FINANCING THE FUTURE
The Investor Argentina 2018 I Finance I Analysis
“ARGENTINA HAS UNDERTAKEN A COURAGEOUS ECONOMIC TURNAROUND, IMPROVING ITS ATTRACTIVENESS TO DOMESTIC AND INTERNATIONAL INVESTMENT.”
After taking office in December 2015, President Macri floated the peso, scrapped most taxes on exports and reduced energy and transport subsidies in an effort to restrain a rising budget deficit. The economy is now moving in the right direction. It has recovered from a recession that began in 2015 and is expected to grow 2.5% this year. Inflation has fallen by more than a third from its peak of around 40% in July 2016. The IMF predicts that the primary budget deficit (excluding interest payments on debt) will shrink from 4.8% of GDP in 2016 to 1.9% by 2020.
President Macri’s main macroeconomic decision has been to reduce the budget deficit gradually rather than abruptly. The pension reform, for example, is expected to save the government the equivalent of 0.5% of GDP this year. This biggest change to the pension adjustment system in this bill is a proposal to modify the formula the way calculations for adjustments are made. The proposed that adjustments be based on the INDEC’s Consumer Price Index and trends in the formal labor market. According to various estimates, the existing formula is likely to come to a nominal increase of between 24 and 25 percent in 2018. With the proposed formula, estimates suggest that pensions would see a nominal increase of between 20 and 22 percent. The IARAF has suggested that with the new system, real pensions would grow by 4.6 percent compared to their current levels by December 2019. That would bring pensions back to their highest ever levels, which were reached in September 2015.
Recently, the exchange rate has depreciated significantly amidst declining confidence and capital flight. The authorities have reacted with higher interest rates, exchange rate interventions, an accelerated fiscal adjustment and negotiations with multilateral lenders. Inflation has rebounded due to hikes in administered prices, currency depreciation and higher inflation expectations. This limits household real income growth and, together with weather-related declines in agricultural output, will dent growth in 2018. The gradual reduction of the high fiscal deficit is being accelerated to restore confidence. Recent structural reforms, such as a tax and capital market reforms, a new competition law, improvements in administrative procedures and lower trade barriers in selected sectors are welcome steps to strengthen inclusive growth. Further reforms to foster the integration into the global economy, enhance competition and improve access to quality education could build on this progress.
Argentina is making progress in its path to advance its growth agenda. The next challenges to be met will be strengthening the pillars of a more productive and inclusive economy, reducing poverty and inequality and improving the well-being of all Argentinians. According to the OECD, aligning Argentinian policy settings in these areas with the OECD average could increase GDP per capita by 15% in 10 years, while reforms to align Argentina with Latin American neighbours Chile, Colombia and Mexico would raise per capita incomes by 8.5% over 10 years. Provided that policies ensure a people-centred growth, with specific policies that shield poor and vulnerable households from bearing the adjustment costs of change, these policy reforms could deliver substantial benefits for all Argentinians.
Although orthodox economists grumble about President Macri’s gradualism, Argentine investors seem to endorse it. Private investment is recovering after a decline in 2016, though it is still lower than it should be. It rose 16% last year and is expected to grow by 14% in 2018. Before Cambiemos’s election victory, the rate of return demanded by foreign investors in Argentine infrastructure and energy was double what projects in other Latin American countries paid, it has since dropped to the same level. Investors are betting that Macri and his party can win again in national elections in 2019. There is a good chance of that, in part because more voters still blame the Kirchners for Argentina’s economic plight. He will then have a chance to use the final term he is allowed in office to modernise Argentina’s economy.
Banks have been changing their funding mix and business strategy to anticipate economic growth and credit demand. There are still challenges to the banking sector from the recent economic drama in Argentina but Argentina’s banks are relatively insulated from the drop in the exchange rate. Banks should continue to enjoy the start of a strong positive credit cycle.
ARGENTINA’S FUTURE WITH THE IMF
Argentina was forced to strike a deal with the IMF earlier this year after a sharp depreciation of its currency and a run on the peso. The three-year standby financing deal is aimed at strengthening the economy and helping it fight inflation. Treasury Minister Nicolas Dujovne has taken the lead on the crisis talks with the International Monetary Fund (IMF) to renegotiate conditions of a $50 billion loan -- the biggest in IMF history -- seeking to secure an early release of funds from the three-year relief package, which would allow the government to avoid asking the bond market for financing in the near term.
The IMF has indicated a willingness to accelerate payments and has agreed to re-examine the phasing of the financial programme. According to the rating agency Fitch, the new fiscal measures and efforts to mobilize greater public sector financing were positive steps that may help reduce deficits more quickly than previously expected. Economists at Fitch expect that, if the Macri Administration is successful in these efforts and in rolling over most of its short-term local treasury bills, then it will have covered its financing needs for 2019 at $25 billion in amortizations and $14 billion in interest payments which should keep bondholders confident. According to a recent statement, the IMF fully endorses President Macri’s goals of achieving sustained and equitable growth and restoring market confidence with a macroeconomic program aimed at reducing financing needs and public debt, and protecting society’s most vulnerable during this transition. The IMF understands that while many policies have moved quickly, the government has also been conscious of the need to build and maintain social consensus in calibrating the pace of their reform efforts, including fiscal adjustment. It was well understood that such an approach carried with it certain vulnerabilities.
While most investors believe that policy continuity is crucial if the economy is to normalise, the turbulence roiling emerging markets adds additional hurdles. The country’s short-term debt obligations are a challenge facing the Government. Between this year and next, Argentina has roughly $50 billion of peso and dollar-denominated debt coming due. The bulk are peso-denominated Lebacs, which are fixed-rate bills issued by the central bank with yields as high as 52 percent.
Following monetary tightening in December 2015, investors focused into these instruments, which have maturities as short as 35 days. At its peak, the amount of Lebacs in circulation exceeded $60 billion, although the market has since shrunk to about $21 billion. Unwinding the stock of short-term Lebacs is an important condition of the IMF’s package. Recently, the central bank announced it would eliminate them by year-end and is encouraging banks to invest in longer-dated, peso-denominated instruments instead. In an effort to restore public confidence in its economic management, President Macri has decided to make changes in its economy team which were well received by the market. The President merged the economy and finance ministries into a single portfolio led by Nicolás Dujovne, and appointed the previous finance minister, Luis Caputo, as the new head of the central bank (BCRA) following the resignation of Federico Sturzenegger. According to Minister Dujovne, meetings with the IMF have been productive and the progress is regarded with enormous confidence.
A RESURGENT ECONOMY
A strong economy should help the movement towards a more competitive market. After swinging between positive and negative growth numbers over the past five years, gross domestic product (GDP) now appears to be on an upward trajectory. Despite still representing only about 1% of Argentina’s GDP, mortgages had nearly doubled in the 12 months to February 2018, according to the country’s central bank. It is instructive to compare this with neighbouring Chile, Latin America’s deepest financial market, where the mortgage rate is more than 20% of GDP. At 14% of GDP in 2016 – also low compared with Chile’s 81% or Brazil’s 62% – overall bank loans to Argentina’s private sector are growing too. Argentina remains one of the most profitable banking markets in Latin America, with average return on capital of 43.22% in 2016.