Global Investing

Chaco signals warning for Argentina debt

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.

Argentine CDS spiral on “peso-fication” fear

Investors with exposure to Argentina will have been dismayed in recent weeks by the surging cost of insuring that investment — Argentine 5-year credit default swaps have risen more than 300 basis points since mid-May to the highest levels since 2009. That means one must stump up close to $1.5 million to insure $10 million worth of Argentine debt against default for a five year period, data from Markit shows.

The rise coincides with growing fears that President Cristina Fernandez Kirchner is getting ready to crack down on people’s dollar holdings. Fears of forcible de-dollarisation have sent Argentine savers scurrying to the banks to withdraw their hard currency and stash it under mattresses. That has widened the gap between the official and the “black market” exchange rate. (see the graphic below from Capital Economics)

While government officials have denied there is such a move afoot, Fernandez has not helped matters by exhorting people to “think in pesos”.  That will be hard for Argentines, most of whom have vivid memories of hyperinflation, default and devaluation. Unsurprisingly, most prefer to save in dollars.