ARGENTINE DEBT Playing by the Rules

September 25, 2007

U.S. banks got another last minute reprieve in June, when Argentina agreed to implement yet another IMF adjustment program. The program re- quired the Argentine government to reduce its budget deficit from 10% of GDP to 3% of GDP by year end and to cut the monthly inflation rate from 30% in May to 12% by December. In a closely related development, Presi- dent Ratil Alfonsin announced tough new anti-inflation measures, includ- ing a freeze on all wages and prices, a promise by the government to stop financing its deficit by printing money and the creation of a new currency, the austral. Without an IMF agreement, the fi- nancial equivalent of a "Good House- keeping Seal of Approval," U.S. bank regulators would be required to classify U.S. bank loans to Argentina as "value impaired." For banks, this would mean considerably lower prof- its. It would also mean that a $14 bil- lion refinancing package, announced only last December, might unravel, leaving banks little choice but to de- clare Argentina in default. The immediate impetus for this latest episode in the Argentine debt drama was a regularly scheduled meeting of the Interagency Country Exposure Review Committee (ICERC). ICERC members--officials from the Federal Reserve Board, the Comptrol- ler of the Currency and the Federal Deposit Insurance Corporation-meet several times a year to review the status of commercial bank loans to developing nations. Under the terms of the International Lending and Supervision Act of 1983 (Title IX, P.L. 98-181), passed in conjunction with the IMF quota in- Alfred J. Watkins, a Washington economist, was a co-author of the MarchlApril Report on the Americas, "Debt-Latin America Hangs in the Balance." crease, banks are required to establish special reserves whenever there is "a protracted inability of public or pri- vate borrowers in a foreign country to make payments on their external inde- btedness." Symptoms of a "prot- racted inability" include a failure to make payments on their external in- debtedness." Symptoms of a "pro- tracted inability" include a failure to make full interest payments or to adhere to an IMF adjustment pro- gram. Argentina was guilty on both counts. As of June 10, the date of the ICERC meeting, Argentina, with an overdue interest bill totalling approximately $1.2 billion, was seven months be- hind on its interest payments. Also, the IMF announced in mid-February that Argentina had fallen out of com- pliance with an adjustment program it had signed only last September. Consequently, without persuasive evi- dence that Argentina was mending its ways, ICERC would have little choice but to declare bank loans to Argentina "value impaired" and to require banks to establish special reserves. Once special reserves are man- dated, each bank must deduct from its income-and place into the special re- serve-an amount equal to at least 10% of its loans to that country. In ad- dition, it must write down--or reduce the value on its books-of its loan to that country by the amount of the spe- cial reserve. For U.S. banks with the largest exposure to Argentina, special reserves would have a major impact on both bank profits and the value of stockholders' equity. According to a June report in The American Banker, a financial daily, Manufacturers Han- over Trust Company, Citicorp, Chase Manhattan and Morgan Guaranty Trust Company have each lent ap- proximately $1 billion to Argentina. Consequently, a 10% special reserve would reduce reported profits and the value of stockholders' equity at each bank by at least $100 million. JULY/AUGUST 1985 Consortium Offers New Money Lower profits might be the least of the problems caused by a value im- paired ruling. Last December, a negotiating committee representing all 320 banks with loans to Argentina an- nounced plans to lend an additional $4.2 billion so Argentina would have enough cash to continue paying inter- est on old loans. The committee also agreed to reschedule-to postpone for up to 12 years-principal payments that were orginally due in 1984 and 1985. However, plans to disburse the $4.2 billion new loan and to re- schedule the old loans were put on hold in February, after the IMF an- nounced that it was suspending its agreement with Argentina. For the big multinational banks with the greatest amount at stake, a temporary delay in implementing the refinancing agree- ment would not be fatal. But the big banks were fearful that many small banks in the rescheduling syndicate would use the ICERC ruling as an ex- cuse to scuttle the agreement. Many of these smaller banks had been reluctant participants from the beginning. They had relatively little money at stake, so an interruption of interest payments, or even a default, would not threaten their viability. Rather than make new loans to a country that bank regulators had deemed uncreditworthy, they would just as soon write off their loans al- together. This would reduce their profits even more than establishing a special reserve. But if their profits were going to suffer anyway, many officers at small banks believed that declaring a default might be better than trying to justify to their boards of directors and stockholders endless rounds of new loans. If the small banks refused to partici- pate in the rescheduling agreement, they would leave Argentina without enough cash either to continue paying interest or to repay old loans that were rapidly coming due. And they would leave the banks, which could not af- ford to walk away from their Argen- tine loans without imperiling their own solvency, with only two options. The big banks could buy Argentine loans from the small banks, knowing 7full well that the small banks would probably demand 100 cents on the dollar for a loan that the regulators would immediately value at only 90 cents on the dollar. Barring that, the big banks could let the small banks scuttle the rescheduling agreement and precipitate a default. Either way, the big banks were facing major losses. Successful Week for Banks Argentina's latest IMF agreement spared the big banks, at least for the moment. And to add luster to the banks' apparent victory, the United States and several other governments agreed to lend Argentina $470 million so it could make an immediate install- ment on overdue interest payments. In addition to this so-called bridge loan, the banks received two additional in- terest payments totalling $570 mil- lion, after Argentina announced it would use some of its own cash to further reduce its interest arrears. All told, it seemed to be a success- ful week for the banks. Not only did they avoid a potential double-barrel disaster, but they received nearly $1 billion for their troubles. However, despite the appearance of total victory for the banks and total capitulation by the Argentines, these events are just one more example of how little lever- age the banks really have, and how easily the Argentine government can orchestrate events to suit its own needs. Argentina's power comes from a basic fact that no IMF agreement can alter: its interest payments are running at a $6 billion annual rate while its trade surplus is only $4 billion. The Alfonsin government has been insist- ing that Argentina will not spend more than $4 billion of its own funds to pay interest; so either someone gives Argentina $2 billion to pay interest, or the banks forego income totalling $2 billion. As long as Argentina receives an adequate amount of new money-- perhaps through a combination of IMF funds, bridge loans from creditor governments and new bank loans-in- terest can be paid and the appearance of bank profitability can be preserved. And as the Argentines are demonstrat- ing to everyone, bank regulators, who are supposed to be preserving the integrity of the financial system, are quite willing to participate in this charade. For their part, all the Argen- tines have to do is give the appearance of capitulating to the banks and the IMF. And as long as it is in the coun- try's interest to do so, the banks can count on compliance from Argentina. Playing by the Banks' Rules Approximately one month before Argentina signed its agreement with the IMF, an Argentine official with close ties to the ongoing negotiations told me, "We'll sign with the IMF in June because it's not convenient for us to have our credit rating downgraded at this time." Presumably, there will be a time when a credit downgrading will be more convenient. But at least for the next few months, Argentina stands to make a tidy profit if it suc- ceeds in convincing everyone that it has reformed and can now be trusted to play by the financial community's rules. The profit comes from the fact that the rescheduling agreement, which provides Argentina with $4.2 billion of fresh loans, stipulates that Argen- tina will receive almost $2 billion in the first disbursement, scheduled for later this year. Thus, for the price of signing an agreement that it has re- peatedly violated in the past, plus the immediate expenditure of somewhat more than $500 million, the Argentine government will receive several bil- lion dollars from the banks and sev- eral hundred million dollars more from the IMF. Seen from this perspective, even Alfonsin's strict anti-inflationary measures are not an indication that Argentina has suddenly decided to play by the banks' rules. As Argentine officials are quick to point out, a 1000% annual inflation rate is a symptom of intolerable social disin- tegration. Curbing inflation, they ex- plain, would be necessary even if the debt crisis did not exist. Under no cir- cumstances did the government an- nounce these tough measures simply so the country would be in a better fi- nancial position to pay interest. In fact, in a nationally televised speech 5 REPORT ON THE AMERICAS spelling out the details of the govern- ment's new economic policies, Eco- nomics Minister Juan V. Sourrouille alluded to the fact that curbing infla- tion is a prerequisite for making new demands on the banks. "A country with a weak economy overrun by in- flation is a country that cannot defend its national interests and make its just demands for a more equitable interna- tional order respected," he said. "Negative on Argentina" Apparently, even the U.S. financial community expects that more troubles are looming just over the horizon. At the same time that Argentina was signing its agreement with the IMF, Moody's, a private credit rating agency that assesses the risk as- sociated with various investments, an- nounced that it was lowering its credit rating of Manufacturers Hanover Trust Company, the bank with the largest exposure in Argentina. In its announcement, Moody's declared, "Loans to Argentina have diminished further in value. Manufacturer Han- over's considerable exposure to Argentina will depress future profita- bility and limit capital adequacy to levels that may be inconsistent with current ratings." An official later explained that Moody's is "more negative on Argentina than it has been in the past." Bank regulators are becoming more negative too, even though they de- clined to require special reserves. After the IMF agreement was an- nounced and President Alfonsin had announced the new round of austerity measures, the regulators issued a cryptic ruling requiring banks to "uti- lize conservative accounting treatment of interest payments received from Argentina." While bank officials are still trying to devine precisely what this means, one interpretation is that banks will no longer be allowed to count interest payments from Argen- tina as profits. Instead they must be used to reduce the outstanding princi- pal. Normally, this accounting treat- ment is reserved for payments from domestic debtors encountering severe repayment difficulties. It is a har- binger of bankruptcy.

Tags: Argentina, debt crisis, austerity, banking, IMF deal

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