Macri Gets the Green Light to Continue Reforms

new Argentina

Argentine President Macri’s Cambiemos alliance won the mid-term elections.  This bodes well for the reform effort and the economic outlook, as confirmed by S&P’s upgrade to B+ yesterday.  The central bank is adding to the orthodox policy mix, surprising the markets with a rate hike last week. 

POLITICAL OUTLOOK

Argentina President Macri’s Cambiemos alliance was the winner of the congressional mid-term elections.  Cambiemos won the five largest electoral districts, including important Buenos Aires province.  There, Macri’s ally Esteban Bullrich defeated ex-President Cristina Fernandez de Kirchner in a victory that should help Macri’s reform agenda advance.  At the national level, Cambiemos won 13 out of 24 provinces with close to 42% of the total vote.

The next national elections will be held in October 2019.  Cambiemos still does not have a majority in either house of Congress, and so will look to build on its midterm victory then.  Fernandez still won a Senate seat on the strength of the party vote, and her continued presence will be an unsettling reminder of Argentina’s recent past.  However, we think Macri’s support will gain as the economy recovers ahead of the elections.

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 dented Macri’s popularity.  Macri just presented another round of economic reforms, taking the opportunity afforded by Cambiemos’ midterm win.

Argentina scores low in the World Bank’s Ease of Doing Business rankings (116 out of 190 but up from 118 last year).  The best sub-categories are enforcing contracts and protecting minority investors, while the worst are paying taxes and dealing with construction permits.  Argentina does slightly better in Transparency International’s Corruption Perceptions Index (95 out of 176 and tied with Benin, El Salvador, Kosovo, Maldives, and Sri Lanka).

ECONOMIC OUTLOOK

The economy is emerging from recession.  GDP growth is forecast by the IMF at 2.5% in both 2017 and 2018 vs. -2.3% in 2016.  GDP rose 2.7% y/y in Q2, the strongest rate since Q3 2015.  Monthly data so far in Q3 suggests growth around 4.5% y/y, and so we see upside risks to the growth forecasts.

Price pressures are rising, with CPI accelerating to 24.2% y/y in September from 23.1% in August.  Further acceleration is likely in light of the weak peso.  Historical data is limited since the government only recently unveiled this new CPI measure to replace the flawed one used by the previous Fernandez administration in order to understate inflation.

The outlook supports the case for higher rates, and yet markets were surprised that the central hiked rates by 150 bp to 27.75%% last week.  The central bank said that it wanted to counter the gasoline price hikes that just went into effect.  This follows up a 150 bp hike back in April to 26.25%.  We cannot rule out further hikes in early 2018 if the inflation trajectory does not improve.

Fiscal policy has improved.  Macri has just proposed a series of spending and tax cuts that would narrow the deficit and boost investment.  Distortionary subsidies and export taxes have been dismantled, but the recession led to a widening budget gap.  The deficit came in at an estimated -1.1% of GDP in 2016, but it is expected to rise to around -6% of GDP in 2017 before narrowing to around -5.5% in 2018.

The external accounts will likely worsen.  Exports remain sluggish, as soy and wheat prices remain near the lows.  On the other hand, the stronger economy is boosting imports sharply.  The current account deficit was -2.7% of GDP in 2016, and is expected by the IMF to widen to -3.6% in 2017 and -3.7% in 2018.

Foreign reserves have recovered after falling over the course of 2011-2015.  Much of this increase has come from external debt issuance.  At $50.2 bln in September, reserves cover nearly 8 months of import but are only a little over half the stock of short-term external debt.

INVESTMENT OUTLOOK

The peso continues to underperform after an awful 2016.  In 2016, ARS fell -18% vs. USD and was the worst EM performer.  The next worse were TRY (-17%) and MXN (-16%).  So far in 2017, ARS is -10 YTD and is the worst EM performer.  The next worst are TRY (-7%), PHP (-4%), and ZAR (-3%).  Our EM FX model shows the peso to have VERY WEAK fundamentals, so this year’s underperformance is likely to continue.

Over the last several weeks, we are finally seeing some foreign investor inflows into Argentina.  While the amounts invested in local currency instruments so far have been small, we are confident that the inflows will grow over time.

Argentine equities are outperforming after a weak 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 71.5% YTD and compares to 30% YTD for MSCI EM and 23% for MSCI Frontier.

Back in June, MSCI delayed its decision on reclassifying Argentina from Frontier to Emerging until next year.  The decision will be announced in June 2018, and we think it will be reclassified then if President Macri is able to further implement his economic reforms, as we expect.  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.”

Argentine bonds have outperformed.  The yield on 10-year local currency government bonds is -154 bp YTD.  This is the best in EM and ahead of the next best performers Brazil (-153 bp), Indonesia (-112 bp), and Nigeria (-104 bp).  With inflation likely to continue rising and the central bank forced to tighten further, we think Argentine bonds will start underperforming more.

Our own sovereign ratings model shows Argentina’s implied rating at B+/B1/B+.  This is consistent with S&P’s decision to upgrade it a notch yesterday to B+ with stable outlook.  The agency noted that “The rating action reflects greater confidence about the government’s political capacity to continue pursuing its economic agenda, resulting in more predictable economic policy and governance.”  We agree.