Argentina looked good for emerging market bond lords and distressed asset investors in late 2017. Everyone believed in the government of Mauricio Macri. He was doing the right thing. Argentina was going to come back, and indeed was already returning to the capital markets with welcoming arms. The reception now is getting cold. If not, it should be, and will be soon enough.
“I have seen all of this play out before: the government is using the central bank reserves to artificially inflate the peso and we have pesky high inflation,” says Fernando Pertini, chief financial advisor with Millenia Asset Management, headquartered in Costa Rica. “Argentina’s economic team looks lost,” he says.
Jorge Compagnucci is a perennial Argentine bear if there ever was one. The Merval stock exchange can be up 25% and for Compagnucci, the sky is falling. Compagnucci is the senior analyst for Buenos Aires-based investment research firm TMG Target Market Global. Like long-term wealth manager Pertini, Compagnucci believes the Macri government is running out of time.
It is time to get out of Argentina and sali corriendo. The carry trade has been keeping Argentina afloat. That’s when investors from low interest yielding nations borrow in their home country to acquire debt of higher interest yielding nations. That trade in Argentina is looking less attractive because, no matter what, bond investors still want to see growth and Argentina is struggling to produce any. The economy has been a roller coaster. Up 10% in 2009. Down 2%, up 2%, down 2%, up 2%. You get the picture.
Moreover, a new tax on investors went into effect in April. The government is looking desperate for money. “That took a lot of foreign investors out of the market and local investors sold and bought dollars instead,” Compagnucci says. “With Treasury bonds at 3%, investors are back to worrying about Macri’s finances in the coming months. If the peso keeps weakening, you could see the government take emergency measures to protect it,” he says.
“The thinking is we could see a repeat of 2001 Argentina,” Compagnucci says, something that includes higher taxes and maybe capital controls. Worse: default risk rising.
Argentinians have seen this movie before. High inflation, a strong peso, ballooning debts. In the 1990s until 2001, Economic Minister Domingo Cavallo wanted a strong peso and fixed the dollar at one to one. The debt load went to $63 billion in the 1990s and started the 21st century at $137 billion by 2001. Argentina defaulted. Cavallo was on TV on Wednesday lambasting Macri’s economic team.
Like before, Argentina faces stubbornly high inflation, a strong peso that was unable to bring it down to single digits, and a government that is taking on more debt again. In the case of an economic downturn either in Argentina or globally, Macri will face his biggest tailwind yet.
The central bank has been buying up dollars left and right, especially heading into May. Word is that the bank used it to fund the bulk of the divestment from short-term debt instruments (LEBAC) after cumulative sales of $4.3 billion last week. This aggressive approach should deter any further de-leveraging but sentiment will remain fragile and require careful management of expectations, thinks Siobhan Morden, a Latin America fixed-income analyst for Nomura Securities in New York.
“The Macri administration needs to reaffirm their commitment to orthodox policy management and fiscal adjustment,” she says. “There is not the same improvement on the growth/inflation tradeoff. The persistent threat from the opposition to delay or undermine the tariff hikes poses the next challenge (for Macri). The economic team will have to ignore the weaker confidence indices and resist any near-term political pressures of the opposition to delay tariff hikes. Argentina is vulnerable. It’ll be really important to manage market confidence with no room for any mistakes,” she says.
The aggressive intervention in the bond and forex markets from the central bank should provide some breathing space after a surprise 300 basis points rate hike, too. The central bank had to adopt a proactive approach since there is not much ammunition for further rate hikes.
For Nomura, expectations are that one-off outflows caused by divestment of non-resident LEBAC holdings should subside with a more orderly pace of currency market intervention of around $3 billion spent a month to prop up the peso, versus the roughly $4 billion they rifled through in one week. It’ll become increasingly important for Macri to minimize the volatility in the peso in order to reduce de-leveraging while continuing to deliver stable economic policy management at the same time. It will be the only way Argentina can attract foreign direct investment, including speculative capital that helps fund this government. But on Thursday morning, the locals seemed to believe otherwise and the peso is showing its vote of confidence in the Argentine economy, and maybe even Macri.
“The situation is more troubling than people think,” says Pertini.
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