Why I’m happy for Argentina to default

As Argentina stands on the brink of another potential default, elsewhere in Latin America, a new breed of open, investor-friendly economies is emerging. James McKeigue picks the best way to invest.

As you read this, Argentina is taking desperate measures to avoid default. Government lawyers have launched an appeal with US courts in what could prove to be one of the final acts of its bitter ten-year battle against the vulture funds'. They're attempting to overturn last week's ruling from US District Court Judge Thomas Griesa, which found that Argentina should pay $1.3bn of outstanding bonds.

The story goes back to 2001/2002 when Argentina made history with the biggest sovereign default ever seen. With its economy in crisis Argentina was forced to devalue its currency and defaulted on almost $100bn of bonds. Over the years Argentina managed to cut a deal with most bondholders, agreeing to return about 30% of their money.

But it has refused to pay a cent to one set of investors the vulture funds. These funds swooped on the debt in the aftermath of the crisis, buying up the debt for a tiny fraction of its nominal value. And, as a result, the Argentinian government sees them as financial opportunists rather than legitimate bondholders.

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One of the funds that snapped up the debt was Elliott Capital, which is headed by US financier Paul Singer. Worryingly for Argentina, Singer has a ruthless record of making countries pay up. In 1995, Elliott bought defaulted Peruvian bank debt for $20m and successfully sued for $58m. One of his other companies also made a killing from debt issued by the Republic of the Congo.

This is a miserable situation for Argentinian president Cristina Kirchner. But it's actually good news for us.

Today I'll explain why that is. And I'll also show you how we can profit as Argentina continues to scare investors away from Latin America.

Argentina is stuck in a hard place

First, I should point out the actual sum involved here isn't really the problem. The court has ruled that Argentina must pay the $1.3bn it owes the vulture funds into an escrow account where it will sit awaiting further rulings. That might sound like a lot of money, but Argentina could pay it.

No, the real problem here is that the judge has decided that this will affect the debt that's already been restructured. If Argentina doesn't put the money into the account then the judge can take the money from its planned payments to other bondholders. Argentina is due to make a payment worth around $3bn on 15 December. If it hasn't paid the vultures by then, those payments won't go ahead and Argentina will have defaulted. Again.

The ruling puts Argentina in a tricky situation. There's no way that president Cristina Kirchner wants to back down to the vultures. She likes to use an aggressive foreign policy to win favour with voters in Argentina and she's turned the repayment into a matter of national pride. She passed the buck for the recent frigate humiliation, with the Navy's top Admiral resigning. But another loss to the vultures could be more awkward to explain.

Aside from politics, there is also the danger that backing down to the vultures now could open the floodgates for other payments. To put it mildly, Kirchner is in between a rock and a hard place. She's a wily politician and I wouldn't write her off just yet but either way we're looking at default or a renewed battle with the vultures.

What default would mean for Argentina

The reason Kirchner could countenance a default is that Argentina is pretty much blocked to international investors already. The central government learned to make do without foreign loans since the last default. Admittedly it would be more of a headache for Argentinian companies and local governments, many of which tap external financing.

Far more important is the psychological impact. Following the high-profile expropriation of Spanish oil firm Repsol's Argentinian assets, a default would be another huge blow for anyone trying to attract international investors to Argentina.

Over the weekend I was chatting with a friend whose job is just that. She wouldn't appreciate it if I said who she works for, but suffice to say her job is "almost impossible" at the moment. The only upside, she told me, is that the few companies that are determined to set up in Argentina are more likely to pay for advice.

Here's the good news

Argentina isn't the only Latin American country facing the wrath of foreign investors. Bolivia and Venezuela have both enjoyed their fair share of expropriations and nationalisations over the years.

These actions generate plenty of dramatic headlines here in the West and do a good job of scaring investors away from Latin America.

But I'd argue that this is a good thing. Because while those three nations might be living up to a lot of Westerners' expectations of Latin American economies, elsewhere in the region things have been quietly changing. Over the last decade a new breed of open, investor-friendly, well-managed economies has started to emerge. And it makes a great deal of sense to me to invest in these economies right now.

Mexico, Colombia, Peru and Chile have all combined economic growth with important reforms. Recognising what they have in common, this year they formed the Pacific Alliance a regional bloc dedicated to boosting trade between members and with the rest of the world.

I've been keen on this bloc for a while now but two weeks ago I heard Chilean President Sebastian Piera talk up the Alliance, when he came to London.

Unsurprisingly he was bullish on the bloc's prospects. But what was really interesting was hearing him explain differences between the Pacific Alliance and the rest of the region.

"Chile and our Pacific Alliance partners have a clear vision of how to deliver growth through open economies, free trade and investment in science and technology I would never want to tell another country what to do but it is clear that others have chosen a very different path."

That's probably as close as a polite president can come to calling his neighbours economic basket cases.

So why should you invest in the Pacific Alliance?

Let's be clear, I'm not saying these countries have always been great for investors. Apart from Colombia, which has the proud record of never defaulting on its debt, they've all let down international creditors at some point in the last 30 years. They've also had their fair share of nationalisations and political interference.

But now it seems that they've broken away from the pattern of unfunded spending, default and drastic government measures.

For starters all four have cut their debt. Indeed, Chile is now a net creditor to the rest of the world.

The other standout characteristic that these four countries share is their attitude to international trade. They are all incredibly open economies and have free trade agreements with vast swathes of the globe. These agreements aren't just about securing export markets. They also help local consumers enjoy cheap imports from around the world and ensure that local companies are competitive. It's a marked contrast to Brazil or Argentina, where heavy import controls that were meant to protect local industry have led to inefficient local manufacturers.

Moreover, these economies look set to become more open. Since signing the pact in June they've been working to ease trade within the bloc.

To begin with the countries will simply strengthen the trade agreements already in place. Then they will link the existing bilateral accords between the four countries and add additional steps, such as making it easier for business travellers to move around the alliance, facilitating student exchanges and integrating electronic markets.

One advantage of taking small steps like this is that such reforms are easier to achieve. As a result, we are already seeing progress. For example, since November tourists can travel freely between the four countries without needing a visa.

Moreover, the effect of all these small reforms' will add up. In the long run they will radically lower the costs of doing business and give firms access to a wider pool of talent, local suppliers and a larger market.

If the reforms succeed in cutting business costs the potential is massive. After all, the group has a population of 215 million, but a GDP of only $2trn. That's a smaller GDP than the UK, but with three and a half times the population. I know who I'd bet on to enjoy the best growth over the next few decades.

I'm not the only one to see the potential of this market. Just two weeks ago Canada and Australia showed their interest by gaining observer' status in the Pacific Alliance.

Another big driver for growth will be improving infrastructure. (Read more about that here: Two ways to play the Latin building boom) Suffice to say that improving road, rail and air links will make local companies more competitive and open up remote markets.

My final bull point about the Pacific Alliance is what lies across the ocean, Asia.

One of the things that made me smile listening to Piera speak was that he mentioned the phrase the new world' about ten times. Now a cynic might suggest that's because his speechwriter and our marketing department studied at the same school of clichs. Perhaps. But I think it's also because we really are seeing a new world emerging. It's not just about Latin America. Piera made it very clear that the members of the Alliance are looking West, across the Pacific, to the rapidly growing economies and populations of Asia.

He spoke of his hopes to integrate the Pacific Alliance with the wider Trans-Pacific Partnership, being cooked up between countries in North America, Asia and Australasia. Nothing is confirmed yet, but if these countries were to strike a wider deal, it would give the Alliance members and extra boost in the long run.

So what's the best way to invest in the Pacific Alliance?

For the average British retail investor, investing directly in the Pacific Alliance countries isn't easy. Accessing the local stockmarkets from abroad can be expensive, but if you buy via an exchange-traded fund you'll find that in the smaller economies the country-specific ETFs are dominated by one or two large, local firms.

I was talking about this problem a few months back with Will Landers, manager of BlackRock's Latin America Investment Trust, and he gave me a useful piece of advice. "If you have a country with a clean banking system and growing economy, buying a bank is often a good way to play the wider growth. It's involved in business sectors across the economy so it's almost like buying an ETF."

Well my favourite bank in the region is CrediCorp (NYSE:BAP) in Peru. It's a well-run bank that provides insurance and retail, commercial and investment banking. Basically it does a bit of everything. Despite being one of Latin America's fastest-growing economies, Peruvian banking remains in its infancy. According to JP Morgan analyst Saul Martinez, bank credit to GDP stands at 28%, compared to 44% in Brazil and 71% in Chile. Moreover, CrediCorp is keen to expand to other parts of the Pacific Alliance. For example, it recently bought the controlling interest in Chilean investment bank Inversiones IM Trust.

Since I first tipped it in August shares are up almost 25%. That's great news for anyone who bought in then but it leaves it looking expensive for any newcomers as it now trades on a forward p/e of almost 13.

The rapid rise means over the short-term it could be subject to a pullback. But if you're prepared to buy and hold for a few years then I still think it's a great way to play growth in the Pacific Alliance.

As you can probably tell, I'm a big believer in the potential of the Pacific Alliance countries. In the coming issues I'll explore industries and companies that I think look well placed to benefit from the bloc's growth.

This article is taken from The New World, MoneyWeek's FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.

James graduated from Keele University with a BA (Hons) in English literature and history, and has a NCTJ certificate in journalism.


After working as a freelance journalist in various Latin American countries, and a spell at ITV, James wrote for Television Business International and covered the European equity markets for the Forbes.com London bureau. 


James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. 


He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.