On June 16th, 2014, the U.S. Supreme Court ruled in favor of NML Capital Ltd (NML) over the Republic of Argentina in a major debt settlement case. The ruling has implications not only for Argentina but also other debt-ridden countries throughout the world. Regardless of how Argentina responds, Prime Minister Christina Fernandez de Kirchner’s options are unattractive.
Argentina reached agreement with a majority of its creditors with only a limited number of holdouts. However, there was a small subset of U.S. creditors led by Elliot Associates, a New York-based hedge fund described as NML Capital Ltd, that were holding out for better repayment terms. They sought and received relief from the Southern District of New York, which can result in a high payoff from their purchase of cheap bonds that occurred from the 2001 default of Argentina.
With the U.S. Supreme Court siding with the creditors, Argentina’s agreement with the other bondholders is now null and void. They face a June 30th deadline when interest payments must be made on these exchanged bonds, though they will likely seek a delay.
Weighing the options
Argentina has three options. First, abide by U.S. Supreme Court ruling and pay back NML $1.2 to $1.6 billion; second, ignore the ruling and risk technical default; third, allow U.S. creditors to swap original U.S.-issued bonds for Argentinian bonds.
The first option is the easiest route for Argentina in rebuilding their credit status, but it carries significant political risks potentially exposes them to further liability. Given de Kirchner’s populist base, succumbing to perceived greedy investors would not play well at home and could stall her agenda as her second term comes to an end next year.
Paying off NML could also violate the “pari passu” clause written in the original bond documents that forbids providing more favorable terms to holdouts. Even though they could amend that law, it could potentially put them on the hook for $15 billion as previous creditors seek similar terms, according to Argentina’s Finance Minister Axel Kicillof.
With current foreign reserves at approximately $29 billion, this exposure is a frightening prospect for Argentina.
The second option is politically expedient, but would halt Argentina’s re-entry into the global financial market. Argentina desperately wants access to global markets to slow its inflation rate and reverse its sluggish economic growth prospects. Currently, the IMF projects negative economic growth for 2014 — even before the adverse ruling. A technical default would be disastrous and why Mr. Kicillof dismissed as “unthinkable.”
The third option will likely be Argentina’s first course of action, but it is highly unlikely that will materialize. For one, it requires convincing bondholders to swap U.S. issued bonds for Argentinian bonds, which would subject them to Argentinian law. Given their low ranking in institutions and susceptibility to corruption, many bondholders would balk at this choice. Additionally, potential third-party financial institutions have expressed reluctance to even facilitate this swap due to potential litigation risk arising from the U.S. judicial ruling.
But none of the three options are likely. Argentina’s best hope is to negotiate a settlement with all the creditors so to regain entry into the global financial arena and stabilize their monetary issues.
Even though some analysts see this as a positive development for credit markets, it sends an ominous sign to developing countries that have taken on significant debt. The ability to restructure debt will become increasingly difficult, ultimately raising the downside risk for developing countries and widen the divide between rich and poor countries.