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Will Argentina Default Yet Again?

Jaime Daremblum

On October 8, Argentine President Cristina Kirchner underwent successful emergency surgery for a chronic subdural hematoma that apparently stemmed from a head injury she sustained in mid-August. It was her second emergency surgery in two years: Back in January 2012, Kirchner had her thyroid gland removed after getting a cancer diagnosis that turned out to be inaccurate. She will now spend the next month recuperating, which means she will be absent for the remainder of the campaign leading up to Argentina’s October 27 legislative elections, in which her ruling coalition is expected to suffer big losses. 

Even Kirchner’s harshest critics should wish her a speedy recovery. With any luck, her health will improve significantly, and she’ll be able to resume her presidential duties sometime in November. The health of her country’s economy is another matter entirely. 

A few days before the public learned of Kirchner’s brain hemorrhage, the Mexican financial and retail giant Grupo Elektra announced that it was ending all operations in Argentina. The company’s official statement represented a blistering indictment of Argentine economic policies: “The exchange-rate controls and import and export restrictions limit access to commercial goods, while controls on capital flows restrict investment,” it said. “High inflation hinders business planning, while labor regulation allows union practices that affect the investment environment. Similarly, there is a culture of nonpayment of debts that makes credit business impractical.“ 

Elektra is only the latest corporate titan to pull back from Argentina amid concerns over the nation’s business environment. Back in March, the world’s second-largest mining firm, Brazil’s Vale, froze all work on its massive Argentine potash project, even though the company had already spent $2.5 billion on the venture and completed over 40 percent of it. Vale explained that the combination of Argentina’s double-digit inflation and its draconian foreign exchange controls had made the project far too costly. Meanwhile, iconic luxury designers such as Armani, Calvin Klein, Cartier, Escada, Louis Vuitton and Ralph Lauren have all closed stores in Argentina, which is still Latin America’s fourth-biggest country. 

How dire is Argentina’s economic plight? Just ask its farmers, who are now hoarding their soybeans as a hedge against rampant inflation. The numbers are quite striking: Agricultural economist Manuel Alvarado Ledesma recently told Reuters that Argentine farmers are saving an estimated 28 percent of their soy crop from the 2012-13 growing season, an amount that is roughly equivalent to $7 billion worth of soybeans. Their concerns are understandable: The online business journal Latinvex has projected that “Argentina is likely to have the world’s highest inflation rate this year, surpassing Sudan and Venezuela.“ 

While the farmers hoard their soybeans, Argentinians of all stripes are busy hoarding U.S. dollars. In late 2011, the Kirchner government tightened foreign currency restrictions in hopes of slowing capital flight. According to the central bank, capital outflows subsequently dropped from $21.5 billion in 2011 to $3.4 billion in 2012. Yet the currency controls — which have since been tightened even more — have also stifled investment and fueled an enormous black market in dollars. “In the heart of downtown Buenos Aires,” writes Financial Times correspondent Benedict Mander, “it is hard to walk more than 20 paces without being accosted by hawkers buying and selling dollars.” Not surprisingly, Argentina is now experiencing a severe dollar shortage, which has prompted Kirchner to extend a tax-amnesty program aimed at encouraging people to invest their undeclared dollars in the national economy. It has been estimated that those undeclared holdings amount to $160 billion.

As of September 30, Argentina’s foreign exchange reserves stood at $34.8 billion, their lowest level in six and a half years, according to the Wall Street Journal. Since 2010, the government has used $39 billion worth of central bank reserves to pay down its foreign debt, and it is planning to spend another $9.86 billion on debt payments in 2014. Following its 2001-02 sovereign default — which at the time was the largest in recorded history ($100 billion) — Argentina was virtually shut out of global capital markets, and its exile has now lasted more than decade. This means that Argentina’s most important source of foreign currency is its trade surplus. Unfortunately, that surplus has been shrinking dramatically: It was 59 percent lower in August 2013 than in August 2012.   

To make things even worse, some of Argentina’s former creditors continue to demand full repayment of defaulted bonds — and on August 23, a New York-based appellate court ruled in their favor. In its decision, which upheld a 2012 district-court ruling, the U.S. Second Circuit Court of Appeals affirmed that Argentina must put $1.33 billion into an escrow account. The bondholders seeking that money have refused to accept the terms of prior debt restructurings conducted in 2005 and 2010. Ratings agency DBRS said the Second Circuit ruling “materially increases the risk of a default on Argentina’s restructured bonds issued under New York law.“   

This past Monday, the U.S. Supreme Court formally declined to hear Argentina’s appeal in an earlier bondholder case. That was obviously a setback for the Kirchner government, but it was not the end of the road. Had the Supreme Court heard the appeal and then ruled against Argentina, the nation’s seemingly inevitable default would have happened much sooner.  

Instead, the government now has some breathing room. It has asked the Second Circuit to rehear the case that was decided on August 23. If (or when) the Second Circuit rejects that request, Argentina can once again appeal to the Supreme Court.   

Moreover, the Kirchner government has already indicated that it will not comply with any U.S. court order to compensate the bond holdouts: Last November, Argentinian economy minister Hernán Lorenzino told a Buenos Aires newspaper that the government would not pay any former creditors who refused to participate in the 2005 and 2010 debt restructurings. Thus, following the October 7 Supreme Court ruling, Ted Olson, the former U.S. solicitor general who is now representing one of the hedge funds (NML Capital) suing Argentina, issued a statement reading in part: “Argentina’s representatives have asserted that it will file another petition, but the facts of the case and Argentina’s disregard for the rule of law remain the same. That petition also should be denied.“   

Regardless of how or when the bondholder litigation is resolved, Argentina’s economy is slowly imploding. It has fallen behind all but two Latin American economies (Venezuela and Cuba) in the Heritage Foundation’s Index of Economic Freedom, and it now ranks lower than Swaziland in the World Bank’s Ease of Doing Business Index. For that matter, in the World Economic Forum’s latest Global Competitiveness Index, Argentina trails several of Latin America’s poorest nations, including Guatemala, El Salvador, Bolivia and Nicaragua.   

The WEF notes that, given factors such as Argentina’s market size and its high level of university enrollment, the country still has “enormous potential.” Right now, however, that potential is being wasted — and the situation will almost certainly get worse before it gets better. 

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