Argentina Squeezes Bondholders

BUENOS AIRES – Argentina is set to begin a debt-restructuring plan that it hopes will close the curtain on the largest sovereign default in history by imposing massive losses on holders of $103 billion (€78.9 billion) in bonds.

Bondholders are squawking, but the Argentine government, through tough negotiating and luck on its side, looks as if it will get most of what it wants.

On Friday, Argentina plans to begin its formal offer to pay only about 30 cents on the dollar -- unprecedented in its stinginess in the history of public debt restructurings. The debt swap has become a test of how far an emerging-market debtor can go in dictating terms to creditors. It also could provide a boost to Argentina's recovering economy, provided the country overcomes resistance from bondholders, including tens of thousands of individual investors scattered throughout the world.

Analysts say that the bond swap needs to gain acceptance from somewhere around two-thirds of holders in order to give Argentina the credibility to begin patching up its relationship with the International Monetary Fund and eventually to regain access to global capital markets. In recent days, Argentina's chances of reaching that threshold have increased, in part because of investor fatigue over a contentious negotiating process that is now heading into its fourth year. There are signs that foreign institutions have tired of pursuing so-far-fruitless legal efforts to force Argentina to pay by trying to embargo the country's foreign assets, including diplomatic residences and even naval vessels.

Even if the swap doesn't draw an overwhelming response, it's not the end of the world, financially, for Argentina. Thanks to a boom in commodities prices, Argentina has enjoyed brisk economic growth the past two years even without financing from Wall Street. Part of the reason Argentina's President Nestor Kirchner boasts high approval ratings at home is the pleasure Argentines take in watching him go mano a mano with bondholders.

Argentina's hardball stance also has earned it admiration among some opinion leaders in countries like Brazil, which has imposed harsh austerity measures to continue paying its creditors.

"President Nestor Kirchner prevailed over financial terrorism," the influential columnist Elio Gaspari wrote this month in the Rio de Janeiro newspaper O Globo.

In 20 sovereign debt restructurings since 1990, the average write-off was just 36%, according to a survey by a group of institutional bondholders. Argentina is asking for a so-called haircut of twice that percentage. But it's unlikely that Argentina, which has suffered economic depression and social devastation since its default in 2001, will become a model for other countries.

"The idea that this is a precedent that says default is costless is nonsense," says Nouriel Roubini, an economist at New York University. "That's medicine no one would want to inflict on their country."

While the size of the financial loss may frighten smaller investors from dabbling in debt of developing nations, institutional firms looking for higher returns are likely to remain big buyers. Over the past few years, larger investors have increasingly distinguished among developing nations -- and demanding lower interest rates of those nations with a firmer commitment to orthodox economics -- rather than lumping all poorer nations into a single category.

Argentina is seeking to swap bonds with a face value of $81.8 billion, which it defaulted on in 2001, for new debt valued at $41.8 billion. It is making different types of bonds available to different investors over the coming weeks and the acceptance rate won't be known until late February or March.

Argentina has enjoyed a stroke of luck since unveiling its offer last year. Analysts say a broad rally in emerging-market debt has increased the value of the Argentine offer to around 30 cents on the dollar from about 20 cents. "The fair market value has increased without the government offering any improvement," says Fernando Losada, an economist at ABN Amro. He projects that the offer will attract somewhere between the two-thirds of bondholders Argentina might consider successful and the 80% which the IMF is believed to want.

Argentina starts out assured of acceptance from the local pension funds that hold about one-fifth of the bonds. In what has become an economic war of attrition, Argentina also enjoys the advantage of having about 40% of the bonds in the hands of individual, or retail, investors with limited wherewithal and sophistication. Among these holders are some 450,000 Italians, 35,000 Japanese and tens of thousands of Germans and Central Europeans.

Stefan Engelsberger, a German craft shop owner who heads a 200-member bondholder organization, said there was intense bitterness over the offer at a meeting of his group a few weeks ago. "Our members were very angry, but now a decision has to be made," he says. "And that decision is not emotional but rational." Mr. Engelsberger himself has already sold some bonds on the market just because he needed the cash.

To appeal to the psychology of small investors, Argentina is offering them special access to "par bonds," which bear the same face value as the original bonds, but initially pay only 1.33% interest and don't mature until 2038.

Still, the thought of swallowing enormous losses is going down hard for the retail holders, many of them middle-class retirees. "Those are savings I worked for my whole life," says Dino Di Carlo, a 72-year-old retired supermarket manager from Rome, who put about $50,000 into Argentine bonds.

Foreign institutions have disparaged the offer, but that's partly a bargaining position. Many of the Argentine bonds have been sold to hedge funds by the institutions or banks that bought them originally. Given the hedge funds' high capital costs and the fact that the Argentine bonds haven't been paying interest, the hedge funds might be tempted to swallow hard and grab the Argentine deal, analysts say.

Over the weekend, Argentina took out advertisements in domestic and foreign newspapers suggesting that there would be no follow-up offers for holdouts. But few connected with the Argentine debacle think the current offer will be the last word. Mr. Engelsberger notes that even if Argentina's offer draws 80% acceptance, that would leave $20 billion in face value of bonds still outstanding, more debt than Uruguay has.

A successful offer would allow Argentina to resume its often acrimonious negotiations with the IMF, which were suspended last September. Argentina has been making debt repayments to the IMF, without receiving reimbursements of principal, which Buenos Aires had wanted as a low-cost source of financing. But Argentina's strong economic growth, along with the fact that it hasn't been paying bondholders, has allowed the government to manage the payments in stride.

Despite the improving outlook, Argentina still hasn't overcome all of the economic after-effects of the default. About half of the population lives in poverty. And the country's status as a financial pariah is causing bottlenecks that the local private sector would like to see eliminated. "Argentina is a country without credibility," acknowledges Horacio Moschetto, president of the Pullman shoe company and a leader of a shoe industry association.

Write to Matt Moffett at matthew.moffett@wsj.com