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Investors Think the Pendulum Could Swing Back on Argentina

Argentina, Latin America’s third largest economy, came roaring back to the markets in 2016 after a 15-year hiatus following its historic default on US$95bn of debt, and the first months of 2017 has shown few signs of deal flow letting up. But some investors are growing increasingly concerned that softer than expected growth and persistently high inflation may threaten the ability of Argentinian entities to repay investors.

Feb 9, 2017 // 5:23PM

The sovereign’s landmark US$16.5bn triple-tranche bond was quickly followed by issuances from a handful of provinces, municipalities, and some of the country’s top-rated corporates, with more supply in the offing.

In early 2017, and in an apparent reversal of commitments made last year, the country’s Finance Minister Luis Caputo announced the sovereign planned to tap international capital markets for a total US$10bn in 2017, kicking off a new borrowing spree with a US$7bn trade.

The dual-tranche transaction included US$3.75bn 10-year notes launched at the wide end of guidance (7%) and a US$3.25bn five-year tranche at the tight end (5.625%).

Argentina also plans to borrow US$4bn from a range of multilateral institutions including the World Bank and Inter-American Development Bank, and issue CHF2bn in Swiss Franc-denominated notes.

Investors have largely received Argie paper with enthusiasm, due largely to their support for policies implemented by the business-friendly government of Mauricio Macri, which has set the country on a path towards economic normalisation.

Pricing on the sovereign’s paper seems to reflect their continued support for the Macri government’s reform efforts. Yields on Argentina’s notes due 2024 have tumbled 2% since the transaction launched, according to data from Bloomberg, showing impressive spread compression – often trading inside the curve of similar notes issued by some of its Latin American peers.

Risks Emerge

To a great extent, politics will increasingly determine how the country’s debt performs. October’s mid-term elections could threaten the fortunes of Macri’s Cambiemos coalition, and the government will be under considerable pressure to bend to the kinds of populist instincts it has done well to avoid. Growth is still sagging and inflation still trending high, complicating matters further.

“If the midterm elections go well for the Macri administration then we can expect good policies to continue for a few more years. This will most likely trigger an improvement in the appetite to invest and a bigger pickup in growth than is currently expected,” explained Jan Dehn Head of Research at Ashmore Investment Management.

Despite the government’s impressive progress in solving a number of economic problems — including removing strict capital controls and ending a long-running debt dispute with international creditors— interest rates in Argentina remain higher than in other countries in the region, making credit relatively expensive. While Argentine sovereign debt yields hover around 6.5%, Colombia can borrow at closer to 2%, Chile at 3.14%, and Brazil 5.21%,

Continued borrowing has led some to wonder whether the country is issuing at unsustainable rates, particularly given headline risks to growth.

Dehn is still quite bearish. Net debt to GDP is about 33%, well below many of its EM peers, and the economy is expected to rebound strongly over the next two years despite a more subdued outlook in neighbouring countries – making it more appealing for FDI.

He also added that the government is only just beginning to exploit the potential of foreign appetite for local currency bonds. A handful of the country’s local currency credits could join the JP Morgan GBI-EM GD bond index as early as March, giving international investors more exposure to ARS-denominated debt.

“Spreads have failed to narrow because every time the bonds rally the government issues a new bond. Argentina has therefore underperformed. This is why the government is now signalling that it will turn to domestic bond issuance,” Dehn added.

Eric Ritondale, Chief Economist at Econviews said the government has financed about 80% of its budget needs for the 2017-18 fiscal year, leaving little need to flood the market with new paper.

But he added that for the government, to put investors at ease, must begin showing more progress on the fiscal and economic front.

“The deficit needs to fall, and the economy needs to start growing for the debt to be sustainable,” he said.

Others have expressed concerns on the sustainability of corporate borrowing in Argentina, in part because they have largely flocked to the dollar market. A number of corporates have rushed to issue debt in early 2017, as the fear of the impact of Trump´s politics and rising US interest rates prompt issuers to issued debt denominated in US dollars. Argentina’s corporates are set to issue about US$4bn in the first half of the year as companies like La Pampa Energía and Arcor search for fresh investment to refinance existing debt.

Many of these companies have revenue denominated in pesos, and with the US dollar looking likely to strengthen, some analysts believe Argentina´s corporates could set themselves up for trouble.

“Argentina so far has been a very promising story. The elections are likely to go well for Macri, and the government has done the bulk of its debt refinancing. But the corporate sector is a concern – their dollar revenues are minimal, and they are issuing at between 50-100bp over the sovereign curve; you would rather be in the sovereign, liquid and tactical, in case things go wrong,” said one EM asset manager.

“About eight out of ten issuances in the corporate sector are coming from Argentina. They should not be issuing internationally, but should instead be tapping domestic markets because they can’t really hedge against FX, largely because the cost would be enormous given local rates. It could turn into a really ugly story.”

The Root of the Problem

Although analysts agree Argentina’s fiscal performance and market savviness minimise the risk of it overborrowing, some have expressed doubts it will address some of the root causes behind the 2001 default.

Some have argued the constitution gives too much borrowing autonomy to the provinces, which over time has resulted in waves of subsidies and excessive spending fuelled by debt issuance at the local level. Once that deficit becomes unsustainable, it is often passed on to the central government.

In 2016, public entities, including provinces, issued US$40bn in debt — three-quarters of it in foreign currency — raising public debt to 50% gross domestic product, up from 43% last December, according to the Institute of International Finance (IIF).

“This can only be solved by overhauling the constitution, which looks unlikely. In the long-term I think Argentina is heading for another default” Dehn acknowledged.

Ritondale also agrees that the provinces could represent a problem in the longer term, but pointed to new rules being considered by the central government that would make it harder for local authorities to issue debt. Without amending the constitution, it is difficult to tell how effective the rules will be.

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