In an ideal world, financial bonds always reach maturity and terms are always fully honoured; this should apply to corporate bonds, but with even more certainty to sovereign debts. However, circumstances can change and businesses and nations can be poorly managed, or simply unlucky, ending up with the debtors being unable to honour the commitments that were made when issuing the debt. On a national level, one of the more spectacular sovereign defaults has to be that of Argentina in 2002 which involved a default on $100 billion of debt – about ten times more than the government of Cyprus needed to underwrite its banks during the European Sovereign Debt Crisis.
If a corporation defaults on its bonds, it may well end up in bankruptcy, sometimes giving it a chance to re-emerge on a more sustainable footing, but nation states can’t declare themselves bankrupt. The consequences of a significant sovereign default may well be that the debtor is locked out of traditional money markets and that international aid can’t be granted until the default is purged. To say that such a nation can’t raise funding would be untrue – the cost of such borrowing rises (alarmingly) as creditors factor in the risk of a future default.
Argentina has reached a “haircut” deal (an agreement to pay only part of the sums owing) with 92% of its creditors, but some bonds were purchased at a heavy discount from the original investors by so-called “Vulture Funds”. These creditors have been insisting that the terms of the debt that they hold are fully honoured and this has led to an impasse between creditors and Argentina which has resulted in judgments against the nation in US civil court. Argentina pays more than twice the 5% interest rate commonly charged to other South American nations for its borrowing.
The outgoing administration, under President Kirchner, refused to deal with the vulture funds, but the administration of President Marci which came to power in December looks set to resolve the issue with a payment of $4.6 billion. The move would require some legislation put in place under Ms Kirchner, to be revoked before the deal can be closed.
If successful, the move should allow Argentina access to international money markets and so slash its borrowing costs and will also facilitate inwards investment.