A Proposed Debt Deal in Argentina Sparks a Constitutional Crisis

For the better part of a decade, overseas investors have viewed Argentina as a pariah: After a currency collapse in 2001, the country suspended payments on some $95 billion in foreign debt—the largest sovereign default in history. Then in 2005, the government offered creditors, ranging from Italian pensioners and American teachers' unions to Wall Street hedge funds, just 30 cents on the dollar if they agreed to swap their old bonds for new notes. About three-quarters of the debt holders grudgingly accepted the deal.

So it should be good news that Argentine President Cristina Fernández de Kirchner is trying to return to the good graces of the global investment community. In December she said she would set up a fund backed by reserves at the Banco Central de la República Argentina to guarantee future foreign debt payments. She's also preparing to offer the thousands of remaining holders of the older bonds—investors such as the Kansas Cattlemen's Assn., the Nebraska Association of Retired School Personnel, and vulture funds that bought in after the default—another chance to swap them for new notes at the same steep discount offered in 2005. The goal is to restore her government's access to financing and tap into global demand for debt that pays higher yields than U.S. and European treasury bonds.

But in her attempts to mollify investors, la presidenta is facing criticism at home and abroad. The central bank chief refused to hand over the $6.6 billion in reserves Kirchner had requested for the fund, and Congress accused the president of raiding the bank so she can continue to pump up spending. "Right when Argentina should be showing investors how capable and solid its strategy is, the different branches of government are fighting," says Esteban Fernández Medrano, an economist with consultancy Global Source Partners. On Jan. 12, creditors holding out for better compensation on the defaulted bonds persuaded a U.S. judge to freeze Argentine government funds on deposit with the U.S. Federal Reserve.

Kirchner's move has sparked a constitutional crisis. On Jan. 7 she fired Martin Redrado, the Harvard-educated head of the central bank, and tried to replace him with a deputy more amenable to her plan. The next day a judge ordered Redrado reinstated, arguing that only Congress can remove him. Congress, in recess until March for the Southern Hemisphere summer holidays, is considering an emergency session to resolve the dispute.

Kirchner has lavished billions of dollars on subsidies for food, fuel, and electricity, sending state expenditures up by some 30% annually since she took office two years ago. The problem is, tax revenues have been rising just 12% annually, so a comfortable fiscal surplus has become a deficit equivalent to 2.5% of gross domestic product over the past two years. To make up the shortfall, Kirchner tried in 2008 to raise export taxes sharply on soybeans and other grains. That led to a four-month standoff with farmers before she backed off. Later that year she nationalized some $30 billion in private pension funds, adding the resources to the Treasury and forcing millions of Argentines to join the government's pay-as-you-go social security system.

SHORT MEMORIES

Such moves contributed to the defeat of Kirchner's Peronist party in last year's mid-term elections. With a presidential vote looming in 2011, Kirchner is eager to shore up support. "What we really have here is a politically weakened government that's desperate to get funds to keep spending," says Daniel Kerner, an analyst with political risk consultancy Eurasia Group.

Even if she manages to win her battle with the central bank, some bondholders may shun the swap—and present more legal challenges to Argentina's efforts to raise funds internationally. But others will be eager to collect some interest on their long-defaulted bonds. If Kirchner manages to persuade the bulk of the holdouts to go along with the debt swap, plenty of international investors in search of high returns are likely to find their way back to Buenos Aires. "One lesson in emerging markets is that memories are short," says Ignacio Sosa, a portfolio manager for Vorás Capital Management. "If the yield is attractive enough, people will invest in Argentina again."

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