Would You Lend Money To Argentina?

Its debt is growing alarmingly, and the government may have to take painful action

Daniel Marx, Argentina's Finance Secretary, doesn't stand on ceremony. These days he's trying to promote the government's recently launched samurai bond, a 61.5 billion yen-denominated note being marketed in Japan. So when visitors arrive at Marx's office, they're promptly given Japanese-language handbills titled "How to survive in a market of low returns." (Marx provides translations, too.) For the first time, Argentina is offering the samurai bonds directly to Japanese investors rather than just big money managers. Marx says the draw is Argentina's credibility. The 4.85% coupon-- compared with the measly 1.32% rate Japanese Treasury bonds carry--doesn't hurt either. So far, sales are strong.

But the truth is that Argentina can ill afford to be issuing new bonds in any currency, and its continued credibility with investors is no sure thing. Argentina's economy is stalled, its dollar-based currency peg is being questioned, and the country is sinking under the weight of public debt. One analyst has even discussed the chance of default.

Since 1993, the government's liability has increased by 87%, to $130 billion--nearly 44% of Argentina's gross domestic product. A widening fiscal deficit accounts for much of the problem. In 1993, there was hardly a gap to speak of; last year, it reached $7.1 billion, about 2.5% of GDP, and was pretty much all the candidates talked of during the country's 1999 Presidential campaign.

When he was inaugurated nine months ago, President Fernando De la Rua promised to cut the inefficient social spending and pork-barrel infrastructure projects that constituted policymaking in other administrations. But he hasn't been able to reduce the government's expenses quickly enough to keep up with interest payments that are growing by $1.5 billion annually. This year, Buenos Aires will spend about $9.7 billion to service its debt. That comes to about 20% of Argentina's 2000 budget; it's the second-biggest item after pension payments, and by far the government's fastest-growing expense.

Now the numbers are starting to seriously worry some Wall Street analysts. Last month, Walter T. Molano, head of research at BCP Securities Inc., in Greenwich, Conn., sent a report on Argentina to clients entitled "Anatomy of Default," which describes how Argentina's escalating debt load could take it to the brink. "Argentina is increasingly looking like a pyramid scheme," Molano told BUSINESS WEEK. "If it can only pay off debt through more borrowing, then lenders will stay away."

Already, the country's risk profile is deteriorating. Argentina now pays 40 basis points more than Brazil on sovereign debt; at the beginning of May it was paying 200 points less. And Buenos Aires is paying almost 200 basis points more for its bonds than Mexico. "The debt isn't manageable if the government keeps losing credibility," says Argentine economist Miguel Angel Broda.

BOOSTING CONFIDENCE. Marx, of course, says he's not worried about a Mexican-style financial crisis. For one thing, much of Argentina's foreign-currency debt is medium- and long-term. The average payback time is eight years, he says, and the government took on only $1 billion in short-term debt this year. Plus, De la Rua's administration is close to completing a $17.5 billion borrowing program that will cover payments until early 2001. Meanwhile, Marx says that planned economic reforms will be potent enough to make more dangerous "magic cures," such as default or devaluation, unnecessary.

Still, the Finance Secretary recognizes the importance of keeping up the confidence of international investors and lenders. "The debt load itself isn't too burdensome," says Marx, a former government debt negotiator. "The problem is the dynamics."

And the dynamics are getting a little more complicated. In early September, Economy Minister Jose Luis Machinea acknowledged that the 2001 fiscal deficit would be about $4 billion, well over the target of $2.8 billion (or 1% of GDP) it set with the International Monetary Fund. Machinea said Argentina would have to renegotiate a new goal with the IMF in order to maintain access to $7.2 billion in standby loans. That was after he had admitted in late August that the government would miss its 2000 deficit target.

Of course, one of the reasons that Argentina carries so much debt is that it is a virtuous borrower. Its peso is pegged one-to-one to the U.S. dollar, its markets are open, and it has always honored its obligations. The country's good credit rating has helped make it the largest borrower in the developing world. Argentina has received $1 out of every $7 raised in emerging market bonds sales this year.

If the country is vulnerable to default now, that's mostly because its economy still hasn't come to life after two years of deep recession. Growth in the second quarter was a disappointing 0.9% year-on-year; Latin America's other major economies, Brazil and Mexico, expanded at rates of 4% and 7.6%, respectively. Most analysts now believe that Argentina will grow around 1.5% this year, far slower than the government's original 4% estimate. "[Officials] wrongly assumed that improving conditions in Brazil and the rest of the world would be enough to speed its recovery," says David R. Malpass, chief international economist at Bear Stearns Cos. in New York.

At the same time, the government's reforms haven't done much but anger voters. De la Rua has tried to attain fiscal solvency by raising income taxes and cutting civil servants' salaries, two predictably unpopular moves. Opinion polls show voter confidence at just 17%, as low as it was during the worst of the recession.

It doesn't help matters that some politicians are still making out like bandits. In Formosa, the country's poorest province, legislators earn $14,000 a month, more than U.S. representatives. And a crackdown on tax evasion, which robs the government of $20 billion a year, is in limbo.

No wonder some observers are looking for an easier way to energize the economy and generate more savings. The favorite target these days seems to be the country's currency peg. The system gets credit for taming Argentina's 20,000% inflation after its 1991 introduction. But it is taking a heavy toll on export competitiveness. And it's being blamed for encouraging capital flight and helping Brazil, which has a flexible currency, steal away foreign investment. Former President Carlos Saul Menem, who instituted the currency board, is arguing that Argentina should adopt the dollar as its currency to dispel doubts about the system.

Would You Lend Money to Argentina? (int'l edition)

Some Wall Street analysts think devaluation--and an end to the peg--may be necessary. But devaluing the peso wouldn't really help. Indeed, it would make paying off foreign currency debt even more difficult. Most Argentines, wary of a return to hyperinflation, still believe the currency board's benefits outweigh its costs. And it's not at all certain that the economic boost from dollarization would last more than a few years or reduce the risk of default. "Nobody has ever tried to get off a currency board," says Peter Luxton, director of economic research for Standard & Poor's MMS International in London. "The credibility Argentina would lose would need to be immediately made up for."

That leaves Argentina's government with few options except to get serious about reform. At least De la Rua can take some comfort in the knowledge that it is still early in his term--and voters may have forgotten the bad taste of harsh economic medicine by the time the next election rolls around.