A third way for Argentina: reprofiling

With its debt neither sustainable nor unsustainable, Argentina meets the test for maturity extensions

Carlos Abadi

Argentina's forward player Lionel Messi controlling a ball during a match in the Russia 2018 World Cup
The path to a deal will be fraught with danger; both sides must put their best players forward © AFP/Getty Images

Despite allegations to the contrary, “reprofiling” is not an Argentine euphemism for debt restructuring. It is a distinct liability management exercise that is optimal, from a welfare standpoint, for certain well-defined sovereign debt crises. In our (preliminary) opinion, Argentina’s situation meets the required criteria for a reprofiling that would defer its maturities for a relatively short period, while not reducing either the face value of its obligations to private creditors or their contractual coupons.

In fact, the IMF incorporated reprofiling to its access policy in 2014, in response to criticism it suffered after its alleged procrastination in requiring private sector involvement (PSI) during Greece’s debt crisis. Until then, there existed only a binary choice for any member seeking exceptional access: they either qualified (as a result of the Fund’s debt sustainability analysis (DSA)) as able to repay “with high probability”, or they didn’t. In the former case they were considered for exceptional access of a “catalyst” nature, and only subject to meaningful PSI in the latter.

However, the 2014 rethink brought the Fund to realise that DSA is not an exact science, especially in that it relies on policy commitments from the debtor to be implemented in the future. Consequently, the IMF allowed a third way for exceptional access: the reprofiling. In the Fund’s view, the reprofiling remedy (which is a form of PSI because, unless the exit yield is less than or equal to the contractual coupon, any maturity extension entails an NPV reduction) is appropriate for sovereign debtors lying in the grey area of their debt being neither sustainable nor unsustainable, in each case under the “with high probability” standard.

While we have not yet concluded our DSA (we expect to do so in the next week or so), we expect that it will place Argentina in that grey zone, at least in the Fund’s mind (if nothing else, because policy undertakings would be made by a new, unfamiliar, administration). Additionally, the Fund subjects exceptional access to the window allowing for a reprofiling to two constraints:

1) The member must have already lost market access — clearly fulfilled in Argentina’s case; and

2) There must be considerable uncertainty regarding the member’s debt sustainability (and, accordingly, doubt about whether market access can be regained) — our intuition is that our analysis will reflect this.

Thus, assuming that Argentina qualifies for a reprofiling, the negotiating variable will be the number of deferral years. I would argue that the extension period should be such that no maturity of the reprofiled bonds should fall due before the later of i) Argentina regaining market access, and ii) the IMF having been repaid in full.

Obviously, should Argentina regain market access, there is no reason for the maturity of the reprofiled bonds to occur much later. The maturity extensions need not be identical for each bond as Argentina i) will be in a position to start repaying shortly after the market opens up, subject to the ceiling set by market appetite, and ii) an identical across-the-board extension could be perceived as unfair by holders of short maturities, since their NPV impairment would be proportionally larger than for those holding long maturities.

We attempted to simplify things here because our goal is to show that there is a path to an orderly restructuring in the form of a reprofiling. But that path is narrow and fraught with danger. As we have argued before, both sides will need to play their A-teams to achieve this value-maximising result. This is because, while any reprofiling transaction will trigger credit default swaps and put Argentina in selective default until closing, it is my expectation that if no deal is reached by the first half of 2020, Argentina will enter a moratorium and its cost-benefit analysis may change.

In particular, Argentina will need to:

1) Be persuaded with convincing econometric evidence that the utility (in terms of future growth) of a market-friendly deal consistent with its economic fundamentals outweighs the sugar high of a strategic default resulting in a reduction in principal and/or interest, and short-term relief from current expenditures;

2) Understand that the NPV reduction resulting from the reprofiling can be communicated internally as a victory, under almost any scenario;

3) Internalise that the economic benefits derived from formulating and implementing a credible path to meaningful primary surpluses will translate into political gains before the end of the next presidential term. Once more, the Argentine side will not take dogmatic generalities about the virtues of fiscal discipline and market reputation at face value; to get the point across, the alternative macro paths will need to be modelled with a robustness nearing the dispositive (an exercise we will start working on immediately following the DSA’s completion); and

4) Realise that a reprofiling deal provides Argentina with the best of both worlds: optionality. Should the government, whether because of externalities, social pressures or mere vagaries, decide that it is not in a position to fulfil its fiscal undertakings, the option to default will remain.

Creditors, on the other hand, will have to struggle with the following internal and external challenges to ensure a satisfactory resolution:

1) Maintaining the cohesion of the creditor group so that precious time is not lost in internal bickering or the formation of competing representative bodies, creating delay and confusion.
Several divisive issues will have to be addressed, including the issue of equity between holders of short and long maturities mentioned above;

2) Negotiating with a party that holds an ace in its sleeve: the ability to strategically default. It is axiomatic that, however costly default may be for a sovereign issuer, it will never be as costly as the same conduct for a domestic corporate debtor. Argentina’s creditors will have to be professional in substantiating with compelling models and data the utility to Argentina (and related agency benefits) of a reprofiling deal consistent with the timing of Argentina’s expected return to market access;

3) Using collective action clauses (CACs) as both a sword and a shield. Creditors will need to:

a. Strive to represent or speak for blocking minorities of substantially all sizeable outstanding issues subject to reprofiling; and

b. Be mindful of the implications (both internal and external) and the effect on potential deal-killing holdouts of the strategic differences between the post-2005 dual-limb vote CACs and the significantly more debtor-friendly more recent single-limb vote issues. To continue with the same example, creditors should be aware that single-limb issues are relatively new, that their “uniformly applicable” condition has not been tested in the courts, and that a uniform extension that causes some bondholders to suffer a greater relative NPV impairment than others may be challenged in court and that such litigation may frustrate the desired resolution;

4) Information asymmetry is another advantage a debtor holds over its creditors, amplified in the case of a sovereign issuer such as Argentina with financial data that are opaque for some periods and outright unreliable for others. Creditors will have to derive or gather reliable data (such as the true quantum of the debt owed to other public sector entities) from private sources in order to rebut potentially abusive demands for further NPV concessions (we are also in the process of plugging those fuzzy data holes).

Finally, no reprofiling (or even restructuring) can happen without an IMF agreement. Much has happened at the IMF in the past five years, including its change of leadership and the 2014-2015 revised exceptional access framework on which a reprofiling deal hinges. But it still has a rigorous credit process, which relies on getting as collateral a credible fiscal programme and trusting that the sovereign’s policy commitments can be implemented.

Given Argentina’s economic and social condition and even though the incoming administration is an unknown, the IMF will probably have to accept that Argentina will be unable to deliver more than a primary balance for the next 12 to 18 months and that such relative fiscal laxity is a necessary condition for the subsequent delivery of sustained primary surpluses.

Argentina’s burden of proof is not as exacting as it could be if it were seeking exceptional access of the catalyst variety. The kind of support Argentina should aim for does not require proof that its debt is sustainable.

Indeed, exceptional access for a standby facility supportive of a reprofiling requires only rejecting the null hypothesis that Argentina’s debt is unsustainable under the “with high probability” standard. To borrow an analogy from law, Argentina’s strategy (with the creditors acting at its amici) should be to introduce reasonable doubt to a hypothetical IMF finding of unsustainability “with high probability”; in other words, to avoid a Type I error.

My opinion has not changed: an orderly debt restructuring is possible, even likely, but if, and only if, both Argentina and its creditors put their respective Messis on the field.

Carlos Abadi is managing director of DecisionBoundaries, LLC, a New York-based international financial advisory firm.

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