It wasn't long ago that Argentina was a top tier player in the securitization market south of the border, but now that the country is scrambling to save itself from spinning further into the red, sources say debt default is almost inevitable. Perhaps even more discouraging is that the tail of the tornado just may knock the wind out of all emerging markets.

When Domingo Cavallo joined the Argentine government in the spring, market participants had high hopes. "If anyone was going to get the job done, it was going to be him," said one Latin American analyst. "He was the last bullet in the gun."

Now, in the face of default, the same Latin American analyst said, "If Argentina defaults, it would pretty much shut down emerging markets and Latin America for quite awhile." According to market participants, 20% to 30% of all emerging market debt is maintained by Argentina.

Many market players have similar opinions, though Roger Scher, a sovereign analyst at Fitch, noted his disagreement. "[Default] would definitely make things very difficult for emerging markets. We've seen a number of crises in the past few years, in Asia, Russia and Mexico, and it did create problems initially, but eventually investors just looked at it country by country." The Mexican, Russian and Asian crises benefited from a strong U.S. economy and unfortunately the same cannot be said for the current Argentine situation.

Contagion Effects

Either way, the contagion effect is clearly inevitable. Brazil, at the brunt of the storm has already begun to feel the turbulence.

Since the start of the year, the Brazilian real has devalued 28%. Although there are existing problems in Brazil that may have contributed to the devaluation, including the energy crisis and the political elections for next year, it is not enough to have caused the real to plummet that significantly.

"There's been no event or series of events in Brazil that would justify taking the real down by 28% since January and if you look at the biggest dips that have taken place, they are because of the Argentine contagion," said a Latin American investor with ANZ Investment Bank.

Although Brazil will be hit the hardest, Chile will also feel the effects of the Argentine situation, despite the fact that Chile is currently stable. Uruguay and Paraguay, smaller and more vulnerable countries, will be more exposed and Colombia may also me somewhat vulnerable to the situation.

Mexico is a bit insulated because the policy environment is strong and it is tied closely to the U.S. economy, though sources warn Mexico is not completely immune to Argentina either.

"The contagion countries are countries that have strong external needs, like Peru, and Colombia," Scher said.

What happened?

For the past few months, it has been pretty quiet on the Argentine home front - until last week. The country slipped further into trouble last Tuesday as interest rates skyrocketed to 14% in bond auctioning, up from 7% to 9% in June when the country completed a successful sovereign bond swap.

To make matters worse, rather than following through with plans to do six-months to one-year paper, Argentina did the bulk at three months, which will be due shortly before the October elections.

"It's going to get worse before it gets better," one Argentine analyst noted. "The risk over U.S. bonds was at 1,500 [last week], when Cavallo came into government the risk premium was at 900."

While market talk says that the country will likely default, the fact of the matter is that it is still unknown. "I think that there is space for maneuvering the situation," said the Argentine analyst. And, if the country does default, it is unclear where the default will land, though many sources say there is more of a probability that it would hit long-term commercial debt as opposed to the multi-lateral debt. Historically, Argentina has never defaulted on multi-lateral debt.

National-scale structured deals are on hold, and there is nothing in line for the global scale market. However, investors are not out of the market just yet. The ANZ Bank investor said, "We continue to extend credit to individual borrowers in Argentina to both correspondent banks and corporate on a selective basis and for tenors that do not exceed one year. We are purely trade finance."

ANZ Bank has about $100 million or less exposure to the country and is not looking at any new transactions now. "If someone were trying to make a deal for an Argentine bar right now, they couldn't have picked a worse time to bring it to the market," the investor said.

What needs to happen to turn the situation around?

That's the million dollar question. But it seems the consensus is that the economy needs to cut spending. Cavallo and President Fernando de la Rua announced spending cuts last week state workers' salaries and government pensions will be reduced by a certain percentage each month. Argentina will also raise taxes to 0.6% from 0.4%.

"We are in a lose, lose situation," said an Argentine analyst. "There's no win situation; there is either suffering or a lot of suffering. I'm praying that after they cut the deficit,...those measures will bring back confidence from abroad and that it will then transcend into lower premiums and increasing investments in the economy."

Both Standard and Poor's and Fitch lowered Argentina's sovereign rating to B- from B+ with a negative outlook. Moody's Investors Service maintained its B2 sovereign rating with a negative outlook, which it was lowered to in March.

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