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Argentina | Costs of impasse outweigh gains

| June 5, 2020

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 has entered its final phase of negotiations with bondholders. The last stage might be the hardest. Economy Minister Martin Guzman may only slightly improve the offer to bondholders to around 50 while the stronger joint bondholder groups rely on their leverage to insist on a higher recovery value around 55 to 60. It seems odd that such a small margin on medium-term debt could create an impasse, but tensions are high after aggressive back-and-forth negotiations. The tense relations may start to harden ideological positions. Despite the apparent pushback from Minister Guzman, the bottom line is that Argentina’s President Alberto Fernandez makes the final decision. If he wants a deal done, then it should be done. The economic costs of an impasse at this stage far outweigh the political gains.

There has been some breathing room as financial markets focus on negotiations and interpret Argentina’s current default as only temporary.   If progress stalls, there is an automatic self-reinforcing mechanism that motivates both sides to cooperate. Otherwise, the parties risk the backlash of lower Eurobond prices and weakness in domestic financial markets that may compromise funding or increase USD demand.  The local headlines show the debate about closing the transaction with minimal participation and coercive tactics.  The risk and reward of this strategy seems poor, with high legal risks and high holdouts, especially if the joint creditor committees motivate holdouts far beyond their 30% representation.

Its worthwhile remembering the initial warning from creditors: “It’s not 2005! Bondholders are well-organized, well-intentioned and well-informed about what Argentina can afford while addressing its current financial challenges.”  The near-term risks are much higher for Argentina as signaled by recent liquidity and economic activity indicators and increasingly desperate foreign exchange and capital controls.

The final minor concessions to bondholders seem a reasonable tradeoff to avoid severe economic recession. The restructuring delays have been costly for Argentina with around $100 million in daily foreign exchange intervention and net foreign exchange reserves slowly decreasing by $1 billion to reach $10.4 billion through end May, or less at $6.5 billion excluding gold and SDRs. The excess ARS liquidity remains a concern with M2 approaching 100% year-over-year expansion at the end May, especially as the restrictions eventually loosen on the quarantine lockdown. The primary source of this liquidity expansion is deficit monetization and insufficient central bank sterilization. The central bank has since resorted to increasing interventionist measures with newly imposed foreign exchange restrictions that have allowed central bank USD purchases of $525 million since May 29. However, these capital restrictions provide only temporary relief by forcing companies to first draw down USD held abroad to pay external liabilities while Fitch warns about “significant risks to corporate issuers’ liquidity” and higher burden on domestic based corporations.

The economic activity numbers are predictably dismal with a 11.5% year-over-year decline in March EMAE, reflecting the coincident demand and supply shocks. The latest REM survey predicts a 7% economic recession this year. The Fernandez administration has been surprisingly popular through the global pandemic. However it may be increasingly difficult to defend popular support against a more intense or prolonged economic crisis with an unresolved debt crisis and rising social pressures.

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