Thursday, July 6, 2017

From Vulture Funds to 100-year bonds: Has Argentina Turned Around?

Just a couple of years ago Argentina’s left of center government was besieged by foreign investors, the hedge funds known as Vulture Funds, that demanded full payment for their bonds acquired at heavily discounted prices in the secondary markets. The New York courts ruled in favor of the Vulture Funds, and Argentina was unable to borrow in international markets, even though during the successive governments of the late Néstor Kirchner and her wife Cristina Fernández de Kirchner the country had successfully renegotiated its debts with 93 percent of the bondholders, and the economy had recovered from the worst crisis in its history, growing at fast pace while diminishing inequality.

In November 2015, the left of center candidate associated to the Kirchners lost a close election to the center-right, neoliberal ex-mayor of Buenos Aires. Mauricio Macri, the new president, the heir to a private fortune amassed mostly during the last and bloody dictatorship and the ex-president of Boca Juniors, the most popular football team in Argentina, had promised reforms to reignite growth, that stalled in the last few years of Cristina Fernández’s administration, alongside with the slowdown of the global economy, and a collapse of the prices of commodities like soybeans, Argentina’s main export resource.

Macri’s administration devalued the peso, even though he had promised he would not do it during the campaign, promoted fiscal adjustment, eliminated export taxes that had been imposed by the Kirchners that affected the wealthy, and agribusiness interests in the country, and increased tariffs of public services, that were seen as distorting the functioning of markets. These market-friendly policies, were seen as the basis not only of a renewed process of growth, but also the fundamentals for establishing price stability. Yet, the economy stagnated and inflation run out of control.

The reasons are simple. A devaluation is generally both contractionary and inflationary, since a devaluation increases the prices of imported goods, directly affecting prices, and also, by increasing the cost of living it leads to a reduction in real wages. Lower wages, in turn, translate into lower consumption, and reduce demand, which leads to a recession. The increases in tariffs deepened the inflationary pressures, while the recession, which implies lower income and a reduction in tax revenue, together with the reduction in export taxes, lead to a worsening of the fiscal accounts. All of that was expected, including by Macri’s government. In fact, higher inflation that reduced real wages, and higher unemployment that weakened trade unions were central to the economic plans of Macri’s administration, as much as renegotiation with the Vulture Funds and reentrance into international financial markets. The US$ 2.75 billion 100-year bond issue is the crowing of these efforts.

The Argentinean bonds will pay around 8 percent per year in dollars for the next hundred years. One may reasonably ask why international financial markets would lend to Argentina, a country that has defaulted between four and seven times before, depending on who you ask. According to the Financial Times it is all a response to the smooth-talking telegenic new president and his market friendly reforms, even though Macri, very much like George W. Bush, was born with a silver foot in his mouth, and the reforms have backfired. In reality the reason for the renewed lending, is that, in spite of its several defaults, the country is a good payer. The very high interest rate implies that even if Argentina eventually defaults, a bondholder can make quite a lot of money. And there is always a chance of selling the bonds in the secondary markets, after making enough back with the high interest rates. Remember that interest rates have been close to zero in international markets, and sometimes negative in real terms, since the last global meltdown in 2008. On top of that, Vulture Funds can always make a buck if Argentina defaults again in the next hundred years. That is their business model.

The question you should really ask is why Argentina would borrow again and continue the long cycle of borrowing and defaults. Macri’s development strategy is a throwback to the Washington Consensus of the 1990s. In other words, the Macri administration is pushing for free trade, financial deregulation and a reduced role for the State at home, when these policies have been under attack and in retreat around the globe, more prominently in recent times with Brexit and the election of Donald Trump in the United States. The hope is that increased integration to world markets would bring investment and lead to growth, and that growth in the long run would make it viable for Argentina to repay its debt. The risks are evident.

It is unlikely, if not impossible, to think that foreign investment will come and promote growth. The narrow specialization of the Argentinean economy on commodities makes it vulnerable to recurrent crises when prices of its exports collapse. Also, the borrowing in dollars implies that only exports can provide the necessary resources for repaying the increasing foreign debt. This story cannot, and probably will not, end well. The only reason to promote this increase in foreign indebtedness is the short run gain associated to the higher interest rates that these 100-year bonds pay. Not only foreigners, and foreign pension funds will buy these bonds, but also Argentineans. For those that are wealthy enough to hold dollar denominated bonds in their portfolios the very high interest rates, even if risky, imply that Argentinean bonds are a good deal, an oasis of high remuneration in the midst of a financial desert.

It is worth remembering, in this context, that it is estimated that wealthy Argentineans hold assets abroad for about the total value of the country’s foreign debt. Macri and his friend are certainly among those that would benefit from his own policies. Also, one should not forget that Macri’s name appears in the Panama Papers, and contrary to what happened in other countries that had politicians implicated, he did not resign after the revelation that he illegally funneled funds to a tax haven. The 100-year bonds are not a sign that the economy is finally doing well, but a brief respite before the coming storm.

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