Argentina: It’s time to take money off the table

News and opinion on finance

Kirchner is calculating that Peronism will get more voters if she isn’t the lead candidate, given her high rejection rate. That’s logical – and so too was president Macri’s response in choosing Miguel Angel Pichetto, a non-Kirchner Peronist to bolster support to his ticket from the moderate left.

In aggregate, these machinations probably result in a small electoral positive for Macri, which was extended in recent days by positive data regarding inflation and the current account. The market feels like momentum is with the re-election bid.

However, it increasingly looks like the country will default, whoever wins the election in November (or October in the unlikely event a run-off isn’t required).

As everyone knows, if Macri doesn’t win, the chances of default are high. But – and investors will probably increasingly grasp this painful point as the months to the election tick down – another Macri administration would also do well not to have to seek a debt restructuring before the IMF’s deal expires in 2021.

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Default looming

Why? Well, for starters, since the collapse in the peso last year debt-to-GDP has climbed to 86% (and foreign currency debts now represent 80% of the total).

Now, the IMF has rosy expectations that this will decline to 60% by 2024. That would require growth of 2.5% a year from next year (whereas GDP fell by about 6% year-on-year in the first quarter). The government will also have to run a primary surplus of 1% a year (currently -2%) and would also need a combination of high inflation and real exchange rate appreciation.

But all these assumptions are unlikely. How will growth come in at 2.5% without investment? And if private sector investment hasn’t been attracted into the country to date – before the economic collapse and the IMF saga – why would it flow in when there is greater FX volatility and a potential sovereign default looming on the horizon?

Also, that requirement for a fiscal primary surplus means the investment can’t come from the sovereign. It will be more than ‘challenging’ to report fiscal surplus for consecutive years given the political construct of the country (powerful provinces with large budgets but with little revenue-generating responsibilities, as well as important elections every two years).

The multi-laterals will do what they can, around the edges, but reports that some have been left high and dry by sponsors walking away from projects amid the financial chaos prove the limits that they can bring to bear. And let’s just say the international capital markets aren’t going to take multi-year project risk any time soon.

Barring some miraculous increase in growth, fiscal surpluses and significant FX appreciation in 2019 and 2020 – there is a pretty good chance that Argentina will default

There’s little reason to assume that high inflation won’t lead to an equal or worse deterioration in the exchange rate (the rate of price rises has slowed in recent months but that’s largely down to temporary price controls that may bring stability ahead of the presidential election but will need to be released shortly thereafter).

Even though the current account deficit has been improving in recent months the adjustment has largely come from a steep contraction in domestic demand (possibly temporary) rather than from import substitution (permanent). Some economists think the currency is still overvalued and, even if it’s not, currencies have been known to fall below real effective exchange rate (REER) and stay there for years.

Capital Economics predicts that “under a more plausible assumption of moderate financial slippage” and a 20% depreciation of the real exchange rate the debt ratio would rise to 120% of GDP by 2024.

And such a trajectory would cause problems with the IMF. To keep the IMF deal on track the fund must judge that Argentina’s debt is “sustainable”. If it’s rising quickly to 120% will that be the fund’s assessment?

Also, because Argentina has an exceptional access deal, the fund needs to be convinced that the government has good prospects for regaining access to the international capital markets.

Political support

Some investors believe that political support for Macri (this projection still assumes that Macri wins) will mean the fund will find themselves reasons to believe that Argentina’s debt is sustainable and that the sovereign has a path back to the international capital markets (though yields would have to compress a lot from the current 11.5% to make that realistic).

But, in reality, politically-motivated debt blindness is unlikely. One of the IMF’s own takes from the 2010 Greek debt fiasco was that it should have pursued a debt restructuring much sooner than it did.

All of which means that – barring some miraculous increase in growth, fiscal surpluses and significant FX appreciation in 2019 and 2020 – there is a pretty good chance that Argentina will default, restructure or re-profile, whoever is the country’s next president. If the debt ratio is well above 100% of GDP when it does, recovery rates could be around 40% to 50%.

So, however tempting Argentine bonds are today, they may still not be reflecting the sovereign’s real underlying risk profile. After all, if a country can default seven times in one hundred years, an eighth such event in the coming years shouldn’t catch anyone out.

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