethan 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 forthe government and for the country going forward. While it is very difficult to gauge what has been the “real” level of inflation over the last several years, it is worth noting that labor unions, which are normally pro-government, have been asking for increases in salaries that are close to 25to 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. Butthis is not the worst problem faced by the current administration. The mistrust this tampering hasproduced is such that nothing the administration does or publishes is credible. This is taking a bigtoll on the economy’s performance, as firms don’t want to invest if they are not going to be able torecover these investments by selling goods and services at the prices they need to sell them. Andmany firms are facing severe pressure from the administration to keep prices of goods andservices sold by those firms down.This has been all too common for this country since the middle of the last century, with thegovernment stepping into firms’ territory and disrupting their ability to price their goods. It has
The foreign debt-to-GDP ratio today issimilar to what it was before the last default.The government  has been tamperingwith the inflationnumbers.

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