Argentina faces serious default risks in the medium term due to the YPF nationalization case in New York

A few weeks ago, the currency market explosion first sparked concern in Javier Milei’s Argentina, causing a sort of panic just after the long-awaited approval by Congress of a billLey de Bases‘ and the accompanying fiscal package. As the government was poised to celebrate its victory lap, its top economic policymakers – Economy Minister Luis “Toto” Caputo and his central bank-installed business associate Santiago Bausili – spooked already nervous market actors, precipitating a peso rally reminiscent of the worst days of Sergio Massa’s term. They were forced to issue a series of emergency measures that are still intended to ease tensions.

It is not entirely clear why this administration, praised for its cutting-edge communications strategy in the hands of chief advisor and spin doctor Santiago Caputo, made such an unforced error late in the evening on Friday, June 28, with many recalling the ill-fated press conference of December 28, 2017, during which then-Central Bank President Federico Sturzenegger was publicly humiliated by Chief of Staff Marcos Peña while flanked by ministers Nicolás Dujovne (Economy) and Luis Caputo (Finance), marking the beginning of the end of “Pax macrista.”

The Argentine public had begun to adjust to an atmosphere of falling inflation and relative stability in the peso-dollar exchange rate, despite the persistent warnings of respected economists, many of whom are ideologically close to the president. So while Milei and his libertarian motley crew took up arms against a sea of ​​political opponents, making enemies both at home and abroad, they maintained unwavering majority support, following the pattern of the second-round vote, in which La Libertad Avanza won 56 percent. With Milei’s reform package finally approved after six months of legislative stagnation, it seemed that this administration would finally have the tools to govern by fixing the fundamental structural problems of Argentina’s macroeconomics. The peso-dollar exchange rate, a gauge of fear in Argentina, was expected to fall, a sign of growing confidence in the durability of Milei’s policy plan, which should further strengthen the value of Argentine bonds and thus lower the country’s risk premium.

Instead, the opposite happened in early July. It had a very real and negative impact on the purchasing power of the population. Caputo and Bausili held a press conference late that day and then met with the banking sector again early the following week, but they failed to present a credible policy path and timetable, particularly with regard to the removal of exchange controls. If doubts about Milea’s ability to lead Argentina were related to governance risk, Caputo’s doubts are related to credibility risk: it is difficult to see how the current policy framework can be sustainable over time. At the heart of it all is exchange rate policy, in which the official peso-dollar exchange rate is allowed to move along a “creeping peg,” meaning a devaluation rate of two percent per month. The significant devaluation in the early days of the administration gave Milea and Caputo a cushion in the exchange rate markets, as inflation was well above the creeping peg and gradually undermined the competitiveness of the exchange rate system. In just a few months, Argentina went from incredibly cheap in dollar terms to relatively expensive, while inflation actually fell sharply on the back of a solid “fiscal anchor,” or budget surplus, and a planned recession. As did the exchange rate premium that allowed the Central Bank to hoard reserves.

The model had run out of steam, both local economists and the International Monetary Fund agreed, leading to the inevitable barrage of insults from the president. The main recipient of his fury was Rodrigo Valdés, the prestigious Chilean economist who heads the IMF’s Western Hemisphere department. The man in charge of negotiating Argentina’s future relationship with the international lender of last resort, had tried to get the Milei-Caputo duo to accept a devaluation and “the abolition of distorting taxes” to pave the way for the abolition of strict currency controls (“flail”), as is the agro-export sector, which has grain stockpiles that affect the Central Bank’s ability to replenish its treasuries with foreign reserves. According to one of the province’s most influential governors, the Milei administration has promised to cut PAIS tax, export taxes and raise “flail”, promises he failed to keep, which led the agri-export sector to adopt a “wait and see” strategy.

Milei and Caputo are clearly not willing to negotiate their economic plan in the same way they ultimately accepted amendments to their “Ley de Bases’ and fiscal package. Their tenacity will be tested by the International Monetary Fund, which has essentially told the ultralibertarian that he must forget about his plans to torch the Central Bank and dollarize the Argentine economy. Caputo already appears to have been leading Milei in that direction. But the real question of their skill in steering the ship through stormy seas is now front and center. As economist Diego Giacomini, an anarcho-capitalist and former friend of the president, has explained, the Argentine government’s hard-currency commitments for Milei’s entire term in office are impossible to fulfill, meaning that he will have to raise significant new funds while renegotiating the debt. Will Milei, with his confrontational style, be able to sit down and hammer out this level of agreement?

One example is the historic YPF nationalization case, currently pending in New York, where Judge Loretta Preska ruled against Argentina, setting the price of compensation at $16 billion. According to Sebastián Maril, principal of Latam Advisors and one of the leading experts on foreign legal issues in Argentina, the sovereign state has already issued $16.35 billion in closed and resolved legal decisions since 2000, has another $19.47 billion in open lawsuits with a verdict (including the YPF case) and $10.245 billion more open without a verdict. These are cases related to unpaid debts (holdouts), expropriations of YPF and Aerolíneas Argentinas, warrants linked to the GDP and others. Given the government’s legal strategy of dragging out cases, there is a risk it could be required to hand over assets, including a potential 51 percent stake in the state-owned energy company, which would pose a number of complications, including requiring passage by Congress.

The majority of these asset seizures are expected to occur during Milea’s administration. “In 2024, Argentina should start treating international legal proceedings as assets rather than liabilities,” Maril explained. “Beneficiaries of foreign judgments should understand that by helping the Republic, they are helping themselves.” In a live broadcast for Profiledigital subscribers, noted that Burford Capital, the lead litigation fund involved in the YPF case, is not a vulture fund like billionaire Paul Singer’s Elliott Management. They could easily be persuaded to negotiate a deal that is worth significantly less than the $16 billion judgment, payable over an extended period of time, while also attracting much-needed foreign direct investment for Argentina.

Is Milei ready to start thinking outside the box, as he did in the election, and adopt a pragmatic playbook in order to get much-needed support from the outside world? Or will he remain capricious, stubbornly pushing his plan until it works or collapses? How long will the population and markets give him the time and space to operate? All these questions are now on the table, and for the first time in his presidency, he is under pressure.

This piece was originally published in Buenos Aires Timesthe only English-language newspaper in Argentina.