WHEN Argentina proposed a brutal 65% haircut to holders of its defaulted sovereign bonds in a 2005 restructuring, one argument the country’s officials used to justify the offer was that the country could not take on more debt than it could reasonably expect to pay. As painful as the loss might be, the argument went, at least the new bonds the government would issue would be creditworthy.

Just seven years later, that claim now looks harder to support. This month the impoverished northern province of Chaco was unable to pay $263,000 of interest, after Argentina’s Central Bank refused to sell it the necessary dollars. That forced the province to announce it would compensate its creditors in pesos, converting the amount owed at the official exchange rate, which is roughly 25% less than the currency’s value on the black market. It was the first time an arm of the Argentine government had failed to deliver a debt payment in full since the country’s massive 2001 default.

Is Chaco's technical default a canary in the coal mine for Argentine debt in general, or merely an isolated nuisance? In the short run, most bondholders can stay calm. Although the Chaco paper is denominated in dollars, it is governed by Argentine law, which allows borrowers to settle their obligations in local currency. Ever since the Central Bank clamped down on the foreign-exchange market last year in an effort to slow capital flight, its official policy has been that local issuers can only buy dollars to fund infrastructure projects.

But just $191m of provincial debt is governed by local law and thus subject to this requirement. Only two other provinces have Argentine-law bonds outstanding, and one of them, Tucumán, has already reassured the public that it plans to continue meeting its liabilities in dollars. The vast majority of provincial debt--around $7 billion--is subject to British or New York law. So far, those securities have not been affected by Argentina's dollar shortage. The Central Bank has $45 billion in reserves, 14 times what the federal government owes to creditors in 2013.

That said, Argentina's medium-term debt picture looks increasingly cloudy. Including provinces and municipalities, the public sector is in deficit even before counting interest payments. There is virtually no chance of retrenchment under the government of Cristina Fernández de Kirchner, whose popularity depends on ever-greater public spending. The overall public debt stock is still relatively low. But because investors demand prohibitive interest rates to lend to a government seen as unpredictable and anti-markets, Argentina cannot refinance its obligations as they mature, and must pay the full principal out of tax revenues or central-bank reserves. And although the economy is likely to recover modestly next year after flatlining in 2012, it receives little private-sector investment. That means there is little chance it will expand fast enough for the government's revenues to outgrow its liabilities.

The bond markets are well aware of all these warning signs. When the Chaco news broke, the federal government's dollar-denominated bonds promptly sold off by 2%. Savvy investors who recognise Argentina's capacity to pay for now but have doubts about its trajectory might consider buying the country's debt that matures in the near future while selling its longer-dated issues.

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