Argentina | Paying for longer

Siobhan Morden | March 8, 2024

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.

For potential returns on Argentina Eurobonds, keep your eye on upfront payments in a multi-year process of resolving macro imbalances. Argentina was one of our top picks heading into this year and so far, 12.3% year-to-date returns have not disappointed. It’s still a highly fluid situation. Argentina needs to reach political consensus on economic reforms, unwind distortive subsidies, lower inflationary pressures and, ultimately, restore a fiscal anchor. This is not easy, especially with continuing social tensions. But there is room for optimism.

The Milei administration has shown unwavering commitment to painful shock therapy. A public awareness campaign is helping. There may be stagflation fatigue but there is also clear recall of bad policy management from prior administrations and consensus for economic stabilization.  The next few months should be critical. Milei will need to leverage political capital for economic reform while unilaterally reducing the fiscal deficit and inflation. This success should allow still for a slow grind higher in Eurobond prices—towards 50 on non-sinking bonds—with increasing possibility of upfront payments and avoiding default next year.

There is palpable optimism about successful fiscal adjustment through this year with not only the determination of the Milei administration but also the broader awareness of the public and the political establishment. There has been an awareness campaign that argues shock therapy is the only way to establish a fiscal anchor. This should provide a few months of goodwill for political collaboration and social tolerance of fiscal austerity, lower growth and the inflationary shock after a realignment of prices.

The political strategy seems to focus on sticks and carrots. Setbacks are met with renewed determination from the Milei administration to seek consensus for deregulation and higher fiscal revenues. Milei has proposed less ambitious bills focusing on income tax and labor reforms after the setback on the Omnibus bill. The political strategy seeks accountability on recognizing past policy failure and agreeing to controversial reforms necessary for restoring a fiscal anchor and a competitive economy. The recent pact with governors recognizes their strategic influence and their need for investment, higher revenues and successful economic stabilization. It should be important to leverage solid approval ratings and show substantial progress over the next few months to reaffirm governability on an economic reform agenda.

Along with political negotiations, Milei will have to make progress on the unilateral effort to reduce the fiscal deficit through tariff hikes and spending cutbacks. The January primary surplus was mostly temporary but still reflects the important commitment to deliver results. The next phase will have to focus on a more collaborative and less regressive fiscal approach. However, the majority of the fiscal adjustment remains unilateral on spending cutbacks. This is why most observers believe an adjustment of at least 3% of GDP is achievable this year. This fiscal anchor is critical for unwinding the excessive peso liquidity and managing inflation expectations. If inflationary pressures peak in March after tariff hikes, then progress on declining headline and core inflation represents the barometer for stable governability. There is also the benefit of the two months of $5.6 billion of foreign exchange reserve accumulation that reinforces the near-term expectations of a stable 2% foreign exchange monthly crawl.  This foreign exchange anchor provides additional anti-inflationary benefit with an unwind in market expectations of any near-term maxi-foreign exchange adjustments.

It’s a fluid process with success depending on meaningful progress in the first half of this year. Success should help sentiment and begin economic recovery with low single-digit monthly inflation towards the end of 2024. The social fallout has been contained with near-term tolerance for stagflation under the buffers from higher relative employment, the social subsidy framework, and the personal dollar savings as well as the marginalization of radical societal and political factions. That said, it’s important that the fiscal adjustment is quick and less regressive with collaboration of burden sharing among the provinces and higher income population.

The economic adjustment program continues to focus on the domestic economic agenda with no mention whatsoever on restructuring of Eurobonds payments. The January coupon payment was a true show of commitment with priority payment to bondholders against extreme cash flow stress of net negative $10 billion in foreign exchange reserves. If the Milei administration wants to restore credibility with a break from past policy mismanagement, then it stands to reason that efforts will continue to honor debt payments into the step-up amortization payments next year. The burden of higher payments next year may be less burdensome under the context of stronger fiscal and external cashflow. Is the additional $4 billion in Eurobond payments worth the setback of another debt restructuring? This stronger legal framework is also important for attracting foreign investment into strategic sectors and shifting towards a private investment-led growth model.

Argentina’s distressed bond prices would benefit not only from upfront payments but higher survival probability on backloaded payments under the success of economic stabilization. The definition of success in 2024 would assume maybe a 3% of GDP fiscal adjustment, single-digit monthly inflation and economic recovery through year-end through an increasingly positive terms of trade shock. This would not only increase the optionality about the sinking fund payments but also increase the survival probability on lower yields of the back-loaded payments. Eurobond prices have already retraced back to post restructuring price highs with the next phase towards normalized yields depend on the execution risks through the first half of this year.