Chaco signals warning for Argentina debt

October 19, 2012

A raft of Argentine provinces and municipalities suffered credit rating downgrades this week after one of their number, Chaco, in the north of the country, ran out of hard currency on the eve of a bond payment. Instead it paid creditors $260,000 in pesos. Now Chaco wants creditors to swap $30 million in dollar debt for peso bonds because it still cannot get its hands on any hard currency.

The episode is a frightening reminder of Argentina’s $100 billion debt default 10 years ago and unsurprisingly has triggered a surge in bond yields and credit default swaps (CDS). But broader questions also arise from it.

First, will debt “pesification” by some Argentine municipalities snowball to affect international bonds as well? And second, is municipal debt likely to become a problem for other emerging markets in coming months?

In Argentina, where the central bank is zealously guarding its sparse hard currency reserves, it does look likely that more provinces will follow Chaco’s example and pay creditors in pesos. But many of these municipal bonds, including Chaco’s, are governed by local law and are mostly held by Argentines. Analysts at Barclays say it is unlikely Buenos Aires will “pesify” debt issued under international law, i.e. force creditors to take payment in pesos. That’s because changing payment terms of international law paper could constitute full-fledged rather than technical default (as in Chaco’s case) and can also trigger cross default clauses. Barclays tells clients:

We believe that local law dollar debt of provincial governments and corporations will be mostly paid in pesos, as per July regulatory changes that ban exchange rate purchases without a “predetermined purpose”. But we do not expect changes in external provincial or corporate debt. Federal government local and external debt will remain honored in dollars, in our view.

The government has rejected allegations it is preparing for a full-scale debt pesification and says dollars will be made available to repay bonds. But the big test of its intentions will come on December 15 when holders of GDP warrants — debt tied to annual economic growth and paid out in pesos — are due to receive their 2012 payment. These foreign investors are wondering whether they will be allowed to convert their payments into dollars at the official exchange rate, as has been the practice in past years, or whether they will have to resort to the parallel market where the peso trades 25 percent cheaper.  Amounting to $800 million at the official exchange rate, that would make a sizeable dent in central bank reserves, Barclays analysts point out.

What of the broader implications of the episode? Province- and state-level debt has emerged as a problem in many developed countries from Spain to the United States and is reckoned to be a huge potential issue in China as well.  David Spegel, head of emerging markets strategy at ING, is inclined to downplay the worries over Argentina:

Really, the Chaco case is just a storm in a teacup. If all Argentine municipals were to default, it would come as a negative surprise for EM markets, of course,  I just doubt it would be a long-lasting shock.

According to Spegel, Argentine municipal debt amounts to $7.2 billion, more than a quarter of emerging markets municipal dollar debt. But it comprises just 0.03 percent of total outstanding emerging dollar bonds.

Across emerging markets, municipal bonds governed by external law (thus excluding debt  such as Chaco’s) total just $28 billion — 1.26 percent of outstanding EM bonds, he calculates.

Consequently external municipals do not pose a huge risk for emerging markets… The sector is too small to have a dedicated investor base.


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