Argentina’s economy stares into the abyss – again

Argentina is once again dealing with the prospect of a sovereign debt restructuring to avoid what would be its ninth default. As the economy falters, the new Perónist government is insisting on expansionary fiscal measures. These could clash with its international obligations with investors as well as with the International Monetary Fund (IMF), to which it owes $44bn in rescue funds.

There are many actors involved, including Pope Francis, an Argentinian, who sponsored informal talks in Rome between Argentina’s finance minister, Martín Guzmán, and the IMF’s new managing director, Kristalina Georgieva. Bondholders are watching, as are the country’s banks. 

Although experienced at navigating Argentina’s various crises, the banking sector has inevitably been hurt by the country’s new high levels of inflation. After plateauing to a much improved 24.8% in 2017, the inflation rate shot up to 53.8% in 2019, its highest level in almost three decades.

Troubled times

Despite appearing healthy in nominal terms, Argentinian banks’ income statements look very different once inflation adjustments are taken into account. This is evident in the Securities and Exchange Commission filings of the four Argentinian banks that issue US depository receipts and which, therefore, need to comply with US accounting rules. These require companies to account for inflation if they operate in a currency of an economy where the three-year cumulative inflation rate exceeds 100% for several months. Argentina has fallen into such a category since July 2018, as reported by The Wall Street Journal. 

The four banking groups, Grupo Financiero Galicia (owner of Banco Galicia), Grupo Supervielle (which owns Banco Supervielle), BBVA Argentina and Banco Macro all reported inflation-adjusted losses for 2018, the latest available financial year. 

More recent results, as well as future ones, may paint a similar picture, and not just because accounting for hyperinflation has become mandatory for local Argentinian reporting too, after January 1, 2020. “This year is not going to be a good year for banks,” says Santiago Gallo, Fitch Ratings director for Latin American financial institutions. Argentina's banks are not lending because of ongoing economic struggles, he adds, while non-performing loans (NPLs) have more than doubled from 2% in November 2018 to 5% as of November 2019. The economic recession from which Argentina has barely emerged is also limiting activity. 

“Until [banks] see that companies are doing better and the credit risk goes down, I don’t think they will start lending,” says Mr Gallo. “We expect that NPLs will broadly continue to increase and high inflation will continue to affect operating costs. And of course, [the banking sector] will be heavily influenced by the success or the failure of the government in restructuring its debt.”

Banco Galicia CEO Fabian Kon adds: “We think that there is big potential [for the banking sector in the near future] as long as agreements with the creditors and the IMF are in place. Argentina hasn’t grown for years, gross domestic product [GDP] per capita has decreased. If things don’t work out, we’ll end up with hyperinflation again and no growth.”

Roots of the problem

Elected on an anti-austerity platform, president Alberto Fernández’s government is expected to be less receptive to international requests on fiscal prudence. His vice-president, Cristina Fernández de Kirchner, had bitterly fought investors who refused the restructuring terms of Argentina’s defaulted debt when she was president. The matter was resolved only by her successor, Mauricio Macri, soon after he came to power in 2015. The international investors’ honeymoon period with the new Argentina was short-lived, and Mr Macri was forced to knock at the IMF’s door in 2018 when the peso plummeted as markets lost faith in his government’s ability to turn the country around. Argentina’s situation remains complex today.

As of mid-February, the government had yet to produce detailed fiscal plans that might justify requesting a haircut on foreign obligations. Analysts remain nervous as to how far each actor involved in a restructuring would play their hand. The case of the Province of Buenos Aires tells a story of a near-default. Earlier in February, US financial services company Fidelity, one of Argentina’s largest creditors, blocked the province’s proposal to delay a $277m debt repayment due on February 5 until May 1. The local administration made a last-minute payment. 

Soon afterwards, the government successfully delayed payment due on a local peso-denominated bond until September, after about 90% of bondholders turned down a debt swap. US holding company Franklin Templeton is said to hold 23% of that debt, according to Buenos Aires-based Portfolio Personal Inversiones and as reported by the Financial Times. In a statement on February 11, Argentina’s Mr Guzmán said: “This government will not allow the Argentine society to be hostage to international financial markets, nor will it favour speculation over the wellbeing of the people.”

Any sovereign debt restructuring negotiation that might follow, as always, will be instructive. “You’ve got three players here: the government, the IMF and the bondholders. All of them think that they have more bargaining power against the other two than they actually do,” says Claudio Irigoyen, Bank of America Merrill Lynch’s head of Latin American research.

He adds that bondholders believe that because of Argentina’s macroeconomic struggles, the government will be forced to offer an attractive deal or risk plunging into a crisis. At the IMF, the new administration may view the record rescue package for the country as a legacy of former IMF managing director Christine Lagarde. Argentina is not sufficiently connected to generate a ripple effect throughout the region or other emerging markets, and maintaining a firm line “could be a wake-up call for other countries, [a signal] that the IMF is not going to just give money [away] for free”, adds Mr Irigoyen. “I think the IMF will not rush to help Argentina,” he says.

On the other hand, Todd Martinez, head of Latin American sovereigns at Fitch Ratings, says: “The IMF very much cares about domestic ownership of its programmes.” It might not wish to impose unpopular measures to recover funds, he adds.

A political risk

While some see Argentina’s as a liquidity problem, others believe there is a sustainability issue too. 

“There is this narrative among analysts that Argentina only has a liquidity problem, not a sustainability one. So a debt restructuring would only need to involve postponing the debt service,” says Mr Martinez. “We have a much more cautious view because Argentina’s debt burden is quite high already.” 

Mr Martinez believes the fiscal adjustment needed to stabilise the debt to reasonable levels would have to be large, and therefore politically unacceptable under the current government. This is because, although not particularly high at 86.2% in 2018, the debt-to-GDP ratio would still need to come down to compensate for the country’s poor standing as a borrower. 

“Argentina is a country with much lower debt tolerance than a lot of its peers,” says Mr Martinez. “While Argentina’s debt [is similar to] Brazil’s, the standard for Argentina, in terms of a prudent debt-to-GDP metric, should be quite a bit lower. This is a country that simply has a hard time borrowing in its own currency and is highly vulnerable to devaluation risk.” A good restructuring is one that involves a “meaningful haircut”, he adds. 

Nikhil Sanghani, an economist at Capital Economics, sees “significant cuts to private bondholders” as the most likely outcome of a debt restructuring.

The future of Argentina remains uncertain, and the government’s unclear policy position could be making matters worse. “It’s not clear who’s calling the shots. Mr Fernández is the president but Ms Fernández de Kirchner is the vice-president and effectively is running the show behind the curtain,” says Mr Irigoyen. He is not hopeful about the immediate future, adding: “What you need for things to get better, is [for things] to get worse.”