The Argentina Dilemma and threats of systematic failure By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran


In 1869 the law relating to bankruptcy was introduced with the provision of limited liability. This ensures that the shareholders of a bankrupt company will be able to walk away from their creditors without paying the full debt. The shareholder wealth is never affected because of this limited liability. In the case of a country, if it borrows in local currency and is not able to repay, it can inflate its debt away. India is currently following this policy. While the real inflation rate is in double digits, thanks to deficit financing to support all social objectives, the government has massively reduced the purchasing power of rupee over time. For example, a kilo of rice sold for Rs. 20 a few years back is selling at 55 Rs. But the problem becomes different when the borrowing is done in a foreign currency.

Currently economically weak country issues bonds in foreign currency which foreigners do buy because of the risk compensating high yield as compared to the US government bonds. In the case of Argentina, the spread over the US government bonds was well over 300 basis points. So the creditor is already compensated somewhat adequately for the risk of default.

Now comes the real story. Thanks to real mismanagement Argentina is on the verge of bankruptcy. Its loans need to be restructured. This involves paying the creditors less than 100 cents on a dollar.

The owners of these bonds fall in the two categories.

(A)those who are willing to accept reduced debt with a deeply reduced face value. For example, a 100 US dollar face value bond is revised to 90 US dollar.

(B)those who hold outs insisting on full payment.

Recently the US courts decided that Argentina should make full payment to the defaulted claim to both A and B if it decides to make any payment on the restructured loans. This idea of giving equal treatments to both A and B is very tough. If all of them turn out to become hold outs, then payment is not going to be possible. On the other hand if all the creditors accept reduced payments then restructuring is possible.

The final outcome of Argentina’s debt problem has far reaching implications to all the debted countries and the creditors as a whole. Long court cases with inordinate delays and frustrating discriminatory judgment unfavorable to them. Countries which are planning to borrow overseas may find this judgment difficult to do so. We in India have an external commercial borrowing of US $ 225 and a foreign reserve of $ 310 bln. The lender will think twice before lending any more money to India and if did it will ask a very high premium. The situation transpiring in Argentina is a major threat to the financial market. The New York court’s decision must be honored. If not, what is really in danger here is the public trust in financial securities market as well as in law enforcement. The conflict between the bond holders and the government must be settled through negotiations which is only the best interest of both parties. If they fail it will set a precedence for other countries to disobey the court’s judgment and then the international finance transaction may become a cause for the total financial breakdown.

Finally, the global financial system is full of cracks waiting to collapse any time. Every country’s duty is to uphold the system which means respecting the court’s decision.

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One Response to The Argentina Dilemma and threats of systematic failure By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

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