By Brad Haynes and Walter Bianchi
BUENOS AIRES Aug 27 (Reuters) - Argentina's borrowing costs rose on Tuesday as an attempt to move the country's debt beyond the reach of foreign law risked aggravating U.S. federal courts that are judging its defense against holdout bondholders.
President Cristina Fernandez offered on Monday to exchange foreign debt for bonds to be governed by Argentine law, which would skirt a U.S. court decision on Friday requiring her government to pay $1.3 billion to creditors who have rejected debt restructurings.
Argentina has so far avoided a new debt crisis thanks to the restraint of judges, who last week surprised some observers with a stay order delaying implementation of their decision pending review by the U.S. Supreme Court.
"The fear is that Argentina is trying to avoid the court's ruling," said Alejo Costa, the head of strategy at investment bank Puente in Buenos Aires. "If Argentina tries to defy the court and judges lift their stay order, we have a problem."
If Argentina refuses to pay holdouts despite a judge's active order, courts could block payment of creditors who participated in the country's 2005 and 2010 debt restructurings.
That would throw some $28 billion of foreign debt into technical default, triggering Argentina's second debt crisis in a little over a decade and threatening a recovery in South America's third-biggest economy.
Argentina's risk premium rose 37 basis points to 1,113 basis points, according to J.P.Morgan's EMBI+ index, representing a rising spread in the yield between the Argentine bonds and comparable U.S. Treasuries.
The country's five-year credit default swaps jumped as much 350 basis points early on Tuesday, before settling with an 85 basis-point rise.
Argentina's dollar-denominated discount bond fell 4 percent in the Buenos Aires over-the-counter market.
U.S. courts have repeatedly rebuked the attitude of officials in Argentina, which 2nd Circuit Judge Barrington Parker has called a "uniquely recalcitrant debtor."
"Argentina's officials have publicly and repeatedly announced their intention to defy any rulings of this Court and the district court with which they disagree," Parker wrote in a ruling against the country on Friday.
Fernandez's protectionist trade policies, currency controls and nationalization of the country's main airline, oil company and private pension system have consolidated Argentina's status as an international markets outcast.
The 60-year-old leader took a drubbing in this month's open midterm primary election partly because of concerns about the double-digit inflation sparked by her unorthodox economic policies.
Candidates backed by Fernandez got only 26 percent of the nationwide vote, which was seen as a important opinion poll on her performance after six years in office. The midterm congressional election is in late October.
Two months ahead of the vote that will determine Fernandez's legislative clout as she enters her last two years in office, she announced a personal income tax cut on Tuesday aimed at increasing take-home pay for low-income Argentines.
The measure will be partially offset by higher capital gains taxes, according to government tax chief Ricardo Echegaray, who said the plan will nonetheless leave a $457-million-dollar fiscal hole to be filled by the government each year.