Argentina Peso Collapses 30% To Record Low After Election Shock

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Helmholtz Watson
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Fitch Downgrades Argentina to ‘CCC’

16 AUG 2019 02:33 PM ET
Fitch Ratings – New York – 16 August 2019:

Fitch Ratings has downgraded the sovereign ratings of Argentina, including its Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC’ from ‘B’.

KEY RATING DRIVERS
The downgrade of Argentina’s ratings reflects elevated policy uncertainty following the Aug. 11 primary elections, a severe tightening of financing conditions, and an expected deterioration in the macroeconomic environment that increase the likelihood of a sovereign default or restructuring of some kind. The primary election results point to heightened risks of policy discontinuity following the October 2019 general elections. This has prompted a collapse in market sentiment, including a sharp depreciation in the peso and widening of sovereign debt spreads, which poses a major setback to macroeconomic stabilization efforts and sovereign financing conditions. These adverse developments could impair the sovereign’s liquidity position in the near term and amplify debt sustainability risks.

The primary election results point to increased chances for a change in government and victory by the opposition ticket of Alberto Fernandez and former president Cristina Fernandez de Kirchner in the October elections. In Fitch’s view, such a scenario increases risks of a break from the policy strategy of the current administration of Mauricio Macri guided by a program with the IMF. In the campaign so far, Fernandez has questioned key elements of the current policy strategy and advocated for some form of renegotiation of the IMF program, while Kirchner’s track record as president in 2007-2015 indicates a similar inclination. Fitch does not rule out a shift in the opposition ticket’s policy orientation or other developments that reduce risks of policy discontinuity but believes policy credibility and market access could still be severely tested amid weak economic conditions, high public debt and inflation.

In Fitch’s view, both sovereign financing and solvency risks have increased. Despite sizeable disbursements under the IMF SBA program in 2019 and other borrowing so far in the year, a financing gap could re-emerge should the sovereign be unable to roll over most of its large stock of short-term Letes notes (currently around USD24 billion, of which half are in USD and three-fourths due by yearend). The sovereign cancelled auctions of Letes expiring beyond November this week amid the market turmoil, a negative signal about its ability to roll these over and a trend that could result in drawdown of liquidity buffers.

Financing pressures could intensify beginning in 2020 when the sovereign will need to turn to market sources to finance a fiscal deficit and debt maturities as IMF disbursements run out. Almost all of USD20 billion in bond maturities due next year are in the local market, and a sizeable share (around 40%) is held within the public sector, but the sovereign must still roll over a sizeable stock of market-held local debt and raise fresh financing under its current policy plans. Foreign bond repayments will increase starting in 2021. Slippage from fiscal targets would add to financing needs and further complicate the ability to fund them. Both roll-over and fresh financing could be difficult if local and external borrowing conditions do not improve markedly from current stressed levels after a surge in risk premiums to around 1700 basis points from below 900 in the past week.

Debt sustainability risks have also increased with the recent sharp FX depreciation (nearly 80% of debt is foreign-currency denominated) and greater scope for deterioration in economic activity and fiscal slippage. Fiscal targets under the SBA have been met so far, but the composition of the adjustment highlights risks of slippage that were rising even before the recent macroeconomic shock. Most of the deficit reduction so far has been achieved via real erosion of spending due to high inflation (which will become harder and could even revert due to backward-looking indexation) and one-off capital revenues. Export taxes have fallen short of budget projections, while federal non-export tax and social security collections have continued falling sharply in real terms in the latest data for July (-8% yoy), and this trend could intensify amid further deterioration in the growth outlook.

Fitch projects a primary deficit of 1% of GDP in 2019, above the 0% target (0.5% with the adjustors allowed in the SBA), and a 4.3% total deficit. For 2020, Fitch projects the primary deficit to remain at 1% of GDP rather than reach the 1% surplus target, absent the strong recovery the authorities expected to help close the fiscal gap and/or additional adjustment measures, and reflecting spending pressures from indexation and potential new policy plans. It is uncertain whether the new government will have the political willingness and capacity to enact structural fiscal measures to boost the credibility of the medium-term consolidation path set in the SBA, which could be even more politically difficult (e.g. pension reform) than those enacted already.

Under these baseline assumptions, Fitch projects federal government debt will rise to around 95% of GDP in 2019. This assumes the peso does not depreciate much further beyond its current level around 60/USD, but this is a clear risk that could lift debt ratios much higher. At the broader general government level (also incorporating provincial debt and consolidating social security fund holdings), Fitch projects debt will also rise to around 95% of GDP, a high level even when excluding the large portion (20pp) held by the central bank (BCRA). The IMF has thus far deemed Argentina’s sovereign debt to be sustainable, albeit not with a high probability, but any downgrading of this assessment could complicate its ability to keep disbursing SBA funds without requiring some form of restructuring of debt with commercial creditors.

Fitch projects the economy to contract 2.5% in 2019, down from a prior forecast of 1.7%, given an increased likelihood that the moderate recovery previously expected for the second half of the year no longer materializes. Fitch projects growth to be flat in 2020 but sees a high degree of uncertainty given lack of clarity around key economic policies post-election. Real growth in wages and pensions remain in deeply negative territory as of mid-2019 and will not meaningfully recover as inflation accelerates again. Domestic confidence could hinge greatly around the election result and policy plans laid out by the next government.

Capital outflows and portfolio dollarization have driven a sharp sell-off of the peso in the past week (-20%), and these pressures remain a risk. These factors have overwhelmed an improvement in FX supply/demand from a large reduction in the current account deficit. The BCRA has validated a rise in rates on its Leliq instruments to 75% (over 100% compounded) to incentivize their rollover and thus restrict peso liquidity that could otherwise add to exchange rate pressures.

The BCRA has engaged in limited direct FX market intervention so far, largely allowing the XR to adjust. This has avoided a major erosion of its relatively modest reserve position (currently USD64 billion in gross terms but USD19 billion net of reserves with corresponding FX liabilities) thus preserving FX liquidity available for near-term sovereign debt service. Nevertheless, the recent currency run and risks of further pressure and volatility are detrimental for sovereign debt sustainability, which had previously been predicated on expectations of a real peso appreciation. It could also derail the incipient economic recovery and fuel a new round of inflationary pressures after some moderation in past few months.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
In accordance with its rating criteria, for ratings of ‘CCC+’ and below, Fitch’s sovereign rating committee has not utilized the SRM and QO to explain the ratings, which are instead guided by the ratings definitions.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centered averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES
The main factors that could, individually, or collectively, lead to positive rating action include:

– Easing of financing constraints, such as a marked improvement in market borrowing conditions, that supports the sovereign’s ability to meet its financing needs;

– Economic recovery and progress on fiscal consolidation that mitigate risks to debt sustainability.

The main factors that could, individually, or collectively, lead to negative rating action include:

– Increased signs of probable default; signals that further financial support from the IMF would entail some form of restructuring of debt owed to commercial creditors.

KEY ASSUMPTIONS
– Fitch expects growth of the global economy, and that of key trading partner Brazil, in line with the projections outlined in the latest Global Economic Outlook (GEO).

https://www.fitchratings.com/site/pr/10086511