BNY’s Newton IM: Commentary on the situation in Argentina

Aug 14, 2019

By Trevor Holder, Fixed Income Portfolio Manager

Main opposition candidate Alberto Fernandez’s landslide success in Argentina’s presidential primary elections on Sunday has triggered an all too familiar scenario of currency and financial market crisis for South America’s serial defaulter.

“So far it seems authorities’ FX interventions have been limited, but none of the policy options are particularly palatable.

“We see four main options for intervention:

1. Following the partial recovery of the Argentine peso (ARS) from the initial 26% sell-off, the first option would be to leave ARS. However, letting the currency go risks a massive overshoot and inflationary pass through which further damages Macri politically and also potentially challenges the basis of the IMF programme with respect to FX and inflation stability.
2. Hiking interest rates is a further option, but the policy rate (Leliq) is already circa 74%. In a full-blown currency crisis higher interest rates are never enough, and such a move will only deepen Argentina’s economic recession over the coming months.
3. A third option is FX intervention which could help to limit further downside for the ARS over the two month run-up to the elections. But spending USD250m a day intervening (the maximum permitted under the conditions of the IMF programme) would drawdown FX reserves by around USD14bn, effectively squandering three-quarters of the USD 20bn extension to the IMF package granted 11 months ago (total package is USD57bn), and significantly compromise the government’s ability to meet its short to medium term hard currency debt obligations. Macri could turn to the IMF for more firepower, but assuming a Fernandez victory they may be wary of throwing good money after bad.
4. The final policy option that we see would be to introduce capital controls of some form. This would not be ideal, but perhaps preferable to squandering FX reserves.

“FX reserves stand at USD65bn, currently enough to cover the next 3 years of hard currency principal and interest obligations standing at: $15bn in 2019, $20bn in 2020, and $15bn in 2021, a total of $50bn over 3 years. But the sovereign also has the USD equivalent of $17.5bn of ARS denominated debt obligations to meet this year and another $15.4bn equivalent next year and a further decline in the Argentine peso of the magnitude seen so far this week will see the sovereign’s overall debt burden rise towards 100% of GDP.

“Some local currency bonds may be particularly vulnerable to coupon renegotiation, as Mr Fernandez has previously indicated.

“Front end USD bonds are now trading in the high 50s and therefore priced for a significant haircut and Fernandez election victory. Argentina doesn’t have to access the USD bond market this year and investors should monitor the situation with respect to the likely new administration’s broad macro policy agenda and IMF negotiations, which may yet prove more orthodox than investors currently fear. Certainly Mr Fernandez apparent margin of electoral safety and the risks of a pyric victory from further market turbulence now incentivises a more constructive tone from the main opposition candidate even ahead of October’s elections.”