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Argentina | Holding pattern

| January 22, 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.

Argentina has had a welcome liquidity reprieve for the past few weeks, thanks to higher soy prices, but no clarity yet on talks with the International Monetary Fund ahead of the March soft deadline. The reprieve probably adds to some complacency, complicating IMF negotiations. The crux of the problem is the high programmed primary fiscal deficit of 4.5% of GDP this year. Argentina Eurobonds have underperformed month-to-date but are still off the December lows. The more important influence remains the external liquidity stress and IMF negotiations over the next two months. There is potential for renewed tension and higher a deal risk premium on Eurobonds if complacency from higher commodity prices postpones a formal IMF program.

The full-year fiscal data for 2020 came out recently confirming a primary deficit of 6.5% of GDP and nominal deficit of 8.5% of GDP.  The 2021 budget reflects only a gradual improvement to a primary deficit of 4.5% of GDP. It reflects continuing commitment to high public spending as an engine for economic growth. Although the primary deficit declines from 6.5% of GDP to 4.5% of GDP, the budget clearly shows stimulus even after excluding the extraordinary Covid-related spending.  The primary deficit in 2021 shows a 25.8% year-over-year contraction; however excluding one-off Covid-related spending, then the deficit actually increases by 33.6% year-over-year with a specific focus on ramping off capex spending.

Who is going to finance this stimulus? Argentina faces insufficient funds to finance public consumption for economic recovery, under-developed local markets and self-imposed restricted access to external credit.  This once again forces reliance on central bank deficit monetization and a potential stalemate with the IMF over the size of the fiscal deficit on whether 4.5% of GDP or 3% to 3.5% of GDP.

There is no other option other than reaching a compromise.  However, there is no obvious compromise on what remains an ideological standoff between the IMF and Argentina.  The early November piecemeal pragmatism has since shifted towards Kirchnerismo and renewed antagonism towards investors (YPF debt restructuring and resignation of Chairman Nielsen) and potential resistance to hike tariffs. There is no room to further delay tariff hikes with the budget already assuming an inflation adjustment for potential savings of 1.6% of GDP. The challenge is not only to hike tariffs but also to identify further savings that are socially and politically feasible on only a slow economic recovery and ahead of October midterm elections. It is not clear that higher commodity prices would in itself provide sufficient relief to the fiscal and external accounts, especially considering the reversal this past week and concerns about weather-related risks. The IMF staff cannot agree to a suboptimal economic program that relies on deficit financing, foreign exchange and price controls, market interventionism and severe macro imbalances that constrain future debt repayment capacity.

There is no other alternative other than reaching an IMF to replace muddling through with a positive direction; however, the timing depends on liquidity management and whether officials can postpone things until after midterm elections. The positive commodity shock perhaps explains the recent $1 billion increase in gross foreign exchange reserves.  However, a formalized IMF agreement is a necessary anchor for investor sentiment to reduce foreign exchange stress on what remains scare and precarious external liquidity. The net foreign exchange reserves are still close to zero while the Blue Chip-official foreign exchange rate differential remains wide against heightened inflationary pressures. It would be a higher risk strategy to postpone an IMF agreement beyond March and allocate scarce resources for the $2.1 Paris Club payment in May and $2.9 billion in cumulative IMF payments prior to October elections.  The positive commodity shock has not yet been sufficient to accumulate sufficient foreign exchange reserves to repay these obligations while macro distortions persist on a wide Blue Chip-official foreign exchange rate differential, foreign exchange price distortions and high fiscal deficit.

The commodity windfall may prove a disincentive to postpone IMF negotiations and undermine motivation for policy orthodoxy that is required for a cycle of foreign exchange reserve accumulation and lower discount rate on future debt repayment capacity.

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