The Big Idea
Argentina | Market stress
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 latest stress in Argentina is a reminder of the importance of a coherent economic program backed by the International Monetary Fund after elections. It leaves the country’s sovereign debt with positive convexity. Eurobond prices remain trapped in a narrow range and highly sensitive to the IMF option. There are obstacles: difficult logistics, a tight timeframe, reluctant Kirchnerismo always the main hurdle against pragmatism. But the latest balance-of-payments stress and overall domestic financial market stress may serve as a catalyst. Province of Buenos Aires debt is a leveraged play on this.
The window for market interventionism should become increasingly narrow with rising foreign exchange pressures and macro imbalances throughout the course of the year. The sensitivity of the local markets to the IMF option should reinforce Kirchnerismo pragmatism after elections later this year. This remains one of the arguments for an overweight recommendation for the Province of Buenos Aires as leveraged trade on the positive convexity; it also is a higher carry spread product relative to the sovereign.
The data watch continues to focus on how authorities manage the balance of payments stress. The foreign exchange reserve accumulation earlier this year has since reversed after a small $3.2 billion accumulation through July. The weak policy framework under Kirchnerismo encourages capital outflows and discourages capital inflows and hence increases the foreign exchange sensitivity to seasonal exports or one-off US dollar outflows. The deceleration in US dollar purchases has been unable to finance the IMF payments this month, triggering a subsequent $375 million decline in foreign exchange reserves. There is less firepower to directly manipulate the blue-chip foreign exchange rate, and that explains the higher regulatory intervention. There should soon be a windfall of the $4.3 billion IMF SDR allocation that will finance the IMF debt repayments through year end.
This should provide a buffer through year-end for the cumulative $4.2 billion payments but not much more room to maneuver if we assume a low level of foreign exchange reserves. The cumulative IMF payments reach an onerous $8.1 billion through the end of March 2022 and leaves a narrow window to finalize IMF negotiations after year-end elections. The net liquid foreign exchange reserves, excluding gold and SDR, have only recovered to $1.7 billion through July 31 against a $2.7 billion peak on July 23. The seasonal agricultural exports should start to recede next month with the central bank only able to rebuild $1.7 billion in liquidity despite supportive high commodity prices.
Meanwhile, the macro imbalances remain vulnerable to further stress. The difference between the blue-chip foreign exchange rate and the official rate remains at a wide 84% margin after the recent regulations. It reflects stubborn inflation and high structural US dollar demand. The latent inflationary pressures continue with recent weak auctions and increasing dependence on the central bank for deficit financing. There has been a surge in transfers of central bank “foreign exchange profits” that substitutes the direct loans but effectively represents deficit monetization for election-related fiscal stimulus. The inflation repression only worsens with a slower monthly foreign exchange adjustment and an increasing subsidy burden on marginal tariff hikes. If the Fernandez administration assumes tough negotiating tactics, then the market backlash could quickly force a more conciliatory reversal. The foreign exchange pressures are typically more acute given a history of year end maxi-devaluations. The declining policy flexibility and increasing macro imbalances should force a more pragmatic stance for the Fernandez administration that lowers the deal risk of an IMF program and reaffirms a view of positive convexity for the sovereign and quasi-sovereigns.
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