Two weeks back, a US court blocked Argentina from meeting its international debt payments if it did not first repay a group of hedge. These hedge funds hold a small part of Argentina's debt and have not accepted debt restructuring that other debtors have, putting at risk Argentina's economy. How can a US Court pass a judgment that causes a sovereign nation's default? How come the US and its courts have this power over the world's financial system? We discuss these issue and the lessons that can be drawn for the international financial order with Prof. Jayati Ghosh, Jawaharlal Nehru University.
Hello and welcome to Newsclick. Last week, an American Court blocked Argentina from meeting it's international debt payment if it did not first repay a group of hedge fund investors whom it supposedly owes money. Despite Argentina having actually made it's payments into a trustee bank these funds can not be disbursed to it's creditors unless it first clears it's defaults with these hedge funds. Now, Argentina has failed in it's appeal to United States Supreme Court, but it has apparently moved to international court of justice. Though, whether the US agrees to accept the jurisdiction of the ICJ is another matter entirely. Now, to discuss rather strange situation and what it means for Argentina and the international world of financial order, we have with us Prof. Of Economics in JNU, Jayati Ghosh. Thanks Jayati for joining us.
JG: It's a pleasure.
RB: Could you briefly take us to the background to developments over the last few weeks. I mean why does Argentina owe this hedge funds money in the first place. And if they do whey don't they just pay them back?
JG: Let's go back to how Argentina got into the situation. If you remember, Argentina in 1990s had a system whereby they peg their currency to the dollar and they had a very rigid system of exchange rate and so on. In that period they contracted a very large external debt. No, ultimately it turned out that this is an unsustainable situation and in 2001, they had to break that link with the dollar and they had a massive depreciation of their currency and they went into a financial crisis. Now, after that financial crisis, in this period of instability where it was an effective default because they seem it could not repay their debt, several things happened. One of them was that the IMF which stepped in as usual wanted all the debts to be repaid on the basis of the old exchange rate for the foreign creditors. But the domestic creditor was supposed to be paid on the new exchange rate which really meant that it was 30 percent of the previous value. This also made the debt that it was impossible for Argentina to repay. In 2004 and 2005, the government of Nestor Kirchner managed to renegotiate the debt with something like 80 percent of the creditors. So they came to a deal whereby they said that look the actual value of this debt as you know is now something like 20 percent the secondary market is trading at 20 percent of the previous value. So will you accept that value and we promise that we will repay you everything on this new and more sensible value. Now, let's also be clear that when people talk about the value of a debt, anything that is unpaid gets added to the principle and compounded. So, may be you have originally borrowed only say ten billion, but when you delay the payment, that interest gets accumulated into the principle so the value of your debt expands to let's say 30 billion. Many of the creditors actually recognizes this. Their original loan was much much less than the current value of the debt and of course the value of the debt in the secondary market it was much less also. So they accepted it. 80 percent as I said of the creditors including many of the major American banks accepted this. A few creditors held out. They refused to accept it. And any way this was done and Argentina proceeded. Now, obviously those who were held out were not getting repaid anything. Then what happened was this hold out creditors as they are called, most of them sold their debt to what are known as vulture funds. Vulture funds are hedge funds that are specifically set up to buy distressed debt and then do whatever it takes to somehow get it. And so that's what they do. So in other words they are not normal hedge funds. In other words, they are not normal hedge funds. Their job is to collect these distressed debt at may be one tenth of the value. In fact, it is estimated that they did most of these vulture funds got these debts at one tenth of the face value. And then they try and use legal means and various other means to pursue and get full repayment. Some of the hedge funds like Singer and Company have actually been successful in other cases with Ghana with number of other cases. And they use all kinds of means to prevent Argentina from being able to repay others until they first repay the vulture funds. Now, what happened in Argentina in this specific case ...
RB: Just would interrupt you Jayati. Why do they expect preferential payment of these cases?
JG: It's not preferential. What they are saying is we never agreed to this debt pre-negotiatons. But you owe us money. So pay us back. So they are going by the original debt, if you like. Not a renegotiated debt. They said we don't accept a renegotiation. So you can not pay us the lower value that you are paying all these other people. You have to pay us the full amount. Normally in fact, whenever there are debt workouts, the US law for example when there is a debt work out, if 70 percent of the creditors have agreed to something the other 30 percent are forced to go along with it. But, there is no international mechanism for a debt work out. There is no international agreed mechanism for a sovereign debt work out. What happened in Argentina's case is that two hedge funds went to a New York court demanding that they be repaid in full and also saying that unless Argentina pay them, they can not pay any other creditor. Now, this revolves around a peculiar clause. It is called pari passu or equal treatment terms OK. And it is a peculiar legal outcome because it is basically saying that we are to be treated on par with all other creditors where in fact, they are not being. They are demanding as you say effectively preferential treatment because of full payment. Judge Griesa, Thomas Griesa in the district court in New York actually went along this and said yes, they have a right and they must be paid in full and only then Argentina can pay the other creditors.
RB: So the court went along purely only the contractual understanding...
JG: Not just contractual it is very unusual interpretation of the pari passu Clause. In fact, it is unprecedented. It is novel, it is unprecedented, it is the first time it has even been interpreted in this way.
RB: Now, how can an American court however can have jurisdiction over Argentinian state? Why can't Argentina say no to this?
JG: The trouble is.. Well, Argentina could ignore it if it wanted to say the hell with you to all it's creditors. But it doesn't. It wants to repay the creditors with whom it has renegotiated in all good faith saying we will negotiate with you, we promised you something, we are going to repay it. However, because all these debts were contracted in New York, or in United States, basically with Wall Street, it is subject in the United States to US law. Argentina can ignore it else where. But what Judge Griesa has done something is even more remarkable. Judge Griesa has said, anybody who assists Argentina in repaying these debts to it's other creditors is also in contravention of the law which is another extra ordinary judgment which is unprecedented. So what it said is if some other bank facilitate Argentina repaying the other creditors, they are also illegal. When people say Argentina is in default, that's false. Argentina wants to pay it's credit. But it is not being allowed to pay their creditors.
RB: Now what does this default does actually mean for Argentina in terms of it's domestic economy as well as it's international commitments.
JG: I will tell you. The reason whey they were anxious to get this because Argentina is being excluded from the Global credit markets ever since then about ten years. So they would like to get back into borrowing from the international markets. It does make a difference to Argentina because it really mean that they can not run a current account deficit. They can not finance it through borrowing at any point. They have managed so far. They have managed to run current account surpluses or just been in balance or manage to raise enough money to actually generate you know what they need. But it is difficult. It does mean that occasionally they have to have import controls, occasionally they have to put balance of payment restrictions. It means that they have concerns about domestic inflations. There are reasons why Argentina would like to be free of this and is making all the efforts required. However, because of this ridiculous interpretation of the pari passu clause and the further requirement that no body else can be repaid even by third parties, it is unable to do so. Now, what people don't understand that the implications for Argentina are much less than the implications for the global financial system. I think that's why it is so ridiculous to see how wall street is not being more aggressive in trying to stop this kind of shall we say court action. The US administration actually Obama administration came out and said it is concerned about this. The IMF has said it is concerned about this and pretty much everybody in Europe is concerned about this because what this means is that it actually threatens any international lending. Let me explain why? Any lending contains the possibility that it is finally of default. That has to be somehow inbuilt into the system. One way it is in built is the credit rate, in the interest rate itself. It is spread over. And anyone who is lending to a more risky client a charging a higher rate. So one point is that already people who is lending to Argentina had already factored in a possibility of default and they have already got a higher interest rate on the basis of that possibility. Number one, so we can't say that you have to be paid back in full then you can not be demanding a higher interest rate in the earlier phases. The second is, that every credit system, national, sub national, international requires this possibility of this default to somehow be incorporated into the system. The United states have many bankruptcy laws, chapter nine, chapter ten, chapter eleven dealing with companies, municipalities, individuals because they recognize there will always be a possibility of default, bankruptcy and you have to have to have what is called an orderly workout of this debt. Many international debt contracts now include what are called collective action clauses which was precisely this. Somehow making an orderly debt workout. So the collective action means 70 percent of your creditors agree on something while the 30 percent have to lump it and go along. The Eurozone debt for example none of the Euro zone debt negotiations would have been possible without this. But basically you can't have a properly functioning sovereign debt system without this. Certainly, an international financial system in which sovereigns can borrow can not function without debt workout mechanism. If every time you have to say not there is no such thing as partial default.
RB: So has this incident led to I mean calls for such a ..
JG: There are indeed renewed calls for this. I am surprised that they are not louder. I think at the moment when it first happened, well UNCTAD came out with a very important piece, they have been in fact always arguing for a sovereign debt restructuring mechanism. But a number of other people actually demanded the as I said even the IMF that we now have to think about way of ensuring that there is an orderly debt workout mechanism internationally. Since then, things have quietened down. Why, because I think it is a fools paradise. People believe that this will be a localized problem in Argentina. We can manage it for now. Just muddle along as we have. I think that's a seriously optimistic position.
RB: So what about this particular incident? Where does Argentina go from here, given that I am pretty sure that America is not going to accept ICJ's jurisdiction over the matter. So what happens now? They just have to make those payments otherwise
JG: Well, what it can do is try and do other ways of making the payments. It is very interesting that China is paying a more active role. China has actually offered to a kind of currency swap arrangement which would dramatically ease it's foreign exchange constraints of Argentina at the moment. There have been suggestions what China should do just buy up all these sovereign debts which it can easily do without even noticing and that resolves the problem from the point of view of Argentina if it buys this debt in the secondary market.