With the fiscal deficit widening and the economy in recession neither Argentina’s government nor the private sector would be able to meet such demands. The country’s highly indebted provinces in particular will struggle to secure funding, according to Carlos Caicedo, Principal Latin America Analyst, IHS Country Risk.
The event is highly damaging for Argentina. IHS forecasts a deeper recessionary environment with higher inflation, potential for rapid currency depreciation, and increased unemployment. The latter is likely to produce heightened social unrest particularly including nationwide industrial action. Unions are certain to demand wage increases that reflect higher inflation levels. With the fiscal deficit widening and the economy in recession neither the government nor the private sector would be unable to meet such demands.
The default is unlikely to be as catastrophic as 2001 and seems unlikely to contaminate the wider Latin American region: the economy is better shape, the country is not as dependent on foreign funding as 13 years ago, and Argentina has still the capability to meet obligations with creditors. Also, there is scope to find a negotiated solution with holdouts once the Right Upon Future Offers (RUFO) clause expires in late 2014.
Argentina will now embark on a damage limitation exercise. It appears confident that it can weather the storm until January 2015 when the RUFO clause expires.
The current default is far from being as catastrophic as that of 2001, but it will have significant negative implications for the country.
The default will further isolate Argentina by sharply constraining its access to fresh sources of funding. The default is a major setback for the country’s heavily indebted provinces, which were counting on a positive outcome in New York to be able to issue dollar-denominated bonds to fund their current expenditure. The default will make borrowing for the provinces in the foreign capital markets prohibitively high.
The default is certain to lead to further declines in the country’s foreign reserves putting renewed pressure on the peso. This is likely to accelerate and make a second devaluation even more likely.
Growing uncertainty and limited access to dollar funding also will impact negatively on domestic and foreign investment, deepening the recession. The economy is already contracting. Most companies are putting planned investment on hold. Moreover, the longer the country takes to reach an agreement with the holdouts, the more serious the economic situation will become in Argentina. Without access to external resources the government will intensify the monetisation of fiscal deficits. In addition, the default will make it more difficult for exporters to obtain pre-financing abroad, which will have a negative impact in the next planting season.
Talks involving a private-sector temporary purchase of debt owned by the holdout funds are likely to continue, according to local media. If a deal was reached, delayed payments could be unblocked with the consent of the New York District Court, so resolving the current technical default.
The RUFO clause in exchanged debt, which Argentina feared would expose it to massive claims from exchanged bondholders if it pays holdout funds in full directly, expires at the end of 2014. Argentina appears reluctant to make any commitment at present given this clause. Once it expires, this obstacle naturally falls away.
Given the potential resolution of the current stand-off, either by private sector channels or by direct means in early 2015, it is far from certain that affected Note holders would see upside benefit from triggering acceleration, rather than awaiting a resolution.