Argentina offers a lesson in debt management
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In his bestseller "The World is Flat", Tom Friedman compared globalisation to the sunrise from the east. Whether one likes it or not, one might as well accept it. And one should learn to deal with the good, the bad and the ugly that accompany globalisatio
The case of Argentina’s sovereign debt restructuring goes beyond the crises associated with the financial contagion that the world has witnessed. Argentina’s debt restructuring has resurfaced because of a recent US court decision. We learned about a legal battle between the government of Argentina and US investors. The latter are looking to use Congress and the courts to extract a heavy profit by collecting on Argentina’s defaulted sovereign bonds that had gone through its debt restructuring in 2005 and 2010. It raised rent-seeking behaviour and greed to a new level in global finance, and the ugly side of hedge funds called vulture funds.
Vulture funds refer to hedge funds that buy up distressed debt in the secondary market at deep discount, typically pennies on the dollar. The investors then use litigation to force the issuer of the debt for full repayment. There is a phenomenal profit to be made, if investors can turn a bond purchased at 10 cents on the dollar into a repayment of a full dollar.
In the late 1990s, Argentina faced a severe financial and economic crisis as real output (gross domestic product) fell by about 10 per cent and unemployment soared. It had no choice but to default on its nearly US$100 billion sovereign debt in 2002.
In January 2005, Argentina offered to exchange defaulted bonds for new ones, whereby the restructured bonds gave holders about 30 cents on the dollar. The new bonds were also indexed to GDP growth. The bonds would pay more, the more the economy grew. Some creditors held out and in May-June 2010, the government made the offer again.
In the two debt swaps, creditors holding about 93 per cent of Argentina’s debt agreed to participate. This was considered a success. Debt restructuring and currency devaluation worked as Argentina’s annual GDP growth reached 8 per cent or higher prior to the 2008 global financial crisis. However, there were creditors known as holdout creditors who did not participate in either restructuring. Notably, the Elliott Management hedge fund in the US, which, according to some estimates, bought defaulted debt for less than $50 million, is now demanding more than a billion dollars in payout through litigation. Elliot Management spent nearly $4 million on consultants to lobby for its cause.
After years of litigation, a lower court in the US ruled in favour of the hedge fund in October 2012. Last month, a US appeals court in New York affirmed the lower court’s verdict and ordered Buenos Aires to pay $1.47 billion, the full face value, to hedge fund holdouts. Courts in Belgium, France and Germany, on the other hand, have supported Argentina.
At issue is the interpretation of a contractual clause called pari passu, (on equal footing). The hedge fund’s litigation strategy took advantage of the clause as a legal basis to demand that it be paid in full when the holders of the restructured bonds are paid. The court would issue injunction to block financial firms to pay overseas bondholders who participated in the past restructurings, unless the vultures are also paid in full. This would create the possibility for new default when the payment comes due.
The US court’s ruling has important implications for sovereign debt restructuring and suggests key lessons for emerging and developing countries contemplating borrowing in the US financial markets. First, if the principle underlying the court ruling prevails, there is no incentive for accepting debt restructuring. This in turn would limit the opportunity to use debt restructuring as an alternative policy to bailout for a country under debt stress to get a fresh start.
Second, conflicts among different claimants often accompany debt restructuring. There needs to be a mechanism to adjudicate disputes, a mechanism similar to bankruptcy laws and courts. Emerging and developing countries should take advantage of the United Nations Commission on Reforms of the International Monetary and Financial System to come up with a fair and better way for the restructuring of sovereign debt.
Finally, the best way to keep the circulating vultures at a distance is for emerging and developing countries to adopt sound macro-prudential policies that would avail them more options beyond the New York or London financial markets for financing need, including the possibility for regional bilateral or multilateral financial arrangements.
Dr Kiertisak Toh is a member of the economics faculty at Radford University, Virginia, and a senior fellow at Duke Centre for International Development, Sanford School of Public Policy, Duke University, North Carolina. [email protected].
