Like shock therapy, Argentina’s new lending agreement with the IMF delivers immediate benefits: increased funding and front-loaded disbursements to meet the country’s budget through next year. It also comes with serious side effects, including a likely deep recession in Argentina and the risk of political resistance leading up to the country’s elections in 2019.
Still, from an investment perspective, we think the new IMF agreement improves on the initial program announced in June, and we see opportunities in segments of Argentina’s bond market where prices reflect the risks.
IMF deal 2.0
As U.S. interest rates and the dollar have risen since April, Argentina’s challenges have escalated, including budget imbalances, inflation over 30%, and a 50% drop in the peso. After a failed attempt to restore confidence with a three-year US$50-billion lending program from the IMF in June, the IMF announced in late September a $7 billion increase in Argentina’s credit facility (to $57.1 billion), together with front-loaded disbursements worth $19 billion. The revised program effectively covers Argentina’s market-related financing needs through 2019.
Although the initial deal was sizable, it fell short in three key areas. Here’s how the new program seeks to address these:
- Fiscal adjustments. The September agreement seeks a faster return to a primary budget balance – by 2019 instead of 2020. The front-loading of disbursements and the upsizing of the program form a credible anchor to Argentina’s credit that we expect to hold through the uncertainty of elections in 2019.
- Money-base targeting instead of inflation targeting. The shift to money-base targeting – effectively tightening the money supply – should incentivize local investors to hold pesos, rather than U.S. dollars, potentially resolving several issues. Investors fearing an inflation-devaluation spiral were running to U.S. dollars, which drove short-term local rates ever-higher, posing a serious challenge for the government rolling over its high volume of short-term debt. The deal includes a new trading band for the peso and requires the central bank to limit intervention, which creates more transparent currency management and more incentive to hold peso assets given the expected reduction in the monetary base in real terms and thus a scarcity of peso assets − eventually reducing the need for external financing.
- Disbursements allocated for budgetary support rather than as a precaution. This enhanced flexibility will mean that Argentina’s treasury will become a net supplier of dollars into the market to pay for its peso obligations. This will provide additional liquidity of up to $10 billion through the end of 2019, on top of what the central bank may have to do, providing a strong disincentive to those seeking to dollarize.
The new main risk: politics
Argentina’s gradual approach to dealing with macroeconomic imbalances has now been jettisoned in favor of shock therapy: Tighter financial conditions in the months ahead are likely to lead to a deep recession. The IMF financing backstop is formidable, but the economy’s contraction will almost certainly raise questions about Argentina’s political commitment to the program during the election campaign next year. A strong harvest in 2019 would cushion the impact on Argentina’s economy, but many investors are likely to focus increasingly on President Mauricio Macri’s approval ratings.
In the end, then, the devil is not in the details of this ambitious IMF adjustment program but rather in its political implications. As investors, we take solace from a fragmented political backdrop − from the currently unpopular leftist former President Christina Kirchner to the muddled moderate Peronist contingent − but the political landscape will likely be prone to rapid shifts as unemployment and public frustration with austerity rise.
We believe that the market will view a victory by either Macri or a moderate Peronist as constructive, while a return to populist rule by the left would probably be perceived by many as the worst-case scenario for Argentina. The road to that outcome could include some wavering by Macri’s government in its commitment to the program if his poll ratings slide.
The bottom line: investment implications
Despite these risks and our expectation for continued volatility, current valuations in Argentina’s credit and local markets look reasonable.
From a valuation perspective, we view the exchange rate as below fair value, which makes exposure to local assets potentially attractive. Choosing which local asset to own in Argentina, however, has been almost as important in this volatile year as being right on the market’s direction.
PIMCO has had a long-standing favorable view on Argentina’s local floating-rate government bonds rather than fixed-rate assets in the rising interest rate environment. And we continue to think floating-rate instruments will benefit from the tighter monetary backdrop under the new IMF agreement.
In credit, we think prices for short-dated bonds will be well-anchored, given the sharp front-loading of the IMF program. Further out on the credit curve, we see value in Argentina’s Par bonds.
For more on emerging markets, please see “Shifting Realities and Opportunities in Emerging Markets.”
Pramol Dhawan is an emerging markets portfolio manager at PIMCO in Newport Beach.