 rgentina
still hasn't been able to reopen its financial markets or its banks.
This country's bad ending (not over yet) is having a negative effect
on other emerging markets. Brazil is already feeling some contagion.
This week, through Wednesday, the Brazilian Real has weakened by 2.1%.
Equities fell 4.5% in dollar terms and bond prices 1.5%.
Brazil's declines
come after very strong rallies in recent months, so don't to read
too much into them — yet. Over time, you can expect to see
further weakness in Brazil and other heavily indebted countries
in response to the Argentina meltdown. You may not be ready to call
this a "contagion," but certainly it is a slowly spreading
debt crisis, somewhat like the one we saw in the 1980s. There are
several transmission mechanisms:
Size of
Haircut. Until now, the perceived downside on sovereign debt
was influenced by the size of the Brady-bond haircut, generally
30%-50% off of the original face value. Argentina will set a new
precedent. It may show that haircuts of 70% or more are plausible
(Argentina's 2008 bond has fallen to $26 while the FRB bond fell
to $27). This changes the risk/return profile of debt in other emerging
markets. Argentina's cost of capital will go up, limiting their
access to capital inflows, reducing their growth rates, and making
their debt burdens less sustainable.
Property
Rights. Argentina is going well beyond expectations in its infringement
of property rights. This has negative implications for the value
of property in other developing countries, likely slowing the rate
of foreign direct investment and banking activity.
Politicians
and Democracy. For heavily indebted countries, the argument
for an early default is politically compelling and will become louder
as 2002 progresses. Some arguments that are likely to be sounded
from politicians in developing countries include: Best to default
now before we look like Argentina; Look at all the money we could
save by defaulting; We're not getting a net capital inflow anyway,
so why keep paying?; The IMF and the U.S. seem to be okay with defaults;
We can blame a default on Argentina; Poverty is rising fast due
to our heavy interest payments — it's not fair!
Lawyers.
Argentina's default will be the first major test of the value of
the Eurobond and Brady bond contracts and their enforceability in
court (Ecuador and Russia weren't clear tests). As lawyers work
to get the best deal for Argentina, their efforts are likely to
show weaknesses in similar contracts elsewhere, lowering their value.
The IMF.
As the IMF explores "bailing in" the private sector (meaning
causing bondholders to take losses), moral hazard concerns, and
the establishment of a global bankruptcy system, it implies lower
values for debt contracts outside Argentina. This will speed the
progression of Argentina's debt crisis into other countries. As
the IMF moves from a bailout model to a bankruptcy model, expect
a transition to be difficult for several emerging markets, slowing
their growth and drawing them toward deep-discount debt restructurings
with their creditors.
Many of the
Argentina consequences will be subtle and hard to attribute directly
to Argentina — but they will be real and far-reaching all the
same. While Argentina's economy is small by world standards, the
accumulation of collapses in emerging markets has lowered the world's
growth potential some. While you shouldn't expect a clearly identifiable
impact on financial markets in Asia, Mexico, or developed countries
like the U.S., Argentina's collapse is adding to the global economic
headwinds.
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