Argentina | Kirchnerismo constraint

Siobhan Morden | May 7, 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. This material does not constitute research.

Kirchnerismo continues to fully assert its populist ideology in Argentina’s election cycle, and it is difficult to be optimistic about policy moderation. Internal battles have taken their toll on efforts to contain inflation. There is a clear political mandate to contain inflation with voters particularly sensitive to foreign exchange risk and supply-side shocks. This creates larger price misalignments and raises post-election policy risk. Both may ultimately compromise the “asymmetric upside” of a coherent IMF program.  Argentina looks unlikely to default on the IMF but may end up with a highly diluted IMF program that undermines potential Eurobond price gains.  Investors can get a better balance of risk-and-reward in alternatives like the Province of Buenos Aires and other quasi-sovereigns.

The internal struggles on policy management have further weakened an already weak economy minister. The CFK refusal to allow dismissal of the Under Secretary of Energy, after refusing to hike tariffs, clearly undermines the authority of Economy Minister Guzman. This is quite worrisome. The markets have adjusted to the deterioration of policy management and are now in a surprising position of cheering for a weak economy minister when only last year the market hoped for his departure. The crawling foreign exchange devaluation has slowed to 2% month-over-month to anchor the increasing inflationary pressures—4.8% month-over-month inflation in March and cumulative 13% in the first quarter, a threat to the 30% annual target. It is political reality that Kirchnerismo now dominates economic policy management and raises concern about whether Argentina can moderate policy after elections.  Minister Guzman represents an agent for compromise, balancing between Kirchnerismo heterodoxy and IMF orthodoxy and a much better alternative than a Kirchnerista ideologue running the economy ministry.

There is no alternative for Argentina other than reaching an agreement with the IMF since default is not an option and repayment is not an option for the $18.5 billion in loans falling due next year.  This sets the stage for possibly excruciating negotiations, especially considering the inflexibility from Kirchnerismo.  It is incredulous that a group of senators are now asking that the windfall IMF SDR allocation of around $4.3 billion expected in September be used not to repay the IMF but rather go towards current spending. The initiative is now under discussion in the senate and finance budget committee.  The $2.2 billion IMF loan payment on September 22 represents a red line with no context for restructuring and payment the only option.  The worst-case scenario is drawing down scarce USD reserves from the central bank; there are slight prospects for USD accumulation through the next few months of seasonally high agricultural exports.  There are clearly cross objectives with some politicians seeking inward isolation while others including President Fernandez himself are embarking on a diplomatic mission abroad to seek debt relief.  The imminent $2.4 billion payment to the Paris Club is more threatening, but with few if any implications if payments lapse other than punitive repayment rates. The most feasible solution is another 1-year deferment from the Paris Club under the same budget and pandemic constraints as last year.

The debt deferments are the main policy priority for maintaining normal creditor relations. The more complex IMF negotiations could come after elections with opposing Kirchnerista and IMF ideologies.  The resistance to realign prices and foreign exchange rates may be less after elections, but the distortions will be greater. This then builds up to potentially intense negotiations with still latent friction to any maxi-adjustments or typical shock therapy. The risk for bondholders and Argentines alike is that the IMF program is so watered down that it does not provide a coherent economic framework.  If it is a pure political compromise to avoid default and an IMF program in name only, then there is minimal if any upside on bond prices.

The upside for bond prices  is a stable economic framework that reduces distortions, stabilizes the external and fiscal accounts, and allows for a more favorable growth-inflation tradeoff.  The potential for an IMF program is probably the singular driver for asset prices and for bondholder upside.  If the weak economic framework continues, accompanied by persistent balance-of-payments stress that does not allow for foreign exchange reserve accumulation, then there is minimal if any upside for bondholders. This is why investors should focus on the quasi-sovereigns with an investment strategy that either attempts to maximize carry returns or seeks out stronger credits that could avoid recurrent debt default. The Province of Buenos Aires has now reengaged bondholders with the latest deadline expiring May 7 and goodwill to reach an agreement with a majority of investors.  This suggests potential for higher recovery value as well as higher carry returns (or PDI accumulation on protracted discussions) and lower recurrent default risk that translates into lower potential exit yields.