The Big Idea
Argentina | No quick fix
Siobhan Morden | June 25, 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 Kirchnerismo influence has dealt a serious setback this year to Argentina’s efforts to solve its debt problems, and now the market is increasingly focusing on whether the International Monetary Fund serves as a catalyst for a rational economic program after November elections. The quality of the economic program should determine the upside on bond prices. Avoiding an IMF default is worth at least some minimal gains. But more important is whether there is a pragmatic approach to unwinding macro imbalances. That would put Argentina on a faster track to rebuild external liquidity.
The best case is probably for Argentina sovereigns to revert to late 2020 levels of lower but still distressed yields and high default risk. That would reflect the opportunity lost the past three years and the quickly approaching debt payments. There is also the prospect of a shift to moderate pragmatism, but not shock therapy, that will compensate for the years of setbacks to the DSA metrics and for the high default risk.
There has been overwhelming focus on an IMF program as the necessary anchor for economic stability. But negotiations are now firmly delayed until next year. The Paris Club agreement provides breathing room until March 2022 to finalize an IMF program as a pre-requisite for an official Paris Club re-scheduling. The IMF talks over the past months have focused mostly on terms for repayments than on the economic program itself. The discussion with creditors under the Fernandez administration typically prioritizes near-term cashflow relief with a passivist approach towards medium-term future debt repayment. The political pressure of the campaign cycle has prevented against any serious discussions with Minister of Economy Martin Guzman recently denying plans for foreign exchange devaluation after elections.
The price misalignments will increase throughout the year with subsequent higher political costs. There is an obvious campaign strategy to minimize any price shocks with a slower pace of foreign exchange devaluation, price controls and more subsidy burden to avoid tariff hikes. The monthly foreign exchange devaluation has slowed to 2% month-over-month with the foreign exchange typically serving as an anchor against inflation. Recent monthly rates have run above 4% month-over-month. Cumulative inflation of 21.5% through May may soon to surpass the annual 30% inflation target. The BCRA real effective foreign exchange rate at 117 as of the end of June and stubborn 3% month-over-month inflation suggests further overvaluation at around 5% real appreciation through this year.
The subsidy burden is also increasing with economic subsidies at 12% of primary spending from January through May this year. That compares to 10% for the same period last year. The initial promise from Minister Guzman was for energy subsidies to remain flat at 1.7% of GDP in 2021; however, there has been considerable political pushback to adjustments with increasing bias to the upside. This should reinforce the high primary fiscal deficit near the 4.5%-of-GDP target with the commodity windfall financing the higher subsidy burden and still far from the prior target of a trend 1% of GDP primary surplus.
The realignment of relative prices should pose the most contentious debate with the IMF staff. It is worth remembering that it is one year on and one year off on any austerity measures considering the recurrent election cycles. Will Kirchnerismo agree to shock therapy in 2022? If gradualism or minimal adjustment is the base case, then yields will remain trapped in distressed territory on a slow and delayed path towards economic stabilization. The Covid shock and election cycle postpones three years of adjustment with the initial DSA targets now far off track against still high debt burden post restructuring.
Let’s review the damage done with a comparison to the March 2020 pre-Covid DSA liquidity metrics. The gross foreign exchange reserve accumulation at $39.4 billion at the end of 2020 was far below the initial forecast of $50 billion. The indirect foreign exchange intervention and policy of inward isolation has been costly with only YTD $3 billion of foreign exchange reserve accumulation against $6.3 billion of net USD purchases for gross reserves of $42.4 billion versus the $54 billion year-end target. The soy windfall finances the suboptimal policy management with unsustainable repressed inflation and weak sentiment that discourages consumption and investment. The gross foreign exchange reserves were targeted at $64 billion for the end of 2024 to finance the resumption of external debt payments. There are no appropriate parallels to reach a gain of $20 billion in foreign exchange reserve accumulation over the next few years under the constraints of Kirchnerismo ideology and without a sufficient positive external shock.
The bottom line is that IMF negotiations should prove difficult, and a delayed gradual economic program is no solution for quickly approaching debt payments. The quasi-pragmatism of Minister Guzman provides some reassurance; however, it is not clear whether he has sufficient political capital to push through difficult measures, and it is not clear whether Kirchnerismo will shift more pragmatic post elections. There are increasing demands internally and externally for a coherent economic framework that encourages private sector growth. The slow path towards accumulating foreign exchange reserves should reinforce the high default probability for the sovereign; however, less balance of payments stress would provide relief to the quasi-sovereigns and corporates with lower debt burdens. The balance of risk and reward continues to reinforce preference for off-index diversification that offers higher carry returns and relatively stronger fundamentals.