No wonder many on Wall Street now believe an Argentine debt default is inevitable. But what exactly would it take to push the country off the edge? And would default automatically spell the end of Argentina's 10-year-old Convertibility Plan, which pegs the peso to the dollar at a 1:1 rate? Here are some answers to questions investors have been asking.Will Argentina honor its foreign debts?
In theory, it can. In June, Economy Minister Domingo Cavallo successfully swapped $30 billion worth of short-term bonds for longer-term ones. That leaves less than $4.8 billion in treasury bills maturing this year. Most of this could be rolled over, provided investors keep buying Argentine treasury bills. But local banks, which hold 90% of these T-bills, keep demanding higher interest rates to compensate for the risk of rolling over the paper. At the latest auction, on July 10, annualized yields reached a record 14%. The government is now negotiating with a dozen banks to refinance the debt at rates it can afford.What is the worst-case scenario?
A lot depends on average Argentines. If they panic and rush to withdraw their money from local banks, a chain reaction could ensue. A full-scale run on the banks could lead to a default, since they are now about the only customers for government debt and without deposits they could not afford to buy T-bills. Default, in turn, could trigger the collapse of the entire Argentine banking system. Indeed, some Argentines already are pulling their money out: Bank deposits have fallen at least $2.4 billion since early July.Would the dollar peg survive a default?
In the ensuing chaos, the government would most likely be forced to devalue the peso. That's a frightening prospect: In Argentina, 70% of all private debt is denominated in dollars because it is cheaper to borrow in dollars than in pesos. A devaluation, therefore, would set off a wave of consumer and corporate defaults as borrowers scrambled for more pesos to service their debt.What are officials doing to avoid a default or devaluation?
The recent bond swap was designed to buy Argentina time as it waited for Cavallo's economic plan to kick in, but there are still no signs of a recovery. So the government finally caved in and on July 11 announced a package of spending cuts worth $1.5 billion, including steep reductions in public-sector salaries and pensions. The political opposition signed off on the cuts, triggering a mini-rally in Argentine stocks and bonds. Yet the fact that the widely held Floating Rate Bond still trades at 70% of face value signals the markets' skepticism that the budget cuts will stick.What would be the international implications of an Argentine debt default?
That depends on how it's handled. A negotiated write-down of Argentina's debt, rather than an outright default, might limit the damage. But time is running out. Since Argentine paper represents one-fifth of the entire stock of emerging-market bonds, any kind of default is likely to affect other nations. Neighboring Brazil already is feeling Argentina's pain: The real has lost more than 20% of its value this year.
For some countries, the contagion could be short-lived. Others could find themselves shut out of capital markets for months, jeopardizing their own ability to pay their debts. Of course, holders of Argentine bonds will take a hit. And foreign companies with on-the-ground assets will also suffer. Spanish business, which has plowed some $30 billion into the country, will be particularly affected. Argentina is still capable of producing some nasty surprises. By Jonathan Wheatley in S?o Paulo