By Meagan Clark - Argentina’s central bank plans to pay local lenders rather than American creditors for its debt Tuesday, exactly the opposite of what a U.S. judge ordered the South American country to do. It's just the latest chapter in a long and bruising battle between Latin America's third-largest economy and U.S. hedge funds, which took Argentina to court to force the country to deliver on promises to pay them back for the Argentine bonds they own.
Many emerging economies, from Russia to Brazil, began taking on significantly more short-term debt from developed economies in the early '90s, which paid for projects like roads and social services, and fueled economic growth. But short-term capital is volatile. When the U.S. Federal Reserve raised interest rates in 1994 to stave off inflation, borrowing costs for people, businesses and countries increased. That pitched Brazil, Russia and others into recession, and Argentina into its Great Depression (1998-2002). During that recesssion, Argentina's economy shrank by 20 percent, inflation soared and eroded the value of Argentinian money, half of Argentinians lived in poverty, foreign investment fled, and the country defaulted on its foreign debt. That drove up interest rates Argentina would have to repay to issue new bonds, amounts of money borrowed over an agreed time period and for a fixed interest rate, to finance its budget as government revenue nosedived.
After creditors around the world bought bonds the country had defaulted on in 2001, about 93 percent of the creditors swapped their bonds for new ones worth about 70 percent less, in 2005 and again in 2010. That helped Argentina slash its government debt at a loss to the creditors. But the American hedge funds did not agree to trade in their bonds for a loss.
The group of investors is led by billionaire investor Paul Singer’s NML Capital Ltd., a subsidiary of Elliot Capital Management. Singer is a lawyer by training and has successfully sued the governments of Peru and the Republic of Congo to deliver payments on their bonds.
When a big business flops on payments owed, it lands in bankruptcy court. But countries have no international court to mediate deals with creditors. In bond sales agreements, the terms usually state that legal battles must occur in either New York or London, the world’s two biggest financial capitals.
Sovereign governments usually win in legal tussles with investment funds on bond cases because when negotiating with lenders, governments disclose the threat of default. And creditors usually accept restructuring deals to at least receive something when a country defaults. But NML Capital is pushing for full payment.
In 2012, U.S. District Judge Thomas Griesa in New York ordered Argentina to pay Singer’s group. The amount they’re owed, $1.5 billion, wouldn’t break Argentina, which has about $16 billion to draw from when excluding amounts on loan to other countries, deposits with the International Monetary Fund and other assets that aren’t easily accessed. The problem is that all the other litigants could join in and ask for full payment, and Argentina still owes regular interest payments to other bondholders.
At the end of June, the U.S. Supreme Court ruled against Argentina that it must pay off the American hedge funds, even though President Cristina Fernandez said the country couldn’t afford to pay them while also keeping up with regular interest payments to other lenders. In July, Argentina defaulted for the second time in 13 years.
So far, Griesa has put off deciding whether to impose sanctions on Argentina after Brazil, but he warned Monday that the country must stop trying to get around his ruling. The Argentine government passed legislation this month that allows it to replace Bank of New York Mellon Corp as trustee for restructured debt with local bank Banco de la Nacion Fideicomiso and then swap debt for bonds. Argentina’s central bank plans to deposit an interest payment of at least $200 million with Banco de la Nacion Fideicomiso on Tuesday.