Vultures in Paris: Bilateral creditors achieve deal with Argentina

6 June 2014 by Bodo Ellmers

Argentina and its bilateral creditors, coordinated by the Paris Club, have reached a deal to settle outstanding loans that were in default since 2001. According to the agreement made on 29 May, Argentina is going to pay $9.7 billion over the next five years.

This finally closes another chapter in the 2001/02 Argentine debt crisis. It is a step towards normalising Argentina’s financial relations and facilitating the return to global financial markets. However, the deal has its downsides as it is overly costly, violates the principle of treating creditors equally, implies repaying illegitimate dictator debts, and might pave the way for a new debt crisis. In fact, the deal provides new evidence that the international regime for sovereign debt Sovereign debt Government debts or debts guaranteed by the government. restructuring needs a fundamental overhaul.

The Paris Club Paris Club This group of lender States was founded in 1956 and specializes in dealing with non-payment by developing countries.

– Winner at last …?

When Argentina defaulted in 2001, the affected debt included official bilateral loans worth $4.7 billion – with Japan (30.6%), Germany (27.7%) and the Netherlands (8.7%) as the largest creditors. The lion’s share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. of Argentina’s $95 billion debt default came in the form of government bonds owned by private investors, however. While the Paris Club was ‘holding out’, private debt was subject to a major debt restructuring in 2005, which involved private creditors writing off roughly 75% of their claims’ value. Still, the vast majority participated in the debt restructuring. Some of those who did not sold their claims to vulture funds Vulture funds
Vulture fund
Investment funds who buy, on the secondary markets and at a significant discount, bonds once emitted by countries that are having repayment difficulties, from investors who prefer to cut their losses and take what price they can get in order to unload the risk from their books. The Vulture Funds then pursue the issuing country for the full amount of the debt they have purchased, not hesitating to seek decisions before, usually, British or US courts where the law is favourable to creditors.
, which are currently suing Argentina for full payment.

The agreement reached on 29 May means that the Paris Club’s holdout strategy was successful. Argentina not only agreed to pay back the full amount of defaulted debt from 2002, it agreed to pay accrued interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. and penalties so that the amount due to Paris Club creditors has now surged to $9.7 billion.

That Argentina gave in is even more remarkable, as much of the Paris Club debt is due to export credits and dates back to dodgy deals of Western firms and governments that propped up the military dictatorship of Jorge Videla. His regime ruled Argentina from 1976 to 1981, quadrupling the country’s debt and murdering an estimated 15,000 to 30,000 citizens. Debt justice groups had expected Argentina to declare these claims illegitimate and repudiate repaying the blood money.

It now turns out that speculating on Argentina’s misery was obviously a good investment, as the yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. since the default in 2001 was about 7% annually. In particular, triple-A creditors such as Germany can refinance themselves cheaply, the yield on Germany’s ten-year bonds fell below 1.5% lately, which means that the money lent on to Argentina yielded a net profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. of up to 5.5% for the German treasury.

Eurodad has repeatedly criticised Europe’s official creditors, who enrich themselves by extending profit-making loans to poorer countries, and to debt crisis countries in urgent need of money, such as Greece.

… Or fooled once again?

The Paris Club had to make one concession, however. The repayment plan stretches over five years, and it is backloaded, meaning that the installments increase towards the end of the plan. Just $1.15 billion is due to be paid during the first year. This means that the Paris Club also speculated that Argentina will remain solvent over the next five years, which is far from certain.

Argentina’s desire to reopen the possibility of borrowing on financial markets has been triggered precisely by the fact that the nation’s borrowing needs are high. A huge balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. of payment deficit, due mostly to profit repatriation of foreign corporations, debt service Debt service The sum of the interests and the amortization of the capital borrowed. on restructured bonds, energy imports and capital flight threatens to deplete the nation’s currency reserves. Argentina intends to fill gaps through new borrowing. The arrears with the Paris Club had to be removed first to enable this. But even if legal obstacles or procedures are removed, the cost of credit remains prohibitively high. According to Bloomberg data, Argentina currently pays a risk premium Risk premium When loans are granted, the creditors take account of the economic situation of the debtor country in fixing the interest rate. If there seems to be a risk that the debtor country may not be able to honour its repayments then that will lead to an increase in the rates it will be charged. Thus the creditors receive more interest, which is supposed to compensate for the risk taken in granting the loan. This means that the cost to the borrower country is much higher, accentuating the financial pressure it has to bear. For example, in 2002, Argentina was faced with risk premiums of more than 4,000 points, meaning that for a hypothetical market interest rate of 5%, Argentina would have to borrow at a rate of 45%. This cuts it off de facto from access to credit, forcing it even deeper into crisis. For Brazil in August 2002, the risk premium was at 2,500 points. of 10.85 percentage points over US Treasuries on existing dollar-denominated debt.

This also implies that the sustainability of Argentina’s debt is questionable, and the fact that the recent deal added $9.7 billion to the bill certainly did not help to improve the situation. So the deal might just have opened a new cycle of surging debt levels, crisis, default and restructuring. This was the ninthagreement between Argentina and the Paris Club since the 1950s, as noted by Spain’s newspaper El País. The tenth agreement might not be too far away.

International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
– the biggest loser?

Argentina’s red line in the negotiations was that the deal must exclude the International Monetary Fund (IMF). This succeeded, which was a political victory for the government of Cristina Fernández de Kirchner. In contrast to most other Paris Club agreements, this one does not come with the condition of implementing an IMF-designed structural adjustment Structural Adjustment Economic policies imposed by the IMF in exchange of new loans or the rescheduling of old loans.

Structural Adjustments policies were enforced in the early 1980 to qualify countries for new loans or for debt rescheduling by the IMF and the World Bank. The requested kind of adjustment aims at ensuring that the country can again service its external debt. Structural adjustment usually combines the following elements : devaluation of the national currency (in order to bring down the prices of exported goods and attract strong currencies), rise in interest rates (in order to attract international capital), reduction of public expenditure (’streamlining’ of public services staff, reduction of budgets devoted to education and the health sector, etc.), massive privatisations, reduction of public subsidies to some companies or products, freezing of salaries (to avoid inflation as a consequence of deflation). These SAPs have not only substantially contributed to higher and higher levels of indebtedness in the affected countries ; they have simultaneously led to higher prices (because of a high VAT rate and of the free market prices) and to a dramatic fall in the income of local populations (as a consequence of rising unemployment and of the dismantling of public services, among other factors).

programme. However, the economic price was high, as this also removed the option for Argentina to receive actual debt relief under the Paris Club’s Evian terms, for which IMF involvement is a condition.

Moreover, Argentinian experts such as Professor Alan Cibils, who was interviewed by Eurodad, argue that there is no point in formally excluding the IMF, when at the same time the government is starting to implement the same policies that the IMF would recommend. This includes raising central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
, cutting subsidies to reduce the fiscal deficits and upholding payment obligations to foreign creditors at any cost.

Implications for global debt crisis management

That the Paris Club applied a similar holdout strategy as vulture funds – and was successful – might have severe repercussions for the reform of the legal and policy framework for sovereign debt restructuring that is ongoing at the IMF and the UN. The holdout strategy of the vulture funds that are currently suing Argentina at New York courts for full payment is a key central reason why the current system urgently needs an overhaul, according to the IMF. Now the private vultures have been joined by an official counterpart. Voluntary debt restructuring will no longer be possible when holdout creditors get their way: if they get paid in full, why would any creditor participate voluntarily and write off their claims?

What is happening now in Argentina is new evidence that holding out is a profitable investment strategy. The participating creditors were the useful idiots whose collaboration restored Argentina’s solvency and freed up the finance to start paying the Paris Club holdouts.

The lesson learnt is that, in order to make future sovereign debt restructurings more effective, a new debt workout mechanism should legally bind all creditors, including official creditors under a comprehensive treatment, and be able to enforce participation in a case of sovereign bankruptcy. For the majority of the world’s countries, developing such a new debt workout mechanism is a priority reform, as recent interventions by the Group of 77 and China at the UN’s Post-2015 and Financing for Development processes have shown.



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