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Argentina: Concerns of Overleveraging in Dollars Gaining Pace

Argentina’s re-entry into international markets last year marked the end of a tumultuous chapter in the government’s troubled history, a period marked by defaults and unsustainable populism. While it has seemingly avoided the populism trap under its business-friendly president Mauricio Macri, concerns around overborrowing at the provincial level coupled with structural inefficiencies in the country’s institutional framework – which could force the federal government to pick up the tab – has analysts worried.

Mar 8, 2017 // 5:11PM

Argentina came roaring back to the markets in April last year with a whopping US$16.5bn triple-tranche bond, one of the largest emerging market bond sales in at least 20 years. Since, both the country’s corporates and provinces have followed suit with a number of issuances on the international capital markets.

This is largely positive for Latin America´s third largest economy, in part because conventional debt financing will provide a critical path to inflation stabilization; inflation is still trending above 30%. It will at the same time enable Argentina to address a huge infrastructure deficit, with many large greenfield and brownfield projects starved due to longstanding lack of access to foreign capital.

Investors have found value in the bonds issued by the country’s provinces, which can offer up to 200bp of extra spread over the sovereign. Since April 2016, nearly every province has taken advantage of a sharp drop in interest rates to finance infrastructure projects and repay existing debt.

But as many both within and outside Argentina know full well, overleveraging – particularly at the provincial level – can quickly spiral out of control, and it will be up to Macri to take on the unenviable task of restraining the provinces.

The country’s constitution allows the provinces to borrow from international markets, however, when the debt burden becomes too heavy, it is the federal government that is forced to step in and foot the bill. This is why the provinces played a significant role in the debt crisis of the early 2000s, which saw the largest external debt default on record until Greece’s recent restructuring. The country’s debts, much of which was provincially incurred but later assumed by the federal government, were enormous, amounting to over US$100bn (including accrued interest payments), and complex, involving 152 types of bonds, six currencies, and eight jurisdictions.

The frequency with which the provinces are tapping the market since last year, however, is raising concerns among investors about longer-term solvency as fiscal deficits grows.

While the provinces' debt loads are still relatively low, growth in fiscal deficits – spurred, in part, by an expected increase in government spending ahead of next year's midterm elections – could eventually raise doubts about their solvency.

The Spree Continues

Both national and provincial debt has grown since the Macri administration ended the decade-long legal dispute with creditors last year. More than one third of Argentina’s provinces sold debt in 2016, and much more are thought to be planning debt issues this year. Many provinces, particularly poorer ones, depend on federal funds to balance their budgets as part of an elaborate co-participation regime. Together, Argentina's 23 provinces and the autonomous Buenos Aires city issued around US$7.9bn in new bonds through February 2017, according to Research for Traders, while the total provincial deficit is expected to rise to 1.5% of GDP in 2017, up from 1% in 2016 and 0.6% in 2015.

Buenos Aires, the largest province with 40% of the country´s population, sold US$3bn in debt last year, a portion of which will be used to fund the projected US$1.6bn deficit. The province's 2017 budget still allows it to take on up to US$3.3bn more in debt.  It was then followed by the City of Buenos Aires, which sold US$890mn in bonds that same year.

Entre Rios raised US$350mn in 7-year notes sold at 250bp wide of the sovereign curve despite warnings from Standard and Poor’s that the province the did not have any debt policy and no debt management office.

Chaco, a cotton-producing province located in northern Argentina and one of the poorest regions in the country, relies on federal government tax transfers for 80% of its revenue, and its GDP per capita is also half the national average. The province sold US$250mn of five-year notes at 300bp wide of the sovereign.

The province of Salta, which is rated higher than Chaco, issued US$300mn of notes to yield 9.1% in June 2016, while La Rioja, one of the country´s smallest provinces, printed US$200m in 6.5-year bonds in early 2017 – but failed to gain enough traction to rein in yields from initial price talk of 10%.

Cordoba, one of the largest provinces in Argentina, sold US$725mn in 7.125% 5-year bonds in 2016 and is set to return to the market this year, as well as Tierra del Fuego, a southern province similar in size to La Rioja.

Currency Mismatch No Biggie – Yet

The bond rush has given some investors and analysts pause. In a recent report, Fitch Rating´s warned that “recent Argentinian local and state government bond issuances are raising risks for their bondholders, as most entities' revenues are in Argentinian pesos while the service on their debt is in US dollars.”

According to Fitch, 80% of the debt owed by the eleven Argentinian local and state governments will be denominated in US dollars, up from just 55.9% of the debt load in 2015.

The ratings agency goes on to say that provinces including Neuquén, Salta, Santa Cruz, Mendoza, and Chubut, enjoy lower risk as some of their revenues are either denominated in, or linked to, dollars. It issued warnings on other larger provinces, such as Santa Fe and Cordoba, which do not have income directly in dollars.

“Moreover, there are no contractual protections for dollar fluctuation and no federal guarantees in place,” the report mentioned.

Around US$750mn more in issuance is in the pipeline for the rest of the first quarter of 2017 alone.

“It is normal for the markets to worry about this, especially given Argentina´s history,” said Eric Ritondale, Chief Economist at Econviews, who added that the economy is in much better shape than it was in the 90s.

“We have a floating exchange rate today, and the provinces that have revenues in pesos can simply go to the Central Bank and buy those dollars to service their debt,” the economist said.

Despite an anticipated strengthening of the dollar, for some state and local governments, dollar-denominated bonds enjoy lower real interest rates than those denominated in local currency, while international investors seem more comfortable taking longer term risk than local lenders.

For Ritondale, the provinces’ voracious appetite for US dollar denominated debt is not a huge concern given their relatively low levels of debt, and their prioritisation of fiscal consolidation measures. But that could change if inflation fails to budge.

“If the pace at which the provinces are borrowing continues it could pose a problem in years to come. The biggest challenge local governments are facing is the high cost in which they are borrowing abroad, which hovers around the 10% mark.”

He believes, however, that the current administration is taking the necessary steps to prevent a repeat of the early 2000s by enacting reforms and offering incentives to encourage local governments to be more fiscally responsible.

“Ultimately, investors should look at Argentina’s ability to rein in the deficit and that is what is going to determine if they maintain a healthy debt load. The same goes to the provinces,” Ritondale added.

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