Significance
The sovereign bond swap launched in mid-January secured a participation rate of 76%, the government said yesterday, easily surpassing analysts' expectations and the 50% benchmark for success the government had established. 

Implications
The swap can be regarded as successful and will thus allow the Argentine government and International Monetary Fund (IMF) to re-start formal talks over the standby programme suspended in July 2004. However, many potential flashpoints remain.

Outlook
The fact that the Argentine authorities managed to secure such a high level of participation is remarkable and will play extremely well with the electorate. While the government would like to rid itself once and for all of dependence on the IMF, it is not in a position to do so and it is therefore only a matter of time before the two sides strike another deal.

Argentine Government's Great Gamble Pays Off
The biggest gamble of Néstor Kirchner's presidency has paid off. Yesterday, flanked by his cabinet, Argentina's head of state announced that the sovereign debt swap launched in mid-January had secured a 76.07% participation rate. This is well above the 50% threshold the government had set itself for success, as well as analysts' expectations as recently as early February. While the final figures are not due until 18 March, the preliminary numbers showed that a surprisingly high proportion of Japanese investors had signed up to the swap while Italian retail investors - who had made their opposition to the terms of the exchange crystal clear - largely stayed on the sidelines. 

Sticks and Carrots
Given the large haircut being demanded - in the region of 70% - how did the government secure such a high acceptance rate? A mixture of sticks, carrots and good luck. Working strongly in the Argentine government's favour were buoyant conditions on global markets: high liquidity, low interest rates and strong investor interest in emerging-market paper. On the incentives side, the authorities had tweaked the offer in several ways since the bare bones were outlined - including accepting unpaid interest accumulated since default was declared in December 2001 and pushing the issue date of the new paper back to 31 December 2003. In addition to its usual 'take-no-prisoners' style, the government in early February pushed legislation through Congress outlawing any improvement or extension to the offer on the table - making even plainer its intentions in this regard. 

While the period from 14 January-4 February saw the participation rate pick up relatively slowly, behind the scenes there was extensive selling-on of defaulted paper from retail investors to institutional investors - who had little interest in signing up to the exchange early on. The final few days of the operation saw players pile into the offer amid rising expectations of a high acceptance rate and growing concern as to what would happen to the value of their holdings should they opt to remain on the sidelines.

Argentine Sovereign Debt Slashed but Remains Onerous
Included in the strategy used by the Argentine authorities to maximise the take-up rate were various initiatives designed to ensure that any defaulted paper not submitted for swapping would be delisted from trading on the Argentine markets and elsewhere. It would therefore become illiquid and extremely difficult to trade. Indeed, the prices of defaulted Argentine debt slipped yesterday on confirmation of the swap's success. Furthermore, Economy Minister Roberto Lavagna, Kirchner et al have made abundantly clear that they have no intention of 'doing deals' with those who refused to sign up to the exchange. While the hold-outs will press their claims through the courts, even if they win their cases there is no guarantee either that the Argentine government will honour their obligations in this respect or that the successful claimants will be able to seize sufficient Argentine assets to make good on their supposed settlements. 

According to official figures released yesterday, the public debt-to-GDP ratio has fallen to 72% as a result of the swap, from 113% in 2001 - US$125,283 billion from US$191.254 billion. It is worth noting that the 72%/US$125,283 billion excludes the US$19.587 billion in bonds not proffered for the exchange. The defaulted paper amounted to US$102.566 billion, with the face value representing approximately US$81.8 billion and the balance being unpaid interest accumulated since December 2001. The new debt, to be issued on 1 April, comprises US$15 billion in Par bonds, which entail no reduction in principal and come due in 2038; US$8.329 billion in quasi-par bonds, which involve a reduction in principal of 30.1% and mature in 2045; and US$11.909 billion in discount bonds, which run until 2033. Debt-servicing costs as a result of the exchange are set to fall to around US$3 billion a year from US$10 billion. 

Standard & Poor's has said that it will accord the new paper a B- rating (six notches below investment grade and on a par with Ecuador), while the exchange will see Argentine bonds' representation in JP Morgan's Embi+ index of emerging-market debt prices rise from their current level of 1.8% to around 3%. This may underpin demand for the new debt in the months ahead as fund managers increase their holdings of Argentine paper proportionately. All the same, international financial markets will remain cautious regarding future external bond issuance by the Argentine government. After all, the haircut investors were obliged to take was unprecedentedly large while the whole restructuring process took more than three years. In addition, not all parties are convinced that the Kirchner administration acted in good faith. Luckily for Argentina, it is unlikely to have to turn to international markets to raise funds within the next couple of years. 

Re-Engaging with the Multilaterals 
This issue of 'good faith' will be of significance to the International Monetary Fund (IMF), with which Lavagna is due to hold talks in the US this weekend. The Fund's initial reaction to news of the exchange's success was muted: while conclusion of the operation represents an important step for Argentina, senior IMF official Thomas Dawson said, many issues must still be addressed. He also stressed that it would be 'clearly premature' to describe this weekend's talks as a re-opening of negotiations over the three-year standby programme that has effectively been suspended since July 2004. It is not known at this stage whether the two sides will work on modifying the deal signed in September 2003 or on thrashing out an entirely new agreement. What is more obvious, however, is that Kirchner and Lavagna will go in with all guns blazing. Even before the dust had settled on the debt exchange, Kirchner had moved on to an issue certain to dominate discussions with the Fund and its sister organisation, the World Bank - utility tariffs. These were frozen and 'pesified' in the wake of the default and devaluation of December 2001-January 2002 and many of the companies involved are now suing the government for compensation. Kirchner has promised to fight them 'tooth and nail'.

The level of participation in the recent swap falls well below the 90%-plus levels secured by other countries, including Ecuador and Russia, following their defaults. In this respect, it could be regarded as setting a precedent for a far more aggressive approach to restructuring by other nations who find themselves in fiscal meltdown. What it is unlikely to do is encourage other countries not to honour their debt obligations: the social and economic costs of Argentina's default were inordinate. Poverty and joblessness soared, as did crime, and GDP plunged by 10.9% in 2002. Although the economy has subsequently rebounded, with social indicators improving as a result, few would argue that the 'social debt' has now been paid. Nevertheless, the swap's acceptance rate is sufficiently high to allow the IMF to conclude that Argentina has successfully resolved the situation and hence move on. As noted above, utility tariffs are certain to be a key sticking point and the government's confidence will have been boosted by its high-risk strategy with regards to its defaulted debt: it will thus demand a less onerous set of reform requirements in any new or revised programme. The stage is therefore set for another round of protracted and fraught negotiations. 

Outlook and Implications
The fact that the Argentine authorities managed to persuade - or arguably cajole - investors holding more than three-quarters of the defaulted paper to accept a haircut of approximately 70% is remarkable. The feat will no doubt play extremely well with the electorate, with Kirchner and his colleagues hardly reluctant to trumpet the sharp reduction in debt they have secured. However, it should not be forgotten that a substantial minority of bonds - 24% - were not submitted for the exchange. Lengthy and multitudinous lawsuits will be a running sore for the Kirchner administration and will ensure that Argentina's reputation with the international financial community is not rapidly restored. It will also be interesting to see whether Lavagna decides to quit while he's ahead. 

With regards to the IMF and other multilateral negotiations, there is a distinct sense of déjà vu. While arguably the biggest bone of contention has now been removed, other highly charged issues - particularly utility tariffs, given their repercussion for companies from chief IMF stakeholder countries - will provide plenty of flashpoints. Argentina would like to rid itself once and for all of dependence on the Fund and thus the need to keep it sweet. However, it is not in a position to do so and it is therefore only a matter of time before the two sides strike another deal.