Friday, August 22, 2014

Washington, New York and the Argentine default

The Argentines blame the ' Washington Consensus' for the real default in 2001 and the New York judiciary and vulture funds for the artificial default on 31 July. The arbitrary court order and the unethical extreme greed of the vulture funds are challenges not just to Argentina; they endanger the global debt restructuring system and contradict the domestic laws of United States. The US President and the Congress  can save Argentina from the pain and put an end to the extortionary tactics of vulture funds as a redemption for the original sins of the 'Washington Consensus'

Washington, New York and the Argentine default 

'Argentina has defaulted', screamed the headlines in financial newspapers on 31 July. But it was not an accurate report. Argentina did not default. It was forced into default by a New York southern district court judge Thomas Griesa. The Argentine government had deposited the payment of 539 million dollars on 26 June ahead of the due date, in a bank in New York to be transferred to the 92.4% bond holders. But Judge Griesa had blocked the transfer of the money. He would not allow this payment to the 92.4 % of the bond holders until and unless Argentina paid the outrageous amount demanded by the vulture funds who hold just 1.6% of the bonds.  So it is an artificial default situation created by Judge Griesa. Joseph Stiglitz, the Nobel Laureate and Martin Guzman from Columbia University call it* as " Griesafault ".  Standard and Poor labels it as 'selective default' while Fitch has categorized it as 'restricted default'. 

The Argentines blame the "Washington Consensus" for having caused the socioeconomic problems of Argentina in the eighties and nineties which eventually lead to Argentina's first default in this century in December 2001. Some even go further and say that the support of Washington DC to the Argentine military dictatorship (whose crimes include incurring unnecessary and irresponsible external debt) was the root of the problem of default. Now they accuse the New York judge for the second default.

Facts of the case

After the December 2001 default on its debt of  82 billion dollars, the Argentine government restructured the debt through agreements in 2005 and 2010 with 92.4 % of the bond holders under which the latter received 'exchange bonds' giving them about 30 cents for a dollar of the old bond. These exchange bond holders have been receiving their interest payments punctually and seen the value of their bonds rise. The remaining 7% of the bond (value 4 bn dollars) holders did not agree to the debt swap. Among this holdouts, the vulture funds hold 1.6% of the bonds worth 1.3 billion dollars. NML Capital, the lead vulture fund sued the Argentine government demanding full payment. Judge Griesa ruled in their favor in November 2012. Argentine appeal in a higher court was rejected and later the US Supreme Court refused even to hear the Argentine appeal. Judge Griesa then forced the Argentine government to negotiate with the vulture funds under Daniel Pollack, a New York lawyer appointed by him as mediator. The negotiations failed since the Argentine  government could not agree to the outlandish demand of the vulture funds and the latter rejected the Argentine offer of payment on the same terms as paid to 92.4% of the bond holders. The deadline of 30 July passed without the payment, resulting in a default situation, although the Argentina has the money and willingness to pay. Judge Griesa has simply put a gun on the head of Argentina saying, 'pay the predators or go bust'

Argentina has now taken the matter to the International Court of Justice, complaining** that the decision of the US judiciary is arbitrary, abusive and beyond its jurisdiction besides ignoring the sovereign immunity of Argentina and hindering the sovereign debt restructuring process. But this would not help if the United States does not consent to the jurisdiction of ICJ on this matter. 

Five fundamental questions

While the wise old ( 83 years) judge and the greedy vulture funds have some sound technical and legal arguments, the case defies logic, common sense and natural justice. It threatens the sovereignty of Argentina and the global system and practice of debt restructuring besides contradicting the basic principles of free markets. It needs to be seen in a larger context with all the facts behind the case. To start with, let us ask five fundamental questions.

1 Did the Argentine government actually borrow money from the vulture funds which have sued Argentina?  No. Neither the vulture funds lent any money nor did the Argentine government borrow from them. The vulture funds bought the bonds cheaply in the secondary market after the default in 2001. They paid 49 million dollars for bonds worth 832 million dollars. NML did not ask the Argentine government nor did it go through American judiciary before it purchased the bonds, knowing fully well the risk. Why should any judiciary be involved now to arrange profit on the commercial purchase? The judiciary should simply let the market forces play freely . They should ask the vulture funds to sell their bonds in the market from where they bought. This would be perfect justice in the land of free market.

2 Did Argentina refuse to pay the vulture funds? No. The Argentine government offered to pay them on the same terms as they paid the 92.4 % of the bond holders. This would give a handsome profit to the vulture funds on their investment. But they want an unreasonable and different treatment. They want an outrageous 1.63 billion dollars which means a return of 1608 %. Some might consider this demand as immoral and unethical but it is business as usual for Paul Singer, the chief of NML and his other fellow vulture friends. They specialize in buying distress debt at rock-bottom prices and then try to collect ransom by litigation and blackmailing.  Argentina is not their first victim. They have already exploited some African and Latin American countries and their last victim was Greece. Jerome Roos of the ROAR magazine calls*** the vulture funds as the 'Taliban of global finance'

3 Have the 92.4 % of bond holders lost out terribly after having accepted 30 cents to a dollar swap? No not at all. They are happy with the value of their exchange bonds which is around 89 cents to a dollar. Since these are GDP-indexed bonds, they have received good returns with the high growth of Argentina since 2003. The interest which they get is high since Argentina is only one of the three countries in the world offering bond yields above ten percent. More importantly Argentina makes interest payments punctually.

4 Will the vulture funds suffer loss due to the Argentine default? No. In fact they might even gain since they own a large quantity of  credit default swaps (CDS) against Argentine bonds, creating a further incentive to not only trigger a default against Argentina; but also to undermine the value of the bonds themselves, as the CDS would pay out at a higher rate if the defaulted bonds decline to extremely low values.

5 Can the Argentine government pay the vulture funds the amount demanded by them? No self-respecting government can give in to such blatant blackmail. Moreover such payment will open a Pandora's Box and the 92.4 % bond holders would also want a similar full payment pushing Argentina into another real default causing avoidable suffering for the Argentine people. Martin Wolf of Financial Times ( 24 June 2014 ) says, ' if Argentina is forced to pay the holdouts in full, the price will be borne by Argentines. This is extortion backed by the US judiciary'. Asking Argentina to make full payment to the 1.6% bondholders while 92.4% have been paid one third of the full value is mockery of justice and undemocratic. Blocking the payment to 92.4% unless and until payment is made to 1.6% is punishment of the majority for appeasing a small minority?

Vulture funds harass Argentina

The vulture funds have been harassing the Argentine government for the last several years by threatening to seize Argentine assets and Central Bank reserves abroad. In October 2012, the vulture funds got a historic Argentine naval sailing vessel seized in Ghana through a local court order. Argentina took the case to the international tribunal for the law of the sea which asked Ghana to release the ship on the ground that the impounding of the ship was "a source of conflict that may endanger friendly relations among states". The incident was a terrible embarrassment for Argentina.

The vulture funds tried to confiscate Argentine assets including those of diplomatic missions  in US, UK, Belgium, Germany, France and Switzerland. Argentina was forced to fight in the courts of these countries to protect its assets.

Even now the Argentine President does not travel in the official plane to US or some other countries where there are risks of seizure of the aircraft by the vulture funds. The President charters planes for such trips.  

The vulture funds are now trying to unearth dirt against the Argentine leaders in order to use them to blackmail as they did in the case of Congo. They have warned, ' the worst is yet to come'.

Argentina has done well on its own after the 2001 default

It should be highlighted here that Argentina had done the successful restructuring of its debt in 2005 and 2010 on its own without the involvement of IMF or any other external rescuer, demonstrating to the world that restructuring could be done without the painful and humiliating austerity conditions of IMF.

It is even more commendable that Argentina recovered from the debt crisis very quickly, resumed economic growth and paid off a significant amount of debt. It repaid its 9.5 billion dollars debt in full to the IMF in January 2006 at one go and has also settled many other external debts. It has brought down its public debt from 166% of GDP in 2002 to 44% in 2013. In May 2014 it signed an agreement with the Paris Club to settle the debt of 9.7 billion dollars. It has been servicing the restructured debt scrupulously paying interest to the exchange bond holders punctually. This has generated a confidence in the market because of which the price of Argentine bonds are holding at 89 cents to a dollar even after the default on 31 July.

Argentina achieved an impressive growth rate of 8.8 % in 2003, a year after the debt crisis and economic collapse. It grew over 8.5% annually from 2004 to 2007. Even after the global financial crisis, the economy grew by 9.2% in 2010. No doubt, Argentina's recovery and growth were helped by the high commodity prices. Despite being cut off from the global credit market for over a decade, Argentina has done not so badly. In contrast, Greece which was bailed out with 110 billion Euros by Eurozone countries and IMF in 2010 is still in negative economic growth with high unemployment and continued suffering by the population due to the severe austerity conditions.

New York verdict contradicts US domestic law

The American court verdict against Argentina contradicts the domestic law of US which allows individuals and companies as well as cities and counties to declare bankruptcy under Chapter 11 and 9 to ensure orderly survival when debts cannot be repaid in full. The reasoning behind this American law is that no credit system can function or has ever functioned with zero default. This possibility of default is embedded into credit contracts through the interest rate, with spreads operating as the market estimate of the probability of a default. So those who are seen as less likely to be able to repay are forced to pay higher interest rates, in both formal and informal credit transactions. A creditor who has been demanding and receiving a higher interest rate based on this probability cannot then demand full repayment as a right, since the contract reflected that very likelihood. So the ruling actually negates the basic principles upon which all credit markets function##. According to Stiglitz and Guzman*" Griesa’s ruling encourages usurious behavior, threatens the functioning of international financial markets, and defies a basic tenet of modern capitalism: insolvent debtors need a fresh start".

Implications for the world

Judge Griesa's decision favoring the vuture funds has provided a potentially dangerous precedent for future debt restructuring of other countries. It is because of this reason that even IMF and the World Bank have expressed concerns that the NML case could endanger the debt restructuring they oversee around the world. Brazil, France and Mexico filed amicus briefs with the US supreme court in March this year arguing that the ruling against Argentina would endanger the sovereign debt markets. Argentina's position in the case has also been supported by Latin American regional groups such as Mercosur, UNASUR, CELAC and OAS besides G-77 and China.

Some US bankers and economists have also cautioned about the adverse implications of Judge Griesa's decision for the global financial system. In a letter# addressed to the US Congress on 31 July, over 100 economists have expressed concern that the court judgement against Argentina could cause unnecessary damage to the international financial system. The letter has called for a legislative solution pointing out the examples of UK and Belgium which have passed legislations preventing such litigations by holdouts. 

Argentina needs alternative credit sources

Judge Griesa's decision has come at a wrong time for Argentina. The Argentine economy has deteriorated since 2007 with high inflation, currency devaluation and shortage of forex reserves among other problems. Judge Griesa and the vulture funds have compounded the economic problems of the country by creating more uncertainties and challenges. The artificial default situation means that Argentina will continue to be locked out of the global financial markets although the country badly needs external funds to finance its development projects. 

Argentina has to look out for non-western financial sources. They have been offered thirteen billion dollars of credit as well as currency swap facility by the Chinese President during his visit in July this year. May be Argentina could become the first customer for the New Development Bank created by BRICS last month. 

The larger issues

The vulture funds vs Argentina case is not just a legal issue about a few billion dollars. It is about the sovereignty of a country, the economic situation of 42 million people and the future of debt structuring for other countries. It is also about the credibility of United States financial and judiciary system.  Stiglitz and Guzman have a warning*, 'The US financial system, already practiced at exploiting poor Americans, has extended its efforts globally. Sovereign borrowers will not – and should not – trust the fairness and competence of the US judiciary'. 

Let us not forget that the extreme and reckless greed of a few had caused the financial crisis for US and the world in 2009. The people and the government of US have paid a high price as a consequence. Such tragedy could be avoided for Argentina and other countries.

Back to Washington DC

The second default of Argentina in this century caused by the New York courts and vulture funds could still be rolled back in Washington DC with Presidential discretion. Greg Palast, who has done investigative reports for BBC, Guardian and Al jazeera, says### President Obama could intervene in the Argentine case in the same way as President Bush prevented the seizure of the US property of Democratic Republic of Congo by the same Paul Singer. But a long term solution lies in the hands of the US Congress which could enact legislation as done in UK and Belgium to prevent the predatory and unethical litigations by vulture funds. It will be a redemption for the sins of ' Washington Consensus'. 

Thursday, August 14, 2014

Federalism – the experience of Brazil

Brazil follows a more decentralised federalism and gives special importance to the municipalities. Port Alegre city's pioneering and successful  'participatory budgeting' is a role model for the world. India could learn from the positive and negative aspects of the Brazilian system.

Federalism – the experience of Brazil

Brazil is one of the largest federal states in the world and one of the oldest, dating from 1889. The country started off with  a unitary central authority as a colony and later as a monarchy when it became independent from Portugal in 1824. It was turned into a federation as it became a republic in 1889 . Since then, it has oscillated between centralizing military dictators and authoritarian regimes and decentralizing liberal governments. When democracy was restored in 1985 after two decades of the last military dictatorship, Brazil became a federal republic under the constitution of 1988, the seventh since independence.

Empowerment of municipalities

The Brazilian federalism is unique since it has recognized and included municipalities as integral entities of the federal structure. The municipalities are invested with some of the traditional powers usually granted to states in federalism. The Brazilian municipalities enjoy independent and coequal status unlike in other federal countries where the states control the local bodies.

Brazil is a federation of 26 states and the 5564 municipalities plus the federal district of Brasilia. The states have their own constitution while the Municipalities have 'organic laws' .

The municipalities, whose populations range from a few thousand to many millions, have considerable autonomous powers and resources.The World Bank in its 1990 report ' The new fiscal federalism in Brazil" has commented that the municipalities have more money than they need while the federal government's revenues fall short of its spending needs. The municipalities are empowered to take decisions in many important areas, such as territorial management, land development, environment, local taxation and industrialization.

How federalism works

Brazil is an example of a more 'robust federalism' in comparison to other federal countries of the world in the extent of decentralization. Few federal countries give such a large share of the total tax revenue to the states and municipalities. The state governors have lot of power and clout  vis-a vis the federal government in certain tax and expenditure functions. After having suffered from the centralized military dictatorship in the past, those who drafted the 1988 constitution seems to have opted for decentralization which creates more powerful local leaders to balance any strong and ambitious president. Governors and mayors of wealthy states and cities compete with the federal president for power and resources. In fact, one of the federal presidents Itamar Franco, who was President of Brazil in 1992-95 later became the governor of the state of Minas Gerais in 1999-2003 and kept challenging his successor in Brasilia.

It should also be noted that another larger objective of such greater decentralization is to bring the government closer to the people. This has served well the young democracy of Brazil.

The Brazilian structure is also described as Cooperative Federalism since the management of the distribution of powers and responsibilities of the federal system is based on the assumption of cooperation between the three federal entities. 

The bicameral national legislature also reflects the federal spirit of the constitution. Each state, big or small, is represented equally by  3 senators elected directly from the states. The number of seats in the Chamber of Deputies is distributed according to the population in each state. In order to balance the larger and smaller states there is a stipulation that the states should have a minimum of 8 Deputies and maximum of 70.

Brazil could afford to be decentralized so much since its population of 200 million speak just one language and follow one religion and the country does not face any centrifugal forces.


Although the Brazilian federal system has served the country well so far, it is still a work in progress and is far from mature since it is just thirty years old. There are many challenges and flaws some of which are highlighted below. 

The excessive emphasis on decentralization in the model of cooperative federalism without defined distribution of responsibilities is a source of tensions. When states or municipalities do not carry out their responsibilities, there is no adequate mechanism for the federal authorities to remedy the situation. 

The structure of the revenue-sharing system is unbalanced and is being challenged frequently and in any case it has not helped adequately to deal with regional and income disparities.

Because of the large clout given to states and municipalities, the political parties have got fragmented and the national parties have become like a federation of state parties and the Congress 'an assembly of states'. The federal legislators give more importance to local interests than national concerns, hobbling and complicating the federal government's functioning and priorities. 

Relevance of Brazilian experience for India

India cannot afford to be as decentralized as Brazil's federation given the  vast Indian diversity of languages, religions, ethnic groups and more importantly separatist history and tendencies. Prime Minister Modi, who advocates a 'cooperative federalism' can learn from the downside of Brazil's excessive decentralization. 

India could study the empowerment of Brazilian municipalities and especially the "participatory budgeting" system successfully pioneered by the Municipality of Port Alegre, which had captured the imagination of Aam Admi party's Arvind Kejriwal. About 50, 000 citizens out of the total population of 1.5 million inhabitants of the city participate in the budget allocation of the 200 million dollar annual fund for construction and services. 

The Indian Ministry of External affairs could learn from the Brazilian foreign ministry's interaction with regional authorities. They have six offices in the major cities and regions of Brazil as two way communication points with state and municipal authorities as well as with civil society. These are headed mostly by ambassador-level officers. The foreign ministry takes the views of the local leaders on board on issues of regional integration such as Mercosur and external trade. MEA has recently opened offices in some cities of India but these are headed by junior level officers and are not able to serve a larger bridging role like the Brazilian diplomats do. 

Tuesday, August 05, 2014

Latin America takes a stand, principled and distinctive, in support of the people of Gaza

Brazil, Chile, Peru, El Salvador and Ecuador have recalled their ambassadors from Tel Aviv denouncing  the disproportionate use of Israeli military force in which innocent civilians including women and children have been killed.  Chile has suspended its trade talks with Israel. During the Mercosur summit on 29 July, the Presidents of Brazil, Argentina, Uruguay and Venezuela issued a joint statement condemning Israel and calling for lifting the siege in Gaza. Venezuela had issued a stronger statement on behalf of the 9-member ALBA (Bolivarian alternative) group. The Bolivian President Evo Morales called Israel as a " terrorist state" and has appealed to the UNHCR (UN Human Rights Commission) to consider " crimes against humanity" and " genocide" by Israel. Most other Latin American governments have also issued strong statements, revolted by the bombings of schools and hospitals. 

Venezuela and Bolivia had cut off diplomatic relations with Israel in 2009 and Nicaragua in 2010 after the last Israeli offensives. Cuba had done it in 1973 as part of its ideological support to the Palestine cause.

The Latin American media has joined the condemnation by taking their own stand refusing to buy the distorted stories and opinions of the biased US media. Latin American Nobel Prize winners Pérez Esquivel of Argentina and Rigoberta Menchú of Guatemala have called for a military embargo against Israel as done against South Africa during apartheid.

Latin America is home to over 500,000 Jews of which 200,000 live in Argentina, 100,000 in Brazil and 50,000 in Mexico. The Jews in Latin America have significant financial clout and control a lot of business. But the Latin American governments have not let the local jewish communities to hijack their foreign policy unlike in US where the Jewish lobby has taken over the middle east policy from the State Department. More importantly, the Jews in Latin America have assimilated themselves fully in the local societies and do not blindly support whatever Israel does. In fact, the Jewish community of Brazil apologized to the Brazilian government over the 'dwarf' statement by the Israeli foreign office spokesman. When Israel tried to interfere in the Argentine investigation of the 1994 Buenos Aires Jewish Centre bombing, Argentine Foreign Minister Hector Timerman (He is a Jew and his father had lived in Israel after he was exiled by the Argentine military in the early 1980s) told the Israeli ambassador on 31 January 2013 ( Times of Israel report on 6 february 2013) that “Israel does not speak for the Jewish people and isn’t their agent. Jews who wanted to live in Israel moved there and became citizens, and those who live in Argentina are Argentine citizens.” 

Chile has the largest Palestine community of around 400,000, followed by Honduras with 200,000, Mexico- 100,000 and other countries have smaller numbers. But most of these are Christians and they have not stood up in any significant way for the Palestine cause. 

Israel owes a original debt to Latin America. Out of the 33 votes for the 1949 UN resolution partitioning Palestine into Jewish and Arab states, 13 were from Latin America. These 13 included Brazil, Peru, Ecuador, Bolivia and Venezuela which have now taken diplomatic action against Israel.  Mexico and Colombia, who  have reacted mildly to the Gaza offensive now as part of their pro-US policy, had abstained in that crucial voting. In the years after the creation of Israel, many Latin American countries had taken Pro-Israeli positions in global fora because of the US influence with the rightist authoritarian regimes in Latin America, with whom Israel had cozy relations. But most Latin American countries changed their stance after the Israeli occupation of Palestine territories and after the restoration of democracies in their own countries. Many Latin American countries have recognized Palestine as an independent state and were sponsors of the UN resolution declaring 2014 as the International Year of Solidarity with the Palestine People.

The vocal criticism and strong language used by Latin America stands out as the loudest in comparison to the subdued response of the Asian and African countries who used to voice their concerns aloud in the past. The Latin American condemnation contrasts with the condoning of Israeli actions by US. The impunity with which Israel has killed over 1400 civilians and the solid  support it receives from US remind many Latin Americans of the atrocities committed by right wing Latin American military dictatorships with similar US backing. Chilean President Michelle Bachelet, a pragmatic and respected Latin American leader, has likened her political exile in Europe during the Pinochet dictatorship to the plight of Palestinian refugees denied the right to return home. This memory has triggered the Latin American governments to react strongly and go beyond the response of many countries around the world. 

Earlier in the year, Brazil was criticized by the US congressmen and media for not taking a strong stand against Venezuelan government after the death of 40 people during the anti-government protests. The Brazilians ask what  has US done when 1400 people have been massacred by the targeted bombing of hospitals and schools in Gaza?  Disgusted by the hypocrisy and double standard of US and Europe, the people of Latin America have come to appreciate the  conscientious and responsible position taken by their governments on issues such as the Gaza tragedy.

There is a larger political message to the world. The vocal and principled stand taken by Latin Americans is yet another clear sign of their growing independence and assertiveness in the global stage.