By Richard Lough, Eliana Raszewski and Daniel Bases
BUENOS AIRES/NEW YORK (Reuters) - Argentina will default on its debt within hours after talks with holdout creditors broke down on Wednesday.
As the clock ticked toward a midnight (0400 GMT) deadline, Economy Minister Axel Kicillof stuck firmly to the government line, repeatedly denigrating the holdouts as "vultures" after two days of intense negotiations.
Argentine banks scrambled to put together a proposal to buy out the non-performing debt held by hedge funds and avert a default. But that deal collapsed, a senior banking executive and a second source from the financial market said.
"It all fell through," said the banking executive.
A default will hurt an economy already in recession, fueling risks to consumer prices in a country with one of the world's highest inflation rates and putting more pressure on a peso that was devalued sharply early in the year.
It also marks a set-back to the Buenos Aires government's attempts to return to global credit markets. Argentina has been isolated from international financial markets since its record $100 billion default in 2002.
The default results from Argentina's failure to comply with a court order that holdout bondholders be paid at the same time as a $539 million coupon payment to those who accepted reduced payments in two prior restructurings.
"Unfortunately, no agreement was reached and the Republic of Argentina will imminently be in default," Daniel Pollack, the court-appointed mediator in the case, said in a statement on Wednesday evening.
Mark Brodsky, chairman of Aurelius Capital Management, one of the two leading hedge funds opposing the deal, referred calls to his spokesman, who said the firm had no immediate statement. Calls to the other leading holdout, NML Capital, a unit of Elliot Management Corp, were not immediately returned.
Kicillof told reporters in New York that Argentina had offered the holdouts the same terms as the bond swaps issued in 2005 and 2010. The funds rejected those terms, Kicillof said before preparing to fly back to Argentina.
"Argentina paid, it has money, it will continue to pay the next installments because we want to do so and because the money is available," he said.
"This money is there. If it were a default, there would be no money."
U.S. District Judge Thomas Griesa in New York, who awarded $1.33 billion plus interest to the holdout hedge funds, has called Argentina's payment illegal and rejected its argument that it has fullfilled its obligations.
Kicillof reiterated the country's position - that it cannot pay the holdouts without triggering a clause that could leave it open to claims worth hundreds of billions of dollars from bondholders who accepted the restructured debt agreements following the 2002 crisis.
"USED TO BAD NEWS"
Many Argentines took the news on the chin.
"We are used to bad news," said 34-year-old office worker Mariano Garcia. "Every 10 years or so there is some cataclysmic event. It's a shame."
The sanguine reaction is a far cry from the chaos that erupted during the country's economic crash in 2001-2002. Millions of Argentines lost their jobs, the economy collapsed and dozens of people were killed in protests that lasted months.
This time the government is solvent. The country's commercial banks are solid, with low capital ratios, and Argentina still boasts a trade surplus, albeit a shrinking one, thanks in large part to high prices for soy.
How much pain the default inflicts on Latin America's third-biggest economy will depend on how swiftly the government can extricate itself from the mess.
"To go home carrying a default in their hands just doesn't make sense," said Kathryn Rooney Vera, senior macroeconomic strategist at Bulltick Capital in Miami.
"If this is resolved over the next few days, the impact is very limited. But if it sticks, it's a very different story."
In a sign of how markets might respond on Thursday, U.S.-traded shares in Argentina's energy firm YPF (YPF.N) slumped 7.7 percent in after-hours trading while Banco Macro (BMA.N) plummeted 12.7 percent.
Argentina had pushed hard for a stay of the ruling by Judge Griesa that set Wednesday's deadline for the Buenos Aires government to pay the holdouts.
It has consistently argued that a so-called Rights Upon Future Offers, or RUFO, clause prohibits it from settling with the holdouts on terms better than those received by holders of the restructured debt. That clause expires at the end of 2014.
Argentina tried making a $539 million interest payment in late June, but Griesa blocked the funds' onward transfer to creditors. The money remained in limbo in the Buenos Aires account of trustee agent Bank of New York Mellon on Wednesday.
U.S. ratings agency Standard & Poor's downgraded the country's long- and short-term foreign currency credit rating to "selective default". The default rating will remain until Argentina makes its overdue June 30 coupon payment on its discount bonds maturing in 2033, the agency said.
Prior to the collapse of the talks, Argentina's markets had rallied on optimism for a deal. Yields on Argentina's key dollar bond due 2033 fell to its lowest level in about three and a half years on Wednesday, and its MerVal index (.MERV) hit a record.
Markets are likely to reverse those moves on Thursday.
"We'll give up today's gains and then some on Thursday. We have to start pricing for the risk that this may not be a negotiation tactic or legal tactic," said Siobhan Morden, head of Latin America strategy at Jefferies in New York.
"If the private sector solution is not real, I'll have to reassess for a much lower target than 68 (cents on the dollar) on the Discount bonds."
(Corrects typo "clocked" in second paragraph)
(Additional reporting by Alejandro Lifschitz and Sarah Marsh in Buenos Aires, Carolyn Cohn in London and Rodrigo Campos and Luciana Lopez in New York; Editing by David Gaffen, Jonathan Oatis and Ken Wills)