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Jeffrey D. SAX *
NEW YORK – When one car slides down an iceberg, that could result in fifty cars crashing. This is what is happening with the international financial markets: Mexico’s failure to pay debts in 1982 led to the accumulation of debts of dozens of countries. The devaluation of Thailand in July 1997 caused the Asian financial crisis. The bankruptcy of Lehman Brothers in September 2008 also triggered the Great Recession worldwide.
IFCs must be smarter to start collapsing 2020 due to Covid-19, and its wisdom will be tested soon.
Argentina was experiencing a debt crisis again, even before Coved-19 plunged the world economy into its worst economic recession since the Great Depression. As often happened in the history of Argentina, which suffers from the problem of defaults, an ill-conceived agreement with rebel creditors in 2016, which was followed by a rapid return to bond markets, proved to be a dream of the then president of Argentina, and the country’s creditors.
The fiscal deficit undermined stability. The 2018 bailout failed to succeed with the International Monetary Fund. Argentina’s debt, which has very high interest rates, has proved unsustainable.
However, Argentina was not the only borrower. The lending criteria of lending thanks to financial markets, and as a result of the abundant liquidity pumped by the Federal Reserve and other central banks, have caused many developing countries to borrow heavily in recent years, and sovereign debt distress is increasingly recognized as a major comprehensive risk. A session at the 2019 IMF Spring Meetings was entitled “Addressing the Next Wave of Sovereign Debt Crises”.
In the context of Covid-19, the collapse of oil prices in March, the start of the near-global closure, the decline in government revenues, and the huge public spending for the survival of the population, led to an unprecedented global financial crisis in peacetime. The US budget deficit will rise to about 18% of GDP, or higher. For many emerging economies, the financial picture cannot be darker.
But even in this context, Argentina made a realistic and appropriate offer to restructure its debt to its creditors. Its creditors must respond positively to it. Here are the details of the offer.
Argentina’s current debt holds an average interest rate of 7%, which is nearly seven percentage points higher than the zero interest that Germany paid on its government bonds for 30 years, and nearly six points from the 1.2% interest paid by the US Treasury. Argentina rightly noted that a 7% interest rate would necessarily result in default. The International Monetary Fund has agreed that it is unsustainably high. Hardly any governments – including the United States – can afford a 7% interest rate in this economic environment.
Argentine creditors say they need an interest rate of 7%, or even higher, because of the possibility of default. But they seem to be unaware that if Argentina’s interest rate is lowered to approach the US interest rate, default will not necessarily happen. Also, a high interest rate of 7% is a self-fulfilling prophecy: it makes defaults inevitable, while that will not necessarily happen if the interest rate is low.
Argentina proposed to refinance existing debt with low safe interest rates, thus avoiding the need to impose a “reduction” on capital. (In fact, in line with Argentine law, the exchange offer includes a small symbolic reduction of the face value of debt, which, in my view, should be canceled in any final transaction) Similar to the mortgage refinancing process, existing bonds will be replaced by bonds that reflect low interest rates Today. However, instead of an interest rate equal to the price of US treasury bonds, Argentina offers an interest rate of 2.3%, higher than the treasury yields in its creditors ’portfolios. There are details of the grace periods and the time paths of interest-bearing operations that must be negotiated, refined, and finalized, in light of the appalling and evolving economic facts.
But the creditors ’phases are strange. They claim that Argentina is imposing a significant reduction in the value of the debt, although it is not essentially there. The Argentine government proposes a safe return above the US safe rate, and its offer is logically correct. Why should she stick to a very high interest rate that creates the risk of default? Why do creditors prefer Argentina’s default on its economic recovery?
Creditors calculate the alleged devaluation of Argentina’s offer using a 10-12% discount rate, as if they deserve a risk-free yield of 10% or higher, when the US Treasury rate is just above 1%. The financial press follows these conditions, indicating, out of a sense of duty, that Argentina imposes a significant reduction on creditors, while it does not. Indeed, Argentina is reducing the interest rate that runs the risk of default, to an interest rate that will not cause this.
I will add another point. Some friendly formal creditors, or multilateral institutions, can improve the deal by guaranteeing some or all of Argentina’s payments on the new bonds. Such a guarantee would be a completely safe bet: with a low interest rate and new entitlement structure, Argentina would not default.
And global financial markets often panic when one country, let alone many, begins to slip. It is possible that 30-40 countries are currently experiencing severe financial stress. All of these countries need to refinance their debts this year and next, until the epidemic recovers from global economic activity, restores government revenues, and reduces the need for emergency expenditures.
In such cases, collective rationality in financial markets requires guidance from the International Monetary Fund and the leadership of a number of key creditors. Otherwise, this will lead to a creditors race to extract the assets (a form of the principle of the prisoner’s dilemma). Each creditor says to the other: “You refinance the debt while I receive the payment, thank you.”
If debt service payments for this year are dealt with cautiously, they can be recapitalized, at low interest rates, and in order to avoid financial accumulation. If not, 2020 will mark a new and devastating episode of the global financial crisis.
When the banks panicked in 1907, it was J. Perpont Morgan and his bank that led the financial system away from the brink. In 2020, the leader must be BlackRock, which was managing $ 6.5 trillion in assets at the end of the first quarter of the fiscal year, and it is one of Argentina’s major creditors. Black Rock can direct the bondholders to refinance Argentina’s debt at a safe rate of interest, and to do the same with other sovereign borrowers, who are suffering from the epidemic.
It’s your turn, Larry Fink, to help prevent a global financial disaster.
Translation: Naima Abarouch Translated by Naaima Abarouch
* Jeffrey D. Sachs is Professor of Sustainable Development, Professor of Health Policy and Administration at Columbia University, Director of the Columbia Center for Sustainable Development and Director of the United Nations Sustainable Development Network. Copyright: Project Syndicate, 2020
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