Mohamed A. El-Erian
Last week, international capital markets enthusiastically granted redemption to Argentina, a serial defaulter on money it has borrowed from external creditors. The scale of this reaction is counter-intuitive and could provide the wrong incentive underpinnings for financial relationships that involve an important element of trust. Yet this kind of forgiveness has occurred regularly – for good and bad reasons – and, for the most part, prematurely.
Argentina defaulted in December 2001 and spent almost 15 years in protracted legal conflicts with bond creditors. Despite many court rulings, the two sides could not arrive at an agreement that normalized badly disrupted capital-markets relations.
The situation changed with the arrival of a new team in Argentina led by President Mauricio Macri, who took office in December. Armed with a new court ruling and a preliminary agreement with most of the holdouts, the government tested the waters through a new issue of long-dated bonds. The result was headline-grabbing.
In what can only be described as a food fight among private creditors, about 2,000 orders were placed for the new bonds, resulting in a total notional demand of around US$70 billion, a record number for emerging markets. Buoyed by the exuberant market reception, Argentina upsized its offering and made it less attractive for potential buyers by reducing the issuance yield by almost a full percentage point.
The result was a US$16.5 billion emerging-markets bond issue and terms that were a lot more favorable to Argentina than the current market pricing for similarly rated debtors.
This type of creditor behavior is not without precedent. The history of emerging-market debt contains other cases when creditors rewarded a borrower that had recently experienced an ugly default, sharp confrontations and hadn’t yet worked effectively with multilateral institutions (Russia after its 1998 default and Venezuela more than once). The creditors’ relatively easy approval has both good and bad reasons.
Given Marci’s electoral promises and initial policy steps, there are reasons to believe that Argentina’s economic outlook could be different this time. It is easy to see how credit committees could convince themselves that the probability of sustained improvement in the country’s creditworthiness and payment behavior is notably higher.
There are also bad reasons. With the prevailing low and, in some cases, negative yields on government bonds, some investors were dazzled by the yields of 7.5 percent to 8 percent on the new Argentine 10- and 30-year bonds.
Others are taking an approach that is even more short term, given the extent to which this bond issue was hyped by the investment bankers. Their expectation of profits comes from the “flip” – that is, selling the security for a gain shortly after they have been allocated their share in this highly over-subscribed event.
There are three conclusions to draw:
- Argentina is being rewarded as much, it is hoped, for its future good behavior as it is for its recent actions. As a result, any notable setback on policy actions is likely to lead to a significant decline in bond prices.
- Rather than signaling an improvement in the markets’ underlying liquidity conditions, the huge Argentine issue could worsen future pockets of illiquidity, especially when some if some of the current debt holders begin to behave more like fleeing tourists than resilient resident investors of emerging markets.
- In a market where short-term behaviors often can diverge from longer-term sustainability, redemption will repeatedly be granted too easily to debtors whose historical record should demand far more discipline on the part of both lender and borrower.
Mohamed El-Erian is the chief economic adviser at Allianz, chairman of President Barack Obama’s Global Development Council and the former chief executive officer and co-chief investment officer of Pimco. © 2016, Bloomberg View.