Nine years after it defaulted on almost $100bn of government debt, Argentina finally looks set to “make peace with international capital markets”, as The Economist puts it. Around a quarter of its creditors refused the government’s 2005 offer of new bonds worth just 35% of the old ones, and obtained court orders barring it from selling debt on the international markets. Now the ‘hold-outs’ are being offered a deal worth more than 50 cents on the dollar. Most are expected to accept.
Greece follows Argentina
The news on Argentina is a reminder that there are “disconcerting parallels” between Argentina’s experience and “Greece’s recent and impending difficulties”, say Lila Shapiro and Peter Boone on www.huffingtonpost.com. What’s most disconcerting is that the situation in Greece is worse. Argentina’s public debt-to-GDP ratio reached 62%; Greece’s was 114% by late 2009. Argentina’s budget deficit in 2001 was 6.4%; Greece last year added 12.9% to its overall debt pile.
Both countries, having seen their competitiveness dwindle over the previous decade through wage and price inflation, “locked themselves into currency regimes”. Argentina tied its peso to the US dollar; Greece is trapped in the euro. With devaluation not an option, the only way to restore competitiveness and bolster growth is through deflationary wage cuts. But these depress the economy and threaten a debt trap.
“The danger is of a downward spiral in which the squeeze on public finances drives the economy deeper into recession,” note Kerin Hope and Ralph Atkins in the FT. In turn, the weakening economy makes it even harder to bring the public finances back “on a sustainable path”. And the high interest rates jittery markets demand for Greek debt are making matters worse. Unless the economy is growing faster than the interest rates on the debt, the debt pile keeps rising.
Will cuts work?
This is the mess Argentina ended up in. Even three International Monetary Fund (IMF) programmes “failed to break” this “vicious circle”, says Daniel Gros of the Centre for European Policy Studies. The upshot was riots, the end of the dollar peg and default. As for Greece, former IMF chief economist Simon Johnson calculates that it needs around €200bn over the next three years to steady the ship, while the EU/IMF loan, which Greece appears set to call upon soon, is set at €45bn.
That implies that savage, politically untenable cuts in wages and services will be needed to tighten fiscal policy enough to bridge the gap. With the economy already shrinking by more than expected and revenues for the budget missing expectations, “the odds are that this is not going to work”, as Erik Nielsen of Goldman Sachs puts it.
Portugal’s next
So while the rescue package buys Greece some time, “Greece is in effect broke”, says Wolfgang Munchau in the FT. Over the medium term, “some form of debt restructuring”, in itself a form of default, is “unavoidable”. But there’s more trouble ahead, says Johnson. Portugal is “next on the radar”. Its overall debt load is already at 78% of GDP and it will have to tighten fiscal policy by 10% of GDP just to keep its debt pile constant. Yet the Portuguese “are not even discussing serious cuts”. Given all this, no wonder Morgan Stanley sees the euro, still at $1.35, falling to $1.24 by the end of the year.