By Richard Lough
BUENOS AIRES (Reuters) - Argentina is suing Citibank Argentina in local courts for striking an illegal deal with a group of U.S. creditors fighting the government over unpaid debt, its economy minister said on Wednesday.
The South American country's legal action marks a fresh low in its deteriorating relations with the local subsidiary of Citigroup Inc (NYSE:C), which has portrayed itself as an innocent party in Argentina's bitter debt battle with the funds.
Citigroup denied violating Argentine laws and said it was disappointed by Argentina's judicial steps. It did not detail what action it would take in response.
Economy Minister Axel Kicillof said last month's agreement involved Citibank, which had acted as custodian of some Argentine-law sovereign bonds, agreeing to handover the details of client accounts and fund movements to the hedge funds.
Kicillof said the deal "violated and interfered with regulations governing our public debt."
Citibank Argentina found itself caught in the eye of Argentina's debt storm after the government demanded it process coupon payments on exchanged debt, in defiance of U.S. court orders.
The case stems from a lengthy legal feud between President Cristina Fernandez's government and the funds led by billionaire Paul Singer's NML Capital over the payment terms offered in bond swaps that followed Argentina's record 2002 default.
U.S. District Judge Thomas Griesa awarded the funds full payment on their defaulted bonds and barred Argentina from servicing its restructured securities until it settled with the creditors.
After Griesa ruled on March 12 that there would be no exemption for local law bonds, Citibank Argentina announced it planned to quit its local custody business because of a threat from the government to strip it of its banking license.
It then reached a deal with the funds, which was approved by Griesa, not to appeal the court's order if it was allowed to process two one-off transfers in March and June while it exited its role as custodian.
"This was not a decision taken lightly," Citigroup said in a statement. "Citibank has acted in accordance with all applicable laws."
Kicillof lampooned Citibank Argentina for signing "a deal with the devil" and said the government had asked the Argentine courts to nullify the pact.
Argentina has suspended the bank from capital market operations and stripped its chief executive of his authority. The central bank on Monday sent regulators into the bank's headquarters to monitor its operations.