Some Thoughts on Recent Argentina Developments

new argentinaArgentina has been in the news this week.  Whilst MSCI delayed its decision on reclassifying Argentina, the nation was still able to place $2.75 bln of 100-yaer bonds even as the economy emerged from recession.  We remain positive on the medium-term outlook, and believe that foreign investors should continue to build up Argentine exposure. 

POLITICAL OUTLOOK

President Macri has done a commendable job of addressing the economic woes since being elected in October 2015.  He quickly floated the peso and eliminated capital controls.  While these moves were necessary, the resulting inflation, austerity, and recession have hurt Macri’s popularity.  There have been numerous strikes by organized labor.

Mid-term congressional elections will be held in October.  Half the seats in the 257-seat lower house and a third of the seats in the 72-seat upper house will be contested.  The ruling Cambiemos coalition currently falls short of holding a majority in both houses of congress.  While most political analysts see Cambiemos as unlikely to gain a majority in either house, any net gain in seats would be taken positively.  A loss of seats would weaken Macri’s hand in terms of further economic reforms.

The next national elections will be held in October 2019.  As such, the midterm elections will be a good barometer of the national mood.  Recent polls suggest Macri’s popularity is rising again.  More importantly, it appears that former President Fernandez remains highly unpopular.  She recently created a new party called Citizens Unity and will compete in the October elections.

The Justicialist Party (PJ) that was founded by Juan Peron has splintered.  The so-called Front for Victory (FPV) is the center-left wing of former Presidents Kirchner and Fernandez.  On the other hand, PJ dissident Sergio Massa formed his own center-right Renewal Front to run for president in 2015.  Massa came in third in the first round and then threw his support for the second round of voting behind Macri instead of Scioli (Fernandez’ hand-picked successor).

 

ECONOMIC OUTLOOK

The economy is finally recovering.  After contracting-2.3% in 2016, GDP growth is forecast by the IMF to accelerate to 2.2% in 2017 and 2.3% in 2018.  Bloomberg consensus is more optimistic, with growth seen at 2.8% and 3.0%, respectively.  GDP rose a stronger than expected 0.3% y/y in Q1, the first positive reading in a year.  Yet unemployment remains stubbornly high at 9.2% in Q1.

Price pressures appear to have topped out, with CPI decelerating to 24.0% y/y in May from 27.5% in April.  A new, improved CPI measure was introduced last year, replacing the untrustworthy measure installed by former President Fernandez.   The central bank and the statistics agency INDEC have regained operational independence under Macri.

Since the 7-day repo rate became the policy rate in January, Argentina hiked rates 150 bp in April to 26.25% currently.  If disinflation continues, the tightening cycle has likely ended.  Next policy meeting is June 28 and no change is expected.

Fiscal policy has improved after years of populist spending sprees.  Costly energy subsidies were reduced, while distortionary export taxes were eliminated.  The primary federal deficit (ex-interest payments) is forecast by the IMF to narrow to -4.5% of GDP in 2017 and -3.6% 2018.  However, there are upside risks if Macri loosens up spending ahead of the fall midterm elections.

The external accounts bear watching.  Low commodity prices and recession in the biggest partner (Brazil) have hurt exports, but homegrown recession helped reduce imports.  The current account deficit was about -3% of GDP in 2016, and is expected to remain steady in 2017 before widening to around -3.5% in 2018.

Foreign reserves have fallen recently after rising steadily over the course of 2016 to peak at $50.6 bln in February.  Now at $46.1 bln in May, reserves cover more than 7 months of import but are only about half the country’s stock of short-term external debt.

 

INVESTMENT OUTLOOK

MSCI delayed its decision on reclassifying Argentina from Frontier to Emerging until next year.  Argentina currently has a 20.27% share in the Frontier index.  The decision will be announced in June 2018, and we think it will be reclassified then if President Macri sticks to his economic reforms.  MSCI noted that “Although the Argentinian equity market meets most of the accessibility criteria for Emerging Markets, the consistency and persistence of the relatively recent changes as measured in practice still remains to be assessed.”

Before yesterday’s spike up to near 16.50, USD/ARS had traded largely in the 15-16 range since last September.  That spike came on disappointment that MSCI did not reclassify Argentina from Frontier to Emerging Market.  However, the pair fell as yesterday wore on and closed near the lows of the day.

The peso has done better after an awful 2016 but continues to underperform.  In 2016, the worst performer was ARS (-18%).  The next worst were TRY (-17%) and MXN (-16%).  So far in 2017, ARS is -2% YTD and is ahead of only the worst EM performer BRL at -2.3%.  Our EM FX model shows the peso to have VERY WEAK fundamentals, so this underperformance is likely to continue.

Argentine equities are outperforming after a poor 2016.  In 2016, MSCI Argentina rose 2% vs. 7% for MSCI EM and -1% for MSCI Frontier.  So far this year, MSCI Argentina is up 41% YTD and compares to 18% YTD for MSCI EM and 13% for MSCI Frontier.

Argentina just issued a 100-year USD-denominated bond.  A total of $2.75 bln was placed with a coupon of 7.125%.  The deep 10% discount pricing resulted in a yield of 7.90%, and helped keep the modified duration relatively low.  Argentina is just the second EM nation to issue 100-year debt, the other being Mexico.

Argentine bonds have outperformed this year.  The yield on 10-year local currency government bonds is about -258 bp YTD.  This is the best in EM and way ahead of the next best performers Indonesia (-109 bp), Turkey (-93 bp), and Peru (-81 bp).  With inflation likely to continue falling and the central bank likely to start easing in H2, we think Argentine bonds will continue outperforming.

Our own sovereign ratings model Argentina’s implied rating steady at B/B2/B after falling a notch last quarter.  This suggests little upgrade potential for actual ratings of B/B3/B.