By Scott B. MacDonald


We have been pessimistic about Argentina for over the past two years, largely due to the large amount of external debt - somewhere north of $125 billion (some estimates put it at $150 billion including provincial debt) - and the currency board which prohibits it from devaluing, which would help boost exports. Recently, there has been some good news about Argentina. Domingo Cavallo has returned as Economy Minister and is regarded by many as the person who steered the country out of its last debt crisis in the early 1990s. Argentina has also made a new agreement with the IMF to help secure its $40 billion support package (already in place but in jeopardy because of missing deficit targets). A debt swap plan for $20 billion has also been announced.

Despite these developments, we still think that Argentina remains in deep trouble and represents the biggest threat to Emerging Markets in the short and medium terms. The pending debt swap deal and new IMF agreement only postpone the probability that Argentina will default on its debt. The most recent economic news reinforces our view. Argentina's March trade surplus was down to $1 million, well below the $267 million surplus predicted by a number of economists. The key factor was a 6% fall in exports. Exports are supposed to be the engine of growth which will allow Argentina to escape its lengthy economic slowdown which began in late 1998. Equally dire, the government's deficit rose 43% to 970 million pesos ($937 million) from 630 million pesos in April 2000. The main reason behind this was lower tax revenues. In addition, Argentina's May 8th treasury auction raised $310 million, but at a yield of 12.44% - all that for 91-day paper.

Our negative outlook for Argentina is hardly alone. Standard & Poor's dropped the country's sovereign rating on May 8 from B+ to B and has left its ratings on Credit Watch negative. S&P stated that Argentina "may be downgraded again in the next few weeks if the government fails to secure needed financing, or if the political or economic situations deteriorate." This does not sound as though the rating agency believes that the near-term outlook is good for Argentina.

We warn Emerging Markets investors to be cautious at this juncture. Argentine debt makes up around one third of the EMBI, an index in which Emerging markets debt is measured. An Argentine default will decidedly have a major impact on Brazil, Russia and other Emerging Market economies. Washington is acutely worried about the Argentine situation and it should be. A major Argentine default will be a setback to free trade in the hemisphere and raise risk to U.S. equity and bond markets at a time of frailness. At some stage Argentina, much like Russia in 1998, will have to face facts - too much debt is too much debt.