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Emerging Perspectives

What Argentina’s shock primary result means for bondholders

13 August 2019
Author: Mike HugmanPortfolio Manager

In Sunday’s primary election, known as the PASO, Argentine voters made clear their frustration with the fragile economic conditions and high inflation they have experienced under President Macri’s government. In contrast, the opposition party’s populist rhetoric clearly paid off and it now seems likely that Alberto Fernandez will beat Macri in the presidential election. We consider the implications for investors.

Key points

  • Opposition party candidate Alberto Fernandez looks set to win the presidential election in October, based on Sunday’s surprise primary election result.
  • Although Fernandez is viewed as a relatively moderate populist and his economic policy stance has appeared balanced, he is expected to shelve some of the current government’s market-friendly policies.
  • Since the result, Fernandez has said he intends to adhere to IMF lending terms. However, we believe that doing so will be challenging, especially given his plans to weaken the currency.
  • We estimate that a 50% haircut could eventually be required on tradable debt to make the debt stock sustainable.
  • We expect Argentine corporate debt to outperform sovereign debt, although short-term volatility in the corporate bond market will likely continue.

Primary result and policy implications

What is the PASO?
The PASO is the primary election in Argentina to choose the presidential candidate for each party/coalition. However, since each party/coalition only put forward one candidate, the PASO was essentially a poll of how people intend to vote in October’s presidential elections.

What happened?
The result shocked the market. With close to 90% of ballots counted, opposition Peronist candidate Alberto Fernandez had won 47.4% of the vote, with incumbent Macri trailing on 37.2%. Third-placed Roberto Lavagna took just 8.4%. In the primary for the key Buenos Aires province, the candidate for Macri’s coalition, Governor Maria Eugenia Vidal, won just 30% of the vote, with opposition candidate Axel Kicillof gaining 50.6%.

It is now clear that the combination of a fragile economy, high inflation and populist rhetoric has worked in Fernandez’s favour. The market reaction to the primary result is likely to exacerbate the above factors, further strengthening Fernandez’s hand.

Why does the PASO result matter?
Voting in Argentina is compulsory, so the PASO result is a good indicator of voter intentions. There is now a good chance that Fernandez will win in the first round of the presidential elections on October 27. To do so, he must: gain 45% of the vote; or gain more than 40% and lead the second-placed candidate by more than 10 percentage points. A 2.5 percentage point swing in Macri’s favour would force a second round, but it is difficult to see how the incumbent could win that vote. If the primary results are repeated in October, the Peronists will likely also take control of congress and the senate.

Why was the result a surprise?
Public poll data is notoriously unreliable in Argentina. Some of the most respected pollsters prioritise private clients rather than publishing their research, and there is a wide dispersion in results and methodologies. The result was expected to be much closer.

What does a Fernandez presidency herald?
It would not be unreasonable to expect a reversal of the market-friendly policies that Macri has tried to implement and that he had promised to follow in a second term. Likely policy implications include:

  • An intention to reduce payments on debt servicing to fund investment and social programmes
  • A desire for a weaker currency to make exports competitive, rather than addressing competitiveness through much needed labour reform.


Implications for economy and bond market

Why is Argentina’s economy struggling?
Global market pressure, combined with the real-economy shock of a drought, led to a series of large devaluations of the exchange rate in 2018, forcing Argentina to take an historic US$56 billion IMF programme and bringing headline inflation to 50% year on year. The significant fiscal and monetary adjustment required to stabilise the situation had its desired effect in reducing fiscal and current account deficits, but triggered a material recession.

What are the implications for Argentine debt?
Alberto Fernandez has stated since the primary result came out that his aim is to remain current on existing debt (in other words, to adhere to IMF lending terms). Although doing so may be challenging, this suggests a new government will not seek a confrontation with bondholders – though market developments may force one.

Our analysis indicates that Fernandez’s planned policy of a weaker Argentine peso (ARS) will likely make the debt stock unsustainable. About four-fifths of Argentina’s debt stock, which represents ~80% of GDP, is in hard currency. Hence a move to, say, 60/1 in the ARS/USD exchange rate (from about 45/1 currently) would put Argentina’s debt/GDP ratio on an unsustainable path.

A further challenge for foreign bondholders is that around half of the sovereign debt stock is owned by the IMF, the Argentine central bank and ANSES (the national pension fund). Thus, a restructuring would apply only to around 50% of the total debt stock, likely requiring a much higher haircut than would otherwise be the case. If a Fernandez government implemented its proposed policies, we estimate a 50% haircut would eventually be required on tradable debt to make the debt stock sustainable.

How long can Argentina sustain its debt burden?
The government has sufficient reserves and IMF funding to make it through to the end of 2020 (assuming it is able to adhere to IMF lending terms), so we estimate another 1.5 years of coupon payments will be made.

What is the likelihood of capital controls being imposed?
There is a risk that panic about the potential for capital controls sparks a capital flight that makes the imposition of such controls self-fulfilling. Hence, we believe there are higher risks associated with local currency bonds and local-law US dollar-denominated debt, which could be caught up in capital controls.

That said, Alberto Fernandez has been very balanced in his campaign speeches on economic policy. While he believes a weaker exchange rate will promote growth, he has been clear he wants to avoid broad capital controls. He also wants to promote foreign direct investment, especially into the Vaca Muerta oil fields and the agricultural sector.

How is the central bank likely to react?
The BCRA (Argentina’s central bank) retains significant foreign-exchange (FX) reserves and has additional room to intervene in FX futures markets under the current IMF framework. We expect that it will look to stabilise the ARS/USD rate into the election, to try to engineer a less disorderly political handover.

What about Argentine corporate bonds?
We remain broadly constructive on Argentine corporate bonds. In general, fundamentals are solid across Argentine corporates as most have conservative financial policies and maintain relatively low leverage. Although debt and liquidity metrics (e.g. leverage and interest coverage) are likely to deteriorate in the near term amid the currency devaluation, weak growth and persistently high inflation, we do not expect a significant increase in defaults as debt remains serviceable. Corporates have opted to scale back capital expenditure plans and shore up liquidity in the face of uncertainty. Convertibility poses the biggest risk for investors, though we assign a low probability to this scenario at present.

Corporate resilience in Argentina has a clear precedent: as an example, energy company YPF remained current on all external debt throughout the prior Cristina Fernandez presidency.

Risks vary across the sectors, but we believe corporates with exposure to the external market will be more resilient whatever the election outcome.

Although the situation remains dynamic, we believe the price action seen in the corporate bond market since the primary election result is extreme, with most bonds being marked down in the range of 10-20 points. Low August trading volumes and thin liquidity mean prices are not commensurate with market transactions and thus true price discovery is difficult. We feel this price action is not a reflection of true corporate fundamentals and as such remain comfortable with our positioning. In the shorter term the overweight positioning by the broader hard currency sovereign market, ETF positioning and low August volumes are likely to all add to continued price volatility.


Sovereign debt outlook and portfolio positioning

How are portfolios positioned?
Earlier this year we took the view that it was hard to call any outcome beyond 50/50 and looked to take a conservative position, remaining close to neutral in our benchmark-relative portfolios. In contrast, our main data sources show that Argentine US dollar debt and the ARS are among the largest overweights held by active emerging market debt (EMD) managers, on average.1

How do you expect your portfolios to be impacted in the near term?
Based on the positioning of the portfolios, we expect the direct, benchmark-relative performance of Argentina in our sovereign and blended portfolios to be fairly neutral. There has been some spill-over impact on broader EM dollar debt markets, which may negatively impact our hard-currency debt and blended portfolios modestly in the short-term. However, we are looking to remain defensively positioned for now and believe alpha opportunities will arise from some of the potential spill-over effects within the asset class.

Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.

 

Investments carry a risk of capital loss.

1 Trounceflow, Bank of America Merrill Lynch, JP Morgan.

Mike Hugman
Mike Hugman Portfolio Manager

Additional Information:

This material is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein.

All rights reserved. Issued by Investec Asset Management, issued August 2019.

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