Walter Molano | Forget the haircut

The next president of Argentina faces many painful decisions, with very little room for manoeuvre.

On one side, he faces a country in the depths of a severe recession. The country’s poverty rate jumped by a fourth during the first half of the year to 35 per cent. This measurement was taken before the debacle of the PASO and the subsequent devaluation.

It is a country that already endures an enormous tax burden, and it cannot withstand more fiscal pressure. At the same time, it is a country with dwindling international reserves. With the International Monetary Fund, IMF, withholding further disbursements until the end of the year, and without any access to the international capital markets, along with an unending wave of capital flight, it will be very difficult for the country to survive until the inauguration of the next administration.

On another side, it is a country with huge capital needs. Vaca Muerta needs more than US$100 billion in investment to achieve its full potential, but it will not be able to attract anything if the country is perceived to be a deadbeat. This is the reason the two presidential candidates are proposing a market-friendly reprofiling of the foreign debt, which does not include any adjustment of principal and coupons. They desperately need access to international capital if they are ever going to achieve their dream of becoming a major oil exporter.

Hostile IMF

Yet, they now face a hostile IMF, which has lost face in supporting a doomed administration and is only worried about quickly recovering the full value of its loans. This is the perennial problem associated with IMF involvement.

Given that the IMF is a senior creditor that always recovers par and before anyone else gets paid, private creditors must take a bigger hit. Instead of providing assistance, the IMF becomes the bully of the playground. That is what is happening now.

Alberto Fernández wanted to do a Uruguayan-styled restructuring, which would have implied the gentle treatment of private-sector creditors. Unfortunately, the IMF’s desperation to cash out as soon as possible from its nightmare is forcing them to demand more pain from bondholders. Given these conflicting parameters, it is difficult to see an easy way out.

IMF officials are convinced that the market has no memory, and the inherent greed of investors will soon have them lending money to Argentina. There is some truth to this train of thought, but they cannot ignore the importance of reputation.

If Buenos Aires imposes a draconian haircut on sovereign bondholders, it will be consigned to the category of uninvestable countries. Previous defaults had some explainable narrative, such as the pari pasu court rulings that impeded the servicing of the foreign bonds in 2014, or the disorderly exit from the fixed-exchange rate regime that wiped out the financial sector in 2001, or even the US Federal Reserve’s decision to push overnight rates to 16 per cent in 1982 that froze all foreign capital flows to the emerging world.

However, there is no narrative for this default. Over the past four years, Argentina was run by the so-called economic dream team. The president was a titan of the private sector. Commodity prices were buoyant, and the country had excellent access to the international capital markets. Moreover, the collapse occurred during a routine exercise of the country’s democratic system.

The electoral loss really occurred due to the seething anger ignited by the government’s forced adherence to the IMF’s cookie-cutter austerity programme, which did nothing to rein in inflation, and its dogmatic commitment to a free-floating exchange rate regime, which facilitated massive capital flight. Therefore, there is no justification why the government must now take the axe to its external private-sector obligations, especially when the IMF shares a great deal of the responsibility for the fiasco.

Washington needs to realise that its actions will have dangerous consequences. Without access to the capital markets, Argentina will become the ward of the multilaterals, something that they don’t want and cannot afford. It will also push the country further into the arms of the waiting Chinese, who are more than willing to put a bear hug on Vaca Muerta.

Not only will it provide them with a treasure trove of hydrocarbons, it will also be an excellent opportunity to pick off the latest fracking technology. Moreover, without access to international capital, Argentina will become a laboratory for heterodox economic policies. Furthermore, there is a fair chance that the Fernández camp may lose out to the Cámpora faction, and the country will return to its Chávezista ways.

It is said that the Trump administration decided to back off after the disastrous PASO results, and it told the IMF to sort the situation out. The technical teams are just looking out for their own hides by trying to recover their Argentine loans as quickly as possible and close this ugly chapter. This is why they are insisting on bondholder pain.

The problem is that this pain will become worse for Washington in the not-too-distant future.

The Argentine dilemma is a problem that will not be easy to solve, but a large haircut is definitely not the solution.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.wmolano@bcpsecurities.com