Argentina | Muddling through

Siobhan Morden | January 8, 2021

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.

The close of 2020 brought some welcome relief to Argentina’s balance of payments stress and helped lift its Eurobonds. The country’s central bank accumulated $1 billion in gross foreign exchange reserves, and both liquidity indicators and Eurobond prices improved.  Some thanks likely goes to seasonal year-end tax demand for Eurobonds from local investors.  But for investors asking whether this represents a reversal towards a sustainable equilibrium in Argentina, the answer, unfortunately, is “no.”

The New Year brings renewed pressure to the supply and demand for US dollars in Argentina while International Monetary Fund talks pose the most important challenge. Argentina needs to resolve structurally high spending and foreign exchange and price misalignments. There has been no policy shift towards fiscal discipline as the necessary anchor for an IMF program, and Argentina perhaps has focused more on what it wants from the IMF than what the IMF wants from Argentina. Liquidity ratios remain precarious while officials continue to rely more on ineffective foreign exchange controls to manage the balance of payments deficit.  The risk is for an unwind of the recent Eurobond price gains on renewed balance of payments stress and high deal risk on IMF negotiations.

The liquidity indicators benefited from seasonal ARS year-end demand with the central bank able to accumulate near $1 billion in gross foreign exchange reserves. This also allowed for an increase in private sector bank deposits in sync with an overall reduction in financial market stress. However, the blue-chip foreign exchange rate differential remains at worrisome levels of 76% while net liquid foreign exchange reserves remain in negative territory at -$1.3 billion on December 23.  The recent policy announcements continue to rely on foreign exchange controls with new restrictions on luxury imports and fixed utility tariffs for the next three months as well as restrictions on corn exports. There has been no commitment to unwind excess ARS liquidity or improve the central bank balance sheet. The country still depends on central bank financing.  This remains the crux of the problem and the stumbling block on IMF negotiations.  It is a tight March or April deadline to normalize IMF relations and postpone payments ahead of the bulky $2.1 billion May Paris Club payment.  The IMF talks are the primary event risk for Argentina; viewed as a potential anchor for investor sentiment with policy revisions that could perhaps allow for a sustainable muddling through scenario or conversely prolonged delays on reluctance to commit to a sustainable economic program.

Argentina’s underfunded 2021 budget remains the primary concern with overly optimistic expectations of domestic funding capacity. The baseline for IMF talks will likely require that authorities reduce the primary fiscal deficit of 4.5% of GDP closer to 3% of GDP.  There is declining policy flexibility given slow economic recovery and a relapse of mobility restrictions.  The Google mobility index shows consistently that Argentina is still the furthest from pre-Covid activity levels compared to other countries in the region. Meanwhile, the resurgence in confirmed Covid-19 cases in December risks renewed mobility restrictions. A potential disappointment in revenues and persistent social pressure for Covid-19 relief spending should weigh on fiscal performance.

The Kirchnerismo ideology and approaching election cycle also continue to reinforce populist foreign exchange and price controls with no signs of the early November pragmatism. The high cost of subsidies to private sector companies at 1.6% of GDP in the 2021 budget remains polemic with increasing reluctance to adjust public tariffs heading into the election cycle and potential for higher subsidy burden. It will be difficult for the IMF to accept the 2021 budget. It offers insufficient sources of financing and de facto dependence upon central bank monetization while social and political constraints deter spending cutbacks or tariff hikes.  This sets the stage for difficult IMF negotiations in the next few months.

The assumption is that both sides will be forced to reach a political compromise, but it could look like another nail-biting standoff similar to the final stages of bondholder negotiations last year.  The recent gains on Argentine Eurobonds appear vulnerable to a retracement. The market could see a reversal to less favorable seasonals and renewed liquidity pressure as well as high deal risk on IMF negotiations.  Argentina Eurobonds have a low correlation with external risk for near zero coupons that do not benefit from the risk-on demand for high carry and instead require a coherent economic program that allows for future debt repayment.