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Argentina - Absence Makes the Heart Grow Fonder

Argentina’s long awaited return to the international capital markets saw investors clamouring for the country’s new issuance, with orders amounting to nearly US$70bn for the US$16.5bn of fresh debt offered. We speak to Alfredo Mordezki, Head of Latin America fixed income at Santander Asset Management, on what drove the levels of demand for this debt and whether its popularity can be maintained.

Oct 24, 2016 // 11:47AM

To what extent was the demand for Argentine paper the main reason the sovereign was able to achieve the pricing it did on its US$16.5bn issuance in April? Were there any other factors that affected the pricing of this debt?

The issuance has to be put in context. There had been a shortage of good turnaround stories from emerging markets in general at the time, so people did not want to miss one when it was coming.

There were a number of important measures that had been prepared to remove the FX controls, and investors remained confident that the government would be able to implement these. It was a matter of confidence. If something went wrong, there was a risk of an out-of-control devaluation.

The FX issue was addressed in December 2015 when the peso was devalued by the Macri government. The outcome was a controlled devaluation inside the parameters of the previous parallel FX regime.

How has Argentine debt performed from an investment perspective in comparison to similar-dated debt in other Latin American countries?

Performance has been very good, in spite of tight pricing in some cases.

At present, in terms of pricing, there is clearly a mismatch regarding the market’s perception of Argentine debt and how it should be performing. The market is not pricing Argentine risk at the levels its current credit ratings would suggest.

The markets are already pricing in some upgrades for Argentine debt. This does not necessarily mean however that there is likely to be an upgrade of Argentine debt any time soon, but rather that they do not see any short-term risk on the outlook for the country.

Is this mismatch in pricing likely to lead to any negative consequences?

It will depend on what happens going forward. Currently, the markets are priced for success, but I would not say they are priced for perfection.

We are seeing some domestic backlash to certain reforms. What investors want to see going forward is a high degree of alignment between the expectations of what the peso’s devaluation will bring and how inflation will perform in the future.

The most significant problem the country faces now is the inflation issue. If inflation is running at above 40% and devaluation expectations are set at 10-15%, then from a corporate perspective, and in particular corporates with dollar-denominated revenues, there will be a significant mismatch. This is the most pressing issue that needs to be addressed at present.

To what extent is the country’s debt still seeing pricing affected by pent-up demand?

After the first wave of issuance following the country’s return to the international capital markets, demand has been satisfied.

Moving forward, Argentina will have to demonstrate that it can perform on the basis of pricing, but there will likely be continued demand from yield hunters and ‘good EM story’ seekers.

It is surprising to note that there is a lot of crossover demand from investment grade investors who can hold 10-15% of their portfolios in non-investment grade credits. Largely driven by the success story of Argentina, they are using this allocation to invest in Argentine assets.

What factors do investors consider when looking at Argentine debt now that the initial ‘rush for Argentine paper’ has died down?

There are two or three things that now need to happen in regards to the macro environment. Firstly, inflation needs to be brought under control.

Secondly, the backlash over some of Macri’s policies in the Supreme Court needs to be addressed. This is not to say that these need to be completely reversed, but we have to see a strong fiscal plan that does not backfire.

Finally, growth needs to pick up. This is a key component for the country to be able to support the US$16.5bn dollars’ worth of new debt issued in April. We need to see a positive trajectory of debt to GDP ratios. In 2015 this stood at 48.40%.

Argentina is currently in recession. When is the country expected to post positive growth?

We hope to see some movement in Q4 2016, and this is when investors will really start looking at GDP numbers. If growth figures do not begin to improve by this time then investors will likely become increasingly anxious.

How does Argentine sovereign/quasi sovereign debt compare? Is there a preference to one or the other? Which provinces look particularly appealing?

The markets have already differentiated between issuers, particularly the provinces. Certain issuers and provinces have already been priced taking into consideration a number of factors. These include the issue size, the province’s resources, its financial situation and the dependency on government transfers.

Which provinces in particular are the most appealing buys at present? Which are a concern?

We have been a large supporter of Buenos Aires’ turnaround story, firstly regarding the City of Buenos Aires, followed by the province.

We do not see any provinces in imminent trouble at present, as they are currently enjoying good liquidity, but the markets have differentiated between those aligned with the government and those that are not.

How is the country’s corporate debt market currently performing? What needs to happen for the growth of this market to continue?

I am actually surprised that there have not been more corporate names coming to the market as the sovereign’s issuance in April opened the international markets to all Argentine borrowers.

The reason behind this could be partially due to the number of provinces that were active on the international markets following the sovereign issue but I would expect some further corporate issuance, particularly from those that have good fundamentals or a positive story.

The macro risk regarding the mismatch between inflation and the devaluation of the peso has to be kept in mind here and could be why corporate issuance has been lower than expected.

This is important because investors are assuming credit risk, but once there is a convergence between the peso’s devaluation and inflation we will likely see more corporate issuance.

Are you considering local currency bonds at all? What should investors be careful of when looking at this space?

We are looking at the local currency market at present and, although we are not yet active in this space, we are keeping a close eye on it.

If there is a convergence however, it will be the dollar market that emerges as more attractive than the local currency market.

Investors need to look for weakness in the FX, however, this could be a positive thing as it could mean that the competitiveness of the Argentine peso would be maintained. This would be beneficial for the country’s economy.

Furthermore, if inflation continues on its current trajectory, we could see local currency premiums become more reasonable.

Do you think Argentina will remain a popular player on the international capital markets over the next year for the global investor community?

It depends a lot on the macroeconomic and credit risk. Positive macroeconomic performance will be a driver of corporate credit risk. If we get a strong trajectory on the macroeconomic side then we could see sustained demand over the next year.

In addition, a recovery in Brazil could help boost Argentina’s attraction. There could be significant support from investors interested in the Argentine export sector which is closely linked to Brazil.

How much of a positive impact would a turnaround across Latin America, and not just Brazil, have on Argentina?

Investors are currently focussed on the two main turnaround stories; Argentina and Brazil.

However, Argentina could also enjoy some general reallocation of funds from market participants on certain risks elsewhere in Latin America, such as a renegotiation of NAFTA following the potential outcome of the US election.

What advice would you give to anyone looking to invest in Argentina at present?

My general advice would be to follow very closely the macroeconomic developments in the country. Eventually we will reach a point where company fundamentals will overtake macro factors on determining credit quality.

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