The Risky World of Argentine Debt

For all that commodity prices might be falling right now, they're still very high -- which is good news for Argentina and its current account. Since its disastrous default and devaluation in 2001, the Land of Silver has managed to accumulate a whopping $47 billion in foreign reserves, which means its ability to pay its debts, at least for the foreseeable future, is assured.

Its willingness to pay, on the other hand, is anything but. And so S&P has now downgraded Argentina to single-B, in line with where Moody's already had the country.

Argentina's debt service is due to rise substantially to $18.2 billion next year, and there's no indication that the government of president Cristina Fernandez de Kirchner puts any particular priority on making those payments. After all, Argentina is still running a budget surplus, so it doesn't need capital-markets access; in any case, because of the large stock of defaulted debt still outstanding, it isn't able to raise money in New York or London in the first place. So realistically it's going to get very little benefit from making those $18.2 billion in payments.

Kirchner's fiddling with domestic inflation statistics doesn't help either: by keeping them artificially and unrealistically low, she's effectively defrauding anybody holding inflation-linked domestic bonds. If she's willing to do that, it's not such a great leap to doing something similar to investors holding dollar-denominated debt.

The most interesting part of the whole story, however, is that the Argentine government is doing the very sensible thing and taking advantage of the low price of Argentine debt to buy it back. With the benchmark 2033 bonds trading in the low 70s to yield more than 11.5%, Argentina is likely to save billions by buying back its bonds at these levels.

It's a trick which is hardly new to Latin American sovereigns: threaten default, watch your bonds plunge in value, and then buy them back on the cheap. If you're really sleazy, you buy credit protection on your debt first, and make profits as your credit default swaps soar in value. Then you write credit protection after the bonds have plunged, locking in enormous premiums for the next five years. And then you fail to default, ensuring that you don't have to pay out on the protection that you wrote.

All of which means that if you're an investor in Argentine debt, beware of being played. It's a high-risk investment, and if you get it wrong you could lose a lot of money. But on the other hand, those double-digit yields from a rich country with a large trade and budget surplus sure do look attractive.