Argentina's debt is unsustainable, the IMF declared on Thursday, asking creditors to accept an "appreciable" reduction that would make it easier for the country to repay the $45 billion it owes the Fund.
And while there is talk of a 15% capital write-off and a certain grace period which, in terms of net present value - the sum of the debt stock and all expected future payments valued at today's prices - would be equivalent to another 15%, the truth is that a reasonable debt stock reduction would not end up solving debt sustainability problems for the country.
To put it simply: if you owe $1000 and the effective interest rate on that debt is 10%, in 10 years' time, if you refinance it, that debt will be $2600, much more than double. If the interest rate is 5% (half), that debt will be $1,600. And if it's 7.2%, it's going to be exactly double.
This is why Finance Minister MartÃn GuzmÃ¡n told the Paris Club that the debt owed to them (at 7% per annum) is unsustainable. Therefore, Argentina cannot take on new debt today: with the current country risk, it should take on debt at 22% per year, which would double the debt in three years.
At present, for the debt stock to be reduced to 75% of the GDP -with the GDP still on the decline-, the removal of the capital should be much higher than 40%. According to Wall Street sources consulted by LPO, a cut of that size is outside the range of any investment fund.
For that reason, the sources said, the success of the restructuring depends more on accepting a bond deduction, that is, on the interest rate earned on each bond, rather than on a sharp capital cut.
"Bonds of between 7 and 8 percent are too high for debt reduction in an economy that is not growing, and more so if it is not going to have a fiscal surplus. To pay that off, the discount on the principal should be much higher than 15 percent. A reduction of that magnitude over the debt with the private sector would allow a reduction of 3 or 4 points over the GDP, it's nothing: it's not sustainable", a source from an important bank in New York said.
"Looking at the equation of public debt sustainability with the market and international agencies (which was 56% of GDP at the end of 2019), the central problem is not so much the level of debt, but the exponential jump in the cost of refinancing the debt in dollars, which is the consequence of a market that sees no margin for achieving short-term fiscal balance in a context of economic growth. Argentina has already made the adjustment to the real exchange rate that returned the trade surplus. So the key is to have an intelligent restructuring that decompresses the maturity profile of the coming years via maturity extension, grace period without interest payment and coupon cutting, rather than a nominal cut of capital (stock)," echoed Federico Furiase, economist, director of Eco Go, and professor of Finance at UTDT.
"To achieve sustainability by growing at 2% in real terms (3.4% in dollars assuming a constant real exchange rate with the United States), with a refinancing cost of 8% of the debt in dollars with private parties and 4% with international organizations, Argentina would have to achieve a primary fiscal surplus of 1.3% of GDP. The problem is that the fiscal convergence paths proposed by MartÃn GuzmÃ¡n imply a much slower fiscal convergence, even in the scenario of greater fiscal constancy. Thus, assuming the same premises, the ratio of public debt to the market and international organizations would go from 56% today to 75%, 70% and 67% in 2030, depending on which of the three fiscal scenarios proposed by Guzman is verified," he added.
"So if we take the scenario of faster fiscal convergence proposed by Guzman, the nominal capital withdrawal required to reach the same debt-to-GDP ratio in 2030 as today would have to be around 25%. And if we want the same debt-to-GDP ratio to remain on a sustainable path - in the scenario with a little less effort to reach the fiscal surplus - then the cost of refinancing the debt in dollars would have to be around 4%, a proxy for the average coupon rate at which GuzmÃ¡n could rush the restructuring," concluded Furiase.
The other variables at play
It is key that President Alberto FernÃ¡ndez seeks a significant grace period, of about three years, in order to use the funds to reactivate the economy. It should be clarified that, without a primary surplus on the horizon - with which to start reducing the debt - as long as the debt is not paid the interest taxi would continue running and would ensure that in 2024 the debt would again be unsustainable.
The other negotiating option is for the taxi to stop running during those years, which would imply a grace period without capitalization; this also seems unacceptable from the side of the funds for such an extended period. That's why analysts don't rule out the possibility that the agreement reached will have a taxi that accelerates in a gradual way: the first years slower and then it will accelerate hand in hand with the economic recovery.
With the current prices of the bonds, the expected removal is much more aggressive than 30% of the present value. In 2005 it was 75%.
But the most relevant point in this discussion is the "exit yield", the return that the funds can earn from holding the bonds once they are restructured to maturity, either from interest rates or from rising parities as the Argentine economy recovers. From the perspective of creditors, it should be no less than 9% per year.
"The balance is very thin. With bond parities around 45%, there would be room for us to end up in a 'win/win' scenario where there is a restructuring that would improve the sustainability equation and at the same time leave the new bonds with parities around 55% and discounts to present value around 40% leaving expectations of a capital gain for private creditors, assuming scenarios with exit yields around 11%. But if we only focus on the discount and not on the consistency of the economic program, it will be difficult to have a consistent exit yield and therefore an entry deal," Furiase explained.
On the other hand, if the restructuring proposal is not reasonable, the debt negotiation would navigate on a very dangerous terrain, given that in a zero-rate world, real money funds have a low opportunity cost to wait and will not accept any proposal," he said.
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