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Argentina | Cash flow watch

| August 23, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Foreign exchange reserve depletion continues in Argentina with net reserves now at $13.4 billion and ongoing uncertainty around central bank intervention and access to voluntary capital markets. The current pace of reserve loss suggests a return to the balance of payments stress of 2015 when net reserves went negative. There is not much the Macri administration can do other than damage control during the uncertainty of the election cycle. It’s a balancing act between preventing excessive foreign exchange weakness or reserve loss, for deterring and funding USD demand, and avoiding the worst case scenario of retail dollarization.

This is the constraint of a dual currency system and repetitive economic crises that reinforces USD demand. The press conferences from the economic team attempt to reassure on foreign exchange competitiveness; however, it remains cash flow watch on monitoring the daily decline in foreign exchange reserves. It’s encouraging that the foreign exchange rate has remained with a range of 55-60, but this has been at the expense of an unsustainable pace of $878-million-a-day (8/12-8/22) reserve loss.

Source: http://www.argentina.gob.ar/hacienda

The negative shock post PASO continues with foreign exchange reserve loss of $7.9 billion through the past two weeks.  This pace is clearly unsustainable against our current calculation of $13.4 billion in net foreign exchange reserves.  What are the future claims against foreign exchange reserves and what are the options for the Macri administration? The market cannot rule out a potential positive shock from the Fernandez team under acute cash flow stress; however, the burden near term remains on the Macri administration to fund the outflows ahead of a worst case scenario of administrative and regulatory restrictions.  The potential claims against foreign exchange reserves through 4Q19 are the USD demand on non-rollover of the private sector in treasury auctions, the local law coupon payments and further dollarization of USD bank deposits.

Source: http://www.argentina.gob.ar/hacienda

The high frequency treasury auctions are the primary concern, especially for risk of repatriation of foreign holdings in LECAP bills. The IMF (table 8 in fourth review) shows the expectations for gross financing needs for 2019 including private sector issuances of $11.3 billion from September through December. The breakdown assumes $5.6 billion for LETES and $4.8 billion for LECAP and other short term bills on a 75% rollover rate.

It’s difficult to reconcile the private sector holdings via specific maturities for the latest investor presentation (7/17/2019), though it looks like a high percentage of private sector participation between 50%-80%.  On referencing the last LETES auction 8/13, the low rollover rate of 43% suggests only public sector support.  The next test will be August 27 and August 30 with $2.5 billion of maturing LETES and LECAP and potential $1.6 billion claim against foreign exchange reserves assuming zero private sector rollover and USD conversion from local and foreign investors.

If this trend continues, then this could represent a potential claim of $11.3 billion through year-end against foreign exchange reserves.  It seems fair to assume a similar shift from maturing ARS/USD local law coupons into cash holdings with $3 billion scheduled for payment through year end. The culmination of maturing treasury bills and local law coupon payments could push net foreign exchange reserves through zero by year end and potentially sooner if reserve loss motivates further dollarization within the banking system.  The market should closely monitor deposit flight at a mature phase of dollarization at 43% (against 10% Kirchner era average).  The $1.5 billion withdrawals of USD private sector bank deposits 8/12-8/15 reduces gross but not net foreign exchange reserves and hence it is more important to monitor the dollarization ratio.  The eroding margin of flexibility would require either conversion of swap lines (gross foreign exchange reserves cannot decline below the $14.5 billion of private sector bank deposits) or administrative controls similar to 2015.

Source: BCRA, Bloomberg

It looks increasingly complicated for cash flow management with liquidity stress potentially triggering a cycle of USD demand. The complacency of the recent run-up on Eurobond prices over the past few days seems to ignore the latest cash flow stress. The liquidity stress could start to contaminate Eurobond performance on a higher sensitivity/correlation on foreign exchange reserve depletion that suggests a test for new lows closer to 40 historic sovereign recovery value. The shortest maturity bonds like the ARGENT’21 should have the highest sensitivity to cash flow stress as the leading indicator for when liquidity risks converge into solvency risks. Further price compression across the Eurobond curve should come if cash flow stress intensifies.  The only effective solution to counter negative investor sentiment is the confirmation of an economic plan based on a fiscal anchor from the Fernandez team.  It’s not sufficient to reject capital controls and debt default without first committing to the conditions necessary to avoid a broader economic crisis.

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