The Big Idea
Argentina | Optionality
Siobhan Morden | February 26, 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.
Recent Eurobond performance, with prices retracing to the lows, suggests the markets are leaning bearish on Argentina. The low cash prices have helped defend against the latest US Treasury weakness. More important is whether there is any medium-term possibility of higher prices. The current bond prices in the $30s are deeply discounted at yields now approaching 18%. This creates asymmetric price upside, but timing is critical. Near-zero coupons offer little carry, and there are no signs of a policy shift or significant external shock that might deliver a meaningful improvement to weak liquidity and uncertain solvency.
Argentina suffers from still a huge debt burden of Eurobond, local USD bonds and International Monetary Fund loans. The low Eurobond prices reflect the heterodox policy management that perpetuates balance-of-payments stress and prevents accumulation of foreign exchange reserves needed to make future debt payments. There is a clear mismatch between zero USD assets (net liquid FX reserves) and a roughly $150 billion stock of USD liabilities (USD denominated debt) that require a shift of balance-of-payments from deficit to surplus to rebuild the stock of USD liquidity. The restructuring of Eurobonds and local USD debt last year only provided near-term liquidity relief by creating lower coupons and delayed amortization payments while IMF negotiations also only seek liquidity relief to postpone loan payments. The annual USD payments after restructuring for Eurobonds and IMF loans would still be high at $10 billion to $12 billion a year from 2025 to 2034.
Argentina should eventually reach an IMF agreement to postpone the huge $49 billion cumulative payments, but risk of delays until later this year are worrisome for what it represents – a reluctance to commit to a fiscal anchor and continued heavy reliance on seigniorage that perpetuates high inflation, undermines foreign exchange competitiveness and sustains balance-of-payments stress. There has also been more emphasis on diplomatic politicking—to lobby IMF board support—than on discussing a reasonable economic program that best delivers a favorable growth and inflation tradeoff. The IMF program will also have to update the DSA metrics. It will be a challenge to explain how Argentina can repay these heavy USD liabilities with low growth potential, no commitment to a fiscal anchor and a relatively closed economy with insignificant foreign direct investment, insignificant capital inflows and persistent capital flight.
There are no catalysts to deter policy management away from the isolationist and interventionist public consumption growth model. The IMF program is mostly a political compromise with expectations of only a “light” program while the current stagflation probably won’t punish the Fernandez administration at the midterm elections. This is somewhat of a disservice to other creditors that are subordinated to senior IMF loans and require policy orthodoxy for future debt repayment.
The market expectations REM survey show an economy that only slowly recovers at 2% annual growth after a 10% GDP decline in 2020 with high inflation at 30% over the next two years. The muddling-through stagflation may avert relapse into economic crisis, but the persistence of macro imbalances does not allow for a quick correction to the balance-of-payments stress and slows the pace of foreign exchange reserve accumulation with only a few years remaining until the first amortization payments.
The muddling-through also does not benefit bondholders holding near-zero coupons and a gradual step-up structure for overall low average coupons. The structural low coupons partly explain the high yields with low current yields that deter against “carry trades” and disincentivize long positions. The 15% to 18% yields are not “cheap” if the extremely low current yields reflect no near-term payments and still high uncertainty about medium-term payments. This shifts countries like Argentina and Ecuador into a separate category versus high coupon emerging markets credits. The decision on whether or not to buy Argentina depends on whether the country can steadily improve liquidity ratios to rebuild foreign exchange reserves for stronger prospects of future debt repayment.
The balance of payments is not only a critical determinant of sovereign debt payments but also increases convertibility risk that weighs on corporate and quasi-sovereign debt payments. (The central bank just extended the regulatory FX restrictions that force a restructuring of corporate and quasi-sovereign Eurobonds. This represents a new worse chapter for Argentina default and emphasizes the importance of resolving the balance of payments stress for all Argentine entities).
What could shift the bearish view? There has been frequent reference to the positive external shock of higher commodity prices. However, the higher seasonal agrodollars from April to July may just reinforce the status quo to repay the Paris Club and IMF, postpone program discussions and interrupt foreign exchange reserve accumulation. The 38% year-over-year increase in soy prices in 1Q21 was only sufficient to stabilize foreign exchange reserves. The higher agricultural exports would have to not only finance the Paris Club and IMF payments but also chronic capital flight. The foreign exchange reserve accumulation depends on a narrowing of the gap between the blue-chip foreign exchange rate and the official foreign exchange rate and a virtuous circle that improves investor sentiment with more orthodox policy management and a fiscal anchor.