Argentina shows the integrity of default Once again, Argentina finds itself at the centre of a dispute that could have far- reaching implications for sovereign debt markets, with last week's US court decision ordering it to repay hedge fund investors who had refused an earlier debt writedown. The country has long been criticised for the unilateral nature of its decision to default on sovereign debt in 2002 - and for the manner in which it announced the decision. But there has been broad agreement that the debt reduction was inevitable in view of Argentina's unsustainable debt burden; and that, controversial as its implementation was, the successful restructurings of 2005 and 2010 played a critical role in restoring growth and financial stability in the economy. Today, since the New York ruling essentially requires Argentina to disregard the results of the restructuring agreements, reached after gruelling negotiations, one may be forced to review the legitimacy of the process. This could have serious consequences not only for Argentina but, more important, for many recent and probably future debt relief cases. Judge Thomas Griesa's decision is disruptive for capital markets, setting perverse incentives and running against fundamental financial principles - for two reasons. The first is to do with the concept of risk premium and the tolerability of defaults. In most cases, sovereign debt is not a risk-free asset. Because a default can be a clear threat, albeit one that evolves over time, sovereign bond yields incorporate a risk premium (or country risk). Investors are free to choose the combination of risk and return that suits their needs and preferences. The provision of sovereign credit ratings by specialist agencies makes this point obvious. But if investors are willing to accept higher risks in order to cash in on the additional spread, they cannot renege on the potential cost when the risk of default becomes a reality. Default, in this context, is not a crime but a legitimate, if unfortunate, part of the game. It is not consistent to benefit from a risk-taking premium and insist on full payment in all circumstances. The legal protection extended to bondholders by Judge Griesa goes against the very nature of risk- taking. If all holdouts are eventually paid in full, the entire price-setting mechanism in sovereign bond markets is rendered inconsistent. Second, enforcing full payment of creditors that reject a restructuring, while applying a hefty haircut to those accepting it, will make it impossible to complete a successful restructuring. Why agree to lesser terms if you will eventually be paid in full? Contracts must be honoured and terms respected but in some circumstances - as the current state of affairs in Europe proves - debt relief is indispensable to restore stability, which is beneficial to the country and the system at large. The New York ruling all but eliminates this leeway. It could make it impossible for debtors to win round enough investors to meet the required threshold in new bonds that include collective action clauses. Moreover, let us not forget who the litigants in this case are. They are the so-called vulture funds, which profit from disrupting markets without providing the stabilising benefits that sometimes arise from speculative operations. By acquiring bonds at fire sale prices, then litigating until fully paid, they block the return to markets of countries that have successfully restructured. What is paradoxical in this case is that, while they insist on privileged treatment relative to the bond holders who accepted the restructuring, they seem to have been rewarded by Judge Griesa on the grounds of "pari passu," or equal treatment. Argentina shocked the global financial system in 2002 with what was then the largest default in history. But it managed to take advantage of debt relief to recover from a crippling economic collapse, restore stability and grow rapidly for a long time. Despite the warranted and unwarranted criticism, its experience proves that there are circumstances in which debt relief, far from being a crime, is an indispensable component of a successful stabilisation programme. The New York court decision, if upheld, would impair this instrument and thus limit the tools available to policy makers in Europe and beyond. While the preservation of the integrity of judicial rulings is paramount, the unintended negative consequences of this case highlight the need to establish an international rule book of agreed procedures to guide and control sovereign debt negotiations. The International Monetary Fund should clarify its position regarding this issue in general, given its relevance to the functioning of sovereign markets, providing leadership and guidelines. As for Argentina, following the restructuring it has shown - and should continue to do so - an ability and willingness to pay holders of the replacement debt issued to those that accepted the haircut. It should also use all legal recourses at its disposal to reverse the New York ruling, which could unfortunately hurt the rights of those that acknowledged the inevitable and accepted the exchange. If successful, this will relay a clear message to the international financial system. The writer is a former governor of Argentina's central bank and a former Bank of England director