Risk drivers and outlook

Since taking office in December 2015, the government of President Mauricio Macri has acted quickly to dismantle interventionist policies (scrapping the bulk of import and capital controls) and undo macroeconomic imbalances (setting ambitious targets to reduce inflation rates and fiscal deficits). Particularly relevant have been the decision to allow the exchange rate to float freely, which has greatly alleviated pressure on international reserves, and the conclusion of a deal with Argentina’s ‘holdout’ creditors, which has restored access to international capital markets. Reflecting these positive evolutions, Credendo Group has upgraded its ST political risk classification to category 4 (from 5).

The renewed borrowing option on capital markets is indeed a real game changer for Argentina. And to reflect that it significantly reduces financial roll-over risk for the public sector in particular, Credendo Group now again provides insurance for MLT transactions with public-sector buyers. Additionally taking into account the benign effects of a debt-restructuring agreement concluded between Argentina and its Paris Club creditors in 2014, it has also been decided to upgrade the MLT political risk classification to category 5 (from 6).

Yet despite this positive view, it should be clear that President Macri’s goal to improve medium-term prospects by furthering investor confidence will not be easy to attain. For one thing, the government inherited deep and interlinked macroeconomic imbalances that will require skilful navigating (allowing the exchange rate to float, for example, has benefited international reserves, but the resulting depreciation has also further stoked inflation). Furthermore, with President Macri lacking a majority in Congress and legislative elections coming up in 2017, he can ill afford unpopular fiscal consolidation measures that would undermine his party’s performance. Postponing necessary measures could obviously delay the much-needed rebound in investor confidence, however. In any case, with the economy in recession and the depreciated currency rendering foreign-exchange-denominated liabilities more burdensome, the Credendo Group classification for Argentine commercial risk has remained in the lowest category, C.

 

Facts & figures

Pros

  • Laudable macroeconomic reforms underway
  • Renewed access to international capital markets
  • Big potential in energy and soft commodities

Cons

  • Government lacks legislative majority
  • Economy in recession
  • Rising external debt

Head of State and Government

  • President Mauricio Macri

Description of electoral system

  • President: 4-year term, limited to two consecutive terms, last election: October 2015
  • Members of Congress: 4-year term in the Chamber, 6-year term in the Senate, last election: October 2015

Population

  • 43.4 m

Per capita Income

  • USD 13,640

Income group

  • High income (though temporarily unclassified by the World Bank)

Main export products

  • Soy (24.3% of current account receipts), manufactured goods (22.8%), cereals (7.6%), tourism services (5.5%), gold (3.1%)

Country risk assessment

Shifting politics

With the notable exception of a period of political instability inspired by the 2001 economic crisis, democratically elected governments have ruled Argentina since 1983. The year before that, a failed attempt to conquer the Falkland Islands from the British heralded the demise of the brutal military junta that had governed Argentina since 1976 (under its rule, tens of thousands of political opponents of the regime ‘disappeared’ in what is now known as the ‘Dirty War’). Despite the democratic consolidation that has taken place, however, Argentine political institutions arguably still lack maturity. In fact, ever since economic opportunities drew in millions of European migrants in the late 19th century (Argentina featured among the 10 wealthiest economies in the world around 1900 and it ranked 12th as late as 1950), politics in Argentina (more so than in other countries, reflecting the contrasting interests of various groups: agricultural vs. industrial, landowners vs. workers, north vs. south, central government vs. the provinces, etc.) has been more about securing benefits for particular constituencies than about building an effective state. This is evident among other things in the fact that politics has been driven by personality rather than ideology. Note that even Peronism – Argentina’s dominant political movement named after former President Juan Perón and his popular wife ‘Evita’ – is difficult to define in terms of policy direction. Indeed, both the neo-liberal governments of Carlos Menem (1989-99) and the leftist administrations of Néstor Kirchner (2003-07) and his wife Cristina Fernández (2007-15) are considered Peronist.

That is not so for the current government of President Mauricio Macri, former Mayor of Buenos Aires and leader of the centre-right alliance ‘Let’s Change’ (Cambiemos). He in fact won the presidential election in 2015 (securing 51.3% of second-round votes to defeat Peronist candidate Daniel Scioli) largely owing to voter fatigue with the ‘Kirchnerist’ Front for Victory (Frente para la Victoria, FpV) and the left-of-centre Peronism it represents. Such negative motivation was somewhat unsurprising given that Cristina Fernández’s second presidential term (2011-15) saw a sharp economic downturn as terms of trade deteriorated and interventionist policies sapped consumer and investor confidence (see below). Furthermore, various civil-society groups had on multiple occasions condemned alleged executive efforts to undermine judiciary independence and freedom of the press, while there had also been considerable concern about the ever-expanding government influence over Central Bank policies and official data released by Argentina’s national statistics agency. The IMF apparently shared the latter concern, as in 2013 Argentina became the first country ever to be censured by the organisation over statistical data deficiencies.

Macri’s difficult drive for change

The fact that over the years certain state institutions in effect became ‘Kirchnerist’ strongholds will probably hamper the effective implementation of new policy initiatives. Moreover, because his coalition does not have a legislative majority (in turn partly due to the fact that only half of the seats in the Chamber of Deputies and just one third of those in the Senate were contested in the 2015 general election), Macri faces the daunting task of securing opposition support for various unpopular decisions that are deemed necessary.

To his credit, though, Macri has so far proven himself to be an agile politician. In particular, by striking a deal with provincial administrations on the contentious issue of revenue sharing, he has secured the backing of a good share of moderate Peronists in Congress. That being said, it seems doubtful that the cooperative attitude will last in the run-up to the legislative election of 2017. If it doesn’t, then Macri may again feel compelled to use decree powers to push through certain legislative changes, as he controversially did during his first weeks in office.

In terms of foreign affairs, the Macri government has strived to mend ties with the international community, which were significantly dented by the Kirchner administrations’ nationalist rhetoric and high-profile expropriations of the assets of certain foreign companies (most notably the Spanish company Repsol’s majority share in the Argentine energy company YPF in 2012). The recently renewed engagement with the IMF is of particular interest, not least because revived Article IV consultations (the first since 2006 was completed in late September) will crucially improve data reliability. A recent visit to Buenos Aires by a senior UK official (the first since 2010) was noteworthy as well, signalling improved bilateral relations and hence reducing the risk of renewed hostilities over the Falklands issue.

From economic boom to bust

As indicated, the poor electoral performance of the FpV in 2015 was primarily to blame on the dire state of the Argentine economy. According to the IMF, GDP shrank by 2.5% in 2014 before rebounding by 2.5% in 2015, while inflation amounted to well over 20%. Such stagflation contrasts sharply with the economic boom that the Kirchners presided over between 2003 and 2011. In that period, real economic growth in Argentina averaged more than 6%, as activity was boosted by booming commodity prices (which benefited agricultural export earnings) and generous redistributive policies (such as conditional cash transfers to the poor, which supported domestic demand).

An economic downturn set in with the end of the commodity boom, however, and as this coincided with a further expansion of public expenditure that outpaced revenue growth (in a countercyclical effort to mitigate the impact of the slowdown), the government balance (in surplus as recently as 2008) declined from -2.6% of GDP in 2011 to -6.6% in 2015. This evolution has led to increasing public debt – expected to reach almost 52% of GDP by the end of 2016, up from merely 38% at the end of 2011 – and is also considered the main culprit for Argentina’s high rate of inflation because the Fernández administration mainly financed the deficits through monetisation (also known as printing money).

Dealing with deficits and inflation

Acknowledging the unsustainable public finance dynamics, President Macri has strived for fiscal consolidation since taking office. The efforts so far have been to little avail, however. In particular, while the government made a swift start by largely removing subsidies on water, electricity, natural gas and public transport tariffs, recent court rulings imply that the price hike for gas – and possibly for other utilities as well – will need to be reversed (thus at least postponing implementation). Furthermore, while the government has pushed for moderation in negotiations with public-sector employees about the upward adjustment of wages, this strategy has yet to bear fruit. As a result, the fiscal deficit is expected to surpass 7% of GDP in 2016 and 2017 before starting to decline after that. Note that this failure to live up to expectations related to fiscal consolidation clearly reflects the political vulnerability of the Macri government, which cannot afford to lose public support ahead of the 2017 election.

In the light of this – and although a medium- to long-term fiscal framework to ensure sustainable public finances is being established – monetary policy has so far been the main tool for addressing inflation. Between November 2015 and April 2016, the Central Bank of Argentina sharply hiked the policy interest rate (applying to its 35-day bills) from less than 22% to 38%. However, the rate has since been lowered again to some 27%, reflecting fears that the tight monetary stance was endangering an incipient economic recovery. The policy reversal thus points to the multiple objectives that the Central Bank is juggling. As things stand, it is accountable not only for monetary and financial stability, but also for fostering ‘employment and economic development with social equality’. Here, the plan is to formally establish an inflation-targeting framework in 2017.

Whether or not the government will achieve its inflation target – a gradual reduction to arrive at 5% (plus or minus 1.5%) by 2019 – remains to be seen. It will crucially depend on the evolution of the exchange rate, which has been the subject of another swift policy shift. Breaking with the past, the exchange controls installed by former President Fernández were eliminated in December 2015 and the Central Bank abstained from further intervention in the foreign-exchange market (except for the purpose of avoiding excessive volatility, that is, thus implying a ‘managed-float’ currency system). Following the moves, the Argentine peso plummeted overnight by more than 25% vis-à-vis the US dollar, notably closing the gap between the official and black-market rates. This devaluation proved very effective to safeguard precariously low foreign-exchange reserves (see below), but it has evidently had an adverse effect on inflation through higher import prices. So it is good news that, thanks to the simultaneous tightening of monetary policy and the fact that Macri seems to be enjoying the trust of capital-market participants, the exchange rate has remained relatively stable since then.

Competitiveness woes and hopes

Apart from protecting international reserves, the peso devaluation has also served to improve Argentine competitiveness. The overvalued exchange rate was indeed a real drag on exports, though certainly not the only one. In particular, high-potential sectors such as energy and agriculture have suffered from years of underinvestment as the uncertain and unfriendly business environment undermined investor confidence. In this context, it is telling that despite vast reserves (the country has offshore oil potential and the ‘Vaca Muerta’ shale gas field is among the largest in the world), Argentina became a net fuel importer in 2011. As for agriculture, note that sector grievances about exchange-rate policies and high export taxes (with the sector feeling like a fiscal cash cow) have in the past few years on multiple occasions led to hoarding of produce by agribusinesses, thereby denying the country badly needed inflows of hard currency.

Subdued competitiveness has thus clearly exacerbated the negative effect of lower commodity prices on Argentina’s export earnings. In consequence – despite the beneficial impact of lower oil prices and the significant administrative burden discouraging imports – the trade balance switched from surplus to deficit in 2015 and the current account balance (in deficit since 2010) further deteriorated to -2.5% of GDP (from -1.4% in 2014).

In view of this evolution, restoring competitiveness has been a top priority for the new cabinet. In an effort to boost foreign-exchange earnings, taxes on beef and manufactured goods exports were lifted and it was announced that the 35% levy on all-important grain exports would be phased out. Still, while this measure will surely further competitiveness, the current account deficit stands to widen to 4% of GDP by 2020. That is partly because in order to limit the adverse effect on public finances, the tax cuts on grain exports will likely only be implemented gradually as of 2017. More importantly, the elimination of administrative hurdles faced by importers as well as the new financing channels at their disposal (see below) will widen the trade deficit. Be that as it may, the government is rightly betting on a more coherent macroeconomic policy framework to underpin confidence and thus boost investment in the longer term. In this spirit, the administration is drafting a new public-private partnership law and engaging with multilateral lenders in order to secure financing for planned infrastructure projects. The IMF indeed expects the investment ratio to gently grow from less than 17% of GDP this year to some 18% by 2019. Partly as a result, after a 1.8% of GDP recession in 2016, economic growth is expected to rebound to more than 2.7% of GDP from 2017 onwards.

Default resolution provides financial breathing room

As highlighted, the devaluation of the Argentine peso in December 2015 alleviated severe pressure on international reserves. During President Fernández’s second term, efforts to preserve the overvalued exchange rate indeed saw those reserves deplete from almost USD 50 billion at the end of 2010 (enough to finance seven months of goods and services imports) to around USD 23 billion at the end of 2015 (the equivalent of barely three months, the standard minimum threshold). At the time, doubts also prevailed about the liquidity of the remaining reserves, and a real crisis was avoided thanks to significant financial support from China in particular, but also owing to a build-up of external arrears, and the hefty import and capital controls in place.

The sales of foreign-exchange reserves under Fernández in effect plugged an external financing gap, itself largely explained by the fact that Argentina had been shut off from international capital markets since its massive sovereign debt default of 2001. It is in this regard that the new government of President Macri can claim its most meaningful accomplishment to date. In February 2016, Argentina reached a deal with its ‘holdout’ creditors (bondholders affected by the 2001 default who refused to accept a 70% haircut on their claims in 2005 and 2010), thereby resolving the new state of default that the country was in since July 2014 (a US court ruled that the ‘holdouts’ should be paid in full, but Argentina failed to comply) and restoring access to international finance. This has been a real game changer for the country, and liquidity and public finance risks have greatly diminished as a result. In terms of liquidity, arrears have been cleared and international reserves had rebounded to almost USD 30 billion (or more than four months of imports) by July 2016. Reflecting this positive evolution, Credendo Group recently upgraded its ST political risk classification to category 4 (from 5).

As for public finances, the renewed borrowing option on international capital markets will accommodate much-needed public infrastructure investments (at both national and local level) and will offer the government an alternative to printing money (in order to finance deficits). In this context of reduced financial risk, Credendo Group has decided to re-establish insurance options for MLT transactions with Argentine public buyers. That is clearly not to say that public finance risks have dissolved altogether, with subnational levels of government remaining particularly vulnerable. That is mainly because of financial dependence on transfers from the federal level. Indeed, although local and regional governments are legally entitled to receive such transfers, intergovernmental conflicts (typically between the federal government and provinces ruled by an opposition party) have in the past often affected financial flows. Even if the Macri government has so far entertained a good working relationship with most local governments (as illustrated by the revenue-sharing agreement – see above), a resurfacing of this type of conflict cannot be ruled out in the current political environment (in view of Cambiemos’s legislative minority and continued Peronist dominance at many subnational levels).

Judging how the renewed international borrowing option affects the overall solvency risk in Argentina is less straightforward. On the one hand, total external debt is expected to increase from less than 27% of GDP as recently as 2015 to more than 34% by 2017. While that is still a modest level, the picture becomes less rosy when comparing indebtedness to current account receipts. Hit by lower commodity prices, external debt has boomed from 160% of export earnings in 2011 to more than 250% today. The ratio is moreover expected continue increasing over the next few years, reaching 300% by 2018, thus indicating significant risk. Yet on the other hand, the new borrowing option – in addition to the debt-rescheduling agreement that Argentina reached with its Paris Club creditors in May 2014 – has clearly reduced the financial roll-over risk. Moreover, limited debt-servicing obligations are relevant as well. These amounted to only 26% of current account receipts in 2015 and are expected to remain at modest levels in the years ahead. Because these boons are likely to dominate any negative effects in the longer term, Credendo Group recently upgraded Argentina’s classification for MLT political risk to category 5 (from 6).