Argentina default may threaten central bank reserves

The Argentine government's debt default yesterday is likely to put additional pressure on the central bank, which saw foreign reserves dwindle over the past year as it fought to maintain the peso's peg against the dollar amid soaring inflation.

The default was triggered early Thursday (GMT), when Argentina failed to reach a deal with holdout creditors who snapped up non-performing debt at a discount after the government's 2001 default, and are demanding to be paid in full.

A US court ruling, subsequently upheld by the country's supreme court, has barred Argentina from making payments on performing government bonds unless holdout creditors are paid in full at the same time. The failure to reach a deal meant the government was unable to make $539 million in interest payments to its other creditors, triggering a "selective" default.

While the event was met with relative calm in markets yesterday, analysts predict that tranquillity is unlikely to last, potentially spelling trouble for the central bank, which has seen foreign reserves almost cut in half over the past three years to less than $30 billion.

The Central Bank of Argentina (CBA) spent more than $15 billion of reserves propping up the peso last year alone. In January, it lifted strict capital controls to discourage the country's widespread black market for dollars.

According to Robert Kahn, a senior fellow for international economics at the Washington, DC-based Council on Foreign Relations, "many expect local market turmoil, including exchange rate pressures and higher interest rates".

Neil Shearing, chief emerging markets economist at Capital Economics in London, said yesterday's default has "potential to cause significant disruption to local financial markets and the domestic economy".

But according to Mike Moran, head of macroeconomic research for Latin America at Standard Chartered in New York, the default's impact on the central bank remains difficult to gauge. "Reserves will be vulnerable, [but it] depends on what the solution [on default] will look like," he said. "It's a murky issue. There's not going to be a lot of clean cut answers for the time being".

Moran added: "There has been so much attention on the July 30 deadline and negotiations with the holdout creditors that perhaps markets have overlooked that Argentina has a fairly heavy debt repayment schedule going into next year... If a favourable scenario emerges, that is not the end of the challenges for Argentina".

Following Argentina's default in 2001 – the largest in history at the time – the central bank spent $11 billion in reserves, amounting to 40% of total holdings, in a quarter.

Few are expecting a similar scenario this time around, however. "The economic and financial market fallout will be nowhere near as severe as it was after the 2001 default," said Shearing. "This default hasn't come as a surprise... much of the impact may already be priced into the market".

Kahn noted that Argentina has long been excluded from international markets, but added that "there was hope that they would re-access those markets". That hope is unlikely to have strengthened since Thursday morning.