Deeper Argentine Default Pain Looms as Cash Concerns Grow

When Argentina defaulted last month, it was a long-standing legal dispute that tripped the government up, not a shortage of cash. Now, though, as the nation sinks deeper into recession, Bank of America Corp. and Jefferies Group LLC are warning the money could soon start running out too.

The distinction between the two events is crucial for bondholders. It’s one thing for an issuer to get entangled in a legal squabble that temporarily blocks debt payments. It’s another thing to not have the cash. While Argentina’s benchmark bonds traded yesterday at 79.9 cents on the dollar, four cents above their five-year average, Jefferies estimates they could plunge to 60 cents if the default morphs into a capacity-to-pay problem.

“Once international reserves start to slide or foreign-exchange weakness accelerates, that should negatively impact bonds,” Siobhan Morden, the head of Latin America fixed-income strategy at Jefferies, said yesterday. “Unwillingness to pay may become inability to pay.”

Morden predicts those reserves, which the country in part uses to service foreign debt, may fall to an eight-year low of $22 billion by year-end from $28.6 billion now if the legal standoff preventing bond payments drags on and stirs capital flight from the country. Bank of America predicts they will drop to $25.4 billion by year-end if the default isn’t remedied.

‘Tight Margin’

So-called net liquid reserves, which exclude assets that can’t be readily deployed to pay debt, will fall to about $8.8 billion, less than the roughly $10 billion that will be needed next year for foreign debt payments, Bank of America said. The measure excludes dollar deposits held at local banks and loans from multilateral lending institutions as well as special drawing rights from the International Monetary Fund and gold.

“It’s a very tight margin” between the country’s net liquid reserves and how much debt it has coming due, Marcos Buscaglia, the chief Latin America economist at Bank of America, said in an interview.

Argentina slipped into default last month when a New York court blocked a $539 million interest payment on new bonds because President Cristina Fernandez de Kirchner didn’t simultaneously pay back creditors who held old bonds dating back to its 2001 default. A U.S. appeals court two years ago awarded full repayment to defaulted bondholders led by Elliott Management Corp., who refused to accept terms of the country’s debt restructuring. Argentina refuses to comply with that ruling.

Capital Flight

Argentina has been shut out of international capital markets since the 2001 default, straining reserves that the country has relied on since 2010 to cover debt payments. Fernandez’s plan to circumvent a U.S. judge’s order by paying foreign bonds through local banks is spurring concern that Argentina won’t resolve the default this year. Prolonging it would quicken the drop in reserves by reducing foreign investment and prompting capital flight.

Economy Ministry press official Jesica Rey didn’t respond to an e-mail seeking comment.

In the week after Aug. 19, when the South American nation disclosed the plan to reroute foreign bond payments through local banks, central-bank reserves fell $172 million to $28.7 billion, the biggest decline in a month. That’s down 46 percent from a record $52.6 billion in January 2011.

Peso Decline

The peso has slumped this month as some Argentines pulled money out of the country after the default. It’s weakened 2.3 percent to 8.4044 per U.S. dollar in the official market and plunged to a record low 14.38 per dollar in the black market. The peso is down 22 percent this year, the worst performer among emerging-market currencies.

Cabinet Chief Jorge Capitanich today said the government won’t devalue the peso, and blamed the weakening of the currency to “speculative attacks” by holdout creditors. So-called vulture funds, or holders of defaulted bonds suing for repayment, and traders in the illegal currency market are causing the peso to decline, he said.

Goldman Sachs Group Inc. and JPMorgan Chase & Co. each have estimated that total reserves will drop to $24 billion by year-end.

“Argentina isn’t looking for a solution in the short term to the holdouts issue,” Mauro Roca, an economist at Goldman Sachs, said Aug. 25. “This means there won’t be external financing, and devaluation expectations will also put pressure on reserves.”

While concern mounts the slide in reserves undermines the country’s debt-payment capacity, bond prices show investors are betting the default will be cured.

The average price for government bonds in the 30 days after a missed payment is about 26 cents, according to Moody’s Investors Service.

Debt Deal

Argentina’s 2033 bonds are trading at more than three times that level partly because investors are speculating that the country will be able to reverse the default, which would allow bond payments to resume, according to Tom Mullen, a partner at TWM Capital in Westport, Connecticut, which owns the restructured bonds. At that point, the country probably would regain its ability to borrow in international markets.

“The bet is a resolution with Elliott” in the first quarter, Mullen said.

Dollar Inflows

Increased dollar inflows from curing the default would alleviate Argentina’s debt burden next year, which will almost double as $5.9 billion on its Boden 2015 bonds come due. An additional drain on central-bank reserves could come from the province and the city of Buenos Aires, which have $1.5 billion of bonds due next year.

The Argentine treasury also uses transfers from the central bank to cover the government’s budget deficit. In June alone, the budget gap was 16.7 billion pesos ($2 billion), quadruple from a year earlier, according to the economy ministry.

“There are no signs that Argentina can return to the market anytime soon, so the decline in reserves and the faster fall in the peso becomes a concern,” said Jorge Mariscal, the chief investment officer for emerging markets at UBS Wealth Management in New York.

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