International Finance
The study of sovereign debt in the global economy has only become more salient in the past year as countries bear the brunt of the pandemic. While economies across the globe are contracting and governments struggle to find alternative sources of financing, many are also using Covid-19 as an opportunity to refinance pre-existing debt. Sovereign debt is undoubtedly a complex topic, and it is important to not only consider the history and recent events that create it, but also the roles of the various players involved.
Argentina, Latin America’s third largest economy, is facing its third sovereign default in two decades. What is more, each default only laid the foundation for the next. It is true that debt rose sharply under President Mauricio Macri, who took on billions of foreign debt. However, he only did so in an attempt to address a large budget deficit inherited from his predecessor. The country saw another crippling cycle of economic contraction, skyrocketing inflation, and a hard currency squeeze. In May 2020, the government officially defaulted after failing to make a $500 million interest payment on foreign debt.
The economic crisis is a product of both long standing issues and recent developments. Since independence in 1816, the country defaulted on external debt a total of nine times. It joined the IMF in 1956 and has entered twenty-one programs since then. Some joke that the government, creditors, and the IMF may be exchanging excels forever. It is clear that Argentina has a long history concerning economic conditions.
When President Macri was elected in 2015, he brought a series of economic reforms including cutting export taxes, lifting currency controls, and resolving debt disputes. The central bank raised interest rates to curb inflation and the Macri administration prioritized the budget deficit. Argentina regained access to international capital markets, a momentous occasion after being locked out for fifteen years, and repaid billions in debt. Most bondholders had settled for thirty cents on the dollar after the 2001 default, and a minority holdout led to the 2014 default. Those repaid in the 2016 settlement saw enormous gains. At the same time, Argentina saw a rise in borrowing costs. The billions in external debt ultimately only caused an increase in the budget deficit over the next couple of years. Capital inflows contributed to an overvaluation of the peso, therein exacerbating Argentina’s currency account deficit.
By late 2017, Argentina’s economic situation was precarious. When the US Federal Reserve began increasing interest rates, investor interest in Argentine bonds dropped. The Argentine central bank reset its inflation targets. A drought in the country hurt commodity yields, significantly eroding agricultural export revenue. As investors began selling Argentine assets in response, the peso depreciated and the value of debt in local currency increased. Still intent on cutting the budget deficit, the central bank increased interest rates and implemented fiscal reform. Yet, market volatility persisted. With an unsustainable buildup of debt, rapid currency depreciation, economic contraction and inflation President Macri sought a bailout from the International Monetary Fund (IMF) in the hopes of avoiding another default. Given his commitment to improving US-Argentine relations and reforming the Argentine economy, the US was a vocal supporter of an IMF program for Argentina. With IMF intervention, the budget deficit dropped from 5.3% in 2018 to an estimated 2.5% in 2019. However, Argentina’s economy contracted again.
It was no surprise when President Macri lost the next election to Alberto Fernandez, who promised to rework the IMF program if elected. Not only did he inherit a huge debt load and a dwindling foreign-currency reserve but, by the time President Fernandez took office, capital flight had accelerated and the peso had continued to depreciate. He adopted a different economic approach aimed at reviving the economy. His administration increased tax revenues to freeze utility tariff prices, reduce medicine prices, increase worker wages, and provide tax rebates, and increase severance pay. It attempted to address public debt by opening talks with bondholders and other creditors. Yet, debt renegotiations saw little progress and conditions failed to improve.
A weakening economic situation was only exacerbated by the ramifications of COVID-19. The bright side was that the pandemic provided a natural argument for postponing debt repayment. Negotiations would have to wait for a more stable economy. By 2020, Argentina had signed a deal with creditors to restructure $65 billion in foreign debt. Without it, Argentina risked being locked out of credit markets for years, once more. The debt relief, involving lower interest rates and extended debt maturities, would last nearly a decade. However, there remains significant concern about the government’s economic response, including tightening restrictions on the purchase of hard currency while printing money to cover a budget gap. There are calls to lower public spending and money printing, lift price controls and lift dollar-purchase restrictions. Economists comment that President Fernandez has simply failed to demonstrate a viable long-term plan, devising short-term responses to long-term problems.