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Thursday, 19 October 2017

Turning a corner

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With holdouts largely on board after the exchange reopening and short-term debt dynamics looking favourable, Argentina can now relish the prospect of returning to the international bond markets. That could be a while off, however, as the price-sensitive sovereign awaits yield levels that may require a significant policy shift. Paul Kilby reports.

Argentina has become the new darling of Latin America’s high-beta universe. As investors grow increasingly wary of Venezuela they are instead focusing their attention on the Southern Cone country’s improving story.

“Argentina has shown a willingness to pay its debt, amortisations are lower and in the near term we are not looking at a default… as opposed to Venezuela which is falling off a cliff,” said one strategist.

Like Argentina a few years ago, worries about a Venezuelan default are on the rise. Strategists still tend to think it an unlikely scenario given its strong oil revenues and its dependence on export markets, which could punish the sovereign if it failed to honour its debts.

Argentina is now the LatAm sovereign investor’s destination of choice. It now trades comfortably inside its high-beta peer, with the sovereign’s five-year CDS being quoted at 765bp on September 17 versus 1,289bp for Venezuela.

Despite lingering doubts about the Kircher administration’s interventionist policies, the country has shown it can emerge from a major global financial crisis, with only a few scratches. It is now in position where the buyside and rating agencies are comfortable about the credit’s short-term outlook, though medium pressures remain a concern.

However, problems remain. It faces amortisation spikes further down the road. And distrust over the government’s statistic reporting on inflation remains high, and will be a major stumbling block for any future negotiations with the IMF.

Still, from a credit perspective, the pall of the 2002 default is slowly being lifted. In July, Fitch upgraded the country’s long-term foreign currency rating to B from RD with a stable outlook. S&P followed suit in September when it brought its rating up to B from B-, with a stable outlook.

Both agencies cite improving debt dynamics. However, this has been achieved largely using unorthodox strategies. Argentina has used reserves to make bond payments and has overseen a major shift of market debt onto government books, with government entities now holding some 35%-45% of the outstanding US$156.7bn in total central government debt, according to S&P.

The strategy has helped reduce near-term rollover risk. But it does not resolve longer-term pressures “that could arise form the social security system and other public sector agencies,” S&P said.

As good as it gets?

High beta credits like Argentina are in vogue with investors seeking yield in this low rate environment. But Argentina arguably has little upside left unless investors see some major policy changes and further normalisation of relations with the market and the IMF.

“I don’t know if I would call it an improving credit story,” saidSebastian Briozzo, a director in the sovereign ratings group at S&P. “Our action reflects the financing profile over the short-term; the next 12 to 24 months look less risky, and this is what has driven our decision.”

The country’s economy is certainly benefiting from higher soft commodity prices and neighbouring Brazil’s strengthening economy, which absorb about 90% of Argentina’s manufactured imports. These factors have helped increase foreign reserves this year to around US$51bn, despite the government using a good chunk to pay down foreign debt. But analysts and investors do not believe such interventionist policies are unsustainable.

And while success of the latest reopening of Argentina’s debt swap helped bring over 90% of the holdouts into the fold, and should prepare the way for renewed access to the capital markets, this is not an upwards ratings trigger by itself. “The debt swap is an important fact, but by itself it really didn’t play an important role in our assessment of the ratings,” said Briozzo.

Yet Argentina’s rating remains two notches below Venezuela’s. There may be room for ratings momentum based on improving financial ratios and a reduction in net government debt levels, said Briozzo. But there are limits.

“The country warrants a B plus rating rather than B,” said David Spegel, head of EM strategy at ING. “But policy risk explains more than 50% of the ratings for speculative grade sovereigns. The default was 10 years ago and it has been a constraint on an upgrade, though on a fundamental basis, it is a B plus and it is treated as such in the external market.”

With its reopening of its debt exchange complete and a large chunk of holdouts taken out of the equation, Argentina is now focusing on a return to the international markets and settling close to US$7bn in Paris Club debt arrears.

Before it can achieve the latter, the government will probably have to make amends with the International Monetary Fund. In early September there was much speculation that Argentina might finally submit to the Fund’s Article VI consultations, which typically opens the country’s public accounts to IMF scrutiny. Such a move would mark a significant reversal for a government that has blamed the Fund for the economic woes that led to the default of close to US$100m in debt in 2002.

Renewed relations with the IMF could in theory provide a boost to the country’s debt prices, and perhaps bring yields in line with where the government would be willing to retap its 2017s. But analysts remain sceptical about seeing any movement on this front, at least in the near term.

The recent appointment of a new envoy to the IMF is really a move to avoid sanctions from the Fund, said analysts at Bank of America Merrill Lynch. Government officials have been quick to contest press reports that they would submit to any form of outside surveillance.

Alternatively Argentina could take the easier path and forgo any IMF negotiations and simply pay down Paris Club debt using some of the US$50bn it holds in reserves.  

Courting the markets

For now Argentina’s priority seems to be preparing the ground for a return to the international capital markets, after an almost 10-year hiatus. Liability management has also been important. In August it looked to swap into dollar debt existing euro-denominated pars and discounts that were issued in the recent exchange with hold-outs.

At first glance it seemed counter-intuitive. But many dollar investors who wanted to snap up non-tendered Argentine debt on the cheap had little choice but to buy into a currency that comprised a large portion of the country’s debt load, said bankers. So accounts have wanted to take it a step further and get their hands on dollar debt.

It is hardly surprising the government is willing to comply: the more dollar debt it has outstanding, the greater participation Argentina has on key dollar indices. In theory this would boost flows and create greater demand for the sovereign’s paper. It makes sense for a country preparing the ground for what it hopes will be an impressive return to the international capital markets.

The Treasury also wants to tackle the heavy amortisation schedule it faces during the next five to seven years. Some sort of swap or refinancing will be in order, said bankers – possibly one involving a retap of the new 2017s. For the 2011 budget, the government has earmarked Ps8.7bn (US$2.1bn) for debt buybacks amid much speculation it will target GDP warrants. The country has some US$10bn–$13bn in yearly amortisation payments between now and 2015 and the government is keen to extend maturities and provide some relief from such a burden.

It is still unclear how it will proceed. But a retap of the 2017s may be a good place to start, and if successful could encourage it to issue a new bond and a longer maturity, said one analyst.

Holdouts may still be in possession of some US$4.5bn of debt and subsequently pose some attachment risk once the government is ready to tap. But such a threat has been considerably diminished now that over 90% of creditors have agreed to the sovereign’s restructuring terms.

Against that backdrop it is thought US courts are less likely to rule against the sovereign, leaving the way clear for an international bond issue. The ball is now in the government’s court to decide whether it wishes to access international funding.

On the other hand, the benchmark 2017s have been bumping against certain resistance levels, and this has ultimately put the breaks on a price sensitive sovereign that can afford to wait and essentially wants to make statement with sub 9% levels.

“They will wait until the yield on the 2017s drops to 8% and that is another 200bp of spread compression,” said Spegel.

Arguably, an improving external backdrop could push prices higher, and in theory the government could quickly tap. But bankers are not holding their breath.

“Ultimately to normalise external creditor relations what the market truly needs to see is a fully fledged policy shift,” said Siobhan Morden, head of LatAm strategy at RBS. “It is the overall policy mix that drives prices of bonds offshore.”

This may mean markets will have to wait until after the presidential elections in October 2011. Many hope that the Kirchner husband-and-wife team will finally lose its grip on power, opening the way for a market friendly president. But this is not a foregone conclusion.

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