Argentina Buys Some Breathing Room

But longer-term debt won't cure an ailing economy

Domingo Cavallo was supposed to be the man in Argentina with the finesse to manage Wall Street. But since he started his second stint as his country's Economy Minister on Mar. 20, more than a few people have wondered if he has lost his touch. Instead of reassuring financial institutions that trade Argentina's $128 billion in debt, he has treated them to one tongue-lashing after another. When default rumors surfaced in April, he blamed "young, myopic" analysts for turning investors against the country. On Apr. 22, he disseminated a three-page "Open Letter to the Markets" expressing outrage at the notion Buenos Aires might default. And he repeatedly rejected calls to offer bondholders less-than-full repayment--a so-called "orderly restructuring."

Then, in a surprise move, Cavallo revealed on May 5 that Argentina had cut a deal with seven creditor banks to swap bonds coming due over the next five years for new ones with longer maturities. The government is mum on the details, citing U.S. Securities & Exchange Commission rules, but markets expect the swap to cover about $20 billion of the $54.9 billion maturing by 2006. If current rates hold, debt maturing in, say, 2010, could yield between 15% and 17%, versus the 12.1% that maturity yielded Feb. 1.

BIG SAVINGS. The deal buys breathing room. If the banks--Credit Suisse First Boston, Banco Santander Central Hispano, Banco Galicia, HSBC, J.P. Morgan Chase, Salomon Smith Barney, and Banco Bilbao Vizcaya--tender the full $20 billion, the government will save some $6 billion in principal and interest over the next three years. "Anything that gives investors more security puts Argentina on the right path," says Miguel Kiguel, president of Banco Hipotecario and a former finance secretary.

Security won't come cheap. The banks get a 0.55% commission for placing the bonds plus a windfall in higher interest. Higher rates on the country's benchmark securities will boost the debt burden and raise local borrowing costs, potentially choking the economy. "[The swap] does nothing to improve Argentina's ability to repay its debt--and probably makes things worse in the long run," says Charles W. Calomiris, an economics and finance professor at Columbia University whom Cavallo verbally flogged for saying in public that Argentina should negotiate with creditors to trim its debt to sustainable levels. "Instead of jumping out of a 10-story building," he says, "the government's setting the stage to take a 30-story plunge down the road."

But short-term default was clearly a real possibility, despite Cavallo's tirades, and he had little choice but to make a deal. Those who know him say that the minister, who earned international acclaim in the 1990s for stopping hyperinflation by pegging the peso 1-to-1 to the dollar, badly misjudged his clout with the markets this time around--hence his attempt to bully Wall Street.

It took the intervention of his old friend, David C. Mulford, former U.S. Under Secretary of the Treasury for International Affairs and international chairman of Credit Suisse First Boston, to bring him to the table. Mulford pushed Cavallo to do the deal, according to market sources, after Argentina abruptly canceled a routine $750 million T-bill auction. Mulford wouldn't comment, but Cavallo has said that Mulford initiated the swap.

Barely in time. Cavallo's reconciliation with Wall Street didn't stop Standard & Poor's Corp. from downgrading Argentina's long-term foreign currency debt for the third time in six months, rating it B, the same as Paraguay's, a few days later. In late April, the interest-rate premium investors demanded for Argentina's benchmark FRB Bond exceeded 1,200 basis points over the rate for U.S. Treasuries.

The debt swap was probably the most palatable solution. Other ways out of Argentina's growth-strangling debt trap--abandoning the peg or defaulting--would do far more harm. And the swap should be successful. All the banks involved except CSFB have big operations in Argentina and at least 25% of their local assets in government debt, so they are likely to tender their bonds.

CHEAPER PESO? It's not just Cavallo's handling of the debt problem that has been disappointing. His economic proposals--especially his plan to peg the peso to a dollar-euro basket--have also been erratic. Local banks hold most of the government debt. If Argentine depositors get too uneasy about the overall economy, they may yank money from the banks, which might not be able to sell the new bonds fast enough to cover any shortfall. Indeed, deposits are down 3.3% since Cavallo proposed altering the peso peg, which Argentines fear could become a backdoor devaluation.

The debt swap will likely save Argentina from financial disaster for the near future. Cavallo will soon see, though, if Wall Street likes his medicine. This patient isn't cured by a long shot.

By Joshua Goodman in Buenos Aires

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