By Lawrence Hurley and Hugh Bronstein
WASHINGTON/BUENOS AIRES (Reuters) - The U.S. Supreme Court on Monday declined to hear a preliminary appeal filed by Argentina over its battle with hedge funds that refused to take part in two debt restructurings stemming from the country's catastrophic 2002 default.
While not good news for President Cristina Fernandez, the court's decision did not alter a lower U.S. court's stay on a ruling ordering Argentina to pay the funds 100 cents on the dollar for the defaulted paper they hold.
Funds that reject the lower payments offered by Argentina's restructured bonds and demand full repayment of original debt totaling $1.3 billion have filed suits that have bounced around U.S. federal courts for more than a decade and could continue without final resolution for another year.
World markets are watching the case for the implications it might have on future sovereign debt restructurings. The International Monetary Fund has voiced fear that if Argentina is forced to pay the holdouts, it would make it more difficult for cash-strapped countries to re-negotiate their bond obligations.
Market reaction to the Supreme Court announcement was muted, with economists stressing the importance of the maintenance of the stay. Argentina's sovereign risk spread tightened 7 basis points to 998 over safe-haven U.S. Treasuries while the rest of JP Morgan's Emerging Market Bond Index Plus was flat at 344 basis points, indicating that Argentina remains the biggest default risk in the market.
"The Supreme Court's decision to not hear our appeal during this session does not change anything," Finance Secretary Adrian Cosentino said in a statement, citing litigation pending in lower U.S. courts, which could lead to another request for high court review next year.
Considering that Argentina can make all the same legal points in its next petition to the Supreme Court as it did in the one rejected on Monday, local analysts said it was reasonable that the high court was reluctant to enter the legal imbroglio while lower court appeals are still unresolved.
"It's the logical outcome," said Buenos Aires-based economist Guillermo Nielsen, who as finance secretary helped push through Argentina's debt restructuring in 2005.
Fernandez is to be operated on Tuesday for a cerebral hematoma, taking her out of action in the midst of the court battle and three weeks before a key mid-term election that will determine the clout she enjoys in Congress during her final two years in office.
Fernandez vows never to pay the holdouts, whom she derides as "vultures" for picking over the bones of the 2002 default, which pushed millions of middle class Argentines into poverty.
The refusal to pay the holdouts in the face of a final U.S. court order to do so could pave the way for another default, as Argentina would be blocked from paying the holders of restructured bonds as well.
Easily re-elected in 2011 on promises of more government intervention into Latin America's No. 3 economy, Fernandez has seen her popularity wane due to high inflation and confidence-sapping foreign exchange controls meant to halt capital flight.
Monday's Supreme Court ruling means it will not at this time review an October 2012 decision by the 2nd U.S. Circuit Court of Appeals in New York in which the court said the Argentine government had broken a contractual obligation to treat bondholders equally.
The Supreme Court's refusal to get involved means litigation in lower courts continues, with Argentina able to seek high court review again at a later date when there is a final ruling in the appeals court.
In August, that court issued another ruling, upholding a lower court's order that Argentina pay the bondholders $1.3 billion. The court stayed its decision pending possible Supreme Court review. Argentina also has asked the appeals court to reconsider its decision.
"If the stay is maintained, the likelihood of a technical default is low, at least in the near term," said Ignacio Labaqui, who analyses Argentina for Medley global Advisors.
The case's end-game has meanwhile shifted to the political arena in Buenos Aires, where the ailing Fernandez is in the twilight of her second term and faces a likely poor showing by her candidates in the October 27 mid-term election, said Gary Kleiman, of emerging markets consultancy Kleiman International.
"With these judicial and political power setbacks, a compromise solution to the long holdout saga involving at least indirect negotiations could finally be on the horizon," he said.
In two restructurings, in 2005 and 2010, creditors holding around 93 percent of Argentina's debt agreed to participate in debt swaps that gave them 25 cents to 29 cents on the dollar.
But bondholders led by hedge funds NML Capital Ltd, a unit of Paul Singer's Elliott Management Corp, and Aurelius Capital Management went to court, seeking payment in full.
The case before the Supreme Court was Argentina v. NML Capital, 12-1494.
(Additional reporting by Walter Bianchi in Buenos Aires; Editing by Howard Goller, Nick Zieminski, Dan Grebler and Andrew Hay)