Argentina looks set to default on its debt for the second time in 12 years next Thursday as negotiations with "holdout" investors seemingly go nowhere and neither side shows signs of blinking first, though a last minute deal can't be discounted.
Latin America's No. 3 economy has for years fought the holdout hedge funds which snapped up its junk bonds after its $100 billion default in 2002 and then refused the restructuring terms, suing for repayment in full.
But time is up. After a slew of legal setbacks for Argentina in U.S. courts, the country has just days to comply with a 2012 ruling by U.S. District Judge Thomas Griesa to pay $1.33 billion plus interest to the funds it calls "vultures."
If the deadlock persists, Griesa will prevent Argentina from making a July 30 deadline for a coupon payment on exchanged bonds, triggering a new default just as the economy struggles with recession, dwindling reserves and soaring inflation.
"The outcome is still uncertain, with just days before a technical default is triggered," said analyst Mauro Roca of Goldman Sachs. "A deal now seems unlikely."
Unlike Argentina's 2001-2 debt crisis when it was broke and could not pay its civil servants, this time around the country is solvent but prevented by Griesa from servicing its bonds until the battle with the holdouts is resolved.
Argentina's combative stance has upped the odds of a default. Efforts to find a solution through a mediator have made scant progress, with one of the lead holdouts saying the government had made clear "it will be choosing default."
Argentina's president, Cristina Fernandez, has not minced words, branding the holdouts extortionists and lambasting the judge for a ruling she says is unjust.
The government argues a deal with the holdouts would leave it at risk of breaking the so-called RUFO clause which bars it from voluntarily offering better terms to investors than what it gave in the bond swaps accepted by 92.4 percent of creditors. RUFO stands for "rights upon future offers."
With the RUFO clause set to expire on Dec. 31, Argentina wants a stay on Griesa's ruling to allow negotiations without risking claims from exchange bondholders that the government estimates could hit $400 billion. So far, the judge has refused.
MESSY OR CLEAN
A high-stakes game of poker is playing out. Griesa's ruling prohibits Argentina from servicing its restructured debt until it settles with the holdouts.
If neither side flinches, Argentina will default as of July 31. Although it will have sufficient finances to service its foreign currency restructured debt, worth $35 billion, it will be unable to get payments to creditors outside Argentina.
A default won't send shockwaves through the global economy: Argentina is already isolated from international capital markets. How much pain it causes at home will depend on how quickly Argentina can extricate itself from the mess.
That will largely be determined by whether Argentina persuades bondholders it is ready to negotiate a swift settlement after the Dec. 31 expiration of the RUFO clause.
If it can, there is less chance of a so-called "acceleration" demand by bondholders for early payment. Bondholders might then simply have to wait a few months for their payments.
In this scenario, Argentina's banishment from global markets would remain and borrowing costs for Argentine companies and provinces would rise.
"We'd likely see higher yields, which is bad for the investment environment, and a default could spark some capital outflows which would start putting a strain on the currency again," said David Rees at London-based Capital Economics.
That would likely push Argentines to increase their dollar holdings, weakening a peso already down 20 percent so far this year on the official rate and putting more pressure on foreign reserves that are at five months' import cover.
Siobhan Morden, head of Latin America strategy at Jefferies in New York, said there was the "risk of worse stagflation." Inflation is privately estimated at above 30 percent.
Farmers in the world's No. 3 soybean exporter say they will hoard the oilseed in the event of a default, potentially pushing global food prices higher in the short run.
However, if more than 25 percent of holders of exchanged bonds call on Argentina to "accelerate" the payments, the country will become mired in a far messier default that will take longer to clean up.
Argentina could restructure its bonds under local legislation to circumvent the U.S. court ruling, though this is seen as unlikely, analysts say. Alternatively, it could offer a new bond swap, still under foreign legislations — a scenario that would likely have to include holdouts if Argentina ever hopes to tap international markets again.
In the interim, financial pressure would grow as debt servicing costs more than double in 2015 and reserves fall to critically low levels.
"If this stretches into next year when you have a $6 billion maturity on the Boden15s ... that becomes problematic to finance," said Stuart Culverhouse, head of research at Exotix, a frontier markets broker in London.
Culverhouse estimated that reserves, already at eight-year lows of about $29 billion, could sink to about $10 billion. "That's where they were in 2001 at one point. It's a bad place to be."
DEAL REMOTE, STILL NO PANACEA
Analysts said Argentina could still pull a rabbit out the hat.
Griesa could still suspend his ruling to avert a default — a scenario he described as "the worse thing I can envision".
Holdouts would need to request the stay and would likely ask Argentina for a guarantee, possibly financial, it would negotiate from January once the RUFO clause had expired.
"There is probably more for plaintiffs to lose than to gain from a default," said Alejo Costa, strategy chief at local investment bank Puente.
"If Argentina defaults, they don't know what is happening and might have to go through another lengthy legal process."
How the holdouts act may depended on how many credit default swaps protecting them against default they hold. They could elect to cash in on those now and hunker down for an even longer legal fight, or take a negotiated deal and move on.
A stay is seen having little effect on an economy analysts already forecast to contract by about 1 percent.
On Friday, Argentine debt negotiators left mediator Daniel Pollack's office after just one hour, pouring more cold water on hopes for a deal, which now seems the least likely outcome.
Even if Argentina does pull off a deal, it will come too late to haul the economy out of recession this year.
"But maybe it makes for a stronger growth prospect next year, if anything because you're lifting consumer confidence, you're easing some of the exchange rate pressures," said Culverhouse of Exotix. "But there will be a delay in getting this resolved and new foreign investment."
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