The Big Idea
A compromise on gradualism
Siobhan Morden | June 3, 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.
Prices on Argentina’s sovereigns have become stuck in a range for the last few months with investors watching the country’s liquidity and solvency. There are clear structural imbalances made more vulnerable by the latest round of external shocks. The shocks have undermined investor sentiment and weakened the external imbalance. This does not suggest a break with the International Monetary Fund. Local headlines suggest that the IMF seeks some reassurance on future fiscal targets that look increasingly more challenging after this first relatively easy IMF review. With this as background, investors should focus on carry returns, especially on the step-up coupons of the ARGENT’38 and ARGENT’41.
It should be an easy sign-off for the IMF on Argentina’s performance based on March data. However, the IMF staff probably wants some reassurance that the program won’t derail on the next reviews. The tensions should run high with push and pull on both sides due to the difficulty of increasing foreign exchange reserves while also adopting pro-cyclical fiscal austerity under difficult global conditions. This does not suggest a break but rather compromise to avoid IMF default. The IMF loan disbursements are critical for putting repayment of other debt back on a still onerous schedule with no other financing alternatives. These tense relations may soften the country’s fiscal targets or require program waivers, but there has been demonstrated goodwill on both sides to reach a compromise on the economic program. It’s also reassuring that Minister Guzman is clearly in charge on the marginalization of Kirchnerismo within the Fernandez administration. The challenging global backdrop may further weaken an already gradual and weak adjustment program, but this is the necessary setback to avoid the worse alternatives of economic crisis or a policy return to radicalism.
The foreign exchange reserve accumulation was sufficient for the March program review, but the current backdrop suggests a challenge to deliver on a targeted $5.8 billion increase by yearend. The comparisons to last year are not favorable. The ratio of blue-chip foreign exchange rate to the official foreign exchange rate remains at extremes of 80%. That compares to the 88% average so far this year and 68% from January through May 2021. Foreign exchange reserve accumulation has slowed from $5.7 billion January through May 2021 compared to $1.1 billion January through May 2022.
The central bank has adopted a more proactive approach on a faster pace of the FX monthly crawl above 4% in May as well as rate hikes to shift real rates into positive territory. However, this isn’t enough of a shock to alter the structural US dollar supply and demand flows on the external accounts. The policy gradualism is not sufficient to attract US dollar capital inflows or reverse structural US dollar outflows. There have only been two periods of significant foreign exchange reserve accumulation: during the commodity boom of 2006 to 2008 and the Macri debt issuance boom of 2016 to 2018. The structural problem of Kirchnerismo is that exports pay for all of the US dollar liabilities.
Although exports have surged with the rise in commodity prices, it hasn’t been sufficient to compensate for the surge in fuel imports and the cyclical higher demand for tourism and imports due to economic recovery. The weaker foreign exchange rate has yet to curb import demand, growing at 25% year-over-year in April, while the service deficit has ballooned from $2.2 billion on a 12-month rolling basis in April 2021 to $6.7 billion in April 2022. This alone should explain the acceleration of the foreign exchange monthly crawl in May, especially as the seasonal exports also should start to fade and demand for fuel imports should continue. There are not many policy options with typically weak economic growth the primary catalyst for a correction on the balance of payments. The central bank cannot engage in a much faster pace of foreign exchange devaluation without risking an inflationary cycle in the absence of a fiscal anchor. The IMF will need to show some program flexibility to adjust to worse than expected external conditions and instead prioritize spending restraint on ambitious fiscal targets.
This slower pace of foreign exchange reserve accumulation may undermine future debt repayment capacity and validate continuing low bond prices. However, at current prices the carry starts to look attractive on higher coupon bonds like the ARGENT’38 and ARGENT’41. That relies on a high conviction view of a medium-term policy and political transition. Argentina has lagged other high beta sovereigns on the latest bounce in external risk with current prices still at historic lows, the bonds carrying around 11%, positive medium-term optionality and near-term IMF anchor.