| BUENOS AIRES
BUENOS AIRES When Argentina defaulted on its debt in 2002, the economy was collapsing and a bloody popular revolt had helped topple two presidents in a week. Now, the country could default again, but it would be over a matter of principle rather than necessity.
After a decade of sleepy litigation, investors got a jolt late last year when U.S. courts ruled in favor of "holdout" creditors who had rejected Argentine debt exchanges in 2005 and 2010 and sued to be repaid in full on their defaulted bonds.
A U.S. judge ordered Argentina to pay the holdouts the full $1.33 billion owed them the next time it serviced restructured debt. Argentina appealed, and a ruling by the 2nd U.S. Circuit Court of Appeals is expected in the coming weeks.
Investors are following the case closely because Argentina appears willing to enter into technical default in order to avoid paying the holdouts any more than other creditors received.
The nearly 93 percent of bondholders who accepted the debt exchanges got returns of as low as 25 cents on the dollar.
Tough-talking Argentine President Cristina Fernandez has pledged to keep paying the restructured debt but vows never to pay the "vultures" that bought the bonds at a steep discount and sued for full repayment.
When Argentina defaulted on some $100 billion in bonds 11 years ago, its debt represented 166 percent of gross domestic product. Bank deposits were frozen and devalued, the economy shrank 11 percent in one year, and millions lost their jobs.
Argentina's economy rebounded after that crisis and boomed during most of the last decade. Although growth slowed sharply in the last year and inflation is high, the debt burden is down to about 42 percent of GDP.
In other words, Argentina could pay the holdouts if it wanted, but it refuses to do so.
"Argentina will not blink and neither will the holdouts, so this will lead to a technical default," said Shahriar Shahida, co-founder of Constellation Capital Management LLC in New York, which is currently invested in Argentina and believes it would be unfair to favor the holdouts over exchange bondholders.
"This is an unparalleled case of somebody defaulting not because they don't have capacity, not because they don't have willingness, but because somebody is forcing them to do something egregious," he said.
MARKETS ON EDGE
Argentina says it will fight the holdouts - led in this case by Elliott Management affiliate NML Capital and Aurelius Capital Management - all the way to the U.S. Supreme Court.
Sources familiar with the position of Elliott and Aurelius say Argentina has never shown a willingness to negotiate.
Investors anticipate the country will eventually defy U.S. courts if they insist the holdouts be paid in full.
In that scenario, Argentina is widely expected to force a technical default on the restructured bonds issued under New York law - which would be most directly affected by the rulings - while trying to create a new payment scheme for those bonds.
One option would be a swap in which the exchange bondholders turned in their New York paper for new Argentine-law bonds. Some analysts warn that might not be doable, however.
The default would be technical because Argentina might try to pay the exchange bondholders without paying the holdouts, and the courts could then disrupt the payments. Or the country could suspend payments on the restructured bonds citing its own laws, which bar it from paying the holdouts on better terms.
Argentine economic officials have refused to discuss whether they are evaluating a "Plan B" for payments. The next interest payments on restructured bonds come due June 2 and June 30.
When the court rulings first came down last year, many investors scrambled to sell off their Argentine bonds and some firms specializing in distressed debt moved in to buy.
The market has since stabilized and the restructured bonds regained some ground in April. Argentina's Global 2017, issued during the 2010 debt swap, is now yielding around 16.3 percent, down from 19.6 percent in early March.
In terms of credit default swap contracts - which act as insurance against a default - the maximum payout possible dropped sharply in late 2012 and now stands at about $1.53 billion, data from the Depository Trust & Clearing Corp shows.
CDS payouts would likely be less, however, after an auction process to determine the recovery value of the defaulted bonds.
Ultimately, Argentina is no longer as relevant to global credit markets as it used to be. It has not issued international debt since the 2002 default and its weighting on the JPMorgan Chase EMBI+ emerging market sovereign bond index has shrunk to 1.8 percent from over 23 percent in early 2001.
Capital controls and more-recent foreign currency restrictions have further isolated the country, which is seen as an anomaly in largely market-friendly Latin America.
Credit Suisse analysts said last week that most of their contacts in Buenos Aires believe the spillover effects of a technical default "would be relatively small due to Argentina's relative isolation from international capital markets and the ongoing deterioration in Argentina's business climate."
In November, U.S. District Judge Thomas Griesa ordered Argentina to deposit the $1.33 billion owed to holdouts in an escrow account by December 15, when restructured debt came due.
He also required that third parties involved in payments on Argentina's restructured bonds be held accountable if the court order were evaded. This included Bank of New York Mellon Corp, which acts as trustee for the exchange bondholders.
The 2nd Circuit suspended these orders under an emergency judicial stay while reviewing Argentina's appeal.
It is not clear, however, that the stay would remain in place if Argentina had to appeal to the Supreme Court. Most analysts seem to think it would, but there is no guarantee.
It is also anyone's bet how the 2nd Circuit will rule. The court upheld Griesa's original decision, finding Argentina had discriminated against the holdouts and violated the "pari passu" or equal treatment clause in their defaulted bond contracts.
But with the U.S. government arguing Griesa's rulings could complicate future sovereign debt restructurings, the 2nd Circuit may seek to limit the scope of the payment orders.
The appeals court asked Argentina to submit its own payment proposal, which essentially echoed the terms of the 2010 swap. NML and Aurelius rejected this outright.
If Argentina appealed to the Supreme Court and its case were accepted for review, a ruling could be made as late as June 2015, according to Bank of America Merrill Lynch analysts.
A new Argentine default, no matter how short-lived, would tend to push bond prices lower and hurt the balance sheets of local banks, which hold lots of debt. But most economists do not think there would be massive fallout, in part because Argentine exporters are much less reliant on trade finance than in 2002.
Guillermo Nielsen, who as finance secretary helped push through Argentina's tough debt restructuring in 2005, said nonetheless a default should be avoided at all costs.
"The New York financial market is important not only for less developed countries but also for developed countries. Even Sweden issues debt in the New York market," Nielsen said. "And here we have everything to be made, to be built, to be created. We need that financing."
(Additional reporting by Daniel Bases in New York and Alejandro Lifschitz and Guido Nejamkis in Buenos Aires; Editing by Kieran Murray, Bernard Orr)