Argentine indigestion

IFR SSA Special Report 2018
10 min read

Foreign investors’ appetite for Argentine sovereign bonds is waning, as the government of President Mauricio Macri pursues populist policies and fails to get the public finances under control.

On January 4, Latin America’s third largest economy, Argentina, successfully conducted US$9bn of international bond issuance. It sold US$1.75bn of five-year paper at a yield of 4.625%, a US$4.25bn 10-year 6% and a US$3bn 30-year at 7%.

But while the government said the yields were the lowest in the nation’s history and the bonds were 2.4 times subscribed, analysts say the sovereign could have an issue finding large numbers of foreign investors for further sizeable market forays.

This is borne out by the fact it has now reduced its level of planned international issuance. Out of the US$30bn of financing needed for this year, it originally said US$15bn would come from the international markets, with the remainder to be raised domestically. But the Finance Ministry is now saying January’s US$9bn will be its only international offering this year.

The shortfall will be made up by an additional US$8bn–$10bn of local issuance, while the government said it could also use a repo facility with international banks. The provinces are also likely to issue a further US$3bn of debt.

“We are meeting our goal of depending less and less on external financing,” Luis Caputo, Argentina’s finance minister, said in a recent interview.

Gabriel Torres, an Argentine sovereign risk analyst at Moody’s, said: “The evidence is that the foreign appetite for Argentine debt is falling a bit. A higher interest rate in the United States has prompted a flight from emerging markets to the higher-yielding US Treasuries. This has made it a bit more difficult for Argentina to compete.”

Investors are most put off Argentina by the size of the country’s primary and fiscal deficits, 4.1% and 6.2% of GDP last year, respectively. The nation also has a large current account deficit, which amounted to US$8.7bn during the fourth quarter last year.

The fiscal deficit is something that Mauricio Macri, the markets-friendly president who took office in December 2015, said he would like to bring down. But he has found this very hard to do in practice because of resistance from Congress and the country’s powerful provincial governments.

Some irritating recent signs of populism have also spooked the markets. It is understood that the government put pressure on the central bank to relax the inflation target, originally set at 8%–12% for this year but now raised to 15%.

“The central bank’s recent decision to relax inflation targets led to a sharp drop in the value of the Argentine peso,” said Edward Glossop, Latin America economist at Capital Economics, a London-based economics consultancy. “The government is signalling a looser monetary policy. It is not clear that this is the right thing to do, as Argentina has the world’s second highest inflation, after Venezuela.”

Overweight investors

Alejo Costa, head strategist at BTG Pactual, the Sao Paulo-based regional investment bank, said: “During 2016 and 2017, investors made very good returns in Argentina. But this seems to have come to an end this year. There is a supply glut of Argentine debt and investors are already overweight in the sovereign. They cannot really absorb any further issuance. Investors are a little bit fed up with the country; they need to see some good news.”

Argentina has pro-actively returned to international debt markets since Macri’s inauguration. It quickly settled a nasty dispute with holdout creditors that had locked the nation out of capital markets for more than a decade, since its massive US$100bn default in 2001. In April 2016, the sovereign sold US$16.5bn of bonds that were four times subscribed.

It sold a US$2.75bn three-year at 6.25%, a US$4.5bn five-year at 6.87%, a US$6.5bn 10-year at 7.50% and a US$2.75bn 30-year at 7.62%. This was a big event for the nation, as it seemed it had finally put most of the issues arising from 2001’s default behind it.

Last June, the sovereign also sold US$2.75bn in a 100-year bond denominated in US dollars. It received US$9.75bn in orders, as foreign investors looked favourably on a yield of 7.90% in an otherwise low-yielding, global fixed income market.

“The Argentine economy is very much a work in progress,” says Alberto Ramos, Latin America economist at Goldman Sachs. “Under Macri, it is certainly more disciplined and more investor-friendly than it was under his predecessor, Cristina Fernandez de Kirchner.

“However, the country still has a very large fiscal deficit. The main difference is the change in the way in which they finance it. Under Cristina, the central bank just printed money and funded it that way, leading to very high inflation. Instead, Macri has turned to international investors. There was a lot of appetite at first.

“His final agreement with the holdouts generated a lot of good will internationally. Furthermore, foreign investors viewed his mix of economic policies as far more orthodox. But the sovereign has now issued a lot and the markets have a degree of indigestion.”

Local leverage

The local markets remain the more important source of liquidity, with a shift towards more aggressive issuance of Treasury bills denominated in US dollars, known as Letes. They offer greater hedging opportunities to encourage rollover and to discourage deleveraging by existing bondholders. Letes issuance reached US$7.6bn for the year to March 15.

On March 14, Argentina sold US$3.4bn in Treasury notes to refinance maturing debt. It offered Ps49.275bn (US$2.44bn) in peso-denominated 182-day notes with a nominal annual interest rate of 25.46%, US$500m in dollar-denominated 182-day notes at a nominal rate of 2.85%, and US$500m in 343-day dollar notes at a nominal annual rate of 3.54%.

The government also said recently it would detail a plan to pay back about ¥2.8bn (US$26m) Samurai bonds that have been in default. Japanese lenders Bank of Tokyo-Mitsubishi UFJ, Mizuho Bank and Shinsei Bank had held out against a debt swap, dating back to the 2001 default. But it seems Argentina is about to normalise its relationship with Japan as it puts this issue behind it as well.

In November, Argentina returned to the European market with the placement of three bonds denominated in euros, raising a total of €2.75bn. This included the sovereign’s first 30-year bond in that currency (€750m, with a 6.25% coupon). It also sold €1bn of five-year paper at 3.375% and a €1bn 10-year at 5.25%. The trade was four times subscribed.

Total international issuance last year amounted US$13.4bn, slightly higher than the US$12.75bn that finance minister Caputo had said the country was targeting in June.

“The Macri administration made some changes that had almost immediate effect and that the markets liked,” said Martin Litwak, a managing partner at Litwak & Partners, a Miami Beach-based law firm that specialises in Latin American finance.

“It freely floated the exchange rate, it had a tax amnesty, and it settled with the holdouts. It was also the first nation in Latin America to become more markets-friendly. It happened there before Chile or Brazil. It made the shift at the right time, when the international appetite for debt was great.

“There is a lot more transparency now than there was under the Cristina administration. However, the size of the state grew under the Kirchners and it continues to expand under Macri. He has taken populist measures, such as increasing the benefits for protestors. He also increased the number of government ministries.”

Argentina continues to suffer from the structural issue of a bloated public sector and a big bureaucracy. The country has more than one hundred different rates of taxation, for example. There are many vested interests, preventing the government from getting a firmer grip on public finances.

The country has 43.8m people and a US$639bn economy. The International Monetary Fund puts last year’s economic growth at 2.4% and is forecasting 2.5% for this year. However, recently, the country has been suffering a bad drought that could knock up to 1% off GDP growth. The IMF estimates inflation at 26.8% last year and expects it to come in at around 18% this year. In 2016, the country recorded a government debt equivalent to 54.2% of GDP.

Recently, the government launched an ambitious US$26.5bn public-private partnership programme. In April, it will name the winners of the opening round of highway concessions. It should follow with roughly another 60 projects in transportation, energy, mining, communications, healthcare and education.

These projects will be a big fillip to Argentine economic growth but the sums involved are not available in the local market, so developers will have to turn to international investors to get the funds they need. This could prove challenging.

Macri has started the process of normalising the Argentine economy. Initially, his administration was very popular with international investors and they welcomed the country back into the fold after a 15-year hiatus. However, he has disappointed them by not managing to reduce the budget deficit more quickly. Greater control of public finances is the key to the country fulfilling its long-term economic potential.

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Argentine indigestion