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Published: Tuesday July 22, 2014 MYT 9:16:22 PM
Updated: Tuesday July 22, 2014 MYT 9:16:22 PM

Analysis - Argentine default in balance as government refuses to capitulate

BUENOS AIRES (Reuters) - Argentine President Cristina Fernandez's unflinching poker face in the battle against "holdout" investors suing the country is increasing the odds that her government will default for a second time in 12 years at the end of this month.

She has refused to budge from her stance that Argentina cannot pay out in full to the holdout hedge funds, which snapped up bonds on the cheap after its $100 billion (58 billion pounds) default in 2002. That is despite indirect talks aimed at cutting a deal.

Fernandez last week told leaders of the BRICS emerging economies that it was "impossible" to pay holdouts the full face value of the debt they hold. The funds, she said, could enter a bond swap matching the terms of restructuring deals in 2005 and 2010, which saw creditors accept large writedowns.

It is an old offer the holdouts have previously scoffed at and they have no reason to take it now given that U.S. courts have ruled in their favour and put Argentina on the verge of default.

While it is part of Fernandez's negotiating position and she still has time to cut a deal behind closed doors, her aggressive tone has repeatedly angered holdouts and the U.S. judge at the centre of the case, making it more difficult to cut a deal.

A default risks more economic pain for Latin America's No. 3 economy which is in recession and grappling with one of the world's fastest rates of inflation.

The funds have said through their lawyers that they are prepared to talk, including listening to Argentina's needs on when it pays. But lead holdout, NML Capital Ltd, said on Friday that Buenos Aires appeared determined to default after a week of defiant rhetoric and no negotiations.

"The chances of a default have increased. I am still hoping they are playing a game of poker" said Claudio Loser, an Argentine who worked for decades at the International Monetary Fund and now is president of advisory firm Centennial Group.

The tough-talking Fernandez has pledged to keep paying the country's restructured debt but vows never to pay at face value the "vultures" that bought the bonds at a steep discount and are suing for full payment.

Argentina's exclusion from global capital markets means an eventual default would be highly unlikely to send shockwaves through emerging markets worldwide.

But it would further weaken Argentina's peso currency, which has fallen 20 percent on the official rate so far this year, and fuel upside inflationary risks.

Foreign reserves, which hit an eight-year low this year, stand at $30 billion and could fall by up to a third, Loser estimated, in a fight to shore up the currency and cover a rising import bill.

While time is running out, some investors hope Fernandez will reach a late deal so that Argentina can once again tap global markets to bolster its thin reserves and finance the development of vast shale oil and gas resources.

"I don't see any scenario in which a default is positive, not even for Cristina's ideology," said Alberto Bernal, a partner at Miami-based Bulltick Capital Markets.

"It would mean she defaults on the bonds that her late husband restructured," Bernal said, referring to Fernandez's partner and predecessor as president, Nestor Kirchner. "She knows that the benefits from an accord would be enormous."

OPTIMISM WANING

For years, Argentina refused to negotiate with the holdouts.

Now it has run out of legal options to circumvent a 2012 ruling by U.S. District Judge Thomas Griesa that it pay the funds $1.33 billion, plus interest. Griesa also ruled it could not service restructured debt before settling with the funds, meaning it would fall into default.

The spread between upside and downside price risk on the Discount bonds showed the probability of a settlement slipping to 65-35 last week from 75-25 in favour of a settlement in the week ending July 11, said Siobhan Morden, head of Latin America Strategy at Jefferies.

Even so, the price of Argentina's U.S. denominated Discount bond is up 14.7 percent since the U.S. Supreme Court declined Argentina's appeal in mid-June, indicating markets still see a positive outcome.

Morden said investors expect Argentina to act rationally and negotiate a settlement, enabling a return to capital markets and relieving stress on its balance of payments deficit.

"If Argentina does not schedule a meeting (this week), then we assume that bond prices will discount higher deal risk ahead of the imminent deadline," Morden said.

The market mood is already shifting because of the lack of progress since Economy Minister Axel Kicillof told mediator Daniel Pollack that Argentina wanted a stay on the court ruling, to allow more time to thrash out a deal.

"We see a 55 percent chance they succeed in winning a stay. We're a bit more pessimistic than we were before," said Alejo Costa, head of strategy at local investment bank Puente.

Argentina also says capitulating to the holdouts would break a legal clause prohibiting it from servicing debt on terms better than those accepted by creditors who took the haircut.

That could trigger challenges from other holdouts and bondholders worth more than $100 billion, the government says.

"There are no signals that show Argentina is getting ready to pay," said Guillermo Nielsen, a former finance undersecretary who was in charge of the 2005 debt restructuring. "There's a feeling we're heading to a default."

DELIBERATE DEFAULT

The equation may change on Tuesday when Griesa will hear arguments filed by BNY Mellon and payment agents caught up in the sovereign debt row.

Argentina in late June deposited $539 million with the Bank of New York Mellon but Griesa blocked the funds' onward transfer to creditors, triggering a 30-day grace period up to July 30, and called Argentina's move "explosive".

BNY Mellon wants clarification on what it should do with the funds Griesa blocked in its account. The bank has said Euro bondholders have threatened to sue it if it returned the funds to Argentina.

Griesa could opt to allow BNY Mellon to release the blocked funds, meaning Argentina would then have serviced its June 30 debt payment. That, however, would require the veteran judge to issue a new stay, lawyers said.

An official at the Economy Ministry said the government was waiting for the results of tomorrow's meeting in New York to decide further steps.

"I don't think (Griesa) will just grant a stay without strong support from the plaintiffs, but why would they given Argentina hasn't been showing much good faith?" said Daniel Kerner, practice head of Eurasia Group's Latin America division.

There may also be a way around the RUFO clause which, in an extra twist, expires on Dec. 31. That would involve the feuding sides agreeing to a delayed settlement as of Jan. 1, 2015, with some form of guarantee written into the deal.

"Most lawyers believe if payment is made into an escrow account, as mandated by a judge, it wouldn't classify as violating the RUFO clause," Kerner said.

However, a deliberate default cannot be ruled out. In that scenario, Argentina may try to launch a new bond swap under Argentine legislation in a bid to escape the U.S. lawsuits. It would be a move fraught with risk.

"Perhaps the risk is higher for exchanged bondholders converting to holdouts and demanding par claim after a technical default as opposed to exchanged bondholders demanding par claim on violation of RUFO," said Morden.

(Additional reporting by Sarah Marsh and Jorge Otaola; Editing by Kieran Murray)

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