The Achilles Heel

During the hectic month of December 2001, Argentina defaulted. Over that month, the economy was reduced to barter, mobs looted bank buildings, and the country went through five presidents in eleven days. After President Néstor Kirchner took office in 2003, Argentina began renegotiating it’s the debt in Dubai. The Argentines put a unique offer on the table with the conditions that the creditors would forgive past-due interest, and the old bonds would be swapped for new ones worth 35 cents on the dollar.  In exchange, the new bonds would include a GDP “kicker,” pronounced “keek-ker” by the Argentinians. This “kicker” promised the creditors additional payments equal to 1/20th of the dollar value of all GDP growth above an initial threshold of 4.2% per year.

The creditors rejected the offer, preferring a “haircut” of 40% on the face value of the debt, no interest-forgiveness, and none of this “kicker” business.  In response, Kirchner told them, the IMF, and the U.S. Treasury that the bondholders could take his “haircut” or nothing. On March 1st, 2005, the president finally repudiated their bonds. In 1998, Argentina’s debt burden came to 38% of GDP, interest payments on the foreign portion totaled 29% of exports, and the deficit came to 1.2% of GDP.  Yet investors pounded the poor country, taking out their money and rolling over the debt at higher interest rates, in addition to rising interest expenses, leading to bigger deficits and even higher interest expenses.

By pulling the plug on Argentina and rejecting the “haircut,” creditors fanned the flames of anti-market, anti-U.S. sentiment across Latin America, which brought Hugo Chavez to power in Venezuela and led to the failure of the Washington-backed Free Trade Area of the Americas. These long term results, a possible warning to Germany and the EU. However, Greece and Argentina are two different economies. Argentina is a food producer and, therefore, has an inflow of dollars to the country given the state of world affairs. That is not the case for Greece, at this point, which is primarily an import dependent economy.

Despite the differences, Argentina has some lessons for Greek policymakers. Unfortunately, none of them are easy and if Greece decides to exit the Eurozone, it could face some unpopular choices to prevent the collapse of the banking system. With the crisis picking up steam in Argentina, between March 2001 and July 2002, unpopular capital controls that only allowed withdrawals of $1200 to $1500 per month were imposed to keep the financial system solvent. The government went further. Wary of massive personal and corporate bankruptcies, it decided to devalue bank deposits at a rate of ARS 1.4 per dollar while keeping bank debt at 1 to 1 with the US dollar. This transition left banks in a fragile state and forced the government to step in and compensate them with some $8 billion in sovereign bonds.

In the end, long-term confidence in the financial system was lost. If Greece chose the same road, the move would obviously lead to social unrest similar to what was seen in Argentina. The economy would also take a dive, possibly contracting by 7% – 8% in the first few years. Greece is also more exposed to the negative effects of a rapid devaluation than Argentina was before the crisis. “The country is a net importer with more than 30% of its GDP worth of imports compared to only 12% in Argentina in 2001” (Financial Times). The move to devalue could outweigh the benefits of any domestic oriented growth in stark contrast to Argentina that managed to export its way out of its mess.

In addition to a heavy-handed policy to force foreign-owned “strategic” industries into local hands over the last 10 years, the contentious debt restructuring has negatively affected foreign direct investment. “FDI inflows to Argentina dropped to just USD 12bn from 2002 – 2010 from USD 76bn in 1992 – 2001”, according to the World Bank. If Greece decides to re-denominate claims into devalued drachmas, Greece may be able to avoid Argentina’s holdout drama. Most of the country’s debt has been issued under the Greek law. “In Argentina’s case, the bonds were mostly issued under New York, not Argentine, law – a move designed to give comfort to investors and reduce the interest rates demanded – which allowed creditors to sue in the US,” said former Secretary of Finance Marx. Additionally, like Argentina, Greece’s bonds do not have a collective action clause forcing creditors to participate in a restructuring if it is supported by a majority of creditors. However with most of its debt under local law, Athens could change the law forcing any untendered bonds to adhere to a deal supported by a majority.

One area where Greece trumps Argentina is the spillover impact of a crisis on its neighbors. When Argentina went through its crisis, the only countries affected were major trading partner Brazil and Uruguay. Rather than being chaotic for Greece alone, a default would affect the Eurozone, challenging the solvency of the regions banks. “Banks are not only exposed directly to the peripheral Eurozone countries such as Greece, but also indirectly via their lending to banks that hold significant peripheral claims,” said Richard McGuire, a senior fixed income strategist at Rabobank.

The quality of the crisis and supports the notion that for all the logical arguments in favor of a Greek exit, the repercussions of such a development will be felt throughout the system in ways likely to be as painful as they are hard to determine. Lastly, one can only hope Greece has leaders who look beyond short-term political costs and decide what is truly best for society.

 

 

 

 

Work Cited

Agustoni, Clara, and Christopher De Vrieze. “Latin Lessons: What Greece Can Learn from             Argentina.” Financial Times. Debtwire, 8 Dec. 2011. Web. 25 Mar. 2013.

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