Wednesday, 19 September 2018

Banking on policy shifts

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Argentina's troubled relationship with the IMF looks to be on the mend. The Argentine government is once again heard to be negotiating for a reopening of its 2005 debt exchange for the remaining holdouts, amid vows to return to the international capital markets to ease short-term refinancing pressures. Markets have reacted well so far, but much depends on future policy shifts. Paul Kilby reports.

With the Kirchner presidency in a weaker position and Argentina facing financing pressures amid a weak global economy, many market participants hope the country will soon reconcile with the IMF. A resolution of its holdouts problems would reopen international markets to the faltering state.

Such talk has of course been heard before and hence generates understandable scepticism. Yet there are signs that this time may be different. Over the last year, efforts have been made to restore some sense of normalcy in Argentina's relationship with the international financial community, while also incrementally buying back maturing debt to ease refinancing pressures.

"I think Argentina's creditworthiness has improved over the last year. There is a willingness to reaccess the international capital markets, there is talk of a normalisation of relationships with the holdouts and there are the Boden buybacks," said Jerome Booth, the head of research at Ashmore Investment. "All of this seems consistent with a desire to normalise relationships with creditors."

This has arguably been driven by necessity more than a genuine desire for change on the part of the government. Shifting policy stances have taken place against the backdrop of a weakening global economy that has hit vital exports and dented fiscal accounts. According to RBS, analysts have seen primary supluses fall from an average of 3% between 2004-2008 to what is likely to be just 0.8% this year. Meanwhile, Argentina faces mounting amortisation schedules over the next few years. This has forced the government to move forward with debt swaps and rethink its strategy toward the international capital markets.

The increasingly hostile political environment faced by president Cristina Fernandez de Kirchner and her husband Nestor has also helped change attitudes. The couple now have less room to maneouver after suffering heavy losses in the June congressional elections. While conflicts between the opposition and the government are likely to increase, exacerbating volatility, in the long run, many in the market hope in the medium to longer term there will be meaningful policy changes. The 2011 presidential elections will be an important watershed for such reform. Losses in the congressional elections forced the president to reshuffle her cabinet, though critics think that such changes were merely cosmetic.

A pleasant surprise

The new economy minister Amado Boudou was not thought likely to instigate a major policy transformation: he was formerly head of the state pension agency ANSES that took over the private pension system last November – a nationalisation that was seen as the means of keeping the country solvent, sending market spreads wider in its wake.

Yet Boudou has made several market friendly moves, aimed at placating international markets to jump start economic growth and aid corporate Argentina in fund raising efforts. He has moved forward with liability management operations, including a series of swaps taking out inflation linked debt nearing maturity for longer-dated bonds tied to Badlar, the whole bank deposit rate.

The idea is to create a local peso curve, allowing the government to fund itself in its own currency and reducing amortisation humps over the next three years. In early September the government announced a high participation rate in recent swaps, which according to Credit Suisse would postpone Ps7.3bn in debt service between 2010-2012.

Boudou has also made overtures to the IMF. He met the director of the Fund's western hemisphere department, Nicolas Eyaguirre, publicly renewing contacts with an institution the Kirchners had blamed for the financial meltdown earlier this decade.

Despite its rhetoric, the government may be more pragmatic than many assume when it comes to eventually renewing ties with the IMF. "The government will have no ideological qualms about signing an agreement with the IMF if it found such an agreement necessary," S&P said earlier this year.

There was even talk in September that the economy ministry would let the Fund assess the country's finances and move forward with an so-called Article IV consultation. "The government has made it clear that it is not interesting in even having an Article IV consultation, so this would be a change of mind," said Guillermo Mondino, head of research at Barclays and former chief economist at Argentina's Economy Ministry. So if correct, the economy ministry’s move will mark a significant reversal in government attitudes towards the IMF, and the first step toward normal relations.

However, any reconciliation with the IMF would likely require the government to take certain steps, namely the reforming of the national statistical agency INDEC. The agency has been accused of skewing inflation numbers in the government's favour and, according to some investors, effectively defaulting on its inflation-linked debt. While some efforts have been made to make the agency more independent, there are serious doubts over whether past data will be amended. Such changes could provoke a backlash from investors who hold inflation-linked debt.

The cost of failure

Opinions vary over whether Argentina really needs to cut an agreement with the IMF. S&P sees it as a precondition for any negotiations on defaulted debt with creditor countries belonging to the Paris Club. It will need their goodwill, and that of the holdouts who didn't participate in the 2005 debt restructuring, to gain access to the international markets.

Others feel an IMF agreement is not essential – either for a holdout agreement or to help prop up its finances. "Their reserves are at US$50bn, so unless money starts rushing for the exits I don't see a need for them to return to IMF,” said one EM strategist. “The only reason may be to create an environment where foreign investors are willing to accept new bonds."

From that perspective alone, however, an IMF stamp of approval makes sense, if Boudou is serious about accessing the international capital markets. An Article IV consultation is liking having a credit rating. "You want something like that to access the market. It provides an independent evaluation of the country. I think that is what the ministry has been thinking about," Mondino said.

Some have predicted that government will emerge with a statement about holdout negotiations by the end of September, coinciding either with president Fernandez de Kirchner’s visit to New York in late September or the IMF meetings in Turkey. But the time between an announcement and formal completion of any agreement could be lengthy.

"I don't rule out the possibility that there will be more concrete news relative to this, but it will be a slow process to complete," said Mondino. "There is a lot of work that needs to be done both on the financial and legal front."

Indeed, a deal with the holdouts has been on the cards for quite some time. Barclays, Citicorp and Deutsche Bank were mandated last year to find a solution to resolve the approximately US$19bn in debt held by holdouts. But such plans were put on the back burner after markets deteriorated further, and government's decision to nationalise the private pension fund system soured sentiment.

To cut deal with the holdouts, the government would also first have to change laws prohibiting the reopening of the 2005 exchange. Many don't see this as an obstacle if the Kirchners are truly on board.

There is also the question of whether the government will take a piecemeal approach to the holdout problem. It could tackle institutional accounts first and leave retail Italian investors for later. Or it might opt to make amendments across the board, including with “vulture investors” such as Elliot Associates and the Dart family. A relatively high participation will be essential if the government wishes to put this problem behind it.

Even if a holdouts agreement is reached, it won't guarantee market access for Argentina if CDS spreads remain at current wide levels. "Spread levels will dictate market access. If they are trading below 1,000bp that means they have access," said Siobhan Morden, an analyst at RBS.

For that to happen, the market will need to see a combination of cumulative policy shifts, with a holdout deal being just one part of a broader picture. The perception of improving credit risk is required to give Argentina market access at a reasonable cost, Morden added.

Still, a combination of buybacks, IMF talks and a possible holdout solution has already led to a contraction in credit spreads. Investor sentiment, no doubt helped by an improving economic backdrop, has become more sanguine toward a country that some call a serial defaulter.

Five-year CDS has tightened to 1.430bp-1,444bp as this report went to press, after trading around 2,675bp in February. Dollar discounts had also climbed to 64.50 in early September, versus around 34 earlier this year. Despite deteriorating fiscal accounts, Argentina's credit metrics are often similar to, if not better than, its EM peers: Credit Suisse analysts said credit spreads are wider than where they should be if solely based on macroeconomic indicators. Market prices are also factoring in policy risk. Any changes on that front are likely to be gradual.

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