Argentina’s currency crisis has triggered an IMF bailout, which the government believes will spark a recovery. Those who recall the IMF’s last intervention, before the 2001 default, less favourably will be hoping the government is right, especially with an election in the offing. Silvia Pavoni reports.

Rescuing Argentina

Argentina’s record-breaking numbers are hard to take in, including, as they do, a $57bn bailout package, the largest ever handed out by the International Monetary Fund (IMF); a 60% benchmark interest rate, the highest in the world; and a planned fiscal adjustment of nearly 4% of gross domestic product (GDP) in just over two years, the steepest in the country's recent history.

Experts warn, however, that the depth of the country’s troubles, as well as the bitter remedy prescribed by the IMF, will be felt sharply by Argentines well into next year. And as voters will choose their next president in October 2019, there is a risk that the country will take a step back towards the protectionist leadership of the past.

Economy minister Nicolás Dujovne has promised: “This has been no precedent in Argentina’s recent history [but] Argentina, right now, is generating the conditions to regain growth.” But if the fiscal squeeze proves too much and the old political ways come back? “Forget it: [Argentina] could turn into Venezuela,” says Claudio Irigoyen, head of Latin America economics and foreign exchange and fixed-income strategy at Bank of America Merrill Lynch.

Losing faith?

How did Latin America’s third largest economy come to this? It has had an ambivalent recent past with the international community but seemed to have turned a corner in 2015 with the election as president of right-wing Mauricio Macri, a former businessman. His administration swiftly came to an agreement with the bellicose hedge funds that had fought his predecessors, the Perónist Cristina Fernández de Kirchner and, before that, her late husband Nestor, following Argentina’s disastrous default in 2001.

The country had been excluded from international markets, but when it re-entered them on the heels of the settlement with holdout investors, it did so with a bang: in April 2016 it issued a $16.5bn bond issuance, the largest ever by an emerging market. Then, in June 2017, it made headlines again by pulling off a rare 100-year bond that raised an additional $2.75bn. Investors starved of yields were flocking to a sovereign that had long been absent from international markets and, finally, was run by a trusted political team.

The new government devised a sweeping reform package that sought to rebalance public spending and remove distortions in the economy, including the wasteful subsidies to utility and transport prices that Argentines were accustomed to. But with a minority in both parliament houses, the government felt it wiser to introduce the most painful changes gradually, until it achieved a stronger mandate in the October 2017 mid-term elections. 

International investors’ support had held strong until then and could arguably finance the government’s activity for a while longer. But the markets’ enthusiasm receded almost as quickly as it had risen when global conditions turned earlier in 2018. It soon became apparent that investors had lost faith in the gradual introduction of Argentina’s reforms.

Kiss of death

“Mr Macri’s biggest mistake of all was not to adjust fiscal policy in a much more meaningful way at the beginning and to think that markets were going to finance a gradual adjustment,” says Mr Irigoyen. “The combination of loose fiscal policy and tight monetary policy created an overvaluation of the currency that was the kiss of death when interest rates started to move higher in the US.”

In May 2018 the peso began to dive against the dollar as the US currency and rising interest rates offered safer alternatives, making Argentina’s dollar-denominated obligations harder to meet, at an estimated 45% of GDP. The central bank intervened strongly – but ineffectively – to prop up the currency’s value. Communication has been a sore spot for the monetary institution; investors complain that its multiple attempts to shore up the falling peso in 2018 led to several unexpected interest rate rises that came with little explanation or longer term guidance. So in June, Mr Macri called the IMF. He secured a $50bn financing package – significantly larger than the markets had expected – to ensure the government would be able to repay investors. Markets were reassured – but not for long.

By the end of September, despite the IMF credit line and after the Turkish currency crisis had spread to the Latin American country, the peso had lost half of its value against the dollar. Mr Macri asked for earlier disbursements and extra financing from the IMF, and a new deal was agreed, pending board approval, which was expected at the end of October (after The Banker had gone to press). The new $57bn package frontloaded payments and changed in nature from precautionary to discretionary: rather than mostly serving as insurance, the money can be used to finance the budget as and when it is needed. But the deal comes with tighter conditions, and the path to agreement was smoothed over by the appointment of a different central bank governor.

Central bank turnover

Argentina’s central bank governor changed twice in just a few months earlier in 2018. Failing to support the currency, Federico Sturzenegger resigned in mid-June and was replaced by finance minister Luis Caputo – who left just over three months later as the government sought to update the initial IMF bailout package. The deal appeared to require a less interventionist monetary authority. At the time of Mr Caputo’s resignation, the government was already struggling with a 36-hour general strike against the new austerity measures. 

The new central bank governor, Guido Sandleris, a respected economist who has worked at the IMF, officially committed to not growing the monetary base until June 2019 in an effort to reduce inflation to single digits by the end of the three-year programme. Monetary base targeting, therefore, has now replaced inflation targeting, which was introduced by the new administration, as part of the new strategy agreed with the IMF. Many consider it a positive shift, given recent challenges in keeping inflation under control. But others have reservations about the measure. 

“The regime is very popular in emerging markets and many countries have used it very successfully – but it requires certain conditions to be effective,” says Martin Castellano, head of Latin America research at the Institute of International Finance. “[For example] you should not have fiscal dominance [where the central bank finances the Treasury]; you need to get used to a flexible exchange rate.” Despite this being the aim of the central bank, there is uncertainty over the effectiveness of the strategy as “those conditions are not met in Argentina [yet]”, adds Mr Castellano. Currently, the government expects inflation to remain above 40% until the end of 2018, and drop to 23% by the end of 2019.

Exchange rate concerns

Other IMF requests relate to rules about the free-floating currency and limits to intervention in the foreign exchange market. Investors have generally welcomed these. There will not be any foreign exchange intervention if the peso remains within a range of between 34 to 44 to the dollar; the band can increase by up to 3% every month. Outside that range, the central bank can use a maximum of $150m to support the currency. This will ensure that bailout funds will not be eroded to underwrite capital flight. But there are concerns here too.

“The main advantage is that [the rule] provides more transparency,” says Elijah Oliveros-Rosen, senior economist, Latin America, at Standard & Poor’s. “The disadvantage is that it sends the wrong signal. Given the large external imbalance, the exchange rate needs to be more flexible not more rigid.” Argentina’s current account deficit was 4.8% in 2017, the highest in 20 years; the IMF expects it to be 3.6% by the close of 2018. Mr Oliveros-Rosen also feels that restricting intervention could dent the credibility of the central bank. “If you do see a sell-off... and that [$150m a day] is not enough, you lose credibility in the exchange regime,” he says.

Following the announcement of the deal, Jim Barrineau, head of emerging markets debt at Schroders, told the Financial Times: “This is a whole new world for Argentina. We and the rest of the market are in a wait-and-see mode to see if the country will be faithful to the IMF agreement and not intervene in currency markets.”

But the biggest reservation is about fiscal tightening. The new IMF conditions put additional pressure on the delivery of public spending cuts against a less-than-desirable macroeconomic backdrop. Under the revised credit line, Argentina is to turn the current 2.8% primary fiscal deficit into a budget balance in 2019 – when, in addition to presidential elections, Argentines will be dealing with a shaky economy after this year’s recession. This dramatically speeds up the pace of the adjustment from the previous package, which had only expected a budget balance in 2020. By then, under the new deal, the government will need to move to a 1% fiscal primary surplus.

First, however, the new austerity measures will need to be approved by lawmakers then implemented successfully by Argentina’s 23 provinces and the autonomous city of Buenos Aires. Economy minister Mr Dujovne is confident this will happen as local administrations have already agreed to fiscal prudence. “We negotiated the budget bill with the governors and 20 of them signed the renewal of the fiscal pack that was approved last year,” he tells The Banker. “That shows that most of the governors of Argentina are supporting the government’s efforts to converge to primary equilibrium of fiscal accounts next year.”

But even with initial political support, national and local politicians will be inevitably confronted by challenges. Healthy economies would find this type of fiscal adjustment hard enough. It is a herculean task for a country such as Argentina, which has been swinging in and out of recession since 2012. 

Tough conditions

Other factors are playing against Argentina and its hopes of sticking to the IMF deal. The government forecasts a GDP contraction of between 2% and 2.5% for 2018, caused mostly by the worst drought experienced by the country in the past 50 years. The economy will remain vulnerable “for the next six months, until the next harvest, and probably for a couple of quarters after that”, says Mauro Roca, managing director for emerging markets at asset management firm TCW.

Some expect an even harsher recession by the end of 2018 and, therefore, a tougher recovery in 2019. Having compared Argentina’s data and financial indicators to other countries that went through currency crises in the past, Edward Glossop, a Latin American economist at Capital Economics, forecasts a much sharper drop of 4% of GDP. “The scale of [the tightening of] financial conditions we’ve seen in Argentina is consistent with a sharp fall in GDP growth,” he says. “This fiscal squeeze of [about] 4% of GDP is one of the largest we’ve seen implemented by IMF programme countries in the past; you also need to consider that the economy will be in a very deep recession. That probably argues against the government really sticking to the IMF deal to the letter.”

Others agree. “What you need to do to win an election is completely different from what you need to do to calm financial markets,” says Mr Irigoyen. “The problem with the [IMF] stabilisation plan is that if the recession becomes really bad – a sort of Brazil-type of recession – will [the government] stick to it? At the end, Mr Macri and people who work for him are politicians and politicians want to win elections. So they might do something [that wins votes but breaks the agreement] and the market is expecting that.” This is why markets are not rallying more convincingly, he adds.

A Fernández return?

Mr Macri’s popularity is at its lowest since he won the 2015 election. At the other end of the political spectrum, the possibility of former president Ms Fernández running is still open, despite her alleged involvement in a wide corruption scandal that echoes Brazil’s Lava Jato (Car Wash) investigation. 

The so-called 'notebooks bribery scandal' was revealed in August and is widely believed to have contributed to the fall of the peso. It is also blamed for jeopardising planned investment that would have contributed to economic growth in the country. A number of Argentinian companies have been implicated. Ms Fernández denies the accusations. Even if found guilty and convicted, she will still be eligible to run for the presidency under local rules, according to Mr Irigoyen. And if the economy severely underperforms she might have a chance.

James Gulbrandsen, a Rio de Janeiro-based money manager at NCH Capital, told Bloomberg: “People will always vote with their wallets. The economy typically trumps outrage over corruption.” NCH Capital reduced its Argentina exposure to zero earlier in 2018.

Mr Irigoyen says: “It is a big political game and Macri will have nothing to offer in economic terms to win an election next year. So the focus will be on politics, [and] it will be a fear campaign: either you vote for me or you go back to the past.” So, adds Mr Irigoyen, Ms Fernández may be the best opponent for the current government because of her polarising effect. But a more moderate Perónist candidate, such as Sergio Massa, former presidential candidate and ex-chief of cabinet to Ms Fernandez, could make the present government’s future all the more uncertain. 

“The situation today is that [Ms Fernández] would defeat any other Perónist in the primaries and make it to a second round with Mr Macri and Mr Macri would still defeat her – but barely,” says Mr Irigoyen. “[But] if for some reason a moderate Perónist makes it to the second round, [they] would defeat Mr Macri.”

Reasons for optimism?

The government is faced with a series of tough decisions. Mr Dujovne remains positive about the economy and is clear Argentina has broken with the past. “We think that the correction of the fiscal balance, the correction of the real exchange rate... the very tough decisions that our central bank has taken to generate very clear, sound tight monetary policy, will help to stabilise inflation and the [peso], and will allow for a recovery that we clearly see [happening] next year. And [this will be done] without resorting to changing the rules of the game as Argentina usually did in the past.”

Others in the country seem optimistic, and believe the stabilisation and gradual decline of the exchange rate since the beginning of October, to about 36 pesos to the dollar by the middle of the month, will lead to a reduction in the eye-watering 60% benchmark interest rate. “We’re optimistic because as the foreign exchange has been stable over [October’s first two] weeks, even decreasing, we think the central bank will start reducing interest rates,” says Fabian Kon, CEO of Banco Galicia. 

The current weak peso is also a boon to exporters. Despite the recently introduced export tax, which Mr Macri defined as a bad but necessary measure, companies selling abroad are better off than they used to be, according to Marcos Wentzel, managing partner of local investment bank Puente.

IMF under pressure

Calling in the IMF was a highly sensitive decision for a country that still nurses sour memories of the IMF’s failed intervention that preceded Argentina’s 2001 default. It is not just Mr Macri’s political future that is at stake. Given the size of the current programme, IMF head Christine Lagarde’s reputation is also on the line. Some wonder how lenient the IMF might choose to be in an effort to support Argentina and make a success of its largest ever bailout deal, while also making sure moneys are returned. 

Others say the plan should have been thought through more wisely at the start. Although it would not be appropriate for the IMF to express political preferences in countries’ elections, investors wished the agreement would have not put so much pressure on an administration that is bringing difficult reforms to a full-of-potential but long-suffering economy.

“[The IMF] should have thought of a plan that maximises the chances of Mr Macri winning, not a plan that maximises the ability to repay [the loan] in the next [few years],” says one professional, speaking privately. “Why didn’t it? Because it screwed up.”

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