Argentina | All about recovery value

| September 13, 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.

Debate about recovery value for Argentina’s debt looks likely to roll on for months as the government’s liquidity ratios worsen and the path of the economy looks more uncertain. Fiscal targets will determine IMF relations, debt sustainability and overall recovery value. The next administration will need to focus on domestic debt restructuring both to get relief from imminent payments and as a prerequisite for external debt restructuring. But negotiations with the IMF could be difficult. The fund will need a realistic economic program to reassure creditors Argentina will be able to repay. If the Fernandez administration delays with a reactive post-election approach and dials up financial stress, more foreign exchange and capital controls would drive up mark-to-market risk until the economic team accepts an IMF-sponsored program.  These are the only conditions that would justify higher recovery value from current prices.

Argentina faces political constraints and the difficulty of promising fiscal austerity to bondholders without undermining support from fatigued voters. It would require extraordinary political finesse to manage bondholders and voter expectations as well as seek consensus from the disparate factions of the coalition.  There hasn’t been much demonstration of political finesse through the campaign, with an increasingly worse tradeoff if economic crisis deepens. The expectation of policy moderation under a Fernandez regime doesn’t provide the positive shock to investor sentiment if there is no commitment to a primary fiscal surplus, and political capital will quickly fade if voters reject fiscal discipline.

The 2020 budget proposes another primary deficit of 0.5% of GDP that reflects the current political constraints of the elections and the slow recovery from the economic recession. It could also compromise IMF relations and further delay any disbursement of the remaining program.  It’ll take considerable effort to achieve a primary surplus and would probably require legislative approval for pension and labor reform, especially if export retentions are only temporary.  There will be a renewed debate about the quality of the fiscal adjustment and whether the economic team shifts back to lower capex, higher current spending on wages and pensions and lower debt service.  This should complicate discussions with the IMF and bondholders.

The fiscal targets should represent the primary focus on renewed IMF discussions.  It’s not going to be easy due to the tension created by ideological differences as well as the anti-IMF rhetoric through the economic crisis and election cycle.  The IMF program has already been stress-tested through 16 months of trial and error with minimal flexibility for overhauling the program, especially if there is no commitment to a fiscal primary surplus as the anchor of the program. The proposal for higher cyclical revenues from growth in strategic sectors like Vaca Muerta would be met with skepticism, and do not seem a viable substitute for lower current spending.  The IMF will also be equally cautious about committing more capital after the front-loaded  roughly $50 billion in disbursements. The negotiations could endure months of tenuous conversations.

An IMF program is extremely important for the next administration as not only a credibility boost for the next economic plan but also the lender of last resort for restricted access to capital markets. The gross financing needs remain a constraint that could force the economic team to accept fiscal discipline if the official creditor community and private investors reject their economic plan, and any restructuring plan will have to focus on step-up or interest capitalization.

The fiscal targets are critical for debt sustainability analysis since they bear on the tradeoff between either a greater haircut on the debt stock or a higher exit yield on the restructured bonds.  The primary fiscal surplus is not only critical for generating cash flow but also an important signal of economic orthodoxy that could attract investment for higher-trend GDP growth.  The Fernandez administration would be starting with a wider credibility deficit based on the recent interventionism and controls that would only further deter cautious foreign direct investment and suggests trend growth closer to 1%-2% than 3%-4%.  There is a high sensitivity analysis to debt repayment capacity depending on savings from a primary surplus that would allow for lower exit yields or a lower haircut, or alternatively, a primary balance/deficit that shifts the burden to a larger cash flow relief or uncertain medium term debt repayment capacity of higher exit yields (overall lower recovery values).

Investor sentiment remains fragile. Investors are still monitoring the cash flow constraints with regulatory controls restraining capital flight and with foreign exchange reserves still vulnerable to treasury US dollar liabilities.  The IMF board is not scheduled anytime soon to release the latest $5.4 billion disbursement, and there is increasing cash flow stress ahead with still burdensome $3.0 billion local law and NY law coupon payments this year as well as $2.5 billion deferred LETES payments.  The increasing foreign exchange and capital controls shift US dollar demand to the parallel foreign exchange markets with a 20% divergence of spread between the contado de liqui foreign exchange rate and the official rate. This could perhaps backfire for further bank deposit withdrawals as the reserve requirement/deposit coverage ratio continues to decline to 36%, through the latest available data on September 7, from 52% on June 30.  These liquidity constraints further undermine governability for the political transition and complicate the initial discussions with bondholders on debt service relief and suggest continuity of capital controls through the uncertainty of the economic transition.  This uncertainty should constrain the upside for bond prices until there is commitment to a primary surplus of the next administration that’s politically viable under current conditions. Delays and complications would lower conviction about recovery value and increase mark-to-market risk near term.

john.killian@santander.us 1 (646) 776-7714

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