Kirchner’s Next Choice

By Alan Stoga*

Argentina is at a crossroads.

President Kirchner’s successful debt renegotiation represents a stunning victory over the banks and other creditors. In the process, he has dramatically shifted the balance between debtors and creditors, not just for Argentina, but potentially for the rest of Latin America and the emerging markets. How the story ends will have profound consequences for the entire region.

The settlement that he drove seems to have established two principles: first, that economic growth must take precedence over repayment and, second, that the decision about what is "reasonable" debt service is essentially non-negotiable. For all practical purposes, the creditors accepted Kirchner’s assertions that a country’s leadership is solely responsible for deciding how to allocate national income between economic growth and debt service and that the bulk of available resources should go to support current economic activity. By remaining quiet, the International Monetary Fund and the G-7 industrial countries seem to have effectively accepted the new rules.

Since the onset of the debt crisis, the relationship had been exactly the opposite. Debt service was supposed to come first, with whatever economic growth was possible financed out of what remained after the banks were paid most, if not always all, of their money. With the active support of the IMF and the World Bank—whose own credits took precedence over those of the private sector as well as of growth—the accepted theory for the past several decades has been that substantial economic recovery could only take place after a country’s creditworthiness was re-established.

The Kirchner solution has turned accepted practice on its head, and the consequences for the global financial system will inevitably be dramatic. On the one hand, other countries will certainly seek to realize Argentina’s debt discount—75%—and to imitate its spectacular economic recovery. And the reality is that Argentina’s growth, although driven by surging commodity prices, could not have occurred if the country had been servicing its debt. On the other hand, if creditors are at all rational, they will either stop lending or seek new ways to secure their loans. That will further transform international markets, making non-debt financial flows, especially direct investment, ever more important.

There is the risk that the same dynamic that produced such a deep change in the relationship between creditors and debtors could spread beyond the debt markets. How much different is it to tell an oil company or an electrical utility or a telecommunication company that they cannot raise prices, make adequate profits, or send dividends abroad, than it is to tell a bank that they must accept a payments holiday and pennies on the dollar in return for the money they lent? It surely is as easy to break one type of contract as another, especially if there is no reason to fear sanctions from the international monetary authorities.

Of course, exactly those kinds of practices are already too common in several countries. President Kirchner’s recent campaign against Shell for raising gas prices and President Chavez’ capital controls are two examples of governments encroaching on the contractual rights of investors.

This is both the risk and the opportunity of what Kirchner accomplished with the banks. If, after years of underperformance, Argentina’s break through leads to a new era of growth in the emerging markets, then everyone would benefit. Investors would enthusiastically pour money into Latin America, which would finally have the chance to achieve Asia-like sustained growth.

But if Kirchner’s debt deal leads to a drying up of capital flows as investors—already nervous about the rhetoric of leaders like Hugo Chavez, Evo Morales, Tabare Vasquez, Andres Manuel Lopez Obrador—seek safer havens, then it is only a matter of time before Latin America’s present commodity bubble driven economic growth cycle bursts.

So, the question is whether Kirchner will use his success to define a new path that encourages investors, regardless of their nationality, to help build a globally competitive Argentine economy or to reinforce his populist, nationalist, anti-capitalist credentials. The former would be good economics; the latter would be good politics.

Unfortunately, politics almost always wins that competition—which means that the real test of Kirchner as a leader is about to start.

* Alan Stoga is president, Zemi Communications, ajstoga@zemi.com.