After having defaulted on its public debt and restructured its foreign obligations in aggressive terms, Argentina appears to navigate in tranquil waters far from the fiscal perils of the past. As a matter of fact, President Kirchner has often proudly pointed out the newly acquired “independence” from the capital market and from the IMF after Argentina’s full repayment to the latter in December 2005.
Of course, many factors contribute to this optimistic impression, from the favorable external environment, to the impressive rate of growth achieved since 2003, and to the fact that Argentina has displayed an unprecedented fiscal surplus thanks to the impact of the devaluation on public sector salaries, and the imposition of new taxes on exports and on financial transactions.
However, as Argentina approaches presidential elections in October, a looming energy crisis, a creeping inflation rate, and a government expenditure rising at full speed prompt the need to re-evaluate already forgotten fiscal and financing risks.
In this note, we focus on Argentina’s debt sustainability and financing risks. Are they really buried in the past?
Let’s compare the situation at the end of 2001 with that prevailing at the end of 2006. In 2001, Argentina’s public debt amounted to USD 144.5 billion, equivalent to 53.8 percent of GDP. The average maturity of the public debt stood at 8.3 years, and the average annual interest rate paid by the government on its debt was 7 percent. Moreover, almost 97 percent of the public debt in 2001 was denominated in foreign currency.
In 2006, after the debt restructuring concluded in 2005, the total public debt still amounted to USD 162.8 billion, equivalent to 76.5 percent of GDP. However, of this debt Argentina’s government remains performing on USD 129.7 billion, as obligations vis-á-vis official bilateral creditors for USD 7 billion continue in default but are included in the official debt statistics, and obligations vis-ä-vis holdouts from the 2005 restructuring for USD 26 billion also continue in default and are excluded from official debt statistics. Hence, performing debt at the end of 2006 was equivalent to 60.9 percent of GDP. As a result of the 2005 restructuring, the average maturity of the public debt stands at 12.9 years. As regards its composition, 94.4 percent of the public debt is either denominated in foreign currency (59.7 percent) or is indexed to the price level (34.6 percent). The average annual interest rate paid in 2006 on the performing debt was 3.1 percent. However, if one considers as part of the interest rate, the debt capitalizations as well as the capitalized price-indexation, the average annual interest rate in 2006 stood at 8.2 percent.
The above comparison suggests the following conclusions. First, Argentina’s public debt as percent of GDP is currently larger than in 2001. Second, the debt composition is not significantly different than in 2001, as most of the public debt continues to be either denominated in foreign currency or indexed to the price level. Third, the 2005 restructuring lengthened further an already long maturity and, considering the cost of indexation, has increased the average interest rate. However, since indexation is capitalized, Argentina’s fiscal accounts only report as interest less than half of the actual total interest cost. In fact, capitalized indexation amounted to USD 5.2 billion in 2006, equivalent to 2.5 percent of GDP, or 71 percent of the reported primary surplus.
Therefore, because of the longer maturity and the capitalized indexation, Argentina’s financial program (defined here as the financing requirement to be met in the capital market) has temporarily been drastically reduced. While Argentina’s financial program amounted to almost USD 15 billion in 2000 (5.2 percent of GDP), it totals about USD 5 billion in 2007 (2.3 percent of GDP).
The relevant question is then to examine how long this temporary financing relief is going to last. In what follows we summarize the results of simulating the evolution of Argentina’s financing program under various alternative scenarios.
Our simulations started by constructing a favorable base-case scenario in which economic growth continues strong, albeit declining gradually from an annual rate of 7 percent in 2007 to 5.5 percent in 2008, 4 percent in 2009 to a steady-state of 3.5 percent from 2010 onward. The primary fiscal surplus is assumed to decline gradually from 3.3 percent of GDP in 2007 to 2.5 percent from 2008 onwards. Inflation falls gradually from 9.5 percent in 2007 to 5 percent by year 2010, and the real exchange rate gradually declines from 1.78 in 2007 to 1.5 by 2010 (where the level of 2001 equals 1). Refinancing rates are assumed at 8.5 percent on dollar debt and at 4 percent in real terms on indexed debt.
In the base-case scenario, the size of the financial program increases to around USD 6.5 billion in 2008 and to USD 10 billion in 2009, remaining at similar levels until 2012. Hence, in the favorable base-case scenario, the size of Argentina’s financial program increases significantly over the next two years, but remains well below the USD 15 billion level of 2000. As percent of GDP, financing needs reach 3 percent of GDP in 2009 and move within a band of 2 to 3 percent of GDP thereafter, well below the 2000 level.
The financing picture deteriorates significantly if the primary fiscal surplus declines. If, ceteris paribus, the primary surplus falls to 1.5 percent of GDP then borrowing requirements would reach in 2009 a level similar to that prevailing in 2000 both in dollar values as well as a percent of GDP, and would reach levels exceeding USD 20 billion and 6 percent of GDP by 2013. Of course, if refinancing rates were to increase, these conditions would deteriorate further.
Notably, if one simulates the behavior of the ratio of debt to GDP under these scenarios it would still show a declining path over time providing a reassuring (but possibly misleading) image of debt sustainability.
This simple analysis shows that sovereign debt restructurings provide a window of relief that tends to be perceived by politicians as much wider than what it really is. In the case of Argentina, the exercise described above simply shows that, under plausible scenarios, the government may need to access capital markets by 2009 in amounts that require a fluid and coherent interaction with the potential investor base. Hence, the challenge for the incoming president in this respect appears much larger than current discussions in Argentina anticipate. Obviously, maintaining over USD 30 billion worth of debt in default and tinkering with price indices will not help in establishing the conditions necessary to access consistently international capital markets. Similarly, allowing primary expenditures to grow at rates close to 40 percent a year may make it very difficult to maintain a primary surplus of the order of 3 percent of GDP.