Argentina’s President Cristina Fernandez de Kirchner has less than a month to choose between two unpalatable options: fulfilling a vow never to pay off creditor hedge funds, or negotiating with them to avoid a rerun of the 2001 debt crisis that forced a predecessor to flee the presidential palace in a helicopter.

With the economy contracting and foreign currency reserves near an eight-year low, she is likely to decide that a deal to pay off the $1.5 billion the funds are demanding is the least bad choice, said Claudio Loser, the head of research firm Centennial Group Latin America.

“A catastrophic situation in the economy would be worse” for Fernandez than any backtracking on her promises, Loser, a former International Monetary Fund director, said by phone from Washington. The government “is very fearful that they could be kicked out or the last year of their term is a disaster.”

Fernandez has already moved to regain access to global credit markets for the first time since the 2001 default. Since October, she has settled arbitration cases at the World Bank, paid Spanish oil company Repsol SA for the expropriation of YPF SA and negotiated with the Paris Club of creditor nations. Now she must go the final yard and negotiate with hedge funds she calls “vultures,” Loser said.

A failure to reach an accord would drain reserves that have tumbled 21 percent in the past year to $29 billion. Success would allow Fernandez to resume borrowing and spending as the fiscal deficit widens to about 6 percent of gross domestic product, or $21 billion, this year, said Dante Sica, director of Buenos Aires-based consulting firm Abeceb.com.

Freedom Margin

While the economic consequences of defaulting wouldn’t bring an economic crisis as severe as the one in 2001, they would bring further pressure on the peso and reserves, said Mauro Roca, a senior Latin America economist at Goldman Sachs Group Inc.

“It would give the government less margin of freedom in their domestic agenda which is pretty complicated,” Roca said in a phone interview from New York.

Economy Ministry spokeswoman Jesica Rey didn’t reply to a voice message and e-mail seeking comment about the possible consequences of not reaching an agreement with the holdouts.

U.S. District Court Judge Thomas Griesa last month blocked Argentina from paying interest on its bonds unless it also pays holdouts from two bond restructurings, led by billionaire Paul Singer’s NML Capital. That meant Argentina missed a $539 million interest payment on June 30, leaving it with 30 days to reach an accord or default for the second time in 13 years.

2001 Crisis

Argentine bonds rallied after the government said it will send a delegation July 7 to New York to meet with court-appointed mediator Daniel Pollack. The bonds rose 0.7 percent today to 84.9 cents on the dollar after gaining 2.2 percent yesterday.

Elliott called on Argentina to begin negotiations this week. The fund manager is prepared to meet with Economy Minister Axel Kicillof who travels today to Washington to make a presentation on the debt case at the Organization of American States, Jay Newman, a senior money manager at the New York-based hedge fund, said in an e-mailed statement.

The litigation dates back to 2001 when former President Fernando De la Rua restricted cash withdrawals from banks to avoid a collapse of the financial system, sparking riots that left dozens dead. De la Rua resigned and was airlifted out of the presidential palace to avoid protesters. A week later, Argentina announced it would default on $95 billion of debt.

Fernandez’s husband and predecessor, Nestor Kirchner, took power in 2003 and negotiated a restructuring two years later in which investors accepted a 70 percent reduction. With a second round in 2010, Argentina was able to restructure 92 percent of the debt.

Argentina’s Duty

Fernandez described last month’s court ruling as “extortion,” and warned that it would open the country to as much as $15 billion in claims from other holdouts on June 16. Four days later she said she would negotiate as long as it is under conditions that respect the country’s constitution.

“We are ready to carry out our duties,” Fernandez said June 20.

The government has its hands tied, said Diego Giacomini, an economist at Buenos Aires-based Economia y Regiones.

Not abiding by the court ruling would force Argentina into a default that would stoke inflation estimated at 40 percent, drive away investment and cause an already contracting economy to shrink further, he said.

The country needs between $13 billion and $17 billion in credit “to get to the end of 2015 without losing too many reserves and without having to devalue the currency too significantly,” Giacomini said in a phone interview.

IMF ‘Dictatorship’

Nestor Kirchner, who died in 2010, blamed the IMF “dictatorship” for supporting a fixed exchange rate and enforcing spending cuts that led the country into the 2001 economic crisis. Now, his wife is seeking to repair relations with the Washington-based lender. The government this year overhauled its consumer price and gross domestic product indexes after the IMF censured Argentina for misreporting its economic data.

Argentina has also settled about $500 million of debt with five companies that had won rulings at the World Bank’s arbitration court, compensated Repsol and agreed to pay the Paris Club of creditors $9.7 billion of defaulted debt.

Negotiating with the holdouts is “the last conflict left to resolve to regain access to international markets,” Sica said. “Financing allows you to kick the can down the road.”

While the $15 billion it still owes holdouts is more than half of reserves, Argentina has the capacity to pay if Fernandez is allowed to pay in bonds, Roca said.

Standing Firm

Fernandez called on her supporters last month to unify in their fight against the hedge funds.

“One of the things we won’t negotiate on is to hand over this country to vultures that want to tear it to pieces,” Fernandez said last month.

Former Economy Minister Hernan Lorenzino said in October 2012 that the government wouldn’t settle with the holdouts.

“We’ll never pay the vulture funds,” Lorenzino posted on his Twitter account. “Whoever thinks otherwise hasn’t understood a thing.”

With debt payments looming, the budget deficit widening and reserves shrinking, the time has come to backtrack, said Manuel Mora y Araujo, a Buenos Aires-based political analyst. Negotiating with the funds is preferable to the prospect of having the country’s foreign assets seized following a default, he said.

It would not be the first time that Fernandez has been forced to backtrack. After vowing never to devalue, Fernandez allowed the peso to tumble 19 percent against the dollar in January, the most since Argentina abandoned the one-to-one peg with the U.S. dollar in the wake of the 2001 default.

Protests over week-long blackouts and a wave of looting following police strikes for higher wages in December were a reminder for Fernandez of how quickly control can unravel in Argentina.

“They have no choice,” Loser said. “They could say they’re not paying but the consequences would be very, very bad. Fernandez doesn’t want to go out like De La Rua.”