• A Road Map to Argentina-IMF- Private Creditors Negotiations

    A Road Map to Argentina-IMF- Private Creditors Negotiations
    “Diplomacy is the art of letting someone else have your way.” – Sir David Frost The upcoming Argentina – IMF – private creditors (AIP) negotiation is not particularly complex. In fact, the only complexity is that introduced by its multi-party nature, and such complication does certainly not rise to the level of, say, the Kigali climate accord (the real negotiation which led to Paris). In addition, the negotiation process has an auspicious starting point: Argentina and its private creditors have1, or should have, a minimally disrupting reprofiling deal as a common goal. In spite of its relative dimensional simplicity, this tri-party negotiation carries high stakes: from the private creditors’ standpoint those stakes can even be quantified as the difference between 20 cents and 65 cents. Combined with the turning points which are sure to materialize until conclusion of a deal, these high stakes leave very little room for human error. This goal of this post is to outline, in the broadest terms, a roadmap for negotiators tending to minimize the chances of human error leading to a bad outcome. As in all negotiations (i.e. conflict resolution processes where important issues must be agreed upon), the AIP negotiation requires each party to obtain the other two parties’ agreement to achieve a deal. Structural analysis of the negotiating landscape is so tautological as to not yield practical insights. The IMF clearly holds the most power (e.g. demand haircuts, pull the plug), followed by Argentina (which, like any sovereign, has the ability to strategically default), then by private creditors holding foreign-law instruments (whose only real leverage is the threat of litigation, but with such threat being credible only insofar as the expected net recoveries from litigation exceed the value of an exchange offer on the table). Argentine-law creditors stand in the most vulnerable position: their claims can be restructured at the stroke of a pen. Thus, under a structural analysis, the AIP can be reduced to a three-party prisoner’s dilemma problem, which any competent negotiator should be able to navigate. A strategic analysis does no better in terms of actionable insights. It merely tells us what any competent negotiator should intuit: at the outset of negotiations (i.e. during the pendency of the Argentina-IMF negotiations), cooperation between Argentina and its private creditors is optimal, with the IMF being, in strategic analysis lingo, the only party which may derive advantage from defecting. That leaves process analysis as the most useful framework for private creditors to plan their approach to negotiations. We try to briefly outline the process below. Naturally, this outline should not be understood as a complete analysis. 1. Negotiations Away from the Table – Scope, Sequence and Process Choices In order to maximize the chances of a good outcome, Argentina’s private creditors should set up or alter the situation before any actual negotiation takes place so that what they seek looks desirable to the other side relative to their no-agreement alternatives. Since discussions around the IMF’s DSA will be the first turning point (in the Druckman sense of the phrase) in the process, and probably its most consequential, Argentina’s private creditors should ensure having their voice heard throughout that stage. Those who attended our DSA presentation last week are aware of our opinion – based on having actually run credible projections through the IMF DFA framework – that, if mechanically applied, the IMF DSA is likely to yield an output adverse to private creditors: the finding that Argentina’s debt is “unsustainable with high probability”. It is thus imperative for private creditors to be heard during this phase and: a) Partner up with Argentina in the development of an economic plan (fiscal, monetary and growth) which maximizes Argentina’s (and its agents’) utility function which, we posit, is to maximize income growth by December 2024. It can be proven that a deal imposing a haircut to private creditors would materially reduce the chances of achieving such goal, by virtue of the front-loading of the effect of Rogoff-Bulow sanctions. Therefore, effective cooperation between Argentina and its private creditors should aim to produce a set of credible projections less likely to lead to the “unsustainable with high probability” outcome. Argentina is already busy at work in populating its historical data and projections in the IMF template and the sooner private creditors can insert themselves in that process, the better. There will be a point of no return. b) Unfortunately, one of key the elements of the IMF’s DSA framework is the credibility of the member’s financial projections based on that member’s past behavior. Therefore, private creditors must find creative, yet academically rigorous, ways to nudge the IMF from a deterministic validation of the intertemporal budget constraint on which its framework relies. To succeed, this exercise in influencing IMF behavior will require that: a. The alternative methods can be proven (both in theory and in practice) to be superior predictors of debt sustainability than the IMF’s templated framework; and b. Creditors speak with such gravitas that their message is capable of proving the case for the consideration of alternative frameworks. The good news is that, as we showed in our 11/12 presentation, the same dataset (i.e. historical data and projections) yields considerably more encouraging results when applied to alternative methodologies which have been empirically proven to be better predictors of sustainability than the “brute force” overlay of the intertemporal budget constraint. Some of our methodologies are very close to the IMF’s own (and thus preferred, to minimize debate), while others take a completely different approach. Among the closely related methods are: a. Intertemporal budget constraint with stochastic inputs: projections are, by definition, probabilistic – not deterministic – data. Intuitively, the farther out in time the projected variable, the higher its standard deviation. After assigning the proper distribution type and associated statistics to each projected value and iterating the intertemporal budget constraint over a sufficiently large number of loops (Monte Carlo simulation), the output (e.g. debt/GDP) will itself be a distribution with its own dispersion. Our analysis shows that, in the case of Argentina, this dispersion is large enough to negate the “with high probability” qualifier from the “unsustainable” finding. b. Steady-state intertemporal budget constraint with deterministic paths: under this methodology sustainability is not defined as a debt stock which is less than the present value of primary surpluses plus seignorage revenues but rather as a series where both debt/GDP and the real stock of debt tend asymptotically to 0 as time increases. We have been able to prove that both those conditions hold true for Argentina under the steady-state with deterministic paths analysis. c. Other approaches based on the intertemporal budget constraint: We have also proven that the intertemporal budget constraint holds true under other empirically validated methodologies, such as recursively running the IMF static analysis. We also applied other, purely stochastic, methodologies to the same data set to conduct, for example, a stationarity analysis under both the Augmented Dickey-Fuller and Phillips-Perron tests. As we showed in our 11/12 presentation, we could reject the hypothesis of a unit root under both tests for both budget balance and debt/GDP, concluding that both series are stationary (i.e., they tend to revert to the mean) and that Argentina’s debt is in fact sustainable. While the use of unit root tests admittedly deviates from the intertemporal budget constraint framework, we have concrete reason to believe that it may be accorded some weight by the IMF. In fact, unit roots tests were the method we used to (correctly) find that Lebanon’s debt was unsustainable and, as a consequence, we were approached by the IMF to invite us to present on the subject. 2. Negotiations on the Drawing Board – Substance: While avoiding a finding of “unsustainable with high probability” by the IMF is a necessary condition to a good outcome for private creditors, it is not sufficient: once the initial commonality of interests terminates, private creditors will still need to negotiate with Argentina. I believe that the Argentina – private creditors negotiation can (and should) transcend the book/seminar win-win framework. Indeed, private creditors should use divergent (brainstorming) and convergent (the finding of a solution) thinking simultaneously to create joint gains based on the negotiation’s underlying economics and structure. For example, a deal offering one year of partial interest capitalization may end up being more valuable to creditors than one that doesn’t. Aside for the obvious case where full contractual coupons in year one could lie through Argentina’s decision boundary (no pun intended), innovative thinking may lead to agreement on an optionality-based sweetener the value of which may more than offset the partial capitalization’s adverse effect. Naturally, many more areas for creative mutually beneficial compromise will be found through private creditor discernment whenever one party or the other is pushed through its no-deal barrier. Common to all exits from these anticipated crises should be the discovery and structuring of solutions with low cost for one party but material value for the other. 3. Negotiating at the Table – Process: When most people think of negotiation, they think of behavior, communication and tactics “at the table.” This is likely to be the least problematic aspect of the Argentina – private creditors negotiation. Many senior businesspeople are already reasonably proficient at this process, bi-lingual, and bi-cultural, and should be able to avoid the most common interpersonal behavior pitfalls. While less important in terms of influence over the outcome than the two dimensions discussed above, I submit that, within that set of senior potential agents, private creditors will be well-served by placing at the table an individual known to (and, ideally, respected by) Guillermo Nielsen, Argentina’s likely debt negotiator. A preexisting trust relationship with Mr. Nielsen is likely to speed the process along and help deal with the inevitable turning points which are all but certain to materialize along the way. These desirable attributes of the negotiation dynamic will result by limiting the amount of second-guessing of good faith proposals introduced by private creditors and its flipside: avoiding crises precipitated by accusations of bad faith often present in high-stake negotiations (with the resulting relatively higher success of de-escalation efforts whenever necessary). Thus, while the initial Argentina-private creditors commonality of interests, the reduced number of parties, and the relatively small number of variables lead us to remain optimistic on the negotiations’ final outcome, we urge Argentina’s private creditors to organize their negotiating strategy around a framework such as the one laid out above in order to minimize the possibility that human error may lead to a bad outcome.

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    Carlos A. Abadi

    Carlos is a 30-year veteran international investment banker who pioneered a number of financial products, such as the trading and swapping of emerging markets sovereign loans in the wake of the 1982 Mexican debt crisis, the trading market for derivatives on emerging markets bonds and loans, the first non-dilutive CET1 transaction compliant with Basel III rules, and the first Chapter 11 filing for a Latin American issuer.

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