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Must-know: Consequences of Argentina’s default

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

(Continued from Part 4)

Default consequences

Troubled countries often find bond investors that are willing to lend them money to pay other creditors. However, for a country like Argentina, that has been locked out of the bond markets for more than a decade, it could be a major task to find new investors. Some investors would probably step up to lend it money, but at very high interest rates.

Implications for Argentina’s economy

According to the current default situation, Argentina’s economy is expected to contract further with the odds of another financial crisis being very high. An economic contraction of 3.5%, an annual inflation of 41%, and a drop in consumption to 3.8% could be the indicators at the end of 2014.

Money demand could become unstable as Argentina scramble for dollars, causing the peso to slump. Also, the default could lead to another devaluation of the peso, which was already devalued 20% in January. A further devaluation would fuel inflation in the country where prices are already up 15% through the first half of the year.

Implications for international markets

Argentina has effectively been shut out of international markets for more than a decade. So, while the default would hurt the already struggling domestic economy it’s unlikely to have serious repercussions in other markets.

However, the bonds due in 2033, which are the subject of dispute, had already seen a price fall of around 12.5% from a reading earlier this month, as hopes for a settlement had diminished. Consequently, average yields on Argentina’s bonds had risen.

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.

To know whether Argentina’s currency can recover in 2014 and how emerging market turmoil impacts the U.S. markets, read our Market Realist series, How has emerging market turmoil impacted the US debt market?

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