Report Nº: 86702/07/2020
The public debt swap to avoid default has become excessively tortuous. The genuine way to reach a solution is not by increasing promises of future payments or giving more legal warrants. The way out is to present a credible proposal for the public sector reform to regain credibility in the chances of repayment.
The renegotiation of public debt implies delivering new securities in exchange of the current ones with more favorable terms for Argentina. In assessing the losses, bondholders compare the nominal value of the security being offered against the present value of the new bond’s expected payment flows. The Present Value is today’s value that, put to work at an interest rate, allows the recovery of the borrowed capital at the end of the bond period. This interest rate used to measure the present value is called the “exit interest rate”.
The level of the “exit interest rate” reflects creditors’ perception regarding the risk of lending to Argentina. This rate has a high impact on the valuation of the new debt. A simple example can illustrate the phenomenon. The present value of U$S 1 million to be paid in 10 years at 12% yearly is U$S 322 thousand. But if a 3% annual interest rate were used, the present value of that same debt would be U$S 744 thousand. Therefore, the loss for the creditors depends not only on the amount and date that Argentina commits to repaying but also on the “exit interest rate” used. That is to say on the credibility that the country generates.
A simulation permits seeing how this valuation is done over the new debt offered by Argentina. Taking the original offer made by Argentina in the shortest bond that is 10 years (maturity 2030), it can be seen that,
These data show that the valuation of the offer made by Argentina depends decisively on the discount rate used to calculate its Present Value. If a 3% rate is used, which is the rate that would be applied to Chile or Uruguay, the offer is attractive since the losses are moderate. Even at a rate of 6%, which is the rate that would be applied to Brazil or Paraguay, the effort required from creditors would still be reasonable. But when a 12% discount rate is used, which reflects the high level of distrust generated by Argentina, the losses for creditors are significant, which causes enormous resistance in accepting the swap.
The central problem is not that Argentina’s offer is petty in terms of the amounts to be paid, but that its credibility is very low. The proof is that the positions between Argentina and the creditors are very close in terms of amounts and timing. The difficulty arises because a group of creditors wants the new bonds to have the conditions applied in the 2005 swap, which are more stringent in the possibility of a future new default. In simple terms, the 2005 bonds required the consent of 85% of the bondholders to impose a rescheduling, while the post-2016 bonds require approximately 66%. In other words, investors want Argentina to put itself more obstacles to the possibility of a new default in the future.
The solution is not –as pundits claim– to increase the amounts offered but to increase the Argentina’s credibility. The more the promises of payment are enlarged, the higher the chances of a new default. Thus creditors increase their pressure for legal safeguards against a new default. More credibility is needed, which requires a serious plan for public sector reform. It is not a simple issue because since it must convince people that more than 60 years of systematic fiscal deficits are going to be reversed.
Basically, it is necessary to address a tax, social security, and administrative ordering. In terms of taxes, a unification at the three levels of government must ensue. In social security, sustainability must be restored by eliminating iniquities such as special regimes and double coverage. In the administrative issue, inefficiencies generated by the interference of the federal State in provincial functions should be eradicated.