Crying for Argentina

Maltastar

Crying for Argentina!

As Argentina moves close to an official default on its foreign debt many Maltese investors have good reason to cry for Argentina.

I always amazed myself at the great exposure Maltese investors accumulated on sovereign emerging market bonds. For those unfamiliar with technical financial jargon emerging market is a polite way of describing under-developed and therefore more risky countries. Because of the risk carried by such fixed interest securities they carry a high interest rate (coupon) which is attractive for unsophisticated Maltese investors particularly at a time of falling interest rates.

My amazement turned to worry whenever I quizzed such investors as to their sensitivity to the risk they are carrying through such holdings. Almost invariably I realise that they had scant appreciation of the risk involved and that they were assured by their investment advisers at the time they parted with their money` that these bonds were `guaranteed`. Clearly the advisers made no effort to explain` that the guarantee was that of the government of Argentina whose credit-rating on the market was low and falling.

I once had the opportunity to flag this concern to senior officials of the Central Bank. I asked whether the Central Bank includes such low rated securities among its portfolio of foreign reserves and was given a flat no answer. They almost looked at me as if I had sworn in church. Then I asked why the Central Bank was therefore not showing any concern to the undue exposure being built at a dangerous national level as private investors are lured by irresponsible advisors to place their lifetime savings in such emerging market fixed debt securities with particular exposure on Argentina, Brazil and Turkey. I interpreted the silent reply as an attitude of we do not care about` what we pretend not to see.

I asked one serious stockbroker about this and he replied that in his firm he has only one investor in such securities and he has a written declaration that the investment was being made against the stockbroker`s advice.` So the problem is not widespread across the whole investment advisors industry.

Be as it is today many unsuspecting Maltese investors who had not the slightest idea of the risks they are assuming are now sitting on spectacular losses on the Argentina bonds. Argentina is planning to default on at least USD95 billion of bonds which dwarfs the 1998 Russian default on USD40million domestic bonds..` Overnight interest on Peso deposits rocketed to 190% as banks in Argentina tried to stem the outflow of capital.` The benchmark price for the 2005 floating rate bond fell on Thursday to 48.75 pushing the yield to maturity to 54.5% p.a.` triple what it was last June.

The default is in the form of a forced swap where Argentina is proposing to force its bondholders to exchange high coupon for low coupon debt in order to loosen the stranglehold of high interest burden which is suffocating the growth potential of the economy. Without such debt swaps further loans from the IMF would be almost impossible and the country would economically collapse forcing a devaluation of the peso and departure` from the parity exchange regime which Argetina has enforced these last 10 years through the Currency Board arrangement.

There is a lesson in all this even for our macro-economic management. Argentina`s debt in relation to its GDP is at 55% lower than Malta`s.` Furthermore Argentina has been forced to make savage and socially painful expenditure cuts to balance its budget to avoid having to increase its borrowing. In Malta our true national debt is around 90% of the GDP and growing at an alarming rate and we still need to borrow to maintain an obstinate deficit which is not responding to increased tax revenues as expenditure keeps rising still faster.

What is shielding us from the Argentinean-style` tragedy is that our debt is mostly in Maltese Lira not in foreign currency and it is well structured on a long term basis. But further accumulation of debt will inevitable loosen the faith of local savers in the local economy forcing Argentian style flight of capital and followed by measures as painful as the Argentinians are having to swallows as their economic dreams are shattered. We have to change economic course before it is too late.` The longer it takes the more painful the solution, no two ways about it!