Lessons from Argentina

The past couple of days have seen Greek debt take a bit of a battering.  Spreads on Greek government bonds are the widest they have been since the inception of the Euro, and Greek 5yr CDS is wider by 100bps+ versus the beginning of the week. This seems to have been driven initially by nervousness around the anticipated bailout, with rumours that the Greeks are trying to renegotiate the deal that was announced on 26th March.  More seriously though, Greek banks, who ironically were the ones responsible for buying a lot of recent sovereign issuance, have now asked for Eur14bn in loan guarantees from the government, perhaps due to recent numbers that showed as EUR10bn drop in deposits (4.5% of Greek GDP!).  This could be the start of a bank run.

Looking to the relatively recent past one will find that Argentina underwent something similar. They went through their debt fuelled crisis in the ‘90’s, with a bank run in 2001 as Argentines withdrew money from banks and converted into US dollars, culminating in sovereign default in late 2001.

The parallels between the two countries are quite striking. Argentina used to operate a currency peg to the US Dollar (abandoned in early 2002), effectively the same as having a common currency, in order to keep a lid on inflation.  Argentina therefore imported US monetary policy, resulting in an artificially strong currency, and this resulted in artificially high imports (which meant a steady outflow of US dollars from the economy). The currency peg also gave the Argentinian public access to cheap US credit, which they were less than reluctant to use. Greece too has spent the past decade or so borrowing at artificially low rates of interest.

Corruption and tax evasion in both countries exacerbated their problems. Admittedly appointing political supporters to Argentina’s  Supreme Court and an (alleged) illegal arms deals could be seen as more morally questionable than cooking the books, but where markets are concerned dishonesty on any level is a serious offence.

The levels of debt of the two however are not comparable. Unfortunately for Greece, they are starting from a considerably worse position than the Argentinians. In 2001 Argentina’s debt/GDP ratio and deficit as a percentage of GDP were 62% and 6.4% respectively. At the end of 2009, Greece’s debt to GDP was 114% and the deficit 12.7%

After the Argentinian crisis, the IMF, who repeatedly lent cash to Argentina in the 90’s, produced an evaluation report entitled The IMF and Argentina 1991-2001. It’s quite a hefty piece but on pages 6 and 7 there is a list of lessons learned and recommendations on how to avoid mistakes in the future. To me, the most interesting lessons are lesson 9 ‘Delaying the action required to resolve a crisis can significantly raise its eventual cost…..’ and recommendation 4 ‘The IMF should refrain from entering or maintaining a program relationship with a member country when there is no immediate balance of payments need and there are serious political obstacles to needed policy adjustment or structural reform’. Recommendation 4 must be a particular worry to the Greeks. This crises has been dragging on for a few months now without any decisive action having been taken and disagreements between Germany and the rest of the Eurozone over whether/how to lend a hand could be viewed as a ‘serious political obstacle’. Clearly the disagreement is what has caused the delay in a resolution but the longer the policy makers procrastinate the more expensive an eventual bailout will get.

When Argentina defaulted, the government offered a debt swap valuing existing bonds at only 35% of face value, the worst recovery rate in sovereign debt history.  76% accepted these terms, but the rest didn’t (and the holdouts are still fighting with the government today, which has locked Argentina out of international capital markets since it defaulted). With over half of outstanding Greek bonds still trading with a cash price in the 90s,  if Greece does default (implied risk from CDS market is over 30% in the next five years) then investors potentially still stand to lose over half of their money. 

A further worry is that when Argentina defaulted, the consensus (seemingly as now) seemed to be that there wouldn’t be contagion (see here).  True, initial contagion at the end of 2001 was limited, but contagion increased through the second half of 2002.  Only a $30bn IMF loan prevented a Brazilian default in 2002, and Uruguay experienced a banking crisis and defaulted in 2003. Argentina’s default resulted in borrowing costs increasing significantly in the region, and growth for all countries stagnated.  What is particularly worrying is that, unlike with Greece now, Lat Am banks didn’t actually have that much exposure to their neighbour’s debt.