Before the debt crisis, debt financing was the dominant source of capital for both public and private sectors, in the form of government bonds and commercial bank loans. The interest rate on public debt directly reflects the country risk. The higher country risk, the higher interest rate. Argentina has a very high country risk because of its fragile macro economy. In recent years the country risk premium has been declining significantly, as shown in the following chart (from Argentine Ministry of Economy, http://www.mecon.ar)
The credit rating of Argentina is still far away from the investment grade. Argentina receives a rating of BB by S&P, Fitch-Ibca and DCR, and Ba3 by moody's, where investment grade has a rating of an AAA or equivalent.
Argentina strives to reduce its country risk premium by continuing its currently successful economic reform, and ultimately to upgrade Argentine debt to be of investment grade. The following sections present debt situation in recent years, debt management objectives, strategies, and implementations. A significant step the Argentine government has taken in winning the confidence from international investors is to reach an agreement with International Monetary Fund, which is discussed in the last section
We analyze Argentine debt situation from three dimensions: (1) amount of total debt as a percentage of main macroeconomic indicators, (2) interest payment schedule and duration and of the debt, and percentage of short term debt over the total debt, and (3) sources of the debt financing, including the currency that the debt is denominated with and distribution of debt holders between domestic and foreign investors.
First, despite the surging international equity market, debt remains the main avenue for public financing in Argentina. The following chart shows the ratio of external debt to GDP and to exports, as well as the ratio of international reserve over financial obligations:
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The lower debt-to-GDP and debt-to-export, the stronger Argentine ability to pay the debt; the higher reserve-to-financial obligations, the stronger Argentine ability to pay the debt in foreign currency. |
The Argentine officials argue that debt-to-GDP ratio Argentina (which is around 30%) is not high compared to that of other countries. For example, the size of Argentine public debt is much lower than the limits established in Maastricht (60 percent of GDP) to join the European Monetary Union. Another example is that Argentine debt is lower than that of many other emerging countries which have an "investment grade" credit rating and a debt-to-GDP ratio of over 40 percent.
Second, the interest payment schedule of Argentine debt is relatively well distributed over time. The total size of short-term debt is only 3% of the total debt in terms of principal due or less than 1% of GDP. Amortization of all debt payments are approximately $11 billion per year or 12% of the total debt. This is a healthy sign because a small short term debt and payment obligation will strengthen Argentine ability to stand the external currency shocks.The following chart shows the maturity profile of public debt: (from Argentine Ministry of Economy, http://www.mecon.ar)
Third, the sources of Argentine public debt. Argentine public debt is issued in both the Argentine peso and US dollar. Who holds the debt, whether the domestic investors or foreign investors, is of significance in the volatile international financial market. The thinking goes that foreign investors are more likely to liquidate Argentine debt prior to their own country's debt. So the more domestic investors holding the debt, the better liquidity situation. The same thinking applies to the diversification of foreign investors, the more diverse the foreign investors, the better liquidity situation. The following chart, complied by the Argentine Ministry of Economy, shows the diversification of Argentine debt financing (1996 data):
Argentine debt management strategy can be categorized into five aspects. The first is to construct a more evenly distributed maturity profile and to avoid concentrating debt in any particular year.
The second element of the strategy is to reduce the size of short term debt so that Argentina will have less obligations to meet in event of sudden liquidation pressure.
The third aspect is to accumulate international reserve in Treasury, since the Central Bank is now an independent branch from the Treasury and is prohibited from financing the debt issued by the Treasury. For the same reason that the Central Bank needs solid amount of international reserve, the Treasury needs to build up sufficient foreign reserve.
The fourth element is to diversify the sources of debt financing. The more diverse of the debt holders, the better, especially on the types of investors' own domestic markets. The stronger investors' own domestic markets, the better for Argentina. Diversification also includes the types of investors, and their investment objectives in holding Argentine public debt instruments such as long-term growth with high volatility versus short-term gain with low volatility.
The fifth element is to develop a strong domestic market for secondary debt instruments. As Argentine financial market has been deregulated, this element of the strategy can be very effective. There are increasing number of domestic institutional investors are entering the Argentine capital markets, such as mutual funds, pension funds, insurance and commercial banks. Developing a solid and stable domestic capital market will directly win the confidence of international investors, hence reduce Argentine country risk premium and increase Argentine credit rating.
Showing the commitment to stabilizing the macroeconomic environment, the Argentine government reached an Extended Facilities Agreement with IMF in 1997. By the agreement, IMF will provide Argentina funds in event of crisis on the condition that Argentina meet the requirements and certain qualitative and quantative targets defined in the agreement for the period 1998-2000.
IMF's requirements are aimed at improving transparency. IMF requires Argentina's public accounts be audited by the international agency, and the goal is to increase the confidence of domestic and foreign investors in the Argentine economy. In addition, IMF requires Argentina government to submit a multi-year budget covering tax income and public expenditure, and the goal is to influence and monitor the public budgeting.
IMF set the following qualitative targets: continue the current market-based economic reform with strong commitment and fast pace, particularly on deregulation and tax collection.
Highlights of the quantative targets for 1998: (1) Reduce fiscal deficit to $3.5 billion, limit public expenditure to $5.7 billion, (2) Reduce short-term debt to be under $2 billion, and (3) Reduce the Balance of Payments current account deficit to be around 3.8% of GDP.
In achieving those targets, the Argentine government has started implementing fiscal and monetary programs. Important issues remain as how Argentina achieves the targets defined by IMF and how IMF monitors and evaluates Argentina's progress.