ARGENTINA: Creditor lawsuits raise new risks

Analysis

On January 15, New York District Court Judge Thomas Griesa delayed a ruling as to whether all of the Argentine state's creditors -- both private bondholders and multilateral lenders -- should receive equal treatment under the 'pari passu' clause, which provides for such equality. In this case, creditors could in theory seize payments to the IMF. If Griesa eventually rejects the position that the IMF is a privileged creditor, the precedent could represent a challenge to the international financial system. On January 14, the US Federal Reserve had called on Griesa to prohibit creditors from interfering with Argentina's payments to the Fund, a stance designed to preserve the IMF's role in the international financial system rather than to support the Argentine government's position.

The same hearing also considered the issue of asset seizures more generally. Griesa maintained his position that plaintiffs must identify Argentine commercial assets in the United States, for which purpose a member of the government could be subpoenaed for questioning. The government is likely to contend that the state no longer has such assets, and that exports by private companies are not liable to embargo. In any case, it is hoped that a new government debt proposal offering some additional incentives will stem the creditor lawsuits now being presented in the United States and elsewhere. (Some 51% of debt to be restructured is subject to New York legislation.)

Private debt talks. At present, talks between the government, the IMF and bondholders revolve around creditor demands that the government reduce its proposed write-down of 75%, and the administration's adamant refusal on the grounds that increased debt payments would affect recovery (see ARGENTINA: Debt proposal creates controversy - September 29, 2003).

The situation has been further complicated by creditor lawsuits and the question of the pari passu clause, which would place all creditors on an equal footing. Without giving a definitive ruling, Griesa stated that bondholders must first take legal steps to embargo the funds, and must give 30 days' notice of their intent to seize the IMF payments, which the judge would decide on a case-by-case basis. Griesa himself had earlier ordered the government to pay 700 million dollars to investment fund EM Limited on a defaulted bond, and in late December authorised creditors to bring a class action lawsuit against the government, the first such lawsuit against a sovereign.

Government position. The government argues that creditors should accept the consequences of the high risk they took in seeking to obtain returns far above those offered by 'secure' investments, and that the IMF is a privileged creditor which cannot be exposed to risk owing to the nature of its loans. Moreover, the only source of funds for debt repayments is the primary surplus, which in turn requires sustained economic growth. The government insists that the 3% of GDP surplus target cannot be increased, on the grounds that that surplus is already precarious owing to the already sharp fall in public sector salaries and a tax structure in which 25% of total revenues are based on distortional taxes.

The process of correcting these distortions has already started through imposition of a minimum salary level for state workers and the gradual reduction of the financial transactions tax -- to be halved by mid-year. Some export tax ('export retentions') will gradually be credited to income tax. If advances are made in this area, a smaller write-down in the debt will be impossible if a new default is to be avoided.

IMF review. After considerable delays, the first review of the IMF programme will be approved on January 28, with no changes to the 3% primary surplus target. The Fund has indicated that the programme is on course with respect to the measures to be taken and the timetable foreseen. Delays in approving the review, originally envisaged for mid-December, related to three pending issues:

• delays in compensation to banks (see ARGENTINA: Financial sector faces frail future - October 7, 2003);
• failure to advance in the renegotiation of utilities contracts and tariffs; and
• doubts as to the government's 'good faith' to renegotiate the debt with private creditors through dialogue, rather than a unilateral offer.

The latter issue will remain of particular concern. If more than half of private creditors reject the government's offer there will be an increase in lawsuits which may force an improved offer -- which in turn will anger the creditors who accepted the original offer. The Fund is pressing for a strategy of reaching a single agreement with a majority of creditors, in order to avoid a rash of international lawsuits. For its part, the government has thus far indicated that it does not regard the question of legal action as a serious problem.

Fund fears. By September Argentina will have to redefine a more stable relationship with the IMF. Some 11 billion dollars in debt payments will fall due, more than 70% of them to multilateral lenders. In March alone, more than 3.6 billion must be paid to the IMF, which under the stand-by accord will then disburse a similar amount to Argentina (retaining only the amount due in interest) (see ARGENTINA: Evasive IMF accord leaves issues pending - September 10, 2003). If relations remain strained, the payment may have to be made with reserves.

Another key moment with the Fund will come in June, when the fiscal targets for 2005 and 2006 will be discussed. Other key issues include advances in debt restructuring talks; a new revenue-sharing accord with the provinces (see ARGENTINA: Revenue-sharing accord in doubt - November 28, 2003); improvements in tax administration and tax reform; recovery of credit to finance investment, production and consumption; a shift towards inflation targeting; and the renegotiation of privatised utilities contracts. The future health of the economy will depend on progress in these areas: even if GDP growth reaches 8% in 2003 and 6% in 2004, by 2005 the economy will have recovered only two-thirds of the ground lost since mid-1998.

Fiscal options. The fact that economic performance is at present better than expected has opened discussion of various options, including:

• a reduction in the proposed write-down and an increase in payments to creditors;
• an increase in public spending to reinforce investment and social spending;
• a reduction in taxes to stimulate private sector growth; and
• establishment of an anti-cyclical fiscal fund.

The government has to date adopted a mix of the second and third options. However, this solution will not be wholly acceptable to any party, and represents a rebuff to bondholders. A number of international banks have warned that the government's inflexible position is paving the way to a new crisis in the medium term if a voluntary agreement with bondholders is not reached. At the same time, 38.4% of defaulted debt is held by Argentine citizens -- more than 70% of pension funds were invested in defaulted bonds -- implying a further negative impact on the domestic economy. In financial terms, failure to pay is reflected in risk ratings -- directly relevant to the cost and availability of credit, and to investor decision-making.