August 20, 2015
A pusher cares less for the health of an addict than squeezing every last penny from the customer. Perhaps this is more so when the victim tries to manage the addiction. Likewise, creditors hardly have the best interests of debtors at heart. Thus, we ought to cast a suspicious eye when creditors make suggestions regarding fiscal policy for their debtors.
In 2002, in the face of a nearly four-year depression and increased borrowing to maintain an overvalued peso, Argentina devalued and defaulted on external debt. The economy recovered rapidly. To come out of default Argentina negotiated in 2005 and again in 2010 haircut deals with the majority of foreign creditors, but a small minority of holdouts continue to prevent Argentina from borrowing internationally. Unable to roll over its debts, Argentina has recently drawn down on foreign reserves in order to make principal payments. Ideally, this is neither better nor worse an option than borrowing. However there is a risk that the drawdown of foreign reserves can feed speculation against the peso, thereby contributing to a black market premium and inflation.
Absent sufficient reserves, Argentina must find a way to borrow or again reduce its debt service. One obvious way forward is for creditors to once again accept new international borrowing from Argentina. This would allow Argentina to roll over its current debt, although it may face a higher interest rate than implied by its current servicing of debt. However, creditors have made an alternative suggestion. According to Moody’s Investors Service, “For Argentina to regain full access to capital markets, its next government will need to reach an agreement with the holdout creditors that have not accepted a restructuring agreement.”
In other words, by bargaining further with its creditors Argentina must now pay for the mere option of continuing to service its debt. With Argentina’s dwindling capacity to pay out of reserves, Moody’s is insisting that Argentina would be welcomed back into credit markets if only it promised to borrow more. Such is the way of the debt pusher—inflicting pain upon anyone who struggles from addiction in the hopes that the struggle is just too great and the victim relapses with greater intensity.
The only question is how deep into debt Argentina is willing to go. This is particularly important question if access to credit does not stop the need to continue draining reserves.
To see how this might work, consider a stylized example of a country initially accumulating foreign reserves of $5 per year. Then, the country borrows $100 at 10 percent interest for 20 years. After 10 years, it starts paying only 5 percent interest and goes into arrears for the rest. After 20 years, the country would like to tap $100 of reserves to pay off the debt. Though it would remain $80 in arrears, it would be debt free and again accumulating reserves. Still, this path is available only if the country has $100 of reserves to use.
Alternatively, the country might continue to bargain after 20 years. In return for paying off one-quarter of its arrears, the other three-quarters is forgiven and it is permitted to borrow at 7 percent. After another decade, it will have $120 of debt; with $8.40 annual debt service it continues to drain reserves.
It is not clear that concessions will help Argentina better manage its reserves, rather than increase its dependence on foreign creditors.