After default: Argentina needs a very substantial reduction in its debt

FT on 30 June 2003

Argentina suddenly finds itself the darling of speculative investors, once again. But it is all too easy to have too much of this particular good thing. Whether Argentina was right to impose controls on short-term inflows of capital, as it did last week, is debatable. But that enthusiasm had been running ahead of realities is not.

Certainly, Argentina's position has shown welcome improvement. Helped by a rising trade surplus, the economy is growing again after the debt default and devaluation of December 2001. The inflationary impact has also been limited, partly because the government has kept its own accounts under tight control. As a result, the devalued peso has been appreciating and the prices of defaulted bonds have risen. Yet, although Argentina is out of intensive care, sustainable recovery is some way off. There are some glaring problems. Banks needs to be recapitalised, for example. In addition, the government faces some immediate challenges in dealing with the aftermath of default.

First, it must find a way to roll over obligations owed to the multilaterals that will fall due after a short-term agreement with the International Monetary Fund expires in August. Nestor Kirchner, its new president, may face difficult negotiations with congressional leaders if he is to deliver the primary fiscal surpluses the IMF is likely to demand. However, judging by the positive remarks last week from Horst Kohler, the IMF's managing director, a three-year deal should be within his reach.

A comprehensive agreement with commercial creditors could prove to be much harder. For a start, there is the scale of Argentina's obligations. Including arrears and interest, defaulted obligations will amount to Dollars 76.7bn (Pounds 46.6bn) by the end of this year. The debt is widely held. More than 600,000 retail investors hold about half of the non-performing paper. To complicate matters, more than 150 separate bond issues in 14 different currencies are involved. Encouragingly, the Argentine government is accelerating its work on its restructuring proposals and now hopes to present a plan to creditors as early as September. But it will need to negotiate a very substantial reduction in the value of the debt.

By year end, Argentina will also owe a further Dollars 95.8bn in performing credits. The debt has been growing, partly because more than Dollars 20bn has been issued in new bonds, to compensate banks for the botched devaluation. Public debt will, as a result, be about 130 per cent of gross domestic product by the end of the year.

Inevitably, Argentina will need a huge "haircut". The needed reduction in the present value of the defaulted debt must be at least 60 per cent and possibly as much as 80 per cent. Without such reductions, the debt burden could prove unmanageable again. The principle is simple: a deal likely to unravel almost as soon as it is agreed makes no sense at all.