Argentina | Running out of options

Siobhan Morden | November 5, 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.

Argentina’s latest economic data look dismal with net foreign exchange reserves back near their worst historic levels, the blue-chip foreign exchange rate at a historic premium and tense rhetoric about the relationship with the International Monetary Fund. The good news is that Argentina honored its recent $389 million IMF payment. But the country’s cash flow stress should only worsen once the $4.3 billion IMF SDRS are depleted after the upcoming December payment of $1.89 billion to the IMF.

The Argentine representative to the IMF, Sergio Chodos, suggests that talks could extend beyond December. It’s a high-risk strategy to take a tough stance on IMF negotiations. Market sentiment will only fuel more USD demand. The market is expressing a vote of no confidence against failed Kirchnerismo policies and an urgent need for a coherent economic program. The informal deadline is much sooner than the hard deadline of March 22 from the Paris Club agreement for the intense cash flow stress. We have been warning since last summer about the difficulty of IMF negotiations for tough politics, worse economics, hard deadlines, and tight finances. The politics further complicate for the weaker political capital ahead of a potential electoral defeat and internal divisions within the coalition.

The cash flow stress is a clear reminder about the slim policy options for the Fernandez administration.  The December payment of $1.87 billion will nearly deplete the remaining IMS SDR cushion against an unrelenting schedule of $3.93 billion of IMF payments through the end of March.  The election-related stimulus and doubling down on policy heterodoxy only worsens the imbalance in USD supply and demand. Argentina is increasing its reliance on deficit monetization and increasing its reluctance to sterilize pesos from the domestic markets. The negative foreign exchange reserves only feeds into worse investor sentiment and flight into USD while also coinciding with seasonal year end USD demand. There is no other alternative other than to reach an IMF agreement quickly after elections.

The logistics are complicated. Sergio Chodos reminds us that is not just a technical agreement with the IMF staff (a highly technocratic and maybe less political IMF staff under the new leadership of WHD Director Goldfajn) but also a social discussion with Argentina’s congress.  The IMF board will not sign off on the program until there is political buy-in and approval from Argentina’s congress. This approval process could complicate if there is a breakaway from radical Kirchnerismo with potentially an unstable coalition after elections.  The controversy over loan surcharges also complicates with the Fernandez team seeking IMF concessions as a political win to secure domestic support.  The surcharge debate only distracts from the crux of the problem with a deterioration on the central bank balance sheet for the enormous stock of LELIQs. The interest payments have doubled from Jan-Oct 2020 into Jan-Oct 2021 and exceed central bank loans and FX profits as the largest contributor YTD to the monetary base.

The markets remain the enforcement mechanism. Our base case scenario has always been for a political compromise of an IMF program post elections. The recent policy announcements to attract USD inflows look almost desperate at an advance phase of cashflow stress with regulations and market interventionism less effective.  This is not a sustainable strategy over the next 2 years.   The headline risk could accelerate over the next few months as defeated politicians may resort to desperate tactics and cashflow stress worsens.  However, politics should soon be subordinated to the economics with the election cycle the catalyst and the markets the enforcement mechanism.  The worse the market stress the higher the optionality for a moderate policy shift.  Argentina prices in low to mid 30s are sensitive to higher positive convexity as the intensity of the domestic stress forces policy moderation. We reaffirm our preference for higher current yield of the Buenos’37A since carry remains an important component of total returns that equally benefits from any positive convexity as a spread product to the sovereign.