Emerging Markets

Argentina on the precipice? Maybe, says S&P


The fallout from Argentina's loss at the U.S. Supreme Court Monday continues to imperil Latin America's fourth largest economy.

Standard & Poor's cut its rating of Argentina's long-term foreign currency debt rating to CCC- from CCC+ with a "negative" outlook. A CCC rating is defined as "currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments," according to S&P.

The ratings agency noted Tuesday that Argentina will owe $225 million to bondholders on June 30 and is also scheduled to pay tens of millions of dollars more in interest in September and December.

That, according to S&P, raises the possibility of default. "Although neither is certain, a default or a distressed debt exchange pertaining to currently serviced debt appears to be inevitable within six months, in our view, absent unanticipated significantly favorable changes in Argentina's circumstances," the rating's agency said in its downgrade report.

"We could revise the outlook on the long-term ratings to stable if threats to debt servicing were to unexpectedly diminish, combined with steps that boost external liquidity in order to meet substantial external debt amortization next year," S&P added.

Read MoreMessage on Argentina: Don't be a debt deadbeat!

A trader works on the floor of the Buenos Aires Stock Exchange.
Diego Giudice | Bloomberg | Getty Images

S&P said that the new rating reflected the Supreme Court's decision on Monday to not revisit a lower-court order for Argentina to pay so-called "holdout" bond holders. The hedge fund holdouts were part of a small group who refused to accept less money for their bonds and have for years sought full payment on the $1.33 billion they are owed. The American courts have ruled that the holdouts must be paid at the same time as the owners of new discounted bonds.

"The negative outlook reflects the likelihood of a further downgrade based on possible payment interruptions or the announcement of what we could consider a distressed debt exchange," S&P said. "Either a payment interruption or a distressed debt exchange would lead us to lower our rating on Argentina to [selective default]."

The downgrade comes as Argentine asset markets were dragged through more drama on Monday.

Stocks on the country's blue-chip Merval Buenos Aires index finished the session lower by over 10 percent on Monday, losing around 812 points. The Argentine peso remained relatively stable but bond yields spiked. The yield on Argentina's U.S. dollar-denominated 2017 global bond had risen to 15.833 percent by Tuesday morning, according to Reuters data, up from 11.545 percent before the ruling. Its U.S. dollar-denominated 2033 discount bonds were yielding 11.9389 percent, rising sharply from 10.6320 percent.

Brian Lawson, a global economic and financial consultant at research group IHS told CNBC via email that it's likely that the fastest market corrections are already behind us, but warned that the country's fundamentals had changed.

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"(There's) clearly increased risk of Argentine technical default: this could encourage further selling over time as well. So, while there may be technical bounces, with buyers attracted by the speed of price changes and apparent bargain prices, there are reasons to fear further falls over time," he said.

"The Supreme Court ruling was the worst possible outcome from an Argentine perspective," Lawson said. IHS had previously had a negative outlook on the Argentine peso but Monday's result has given further downward pressure on that estimate. IHS had predicted that the peso could be worth $12.2 by end year, with it currently trading at around $8, and $15.6 by the end of 2015.

"Sharper and earlier devaluation now represents a clear possibility. Far higher volatility in the peso also appears a severe risk," he said.

"Ironically, this may actually be good news, in that it could force Argentina to devalue faster, and with less prior use of its reserves to improve its international competitiveness, rather than doing so after a long and unsuccessful struggle to fight the markets. A devaluation appeared very likely given the country's weak economic fundamentals."

Contagion risk?

Forced into action, President Cristina Fernandez de Kirchner said in a speech late on Monday that Argentina would honor its payments to holders and would avoid any default. Deutsche Bank analysts remained upbeat after her statement, writing in a research note Tuesday that it was positive that she explicitly noted that the government would be willing to negotiate. The German bank also noted that she never said Argentina would not pay the holdouts.

Read MoreArgentina: We will not default on restructured debt

Meanwhile, Lawson called Argentina a "special case". He said there was no other country facing the same legal challenges. However, he added that the sell-off may hinder Ecuador´s planned return to the international capital markets, at least on a temporary basis, and could also delay planned investments into Argentina's energy sector.