A tear for Ar­gentina

Financial Mirror (Cyprus) - - FRONT PAGE -

Ar­gentina’s lat­est de­fault poses un­set­tling ques­tions for pol­i­cy­mak­ers. True, the coun­try’s pe­ri­odic debt crises are of­ten the re­sult of self-de­struc­tive macroe­co­nomic poli­cies. But, this time, the de­fault has been trig­gered by a sig­nif­i­cant shift in the in­ter­na­tional sov­er­eign-debt regime.

The shift fa­vors hard­line cred­i­tors in bond is­suances gov­erned by US law. With emerg­ing-mar­ket growth slow­ing, and ex­ter­nal debt ris­ing, new le­gal in­ter­pre­ta­tions that make debt fu­ture write-downs and reschedul­ings more dif­fi­cult do not au­gur well for global fi­nan­cial sta­bil­ity.

There are no he­roes in this story, cer­tainly not Ar­gentina’s pol­i­cy­mak­ers, who a decade ago at­tempted uni­lat­er­ally to force a mas­sive gen­er­alised write-down on for­eign bond­hold­ers. Econ­o­mists who trum­peted the “Buenos Aires con­sen­sus” as the new way to run economies also look fool­ish in hind­sight. The IMF has long recog­nised that it made one too many loans to try to save Ar­gentina’s un­sus­tain­able dol­lar peg as it col­lapsed back in 2001.

This is not the first time that an Ar­gen­tine de­fault has up­ended in­ter­na­tional cap­i­tal mar­kets. Ac­cord­ing to the tab­u­la­tion that Car­men Rein­hart and I com­piled in our 2009 book This Time is Dif­fer­ent, Ar­gentina has de­faulted on seven pre­vi­ous oc­ca­sions – in 1827, 1890, 1951, 1956, 1982, 1989, and 2001.

Ar­gentina may be al­most as fa­mous for its de­faults as it is for its soc­cer teams, but it is hardly alone. Vir­tu­ally ev­ery emerg­ing-mar­ket coun­try has ex­pe­ri­enced re­cur­rent sovereign­debt prob­lems. Venezuela is the mod­ern-day record holder, with 11 de­faults since 1826 and pos­si­bly more to come.

Back in 2003, partly in re­sponse to the Ar­gen­tine cri­sis, the IMF pro­posed a new frame­work for ad­ju­di­cat­ing sov­er­eign debts. But the pro­posal faced sharp op­po­si­tion not only from cred­i­tors who feared that the IMF would be too friendly to prob­lem debtors, but also from emerg­ing mar­kets that fore­saw no near-term risk to their per­ceived cred­it­wor­thi­ness. The healthy bor­row­ers wor­ried that cred­i­tors would de­mand higher rates if the penal­ties for de­fault soft­ened.

Re­cently, as an out­growth of a re­con­sid­er­a­tion of the IMF’s lend­ing to the pe­riph­ery of Europe (and Greece in par­tic­u­lar), the Fund has ad­vanced another ap­proach to debt reschedul­ing, one that might be eas­ier to im­ple­ment. The IMF now recog­nises that the bulk of its fi­nanc­ing was ef­fec­tively be­ing used to al­low short-term cred­i­tors to exit loss-free. As a re­sult, there was not enough money left over to help soften bud­get cuts ne­ces­si­tated by the sud­den stop in for­eign fund­ing.

The ex­pe­ri­ence of the re­cent eu­ro­zone cri­sis stands in sharp con­trast to the Latin Amer­i­can debt cri­sis in the 1980s, when banks were not al­lowed to exit pre­cip­i­tously from their loans. If the new pro­posal is adopted, the IMF would con­di­tion­ally refuse funds to coun­tries car­ry­ing debt bur­dens that Fund staff de­ter­mine are most likely un­sus­tain­able; cred­i­tors would first have to agree to a “re­pro­fil­ing” of debt.

Re­pro­fil­ing is a eu­phemism for debt re­struc­tur­ing, which al­lows coun­tries to bor­row from ex­ist­ing cred­i­tors for longer pe­ri­ods and at lower in­ter­est rates than they would be able to do on the open mar­ket. Although it is far from clear how eas­ily the IMF could hold the line against hard-bar­gain­ing cred­i­tors, the new pol­icy, if adopted, would toughen the Fund’s ap­proach to cases where it finds it­self re­peat­edly throw­ing good money af­ter bad.

At present, the United States seems re­luc­tant to go along with the IMF’s pro­posal. Ev­i­dently, US au­thor­i­ties be­lieve that in some sit­u­a­tions geopol­i­tics trump eco­nom­ics (re­flected, for ex­am­ple, in the IMF’s re­cent re-en­try into Ukraine af­ter a string of failed pro­grammes).

This Amer­i­can re­sis­tance is un­for­tu­nate. It would be far bet­ter if the US found ways sim­ply to or­ga­nize out­right grants in ex­cep­tional cases like Ukraine, rather than de­sign the in­ter­na­tional fi­nan­cial sys­tem around them.

Given the re­cur­ring com­pli­ca­tions of ad­ju­di­cat­ing sov­er­eign-debt con­tracts in for­eign courts, and the world’s in­abil­ity to or­gan­ise a cred­i­ble and fair pro­ce­dure for for­eign bank­rupt­cies, per­haps the best idea is to steer the bulk of in­ter­na­tional debt flows through debtor-coun­try courts. Jeremy Bu­low and I made a pro­posal along these lines 25 years ago; it is still the right ap­proach.

In this sce­nario, coun­tries in­ter­ested in bor­row­ing large amounts from abroad would need to de­velop in­sti­tu­tions that made the prom­ise to re­pay cred­i­ble. By and large, ex­pe­ri­ence sup­ports this method. In­deed, the huge ex­pan­sion in emerg­ing-mar­ket do­mes­tic-debt is­suance in re­cent years has helped re­duce mar­ket ten­sions (though con­tin­u­ing re­liance by cor­po­rates on for­eign debt still leaves many coun­tries vul­ner­a­ble).

But do­mes­tic bor­row­ing is not a panacea. To be­lieve that any coun­try is­su­ing debt in its own cur­rency is risk-free as long as the ex­change rate is flex­i­ble is as­ton­ish­ingly naive. For one thing, there is still in­fla­tion risk, par­tic­u­larly for coun­tries with weak fis­cal in­sti­tu­tions and heavy debt bur­dens.

Nonethe­less, Ar­gentina’s lat­est debt trauma shows that the global sys­tem for sov­er­eign-debt work­outs re­mains badly in need of re­pair. Deep­en­ing do­mes­tic debt mar­kets – and per­haps change along the lines pro­posed by the IMF – is sorely needed.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.