Critics Call Bond Swap Nearly a Debt Default

By Paul Blustein and Anthony Faiola
Washington Post Staff Writers

Scrambling to stave off a financial collapse, Argentina is taking a step it has long resisted -- pressuring its creditors to accept less than they are owed.

In recent days, the Argentine government has presented domestic pension funds and banks with a plan for swapping about $30 billion worth of high-yielding
government bonds they hold for new securities paying much lower interest. Officials and economists in Buenos Aires depict the plan, part of which may be unveiled
as early as this week, as an effort to ease the nation's debt burden and thereby restore confidence in the nation's financial stability.

But in financial capitals elsewhere, the move is being widely interpreted as akin to default, or a major step in that direction. Two credit rating agencies, Moody's
Investors Service Inc. and Fitch, cut the ratings on Argentine debt late last week to rock-bottom levels on the grounds that the government was apparently using its
power as a regulator of local financial institutions to force them to take losses on their bonds. If those bondholders do suffer losses after the details of the exchange
are clear, Fitch said, it will "consider the debt exchange a default event."

An Argentine default, or even a quasi-default, could deal a severe blow to financial markets in Latin America, and possibly to emerging economies all over the world
-- hardly a welcome prospect at a time when global markets are just recovering from the shock delivered by the Sept. 11 terrorist attacks. Although the "contagion"
effect of such events is difficult to predict, memories remain fresh of Russia's default in August 1998, which prompted money managers to yank funds out of emerging
markets and race for the safest investments they could find -- a development that in turn caused massive turmoil in U.S. markets.

Yet many economists would welcome Argentina's acknowledgment that it can't pay its debts. While the impact may be harsh, they contend, the government has only
made matters worse by postponing the inevitable for many months.

"Argentina is not solvent by any stretch of the imagination," said Michael Mussa, who recently left the International Monetary Fund, where he served as chief
economist. "They need a new strategy that forcefully and clearly acknowledges that their old strategy has failed," he said -- a policy that would include inducing
creditors to accept significant write-downs in the value of their claims.

In Buenos Aires, many view the proposed bond exchange as Economy Minister Domingo Cavallo's last attempt to ease the crisis. Sources said that while
negotiations remain delicate and may fall apart, some of the details of the plan are almost finalized, including an arrangement with pension funds holding $3 billion
worth of bonds yielding 14 percent, which would be swapped for new issues with interest rates around 8 percent.

Another part of the agreement making fast headway is a deal with local banks to swap $7.5 billion in provincial bonds, with yields as high as 40 percent, for new
bonds yielding "substantially less."

To induce the financial institutions to go along, the government is proposing to pledge certain tax revenue as a guaranteed source of funds to pay interest and principal
on the new bonds. But domestic creditors are also being asked to accept the deal "for the patriotic good of the nation," based on the argument that the financial
implications of a broad default would prove far more devastating in the long run.

"I think we are looking at it from this perspective," said one high-ranking official with a lending institution asked to participate in the swap. "Though this might not be
something we are ecstatic about, our greater interest is in the long-term health of the nation. If this is something that we have to do, we'll do it voluntarily because the
consequences of not doing it are worse for us and the country."

Argentina enjoyed rapid growth in the early and mid-1990s, but its woes began deepening in 1999 when a financial crisis forced Brazil to allow its currency to fall
sharply. Because the Argentine peso is rigidly tied to the U.S. dollar on a one-to-one basis, the cheapening of Brazilian products eroded the competitiveness of
Argentine goods, causing many Argentine factories to cut operations and close as a recession developed.

With the help of IMF loans, the government continued to maintain its dollar peg and paid its debts, even though the high interest rates demanded by financial markets
became a major drain on the economy. Officials vowed never to devalue or default, in part because many Argentines had borrowed in dollars -- in many cases, even
their home mortgages are dollar-based -- so a failure by the government to honor its promises would mean ruinous losses both for financial institutions and
individuals.

But the recession has only worsened this year as the government's economic team has slashed the budget deficit in an effort to avoid more expensive borrowing. As
default fears mounted during the summer, the IMF added a $5 billion emergency loan to a previously granted $14 billion rescue package, saying Argentina was
taking the necessary measures to get its economic house in order.

But in a blast at his former employer, Mussa criticized that move as a futile effort to avert default. "In my 10 years at the IMF, the decision to extend further support
to Argentina in August was the worst mistake the fund made," he said.

The IMF is keeping its distance from Argentina's planned bond exchange. A fund spokesman declined comment, but staffers said privately that the government was
risking undermining the confidence of investors and depositors even further because it was obviously strong-arming banks into taking losses. Other foreign critics of
the plan, including Mussa, said the government should restructure all its debt instead of doing so piecemeal.

But Argentine economists said their Wall Street colleagues don't have a firm understanding of the deal.

"What the government is trying to do, with the voluntary support of Argentine institutions, is show that the level of debt here is in fact sustainable -- something that
foreigners have been demanding from Argentina for some time," said Martin Redrado, chief economist for Buenos Aires-based Fundacion Capital.

"In my view and in the view of many, no one is being forced to accept anything. The rates offered are still attractive, and they are safer because they are backed by
tax dollars," Redrado said.

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