Argentina | State of play

Siobhan Morden | October 15, 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.

There has been a flurry of headlines about current International Monetary Fund negotiations with Argentina. It’s mostly noise. A formal IMF program later this year or early next is still the most likely path. The Fernandez administration may want to alter the international infrastructure, but it’s isolationist approach gives it limited geopolitical influence. The more important discussions for bondholders and Argentines alike focus on the context of the economic program. This should determine the extent of any relief rally in the country’s sovereign debt and the amount of upside from recent price lows. The talks are now entering a more interesting phase with Argentina’s cash flow stress expediting discussions for an IMF program following November elections.

The negotiations are now divided between a political and an economic agenda.  The majority of the headlines focus on what Argentina requires from the IMF in repayment terms.  This represents an important political strategy for Kirchnerismo. The administration needs to market an IMF program to its constituents and capitalizing on lower debt service. The stumbling block is the controversy around surcharges on the 1,100% quota of IMF loans.  The request for temporary relief seems reasonable based on a track record of IMF goodwill to relieve financing stress following pandemic.

“The lender charges a rate of 200 bp, on outstanding loans above 187.5% of a country’s quota, growing to 300 bp if a credit remains above that percentage after three years.” (https://blinks.bloomberg.com/news/stories/R0K5WET0G1KW).

There are tough politics and logistics to encourage the IMF board to alter these surcharge fees. There has been no apparent progress on this controversial topic with the IMF defending these charges and defending its balance sheet. Despite this setback, the forfeited cash flow savings isn’t sufficient to thwart negotiations. Argentina’s precarious liquidity requires an IMF program.

The IMF agreement is both an economic and political decision for the Fernandez administration and, as such, explains the delegation of Finance Minister Guzman and Interior Minister Manzur to meet with IMF officials.  This will expedite logistics since the IMF agreement will require legislative approval prior to final sign off from the IMF board. The delegation also anticipates unrelenting IMF payments heading into next year. The economic discussions are much more relevant for bondholders on how much flexibility Kirchnerismo will concede on fiscal austerity and relative price adjustments. Let’s be clear: there is no context for shock therapy; a negotiated IMF program is more of a political compromise to avoid default than an economic solution.  The push-and-pull between the disparate ideology of the Fernandez administration and the IMF staff suggest an unprecedented flexible program with room to phase-out market interventionism and overall gradual adjustment.  It’s also important to remember the recurrent elections cycles only allows for unpopular adjustment every other year. Next year is the only year that will allow for fiscal austerity and price adjustments ahead of 2023 general elections.

The latest announcements from Minister Guzman confirm high level IMF meetings in Washington and progress on negotiations.  There have been no specifics yet on the economic terms, though presumably negotiations must be advanced to reach a final agreement late this year or early next year. There is no chance of reverting back to the initial DSA guidelines from March 2020, however there should be pressure to unwind the election-related fiscal stimulus and price repression. This would require a one off, say 20% adjustment, on the official foreign exchange rate and back to a 3% monthly foreign exchange crawl.  It would also require a dismantling of all other price controls and unwinding the fiscal stimulus from the fourth quarter of 2021. The initial rhetoric shows no commitment to any maxi-adjustment that doesn’t conform with the 2022 macro guidelines within the budget (3.3% of GDP primary fiscal deficit and 131.1 end-2022). The slow pace of fiscal adjustment implies still reliance on foreign exchange as an inflationary anchor. The only effective recipe is a reversal towards a fiscal anchor that allows for greater foreign exchange flexibility. They’ll have to unwind the worst of the heterodox measures and limit central bank deficit monetization and reduce price controls.  How soon will authorities commit to a primary fiscal surplus of 1% of GDP?  The 3.3% of GDP primary fiscal deficit in 2022 is far from the original projections of fiscal balance under the earlier DSA metrics.  The compromise may just reaffirm a gradual fiscal adjustment, less price repression and accelerated foreign exchange monthly 3% crawl without any near-term shocks.

The balance between the blue-chip foreign exchange rate and the official foreign exchange rate is probably the best barometer of the macro imbalances with an elevated 95% differential far from 55%-65% earlier this year. This differential would have to narrow probably closer to 30% or less for a more favorable USD supply/demand equilibrium necessary to accumulate foreign exchange reserves.  Will the IMF program in itself prove a sufficient credibility shock to reduce US dollar demand sufficient to accumulate foreign exchange reserves at an annual pace of $5 billion?  The IMF program represents a political compromise to avoid IMF default as opposed to a coherent program that prevents Eurobond default. We assume upside gains for Eurobonds but not a normalization of yields from distressed levels. This is why we prefer the higher carry alternatives and proxy trades to the sovereign that benefit from positive convexity but offer higher carry as an important component of total returns.