Argentina | The markets as enforcement mechanism

Siobhan Morden | January 7, 2022

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.

The recent presentation from Brazil’s Minister of the Economy, Martin Guzman, looked more like political theater than a technical discussion of an economic program.  It was always going to be difficult to reconcile Kirchnerismo and the International Monetary Fund under the pressure of tight deadlines and difficult logistics.  But the presentation seemed a defiant defense of a failed economic model. The market has responded, and it is not encouraging.

Argentina has no leverage for now. There is no alternative isolationist path that would deliver economic stability. Everyone remembers the corralito. It is not clear what political game Minister Guzman is playing, but the markets remember recurring crisis in Argentina and remain an enforcement mechanism. The knee-jerk negative reaction after the presentation provides a reminder. It looks likely that either an IMF program or an economic crisis catalyzes political crisis. There seems no other viable alternative than a compromise solution with the IMF by the end of March.

The market assessment on Argentina shifts to game theory.  Neither counterparty benefits from a default on IMF loans, with both lender and creditor at risk for the large $37.8 billion outstanding. The latest state of play shows stubborn deal risk with high tensions and fundamental disagreements. This could definitely play out until the March deadline.  The crux of the problem is fiscal policy, with Argentina insisting on a failed public consumption model and the IMF requesting a faster pace of fiscal adjustment.  Perhaps Minister Guzman may need to push for concessions from the vilified IMF as a requirement to reach political consensus from within Kirchnerismo.

It’s important to remember that Minister Guzman has to balance domestic political and economic objectives. The presentation showed a clear strategy to discredit the IMF and the Macri administration for the failed program in 2018-2019. There was also a focus on the heavy debt maturities, but reluctance to admit that Argentina has been overborrowing to finance public spending. The best reference in the presentation was the question of “Why an IMF program?” and the simple answer was to disburse funds to repay the loans from the Macri administration. There was no admission that an IMF program was necessary for restoring investor confidence. There were also no specifics on the opposing paths for fiscal adjustment; however, local headlines suggest debate over the initially proposed 3.3% of GDP primary fiscal deficit in 2022 and a counter-proposal of a deficit closer to 2.5% of GDP and only reaching primary fiscal balance in 2027.

Argentina insists that fiscal gradualism will allow for sustainable economic growth. There is an unwillingness to adopt pro-cyclical fiscal austerity. There is skepticism that an IMF program wouldn’t deliver a sufficient positive shock and mitigate the downside risks to growth.  That specific criticism is warranted.  However, an economic downturn is now probably unavoidable with an IMF program the best of the difficult options.

There is a failure to recognize that fiscal laxity and deficit monetization dampens investor sentiment, encourages US dollar demand and further undermines economic stability.  Argentina has now reached a mature stage of policy failure with few if any alternatives. Access to external credit is restricted, and it has zero stock of US dollar assets and continuing negative cashflow.  There are sizable IMF payments through March just as net liquid foreign exchanges reserves make new lows of -$6.1 billion on 12/23/2021. The hard truths are that the public consumption model doesn’t work, and market interventionism doesn’t work. This is especially the case for countries with repetitive crises from policy mismanagement. The market participants are quick to react with a flight to US dollars and, in acute cases, a withdrawal of US dollar bank deposits that only accelerate economic crisis.  The market sentiment is particularly sensitive at an advanced phase of balance of payments stress.

The IMF program is the only viable anchor to avoid a full-blown foreign exchange crisis of confidence. How could the political establishment not remember the corralito? The markets remain an enforcement mechanism with a clear memory of repetitive crises. The initial negative reaction serves as a reminder about the channel of financial contagion to real economy contagion. And policy alternatives as capital controls typically only accelerate US dollar demand.  It’s either an IMF program or a worse economic crisis that undermines governability.  The foreign exchange reserve accumulation has to occur under the context of a rational economic program that commits to fiscal discipline. If there is no commitment to an IMF program and fiscal discipline, then there is no obvious path of stable (say 2%) GDP growth that allows for passive fiscal adjustment.

The noisy headlines may persist; however, the political theatrics should soon shift to serious negotiations as the IMF loan payments escalate through March. There should be sufficient awareness among the Fernandez administration at what’s at stake between normalized IMF relations and default.  If the IMF doesn’t capitulate (and probably won’t) then Argentina will have to reach a compromise on fiscal adjustment. The perverse logic still holds as it gets worse it should get better.  The market stress should continue to reinforce discipline among the political establishment to reach an agreement. The politics are now subordinated to the economics.