We have noticed a significant increase recently in client inquiries regarding onshore investing in Argentina. Given the strong demand seen for its recent USD-denominated bond issue against an improving economic backdrop, we believe Argentina will eventually prove to be an attractive destination for local currency foreign investors.
President Mauricio Macri has kept his campaign promises to dismantle the statist economic approach of his predecessors. These moves include easing capital controls, floating the peso, and introducing a more orthodox monetary policy framework.
Quickly addressing the default holdouts allowed Argentina to return to the global capital markets last year with several bond issues. This year, a $7 bln USD-denominated bond issue was met with bids totaling $21 bln. Relations with the IMF have been normalized, with the agency holding an Article IV consultation for the first time since 2006.
Yet these reforms have come at a cost. The economy is in recession, the peso has weakened sharply, inflation has spiked, and government subsidies for energy and transportation have been cut. Some investors are growing concerned that the poor economic showing will delay or derail the reform agenda, which may explain why we haven’t seen significant onshore investing yet despite official efforts to open up the economy.
Polls show Macri’s popularity falling close to 50% from over 71% when he first took office. This does not bode well for Macri’s Pro party in the mid-term congressional election this October, and we need to watch polls closely as the election approaches. We believe that Macri will remain committed to the reform program. Furthermore, as the economy improves this year, Macri’s popularity should edge higher.
There was a minor cabinet shuffle in December. The new Treasury Minister Dujovne is widely considered to be a fiscal hawk, which we believe sends a strong signal that Macri will stick with his unpopular austerity measures despite his falling popularity.
The economy is in recession but this should end in 2017. GDP growth is forecast by the IMF to accelerate to 2.7% in 2017 from -1.8% in 2016. The agency sees growth remaining close to 3% over the next several years through 2021. GDP contracted -3.8% y/y in Q3, while data so far in Q4 show growth tracking around -3.3% y/y.
Price pressures are falling, with Buenos Aires CPI decelerating to 41% y/y in January from 44.8% in December. This is the lowest rate since April. Still, it seems too early to expect a resumption of rate cuts until inflation falls a lot more. The IMF does not see single digit inflation until 2021. A new national CPI measure was introduced last May, but a lack of historical data has led many to use the Buenos Aires measure for now.
The central bank moved to a new benchmark interest rate (the 7-day repo) as part of its move to a more traditional monetary policy framework. This rate has been kept steady, and but easing seems unlikely this year due to high inflation. Previously, the central bank’s main policy tool was the interest rate on its 35-day Lebac note.
Fiscal policy has been tightened but more needs to be done. Under the previous two administrations, subsidy costs led the budget gap to balloon. Macri has eliminated or reduced many subsidies, but the recession helped widen the budget gap to an estimated -7% of GDP in 2016. The budget deficit is expected to remain near -7% in 2017 before narrowing to -6% in 2018 and -5% in 2019.
The external accounts bear watching. Lower commodity prices have hurt exports, but the recession helped reduce imports. The current account gap is estimated to have narrowed from -2.5% of GDP in 2015 to around -2.3% of GDP in 2016. The IMF sees the gap widening back to -3.2% in 2017 and then to around -4% by 2019 and 2020.
Foreign reserves remained fairly steady at around $30 bln for most of 2016, but jumped to $37.2 bln in October and then to $46.9 bln in January. The increases were due largely to large-scale bond issuance as well as a tax amnesty program. Reserves cover more than 8 months of import and fully cover the stock of its short-term external debt.
The peso continues to underperform after a poor 2015 and 2016. In 2015, ARS lost -35% vs. USD. This was by far the worst performer in EM, followed by BRL (-33%), ZAR (-25%), COP (-25%), and RUB (-20%). In 2016, ARS lost -19% vs. USD and was again the worst performer, followed by TRY (-17%), MXN (-17%), and CNY (-6.5%). So far in 2017, ARS is up 1.3% YTD and is in the bottom half of the EM pack.
The peso has stabilized in the 15.50-16.00 range since late November. With inflation remaining high and the US dollar rally seen resuming, we believe the peso will come under pressure again. Our EM FX model shows the peso to have VERY WEAK fundamentals, so this continued underperformance is to be expected.
Argentine equities have outperformed this year after a decent 2016. In 2016, MSCI Argentina was up 2% while MSCI Frontier was -1%. So far in 2017, MSCI Argentina is up 25% YTD and compares to an 8% YTD gain for MSCI Frontier. We believe that as the government continues to open up the nation, strong growth prospects will attract foreign equity investment.
Argentine bonds have outperformed. The yield on 10-year local currency government bonds is about -215 bp YTD. This is the best performer and is ahead of next best performers Brazil (-82 bp), the Philippines (-38 bp), and Indonesia (-36 bp). With inflation likely to continue falling, we think Argentine bonds will continue outperforming.
Our own sovereign ratings model shows Argentina’s implied rating at B/B2/B. We view Fitch’s B rating as right on target, but believe there is upgrade potential for S&P’s B- and Moody’s B3 ratings.