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Argentina's foreign investors try to read the default runes

EconomyAug 29, 2019 03:55PM ET
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By Karin Strohecker and Tom Arnold

LONDON (Reuters) - Holding Argentina's sovereign debt has never been for the faint-hearted but the government's announcement of a debt overhaul plan has sent investors scrambling to assess the likelihood that country will again plunge into full-scale default.

Argentina's assets tumbled in the wake of President Mauricio Macri suffering an unexpected bruising primary election loss this month at the hands of populist-leaning Peronist Alberto Fernandez, with the central bank forced to burn through its reserves to prop up an ailing peso.

Unable to roll over much of its short-term local debt, Treasury Minister Hernan Lacunza on Wednesday announced plans to extend maturities of local law bonds held by institutional investors and stated intentions to do so on international debt and dues owed to the International Monetary Fund.

Some $7 billion of short-term debt, $50 billion long-term debt and $44 billion of IMF debt are earmarked for an overhaul, according to calculations by developing markets investment house Tellimer.

The country of 44 million people is no stranger to defaults. The last major one in 2001 pushed Argentina into years of recession and economic crisis from which it only emerged in 2015.

The current proposal - which still has to be signed off by Congress - envisages maturity extensions, but no haircuts or reductions in the principal.

Yet investors disagree on whether a full blown default is now inevitable, whether the planned overhaul will cure Argentina's ills and what hit holders of international law bonds may face.

Deutsche Bank's Hontao Jiang said the proposed measures could work, if the country faced only a liquidity crisis, but this was unlikely given questions over its solvency.

"Make no mistake about this, this will be a debt default on Argentina's external debt," predicted Jiang in a note to clients. "Whether this announcement itself constitutes a default that triggers CDS (credit default swaps) or not, we are not sure, but if such debt operations do take place, it would be a default and it would trigger CDS."

CDS, a way to insure default risk, have rocketed by more than 2,000 basis points since the Aug. 11 primary vote, and imply a roughly 50% probability of default over the next 12 months. That probability rises to over 80% over the coming five years.

GRAPHIC: Argentina 5-year credit default swaps - https://fingfx.thomsonreuters.com/gfx/mkt/12/5382/5332/Capture1.png

The peso has shed some 22% of its value against the U.S. dollar over the same period, and the tumbling currency is ramping up the pressure not just on repayments but also on the sustainability of the debt stock more widely.

Deutsche calculates that Argentina's current gross debt has surged to about $325 billion, or 103.5% of its annual gross domestic product following the currency depreciation.

"Even if all debt maturities are extended, without nominal haircuts to reduce the debt stock - especially the external debt stock - it won’t solve the solvency issue," Jiang added.

Deutsche calculates that markets are currently pricing a 30% nominal haircut if an exit yield is 12% and 10% respectively under a scenario where all international dollar- and euro-denominated bonds are exchanged into 15-year bullet bonds with a coupon of 6.5% and 5% - reflecting the average coupon of the existing bonds in those currencies. The exit yield is the market's forecast of the value of sovereign bonds after a restructuring.

BNP Paribas (PA:BNPP) calculated earlier in August that holders of Argentina's debt could face a 40% haircut, though the range of possible writedowns stretched from 38.6% to 62.7%, depending on scenarios.

Argentina has long been on the high-risk list: BlackRock (NYSE:BLK) in June ranked it 57 out of 60 countries on its sovereign risk index measuring factors such as willingness to pay, fiscal breathing space, the health of a country's financial sector and its external finance position.

That ranking put Argentina just above Venezuela, Lebanon and Egypt.

GRAPHIC: BlackRock Risk Indicator - https://fingfx.thomsonreuters.com/gfx/mkt/12/5305/5262/BlackRock%20Risk%20Indicator.png

The government's latest strategy faced a myriad of risks, J.P.Morgan's Diego Pereira said.

"Pressure on international reserves may linger," Pereira wrote in a note to clients, adding this could come from FX deposit withdrawals and dollarization even though the maturity extension would give the Treasury some breathing space.

The reaction of Argentina law debt holders was also unclear, especially if Congress would address the local debt re-profiling bill only after the October election, Pereira said, adding that the IMF reaction had also been "cautious".

GRAPHIC: Argentina foreign reserves - https://fingfx.thomsonreuters.com/gfx/mkt/12/5329/5281/CCapture.png

Yet others say that with bond prices having tumbled to around 40 cents for some key Eurobond issues, holders of international debt may get away without a haircut.

"This is one of the worst run, badly managed, most unpredictable and screwed-up countries on earth. It has one of the highest rates of default among any country on earth," said Jan Dehn, head of research at Ashmore Group.

"The reason we're willing to take volatility is because ultimately we think Argentina is sustainable."

Argentina's foreign investors try to read the default runes
 

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