Argentina: Positive on the medium-term outlook – BBH

Argentina has been in the news this week, whilst MSCI delayed its decision on reclassifying Argentina, the nation was still able to place $2.75 bln of 100-yaer bonds even as the economy emerged from recession, explains the research team at BBH.  

Key Quotes

“We remain positive on the medium-term outlook, and believe that foreign investors should continue to build up Argentine exposure.”  

“Political Outlook

• President Macri has done a commendable job of addressing the economic woes since being elected in October 2015.  He quickly floated the peso and eliminated capital controls.  While these moves were necessary, the resulting inflation, austerity, and recession have hurt Macri’s popularity.  There have been numerous strikes by organized labor.”

“Economic Outlook

• The economy is finally recovering.  After contracting-2.3% in 2016, GDP growth is forecast by the IMF to accelerate to 2.2% in 2017 and 2.3% in 2018.  Bloomberg consensus is more optimistic, with growth seen at 2.8% and 3.0%, respectively.  GDP rose a stronger than expected 0.3% y/y in Q1, the first positive reading in a year.  Yet unemployment remains stubbornly high at 9.2% in Q1.
• Price pressures appear to have topped out, with CPI decelerating to 24.0% y/y in May from 27.5% in April.  A new, improved CPI measure was introduced last year, replacing the untrustworthy measure installed by former President Fernandez.   The central bank and the statistics agency INDEC have regained operational independence under Macri.
• Since the 7-day repo rate became the policy rate in January, Argentina hiked rates 150 bp in April to 26.25% currently.  If disinflation continues, the tightening cycle has likely ended.  Next policy meeting is June 28and no change is expected.  
• Foreign reserves have fallen recently after rising steadily over the course of 2016 to peak at $50.6 bln in February.  Now at $46.1 bln in May, reserves cover more than 7 months of import but are only about half the country’s stock of short-term external debt.”

“Investment Outlook

• MSCI delayed its decision on reclassifying Argentina from Frontier to Emerging until next year.  Argentina currently has a 20.27% share in the Frontier index.  The decision will be announced in June 2018, and we think it will be reclassified then if President Macri sticks to his economic reforms.  MSCI noted that “Although the Argentinian equity market meets most of the accessibility criteria for Emerging Markets, the consistency and persistence of the relatively recent changes as measured in practice still remains to be assessed.”
• The peso has done better after an awful 2016 but continues to underperform.  In 2016, the worst performer was ARS (-18%).  The next worst were TRY (-17%) and MXN (-16%).  So far in 2017, ARS is -2% YTD and is ahead of only the worst EM performer BRL at -2.3%.  Our EM FX model shows the peso to have VERY WEAK fundamentals, so this underperformance is likely to continue.
• Argentina just issued a 100-year USD-denominated bond.  A total of $2.75 bln was placed with a coupon of 7.125%.  The deep 10% discount pricing resulted in a yield of 7.90%, and helped keep the modified duration relatively low.  Argentina is just the second EM nation to issue 100-year debt, the other being Mexico.    
• Argentine bonds have outperformed this year.  The yield on 10-year local currency government bonds is about -258 bp YTD.  This is the best in EM and way ahead of the next best performers Indonesia (-109 bp), Turkey (-93 bp), and Peru (-81 bp).  With inflation likely to continue falling and the central bank likely to start easing in H2, we think Argentine bonds will continue outperforming.  
• Our own sovereign ratings model Argentina’s implied rating steady at B/B2/B after falling a notch last quarter.  This suggests little upgrade potential for actual ratings of B/B3/B.”