Some investors in emerging markets may have considered Argentina and moved on, judging the dangers too great, while others have lingered, courting the bond markets and their potential for higher returns. Those still on the fence might want to consider these three top challenges to investors as they make their decisions, and consider the fact that they may present opportunities as well.
1. Recession. Argentina battled its way back from a debt crisis in 2001 that saw it default on some $95 billion in bonds. While the going was tough at first after the default—the Argentine economy contracted by 4.4% in 2001 and then shrank even more in 2002, by a whopping 10.9%—it actually managed to return to growth in 2003, since which time it’s averaged expansion of 6.2% annually. Not a bad accomplishment.
However, for the first time in 10 years, Argentina’s steady growth has slowed enough to push the country into recession. While it grew by 3% last year, in Q4 it lost ground and the situation did not improve in January. The Argentine economy is now expected to contract by 1% in 2014, shoved in that direction in part by a currency devaluation at the beginning of the year that has led to the second threat: inflation.
2. Inflation. Argentina was chugging along relatively well until that slowdown at the end of 2013. But when the economy slowed, the country’s response in January was to devalue its peso by a hefty 20% and bump up interest rates. That made things worse; it hit consumer spending hard—which in turn fueled the growing weakness in its economy.
Inflation has grown as everything from imports to houses to food has become far less affordable, and consumers have cut back, even shunning beef consumption in favor of cheaper meats—according to the Argentine agriculture ministry, beef sales in Q1 dropped by more than 5%. Economists say it’s going to get worse, with predictions of the inflation level for the year ranging from 30–45%. Wages, of course, have not kept pace, so foreseeing a worsening downturn hardly needs a crystal ball.
3. High risk. This one’s a bit more complex, coming as it does from a multitude of causes. Argentina has a bit of a bad name in the international community for such actions as its massive default (it’s still negotiating with holdouts who refused to accept a debt restructuring that offered bonds at a 75% discount) and its seizure of Spanish oil company Repsol’s stake in YPF SA, the largest producer of crude oil in the country (it also seized private pension funds and an airline a few years ago).
However, in March, after Argentina finally reached a settlement for $5 billion with Repsol over the YPF seizure and made some progress in discussions with the Paris Club over some $9.7 billion that the country still owes its member nations, it said it had received offers of loans from financial institutions that it declined to name.
Fast forward to the end of May, when Argentina reached an agreement to repay the Paris Club $9.7 billion in full over a 5–7 year period, according to Axel Kicillof, the country’s economy minister. Things are looking rosier, right?
Not necessarily. Back up to February, when Argentina reached the settlement with Repsol. At the time, Antonio Brufau, Repsol’s chairman, said it could take up to two years to sell off the $5 billion in bonds. On May 8, however, Miguel Martinez, Repsol’s CFO, said that the company could sell them sooner if it found “a window of opportunity.” The window opened, and the bonds flew out and into the coffers of JPMorgan, which bought the first package of bonds on May 9 and the rest on May 23. Then JPMorgan began to sell the bonds, which flooded the market and further depressed already-falling emerging market bond prices.
Then there’s Elliot Management Corp. Billionaire Paul Singer’s firm is one of the holdouts that refused to settle with Argentina at the time of negotiations on default, instead holding on and insisting on better terms than were accepted by 93% of the nation’s creditors. Singer has already sued Argentina, and Elon Musk’s Space Exploration Technologies Corp., over rights to launch-services contracts.
The firm is also awaiting a decision by the Supreme Court about whether justices will hear arguments to uphold a lower court judge’s ruling that mandates Argentina to pay the holdouts in full when it pays restructured bonds. The country has said the cost of such a payoff would be $15 billion; fears are that a Supreme Court decision not to hear the case could spark another default.
And now Elliot Management Corp.’s NML Capital claims to have found a “smoking gun” indicating that Argentina intends to default if the Supreme Court decides not to hear the case. A memo containing legal advice to Argentina’s economy ministry is at the heart of NML’s action.
The memo, from law firm Cleary Gottlieb Steen & Hamilton LLP, was posted by an “unauthorized” person to the Argentine website Seprin.info, and says in part, “We believe that, barring revision by the Supreme Court of the lower-court’s ruling, the best option for the Republic is to permit the Supreme Court to force a default and then immediately restructure all of their external bonds such that their payment mechanism and other related aspects stay outside the reach of the American courts.”
Nicholas Smithie, chief investment strategist at Emerging Global Advisors, said that Argentina is in “almost an un-investable bracket … following the nationalization of YPF and repercussions with Rebsol and Spain, [Emerging] thinks that the equity market is considered to be amongst the highest risk of all, and excludes it from eligible countries for investment.”
However, Fran Rodilosso, portfolio manager of the Market Vectors taxable fixed income ETFs at Van Eck Global, had another view. While the Supreme Court decision looms, Rodilosso said, “An adverse ruling against Argentina raises risk in the market, but does not mean that they will fall into default on their outstanding debt. There’s probably greater risk to bonds issued under international law rather than local law, as far as their ability to make payments.”
Rodilosso characterized Argentina as “a small yet noisy part of the [investing] universe,” and pointed out that there is still demand for its debt, which has “traded very well this year…. Investors don’t forget, but they’re willing to forgive, if you pay enough. A lot of people stayed away from Argentina on the active side for a long time, but part of what drives a rally is people chasing returns. So you see Argentina performing fairly well.”