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Must-know: What caused Argentina to default?

Surbhi Jain

Must-know: Argentina defaults for the second time in 13 years (Part 4 of 5)

(Continued from Part 3)

What weakened Argentina?

After the financial crisis and default of 2001, restoring Argentina’s sense of pride and sovereignty has been a key objective for Argentina’s President Cristina Fernandez de Kirchner and her predecessor and late husband, Nestor Kirchner.

So far, the duo has:

  • Negotiated or paid off most of Argentina’s defaulted debt
  • Nationalized the pension system
  • Kept energy cheap through subsidies
  • Dug deep into the Treasury to redirect revenue to the poor

However, the effort to restore the economy has left the country in a situation where it’s unable to honor its current debt obligations in full. In their pursuit of restoring the economy by providing energy subsidies and funding social programs, they’ve literally drained out the Central Bank’s reserves. Also, Argentina’s economy has weakened to the extent that the authorities have little control over the burgeoning inflation rate. Argentina currently has one of the world’s highest inflation rates.

Among the many financial problems Argentina is facing today, here are a few:

  • An economy in recession
  • A burgeoning inflation rate
  • A shortage of money supply (or dollars)

Government’s take on the situation

Argentina’s government doesn’t see the new default impacting most citizens. Their assurance is based on the ground that the default has no link with the economic activity of the country. The economic activity of the country is independent of debt repayment or default or any restructuring processes that could stem from it. The government also doesn’t see its future cash position in red. Argentina’s cash flow is guaranteed by the surplus in its trade balance and recent investment deals signed with China.

Can Argentina afford the repayment?

Considering that full payment to the hedge funds would have triggered lawsuits from other bondholders demanding to be paid in full as well, Argentina needed to assess the funds at its disposal before entertaining repayment requests of any of its creditors.

By defaulting on July 30, Argentina has triggered bondholder claims of as much as $29 billion which is equal to all its foreign-currency reserves. While Argentina has nearly $29 billion in foreign reserves, those include loans to other countries, deposits with the International Monetary Fund (or IMF), and other illiquid assets. As a result, Argentina claims it can’t afford the potential new debt payments because it would slash its foreign-exchange reserves. Argentina’s current cash position doesn’t allow a full repayment.

Argentina, a country that has attracted international brand companies in the past like Coca-Cola’s (KO) bottler Embotelladora Andina (AKO.A), Ralph Lauren (RL), and Louis Vuitton SA (LVMUY) as private consumption accounted for about two-thirds of the economy, has defaulted on its international debt obligations. U.S. investors with exchange-traded funds (or ETFs) like the Global X FTSE Argentina 20 ETF (ARGT) in their portfolio may want to reassess their holdings.

The next part of this series analyzes the probable consequences of the Argentina default.

Continue to Part 5

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