Cover story - LatinFinance, Number 113
by Peter Hudson
On a chilly day in July, Eduardo Duhalde, presidential candidate of Argentina’s Peronist party, announced that he would call on Pope John II to urge the world’s rich countries to forgive debts owed by developing nations, including Argentina. It was an election gimmick intended to pep up his flagging presidential campaign with some old-fashioned Peronist populism.
Immediately, share prices on the Buenos Aires stock exchange dropped 8.7% and the spread on Argentina’s benchmark bond widened to more than 1,000 basis points over Treasurys. Wall Street economists again began debating how long the peso’s dollar peg would last. Rumors that Roque Fernández, the economy minister, was quitting added to the panic.
Fernandez stayed on to the end of Menem’s term, but to Argentina’s voters the market rout was particularly frightening. Memories of the financial and economic instability that threatened to push Argentina into civil conflict a decade earlier are still fresh. The media ridiculed Duhalde’s appeal for debt forgiveness. Fernando de la Rúa candidate of the center-left Alianza coalition, only gained in stature with his message of gradual change to Menem’s free-market policies.
Three months later, De la Rúa inflicted a humiliating defeat on Duhalde. By then, the spread on Argentine bonds had narrowed to 750 basis points and the Buenos Aires stock market’s Merval share index was up to 550 points, although still some way off its peak in May. Markets again perked up on November 22, the day De la Rúa’s camp leaked the names of his new cabinet, which included four orthodox economists in key ministries.
De la Rúa appointed the urbane José Luis Machinea, a former central bank president, as economy minister. Although he was central bank president during one of Argentina’s bouts of hyperinflation in the late 1980s, Machinea is respected in Buenos Aires as a sound economist who has the president’s full confidence. Economists also head the foreign, defense and education ministries. Pedro Pou, appointed central bank president under Menem, by law retains his post until 2004.
The Road Ahead
De la Rúa and Machinea face considerable challenges. The outgoing Menem government accumulated budget deficits between 1995 and 1999 of over $25 billion. Central government debt rose even faster over the same period—by $38 billion to $118 billion—mainly because the government owed up to debts it had previously not recognized. “That level of debt is manageable, if you can achieve fiscal balance and economic growth,” says Ricardo Fuente, a partner at economic consultancy Latin Eco. But achieving this will require considerable political mettle from De la Rúa, particularly since the Senate, the Supreme Court and key provincial governments are all dominated by the Peronista.
However, Miguel Kiguel, Menem’s astute assistant secretary of finance, is not concerned. He says that at 47% of GDP, total public-sector debt is not excessive. Kiguel, widely respected for his management of Argentina’s foreign funding program, says “if you look at that debt level by international standards, it doesn’t seem too bad.” Projections by the Menem administration show the debt level dropping to around 35% of GDP during De la Rúa’s four-year term. The economy is set to rebound by 3%-3.5% in 2000 and the new government must keep spending under control to comply with the fiscal convertibility law that requires the budget deficit to be eliminated by 2003.
Kiguel succeeded in raising the average maturity of Argentina’s foreign debt to 8.1 years in 1999 from 3.2 years in 1994 in spite of turmoil on world financial markets. He dismisses fears that the new government could face trouble financing the country’s debts. And he doubts Machinea “has any intention of making important changes in financial strategy.” Daniel Marx, a former executive director at MBA, a Buenos Aires investment bank, and a veteran debt negotiator, is the new capital markets secretary “He has an excellent knowledge of financial issues and is known by foreign investors. They couldn’t have made a better choice,’ says Kiguel.
The new team inherits a financial system reconstructed after the disaster of hyperinflation. Menem introduced a Chilean- style private pension fund industry, which now has assets of $12.5 billion. The banking system sailed through the Brazilian devaluation crisis in January. Argentina has about $33 billion in foreign reserves and can call on a contingency liquidity facility with a consortium of international banks if needed.
But Argentina’s capital markets are still very small. Although Kiguel has turned increasingly to domestic markets, which met around just under half of the government’s $17.4 billion borrowing needs in 1999, there is little room for bigger placements. “It’s a tough choice,” says Lacey Gallagher, director of Latin American ratings for Standards & Poor’s “It’s either crowding out domestically or overdependence on foreign financing. That makes it different for some of its peers like Brazil, which raises four-fifths of its financing needs domestically”
The growing size of the debt also reduced the proportion of borrowing Kiguel could cover in advance. The roughly $3 billion he raised before De la Rúa took over was only sufficient to cover payments due in the first couple of months of the new year, somewhat less than a full quarter’s coverage he wanted. ‘The deficit was higher than we thought,” Kiguel explains, “and the markets were more difficult, [but] we are leaving the largest cushion we have ever had.”
Argentina needs to raise $17-18 billion in 2000 to service its debts and finance the government’s budget deficit, of which Kiguel has already raised about $3 billion. Furthermore, Marx’s team has time to prepare for the nearly $5 billion in public debt maturing in the third quarter, over one-third of the total $11.78 billion due in 2000.
However, Moody’s downgraded Argentina in 1999 and Standard & Poor’s put the country on negative outlook, the first step toward an eventual downgrade from its current BB rating. Debt servicing will take up 15% of government revenues this year, according to Gallagher, double the proportion five years ago. Public and private medium and long term debt maturing in 2000 will reach $15.78 billion, more than twice as much as 1999.
Markets are wary of the new government’s declared preference to issue debt in international and domestic markets rather than borrow from multilateral institutions. The government would use multilateral loans in case instability in local or world financial markets cut Argentina off from capital markets.
De la Rúa will also have to negotiate with spendthrift provinces ruled mainly by Menem’s Peronist party.
Still, a deal is possible. “The provinces are highly dependent on the national treasury. They are not going to want to burn their bridges,” says Roberto Guevara, senior country analyst for Merrill Lynch.
A political arrangement with the Peronist opposition—and the Alianza’s left-wing fringe—would underpin a tight fiscal policy and help lower interest rates. Economic recovery, the peso’s solid peg to the dollar and the president’s commitment to orthodoxy should further help De la Rúa.
Freddy Thomsen of ING Barings in Buenos Aires says the president “will have to beg, negotiate and convince. I think it will work. It will make us more nervous, but you have to live with that.” LF