The Big Idea
Highlights of relative value across Latin America
Siobhan Morden | December 8, 2023
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, Bahamas, Ecuador and Panama. All have undergone major change in the last year and have challenges ahead. Each one occupies a unique place in the constellation of relative value across Latin American sovereigns.
Argentina: Evaluating the upside
There is tough resistance at the ceiling of the well-defined YTD trading range across Eurobonds. However, shock therapy optimism could maybe test to the upside towards post-restructuring price levels. The reasons for optimism under the Milei administration: the clear ideological shift, the high political capital, the policy pragmatism, and the forced austerity under credit constraints of the incoming Milei administration.
There is also another notable takeaway from the current economic crisis: renewed commitment to pay bondholders. The commitment to pro-cyclical fiscal discipline into already acute stagflation will ultimately determine the probability of default and recovery value post restructuring. However, current bond prices probably also underestimate the ideological commitment and binding constraints under the reality of credit restrictions and memory of crisis. The base case scenario has to assume some initial success on fiscal adjustment (spending cutbacks of 3%-5% of GDP) and some reasonable burden sharing for bondholders with recovery value above these historic lows. The initial positive momentum on policy announcements should at least push bond prices outside of the year-to-date trading range to test post-2020 restructuring price levels.
Bahamas: Fiscal target challenge
Officials met the fiscal target for FY2022/23, but this fiscal year’s target looks challenging. There is minimal flexibility at a mature stage of adjustment. Most spending categories have adjusted back to pre-pandemic levels on unwind of subsidies and social spending. But unfortunately, debt service now is much higher at 4.2% of GDP and revenues have stalled at 21% of GDP. It’s not clear how the roughly 4% of GDP fiscal deficit in FY2022/23 will reduce to near balance this fiscal year.
The public debate needs to quickly shift to tax reform (especially for the gross financing needs at 22% of GDP and debt service at 23% of revenues). There has been on/off reference to tax reform but no firm official commitment. The IMF Article IV summary echoes these similar themes. “While the objectives of the authorities’ medium term fiscal plan are laudable, staff assesses that more policy measures will be needed to achieve this targeted adjustment. ” The IMF estimates a fiscal deficit of 2.6% of GDP in 2023 and the trajectory of still high 80% of GDP debt burden through 2025). There is no immediate risk on relapse into crisis for an unblemished Eurobond repayment track record and financing flexibility on the low gross financing needs. There is also no near-term amortization after the January 2024 Eurobond amortization. However, the high debt ratios and cashflow deficit remain vulnerable to latent shocks that validates still high 11% Eurobond yields and maybe higher volatility-adjusted returns for 2024.
Ecuador: Divergence trade
There is a clear contrast between how Argentina and Ecuador respond to their fiscal problems. There are many obvious comparisons for the two new administrations that inherit large 5% of GDP fiscal deficits with few if any financing options. President-elect Milei promises 5%-7% of GDP in spending cutbacks with a quick resumption of the IMF program. President Noboa instead proposes tax cuts with no commitment to an IMF program and no plan on how to finance near-term a large fiscal deficit. Does this then translate into a divergence trade? There was a predictable bounce off the lows of Ecuador bonds with still some optionality to avoid worst case scenarios. However, I still view Ecuador as only a tactical trade with still high implied probability of default beyond 2024 and bond prices trapped within a low trading range until when/if there is commitment towards a medium-term fiscal plan.
Panama: Downgrade risk
Cobre Panama issued a press release warning about all of the environmental and economic logistical issues after a shutdown of their mining operations. However, there hasn’t been any signs of flexibility from the Cortizo administration under still the persistent social and political pressures. Is there still optionality to backtrack after when these problems hit full frontal and reassess the mine closure? It’s hard to assess what has been irrational policy management and dominant social/political pressures. Moody’s has since warned about the fiscal targets for this year and next year while local business organizations discuss downside risks to growth. The consensus is now shifting for a loss of the investment grade rating early next year and de-indexation from investment grade indices next year. There is no rush to buy for a carry trade, especially on the unresolved event risks. This is not only about relative valuations with risk of an overshooting from 1.) disruptive flows, 2.) policy unpredictability on persistent social tension, 3.) an uncertain funding strategy that requires significant new issue premium and, 4.) ultimately the knock-on effect to the high growth/high FDI model. There is no rush to capture only carry returns against other favorable alternatives for either stable credit risk in Colombia or positive credit risk in the Dominican Republic (after recent positive outlook on BB- rating from Fitch).