Restructuring
Debt relief in the midst of a pandemic came as welcomed news to Latin America’s serial defaulters. Even if the pandemic clears, questions linger on their financial outlooks.
BY Charles Newbery
In August, when Argentina and Ecuador reached deals with their creditors to restructure billions of dollars worth of foreign law bonds, leaders of both cash-strapped countries were visibly ecstatic. Ecuadorian President Lenín Moreno called it a huge relief. Argentina’s Alberto Fernández broke the social-distancing measures for COVID-19 to hug his economy minister.
There was reason to cheer. Argentina swapped $66 billion and Ecuador $17.4 billion in old debt for new bonds with longer repayment terms, lower interest rates and debt relief. Argentina has a breather on principal payments until 2025; Ecuador until a year after that.
But there’s no time to waste. “The debt restructuring provides an opportunity for both, but there's no guarantee,” says Lisa Schineller, a sovereign ratings director and economist at Standard & Poor’s in New York. “You need to have strong policy commitments and execution moving forward.”
This includes restoring economic growth, narrowing fiscal deficits and taking on politically sensitive reforms, from labor to social security and tax regimes. Argentina has never fared well at this — it has defaulted nine times. Ecuador has failed to pay its debts 10 times.
“This is like someone who had a problem, undergoes a harsh treatment, comes out and still has a very high fever.”
Daniel Marx – former Finance Secretary of Argentina
The most immediate task for both nations is to boost their economies. A more than six-month lockdown for the pandemic has pushed Argentina’s gross domestic product into a more than 12% contraction this year, perhaps its worst in history, according to most private estimates. Ecuador should shrink 11%, according to the International Monetary Fund (IMF). The rebound won’t make up for even half of the lost ground in either country in 2021, most estimates show.
Daniel Marx, executive director of Quantum Finanzas in Buenos Aires, says the restructuring deals have helped, but only to shake off one ailment.
“This is like someone who had a problem, undergoes a harsh treatment, comes out and still has a very high fever,” he says.
As a former finance secretary from 2000 to 2001 and chief debt negotiator from 1998 to 2003, Marx knows that emerging from intensive care has never been easy for Argentina.
While the country has regained the trust of investors in the past, even allowing it to sell $2.75 billion worth of 100-year bonds in 2017 only a year after emerging from a 15-year default, it has fallen back as often.
This time won’t be any easier because of the deep recession, 40%-plus inflation, dwindling international reserves, little confidence in the peso and a patchwork of capital and price controls to try to keep the exchange rate stable.
Bondholders are wary that progress can be made. The new bonds that Argentina issued in the swap debuted at prices yielding 11% to 12%, and even higher, in September.
The restructuring deal may have bought five years of debt relief for Argentina and reduced the average interest rate on the bonds by more than half to 3.07%, but the minor 1.9% principal reduction means that the foreign debt is still at an uncomfortable 70% of GDP.
To service this debt, Argentina must return to economic growth, reduce a large primary fiscal deficit — some estimates put it above 8% — and avert sharp falls in the real exchange rate that would push up its foreign debt burden in peso terms.
“It seems virtually impossible to achieve all three aims,” says Nikhil Sanghani, an economist at Capital Economics in London.
Reducing the budget deficit would hamper the economic recovery, he says. And if the strict capital controls — individuals can only buy $200 worth of dollars per month, and companies can’t access all they need to pay foreign-currency debts — are sustained, that would keep the peso from depreciating. But this would come “at the cost of an increasingly overvalued exchange rate which would erode the competitiveness, and growth prospects, of the external sector,” Sanghani says.
It’s such a hard and long-term task that Argentina will find it hard to do what is needed to pay the new bonds when they start coming due in 2025, says Todd Martinez, director of Latin America sovereigns ratings at Fitch Ratings in New York.
“It looks like a pretty tight window to me,” he says.
To make these adjustments, Argentina needs money. But after defaulting yet again, the international markets may not be accessible any time soon — and probably will be expensive.
“Perhaps we are in a situation of once bitten, twice shy,” says Martinez.
Argentina has said it wants to narrow the primary fiscal deficit to 4.5% of GDP in 2021, an advance, but it still must be financed. International reserves tumbled 45% since April 2019 to $42.5 billion in mid-September, but what’s available to prop up the peso and lend to the government is less than $8 billion, the central bank has said.
Argentina implemented additional currency controls on September 15 in order to protect its reserves, making it that much harder to service US dollar-denominated debt. The Argentina peso has since slid to record lows against the greenback.
This begs the question of how it will finance the fiscal adjustments when its own capital market can only provide so much as one of the smallest in Latin America, and multilateral lenders can only put in so much. An option is to negotiate additional funding as part of a new program with the IMF, which has loaned it $44 billion since 2018, but that would be politically unpopular, S&P’s Schineller warns.
Indeed, Martinez says Argentina may have to look for conditional funds from China, for example, or through repo transactions with foreign commercial banks, as it has done in the past, until it can show that it is making progress on a credible growth and fiscal plan to borrow from the international markets.
Ecuador doesn’t have it much easier after its restructuring, but it is making more strides. It has reached an agreement on a new $6.5 billion extended fund facility with the IMF to help it restore economic stability. It also has stretched out the repayment schedule on more than $800 million of the some $5 billion it owes to China.
“If they continue to be too dependent on oil, basically they will be in trouble again any time soon.”
Andrés Abadia - Pantheon Macroeconomics
But it faces a presidential election in February 2021 that could sideline the painful fiscal austerity measures needed to achieve debt sustainability. “It’s likely that there will be some fiscal slippage, which may cause concerns amongst investors and a sharp rise in borrowing costs,” says Sanghani.
Ecuador’s economy was hit doubly hard this year from the pandemic and a plunge in the international price of oil, its main export, exposing yet again its over reliance on that sector.
“If they continue to be too dependent on oil, basically they will be in trouble again any time soon,” says Andrés Abadia, senior international economist at Pantheon Macroeconomics in Newcastle upon Tyne, England.
“We see opportunities to invest in Argentina and Ecuador,” he says. “But if you have all these structural issues, nobody is going to invest.”
If, however, they can rebuild investor confidence, then international creditors may be keen to lend for the higher yields as global liquidity runs high and interest rates stay low. This could be a curse in disguise. “If they are able to borrow, I think that will be good news for both economies,” Martinez says.
“But a perennial risk in both of these economies is if that ability to borrow generates some complacency and takes some of the urgency out of the adjustment that both economies need to.”