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Economy

Argentina on the brink of default, again

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The facade of Argentina's Banco Central (Central Bank) is seen in Buenos Aires.   © Reuters

SAO PAULO -- Following an order from U.S. courts to service debt related to its default in 2001, Argentina is again on the brink of default. It is preparing to negotiate with creditor U.S. funds over the conditions for debt service, but the results are unpredictable. Despite the tension in the air over the nation's imminent default, the nation's stock market is peculiarly bullish as investment continues to flow in.

     June 16 brought a turning point for Argentina in its court battle with U.S. funds demanding full repayment, as the U.S. Supreme Court ruled in favor of creditors. On that day Argentina's Merval stock market index plunged 10% against the previous business day at one point.

     On June 17 a leading ratings firm lowered its long-term foreign-currency rating for Argentina by two levels, to CCC-. Moving against the adverse effects that followed, equities remained strangely buoyant. On July 4 the market average closed at 8,141.70, near its record high of 8,291.81 on June 9.

     January's "Argentina shock" shook the world with a massive selloff of pesos as investors concluded that the government was failing to defend its currency, leading to concern about the currencies of many emerging economies as well. But Argentina's stock market was little affected. Since the beginning of the year its market index has risen faster than in many other countries, including India, the U.S. and Japan.

     Why would equities be rising with the nation's economy so clearly in trouble? One factor is buying in anticipation of recovery.

     Since the new year Argentina has been rebuilding relations with the international community. It has agreed to resume talks with the Paris Club of leading creditor nations over service on its debt since the 2001 default. Representing the creditor consensus, one foreign bank source predicts that Argentina will put priority on preventing default in negotiations with the U.S. funds.

     A return to international financial markets carries great significance for Argentina, as it must procure funds from abroad to develop the shale oil and gas reserves it holds in the southern region of Patagonia. Investors anticipate that acceleration of currently slow development will revitalize the nation's economy, sparking a virtuous cycle.

     Beyond this optimism, another key factor sustaining Argentina's equity values is an investor trick for securing dollars.

     Paying down the debt will eat up the nation's foreign-currency reserves and likely accelerate devaluation of the peso. Argentines are not confident about their nation's currency to begin with, and tend to prefer equities over currency. They buy shares in firms that have depositary receipts listed on U.S. markets so they can move from equities to depositary receipts in the future, reportedly a defensive position for investors who want to indirectly own dollar-denominated assets.

     The deadline for Argentina's negotiations with its U.S. creditors is July 30. If it fails to reach an agreement, Argentina may be considered in technical default, having backed away from debt servicing even though it is capable of it. 

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