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Deadline looming

Jan D. Walter / bkJuly 23, 2014

Argentina is facing bankruptcy, its government is facing political crisis, and US hedge funds are facing millions in losses. The various parties now have a week to find a solution.

Geierfonds in Argentinien Startbild Bildergalerie Juli 2014
Argentinean President Kirchner (top left), and hedge fund manager Paul Singer (bottom center)

President Cristina Fernandez de Kirchner's government keeps insisting: Argentina intends to repay the debts incurred by the state bankruptcy of 2001, but New York judge Thomas Griesa is preventing the country from doing so.

In 2012, Griesa ruled that US hedge funds NML Capital and Aurelius were owed $1.33 billion (one billion euros) for Argentinean state bonds that the country had failed to service following its 2001 bankruptcy.

These are so-called holdouts, owners of bonds whose debts were not restructured following the default. In 2005 and 2010, a total of 92.4 percent of the bonds were shorn of two-thirds of their face value. But the country has only been paying back installments on the loans it has taken on since then, and only to creditors who participated in the restructuring.

But Griesa ruled that servicing these loans was illegal - older loans had to be paid off first. Argentina has been resolutely resisting the ruling, but after Griesa blocked the payment of a later installment at the end of June, Argentina was given until July 30 to find a solution. If Argentina fails to pay its installments by then, it will technically be bankrupt.

On Tuesday (22.07.2014), representatives of both sides met in New York to find a solution to the problem. Judge Griesa ordered round-the-clock talks between government negotiators, holdout investors and a court-appointed mediator and said all parties had to work until a solution was found. The mediator requested the parties meet on Wednesday morning in New York.

Neither side has any interest in Argentina failing to pay - Argentina wants to prove its creditworthiness, and the creditors want their money. "The basic problem is the now poisonous atmosphere of the negotiations," says Latin American economist Federico Foders of the Kiel Institute for the World Economy.

Argentina blasts US hedge funds

Now hardly a day goes by without a member of the Argentinean government attacking America's "vulture funds." Political organizations associated with the government have been supporting these rhetorical attacks with demonstrations. Kirchner has even been lobbying for support against the hedge funds abroad - most recently at the BRICS summit in Brasilia in mid-July. Various Latin American governments have already expressed their support.

BRICS UNASUR Treffen in Brasilia 16.07.2014 Gruppenfoto
Argentina won some friends at the BRICS summitImage: Reuters

Argentina's government needs to put on this show because of its domestic situation. It was weakened by the parliamentary elections of last October, and next year will see the end of the second and final tenure of its most vital public figure - President Kirchner. But all this will fail to impress Griesa, because the legal situation is fairly clear - unlike other legal systems, New York law has no Collective Action Clause (CAC) for state bonds, in which all creditors must agree to a restructuring in the case of bankruptcy. But that is exactly what the Argentinean government did, giving out state bonds in the 1990s according to New York law, without agreeing a CAC.

The Argentinean government is clearly aware that Griesa's ruling was legally correct, since its arguments are less legal than political, which is not to say polemical. They claim the hedge funds bought the bonds at knockdown prices and that the profits they are making are immoral. On top of that, Buenos Aires can't currently afford servicing the debt, since that would require new debts of $120 billion, which would once again plunge the country into bankruptcy.

No state bankruptcy

The government justifies this danger with the so-called RUFO (or Rights Upon Future Offers) clause, allegedly contained in all restructured bonds. This forbids the voluntary favoring of other creditors. The owners of restructured papers could therefore, according to the government, demand the full sums, if the holdouts were serviced.

But serious doubts complicate this approach: first, Argentina is not preparing to favor the holdouts "voluntarily" - it is being forced to do so by Griesa. Second, says Foders, only a few of the bonds contained the RUFO clause. "The RUFO clause really doesn't play a role," he said.

It is not clear exactly how high the demands are that Argentina faces. The government claims that it "would have to pay $15 billion immediately." But up until now, the many small-time investors among the holdouts have yet to successfully contend for a legal title, which makes these demands completely theoretical up until now.

Cristina Fernandez de Kirchner beim BRICS UNASUR Treffen in Brasilia 16.07.2014
Kirchner is facing a tough weekImage: Reuters

If all the creditors were to claim their demands, it would certainly be a heavy sum, not least because further installment payments would be due. The Central Bank does have reserves of $29 billion, so Argentina is not facing bankruptcy just yet. Moreover, the good harvest of 2014 promises further income from agricultural exports, and a solid economic policy could exploit further raw materials and turn a profit.

New capital

China has just agreed another $7.5-billion loan - tied to developing infrastructure projects, and Russia has also signaled interest in investing in the Argentinean oil and gas sector. But to get the economy moving without becoming dependent on other states, Argentina needs access to other international credit markets. For that, the country will first need to avert the danger of technical default. "Paying the debts it owes now would be an important step to giving creditors new faith," said Foders.

That much is probably obvious to the government. Economy Minister Axel Kicillof is a qualified economist, after all. The question is whether the government can find a solution to the current crisis - even though most observers are working on the assumption that there will be an agreement in the next few days. One solution would be for Griesa to temporarily delay the implementation of his ruling and release the frozen funds, so that Argentina can service its restructured installments - thus saving the country from defaulting.

But a precondition for that would probably be Argentina agreeing a payment deferral with the hedge funds. On Monday (21.07.2014), Kiciloff wrote to Griesa that Argentina would not be able to pay the holdouts this year. That would mean payment would be deferred to January 1, 2015, by which time the RUFO clauses, which are apparently causing the government such a headache, would expire. For the hedge funds, waiting another six months is probably not the essential issue.