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Argentina | Difficult economic transition

| September 27, 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.

Argentina remains in limbo with cash flow stress under the Macri administration and only a slow economic transition with the Fernandez administration. The effectiveness of liquidity management will determine policy flexibility for the next administration. Capital controls have discouraged capital flight and encouraged exporter supply with foreign exchange reserve losses decelerating to around $100 million a day—despite persistent foreign exchange intervention and bank deposit withdrawals. But Argentina’s liquidity situation continues to worsen.

Argentina still needs liquidity to meet a consistent schedule of US dollar coupon and amortization payments. Export flow is insufficient to cover imports, tourism and debt service over the next few months, especially as declining foreign exchange reserves may re-accelerate US dollar demand.   President Macri looks likely to remain current on domestic and external debt liabilities with the domestic debt restructuring legislation delayed until after the elections. The net foreign exchange reserves of $10.7 billion (9/15) would need to cover $2.6 billion in local law and NY law coupon payments and $2.5 billion of LETES from October to December 2019. This suggests manageable cash flow dynamics through year end even without the $6.3 billion of IMF disbursements.

Despite the recent high level meetings between the IMF and Argentina, IMF disbursements look unlikely until there is clarity on the economic program after the political transition.  It will require highly efficient economic transition to negotiate with the IMF and bondholders to avoid an accidental default for the low $10.6 billion net reserves against high priority $7.2 billion in payments next year including $4 billion of NY/UK law coupons, $CHF400 million amortization, $2.3 billion provincial debt service and $500 million for YPF debt service.  The domestic debt restructuring logically should be the first on the agenda soon after elections considering the $7.8 billion in US dollar equivalent coupons and $25 billion in US dollar equivalent amortizations in 2020. This explains the recent proposal sent to the legislature that sets the legal framework for a domestic debt restructuring via collective action clauses.

Exhibit 1: The pace of FX reserve loss slows                            Exhibit 2: USD claims on treasury payments

Source: Amherst Pierpont Securities

The initial reaction from the opposition suggests that the domestic debt restructuring will only occur after the elections. The  Macri administration most likely focuses on liquidity and crisis management with all major initiatives including IMF and bondholder relations delayed until after the political transition. The logical sequencing of events should include a domestic debt restructuring and then negotiations with the IMF to develop a coherent economic plan as the basis of discussions of debt repayment capacity with external bondholders.   How prepared is the Fernandez administration to quickly negotiate with the IMF and bondholders? This will define whether it’s an orderly or disorderly default next year. Is it possible to restructure debt prior to an IMF accord or fast track negotiations with the IMF or creditors?

The high level meetings between Argentina and the IMF arranged for more meetings on October 14; however acting MD David Lipton states that the situation is “extremely complex” and “the resumption of a financial relationship may have to wait awhile.”  It would require a minimum of reworking the targets and DSA assumptions—not yet knowing the cash flow or solvency relief from creditors—for the SBA if not a complete conversion to an EFF to re-profile the heavy amortizations. The IMF relations cannot be avoided for the heavy net repayment schedule of $20 billion in 2022 and $22.6 billion in 2023.   The active discussions may facilitate negotiations on the political transition; however it would be difficult for the IMF to resume the program without the full backing from the next administration. Perhaps the preliminary discussions could reduce the political costs; however it should still prove difficult to commit to a primary fiscal surplus that includes pension and labor reforms. The IMF relations are important for providing a credibility boost on economic policy management and access to credit (minimum of the $12.32 billion remaining of the current program) for a country that will struggle with large gross financing needs post restructuring.

Is it possible that negotiations with external bondholders commence prior to an IMF agreement? The recent headlines suggest that there have already been “friendly” bondholder proposals and informal discussions with the Fernandez team. The market cannot rule out preemptive debt restructuring that only focuses on liquidity relief; however it would require high exit yields on the still heavy debt burden and the uncertainty of medium term debt repayment capacity. This would still allow for potentially much higher recovery value compared to current prices–around 65 under assumption of coupon step up/accrual similar to the Discount bond, 15-year maturity extension, 5-year amortization structure with 14% exit yields. This would also imply more difficult IMF negotiations that emphasize more rigorous fiscal adjustment that reassures for medium term debt repayment capacity.  There is a clear debate on whether it’s a liquidity crisis—politician’s narrow focus on near term problems—or a solvency crisis—a more realistic medium term assessment after pronounced foreign exchange weakness and downside risks to trend GDP growth.  Meanwhile, bond prices remain in a consolidation range awaiting clarity from the Fernandez team post elections on how efficiently and effectively they can manage the economic transition and difficult internal negotiations with politicians as well as external negotiations with creditors.

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