Uruguay: A Well-Executed Model for Debt Workouts

Its maneuvering to avoid a default in 2002 provides a lesson in how the crisis-prevention process should work

To foreign bondholders still licking their wounds from Argentina's massive 2001 default, the situation in neighboring Uruguay last year had all the earmarks of another disaster. Even though this tiny nation of 3.4 million boasted a solid reputation for repaying its debts, the crisis next door sparked a run on Uruguay's currency and on bank deposits that drained 80% of foreign reserves. Things unraveled so fast that Uruguayans didn't even have time to lament the loss in February, 2002, of the country's coveted investment grade status. By July, protesters filled the streets of Montevideo, demanding President Jorge Batlle's resignation. Clearly, Uruguay was in no position to meet payments coming due on its $10 billion in foreign debts.

But an unusual thing happened on the way to Uruguay's meltdown. Instead of the acrimonious, chaotic confrontation foreign bondholders had come to expect in crisis-ridden emerging markets, Uruguay sucked in its pride and told foreign creditors it needed help. It first secured a $1.5 billion lifeline in mid-2002 from the U.S. Treasury as a stop-gap measure until a new accord could be worked out with the International Monetary Fund. With that in hand, President Batlle and Uruguay's investment banker, Salomon Smith Barney, were able to convince holders of 19 different bond issues denominated in five currencies to accept new terms. "Uruguay shows how the crisis-prevention process should work," says Citigroup Senior Vice-Chairman William Rhodes, a veteran of numerous Latin debt workouts.

Uruguay's rescue was handled so efficiently that many of the deans of global finance are holding it up as a model for defusing future sovereign debt bombs. Uruguayan bond spreads over U.S. Treasuries, a gauge of investor sentiment, have narrowed to around 700 basis points, after peaking at 3,000 in 2002. How did the workout get worked out? After Batlle pushed controversial bank reforms demanded by the U.S. and the IMF through parliament, Uruguayan officials and their Salomon advisors went on a two-week road show to present their case to private bondholders in New York, Tokyo, and other cities. Salomon had experience: It helped Ecuador renegotiate sovereign bonds in 1999, in a process that became a messy fight between the government and foreign investors.

In Uruguay, bondholders were given plenty of warning, and it was made clear that without a deal, default was all but inevitable. When the swap offer was launched on April 10, institutional bondholders were given two choices: They could either stretch out payments on $5.4 billion in bonds for another five years or opt into a new, more liquid bond worth less on the market. A total of 93% of bondholders signed on to one course or the other. "Compared to Ecuador, where Salomon just waltzed in and put a deal on the table, this time they actually listened to us," says a manager of a hedge fund holding Uruguayan bonds.

What was crucial to the bondholders was that they not take a haircut on the principal of the loans. Once that was settled, the rest was a matter of deciding the maturities and interest rates of the new issues. Throughout the process, participants say, the Uruguayan side strove to make the offer as attractive as possible. Says Isaac Alfie, Uruguay's lead debt negotiator, since promoted to Economy & Finance Minister: "Anyone who thought it was just an exercise to save face is dead wrong. Several changes were made that perfected and enriched the offer."

It helped that Uruguay was the only country in Latin America never to default on interest payments during the "Brady-bond" restructurings that bailed out several debt-burdened Latin American nations in the 1980s. "Uruguay was given a second chance because of its tradition and because it acted prudently in a moment of extreme crisis, not because the debt dynamics have improved," says Gabriel Oddone, an economist in Montevideo for consultancy CPA Ferrere Lamaison.

Indeed, it's too soon to declare Uruguay out of the woods. Skeptics fear its refinancing deal, similar to a less investor-friendly one Argentina executed six months before it defaulted, may do little more than delay a crash. The chief difference is that while Argentina was in denial, Uruguay sought out help in advance of its payment crunch. Still, Uruguay's $10 billion debt load is equivalent to about 100% of gross domestic product, one of the highest levels in the developing world. And its small economy remains tied to the fortunes of its ailing neighbors: Growth in 2003 is expected to be nil after a four-year slide. Some are concerned that Uruguay was too soft on investors and could be forced later to renegotiate.

Even so, the level-headed way that Uruguay's crisis was handled may be a template for similar deals. Certainly when future sovereign debt crises arise anywhere in the world, Uruguay will be held up as the little country that could.

By Joshua Goodman in Montevideo with Pete Engardio in New York

    Before it's here, it's on the Bloomberg Terminal.