Argentina just issued a 100-year bond. Despite a history of defaults over the past 100 years, investors seem happy to try their luck for the next 100. Are they being wise or foolish?
One factor in favour of investors is that the yield on the hard-currency bond when it was issued was 7.9%. If recoveries after defaults are expected to be 40%-50%, they will not have to wait many years to break even.
Ricardo Adrogue, head of emerging market debt (EMD) at Barings, and himself an Argentinian, believes that the country should not have issued a 100-year bond.
His rationale is quite simple: Argentina is rated B by credit agencies, while Barings would give the country a BB rating by their internal measures. If economic conditions are improving in the country such that Argentina would be able to issue debt at a lower coupon in five years’ time, why not just issue a five-year bond and then roll over the debt at a lower coupon?
While investors may have a high regard for the current administration, history cannot be forgotten. In the last 100 years, Argentina has defaulted many times – so much so that Argentinian economic history has become a subject in its own right. There is the “Argentine paradox”: how can a country that at one stage in the early 20th century was perhaps the richest in the world on a per capita basis experience such a deep and prolonged reversal?
For Adrogue, the fundamental problem with Argentina is that it does not have a good institutional framework to deal with a commodity-driven economy. It became the richest country in the world after the UK had opened up global trade, and the revolution in refrigeration technology enabled the transportation of soft commodities such as meat. Argentina benefitted from being in the right place at the right time, but it did not necessarily have the right policies. Once that came to an end, the country began a long decline.
Adrogue argues that one fundamental problem is that the population has a misplaced belief that the country is rich. The standard joke about Argentinians is that they are Italians who speak Spanish but think that they are English. But if everyone believes they are richer than they really are, the sum of total demand becomes larger than the supply available in the country. This gets reflected in large and persistent fiscal deficits, which never get adjusted and eventually lead to defaults.
The current president, Mauricio Macri, may be successful for a time until the population changes its mind and realises that there are limits to the supply of resources and the population needs to share the resources that are available.
For Adrogue, the bigger issue is not the type of government that Argentina has but the institutional framework that gives the president too much power and therefore takes away the requirement to negotiate with congress to reach compromises and agreements. Those who achieve power have no constraints, which leads to big swings in economic policy. The last swing, under Cristina Fernández de Kirchner, was to the left. Under Macri we are seeing a swing back. It is very difficult contain those swings because the president has so much power relative to congress.
Argentina copied the US constitution but gave the president too much power. It started with the assumption that the underlying institutional structure was similar to the US – this was incorrect. In the US, the individual states were created prior to the formation of the country itself. In Argentina, the provinces were created after the country got its independence. This, combined with a commodity-based economy, made it very difficult for the population to separate good policies from luck. When commodity prices go up, no matter who is in charge, the population always perceives them to be a great government. When commodity prices are low, no matter how good the government is, the population perceives them to be bad.
Barings is not buying the 100-year bond. The company likes to look at countries in which fiscal dynamics are somewhat independent of the ability to access credit – it doesn’t abandon or change its story on fiscal policy just because it has access to credit. This can cause problems and ultimately defaults.
Argentina just issued $3bn (€2.6bn) of debt that the government said it didn’t need. For Barings, that is a bad sign. The market could end up having to discipline the government, when governments should have self-discipline.