In a phenomenal twist of events showing how sensitive the financial markets have become, in just a few hours, Argentina went from weathering-the-storm mode to a shipwreck as investors
dumped government debt on fears of yet another potential default.

Partial Elections

The trigger was last Sunday’s elections were Mauricio Macri got pummeled at the polls Sunday with voters giving his opponents Alberto Fernandez a 15-point lead.

Expected to trail his opponent in a mandatory primary election that serves as the most accurate preview ahead of October’s presidential vote by just a few points, President Mauricio Macri’s upset paves the way for a more protectionist government to take over in December and increases the view in the markets that outstanding bonds and an International Monetary Fund program will have to be renegotiated.

For a nation with a long history of defaults that only resolved the previous debacle in 2016 under Macri, the sudden shift in political sentiment is scaring foreign investors and Argentines alike who have already suffered through years of high inflation, economic malaise and political division.

The uncertainty for investors is all about Alberto Fernandez. Born in 1959, Fernandez was the Chief of the Cabinet of Ministers during the entirety of Néstor Kirchner’s presidency, and the early months of Cristina Kirchner’s as Vice President.

He then fell out with Cristina Kirchner, only to return as the presidential candidate with her on his ticket. Cristina Kirchner’s eight years in office were marked by currency controls, data manipulation and protectionist policies on trade to protect national industry as well as another default.

Extremely violent market reaction

Argentina Government dollar bonds lost about 25% on average on Monday, pushing prices to a range of 55-60 cents with yields spiking to as high as 35% on short-term notes.

Credit-default swaps now show an implied probability that Argentina will suspend debt payments over the next five years at about 75% versus just 49% at the close of the trading day on Friday.

The 5 year Dollar Bonds are now trading at 18 % in US Dollars, the 100-year bond sold
during peak optimism of Macri’s reform drive about two years ago is now trading at about half the value at which it was first issued.

The peso tumbled as much as 30% to a record-low 59 per dollar and the Merval stock index lost the most ever in intraday trading losing 37 % of its value

Global equity markets rolled over across the board while bonds and Gold recorded new highs.

Pricing Defaults

The market is clearly starting to price in default and unwilling to give Fernandez the benefit of the doubt. What is being priced right now is radical change in economic policies, another bond default and another fight with the IMF.

However, it is likely that the Peronist candidate will moderate his stance and try to gain some marginal votes from Macri disappointed voters. If Fernandez comes out with some market friendly comments (especially on the IMF front) and/or a credible economics team, this would certainly help the sentiment.

More importantly, partial elections have always been used by voters to send signals to politicians in power and do not automatically mean that the end-result will be the same. There are another three months before the October elections and Macri will certainly listen to the message.

The fall in the financial markets on Monday in itself is a warning short to voters,

“This has been a bad election. We must redouble our efforts tomorrow so that in October we can continue with [our project for] change,” Mr Macri told dejected supporters on Sunday night after his first election defeat since turning to politics almost two decades ago. “October could perhaps define the next 30 years for Argentina,” he added.

Government supporters point out that in the 2015 elections the Peronist candidate Daniel Scioli led Mr Macri by around eight points in the primary elections, with that gap narrowing to just three points in the first round. As no candidate won outright, a run-off vote between the two leading candidates was held, which Mr Macri won by almost 3 points.

A long History of Defaults

Very few countries have seen as spectacular of a decline in economic standing over the past 100 years as Argentina has.

The country started the 20th century as one of the richest in the world, but has fallen behind as a result of its turbulent political history and inconsistent economic policies.

Argentina defaulted on its international debt EIGHT times and on its domestic debt FIVE times since its independence in 1816.

The first sovereign default came only 11 years after independence.

Before Europeans reached the Argentine area of South America, the region was scarcely populated.  Spain colonized the country in the 16th century and instituted a strong central government.

A sizeable railroad system was built under Spanish rule, which helped transport the country’s agricultural products to the coast for shipping.  The economy grew via strong export expansion.  As the Spanish kingdom weakened due to constant wars in Europe and abroad, a military junta took control of Argentina.

The country declared its independence in 1816 and a bitter internal struggle between different military factions ensued.

Argentine economic growth in the 19th century was primarily driven by the development of large farms.  The fertile land and availability of cheap labor allowed the country to produce and export large amounts of grain and meat products.  Additionally, Argentina is extremely commodity reliant.  The country is rich in resources.

Argentina became the “land of opportunity” as it was a destination for many European immigrants.  Prior to WWI, Argentina was the 10th wealthiest country in the world in terms of GDP per capita.

WWI took a large toll on the economy and the Great Depression in the U.S. further weakened the country as global economic growth slowed, leading to increased unemployment and social unrest in Argentina.

This also marked the beginning of a long period of political instability in the country.  The military took power in 1930, instituting import substitution to achieve self-sufficiency, turning the country insular.  For the rest of the 20th century, 14 generals and 11 elected civilian presidents would run the country.  In fact, between 1930 and 1983, presidents averaged only two years in office.

In 1952, Juan Domingo Peron was elected president on the back of increasing social fragmentation. Peron promised to redistribute wealth and power to the large urban working class, and away from the bourgeois land owners.

Peron nationalized several private and foreign-owned companies, leading to large capital outflows as foreign investors became increasingly nervous. Capital flight, combined with falling commodity prices, caused severe economic turmoil, while labor and trade restrictions pushed inflation to 40% annually.

Peron kept social unrest at bay through increased social spending. In many ways, Peron shaped the economic development path that Argentina has followed. The economic calamity and the death of Peron’s wildly popular first lady, Eva “Evita” Peron, caused extensive discontent and, once again, the military took over.

A series of military and civilian presidents followed, but the economy suffered as inflation reached record highs and unemployment surged.

The 1990s were a period of free trade and economic growth for Argentina under a more economically liberal president, Carlos Menem. The country cultivated foreign investment, slashed trade barriers and tariffs, and privatized state enterprises. It also stabilized its currency, the peso, by pegging it to the U.S. dollar via a currency board.

This currency peg stabilized the economy and eased inflation, leading to large capital inflows into the country. However, corruption was rampant. For example, in 1989, only 30,000 out of 30 million Argentinians paid any income taxes.

The 1997-99 Asian financial crisis affected Argentina as international capital flows reversed, with investors pulling funds out of emerging markets at a rapid pace. The currency board proved unsustainable as growth faltered. This led to the government’s inability to make payments on its loans in 2001, leading to the world’s largest sovereign debt default of $100 bn.

The roots of this default lay in the heavy borrowing during the 1990s to finance the unsustainable fiscal deficits that the government had been running for several years.  Argentina desperately wanted to avoid another default, so it initiated a debt exchange.  To avoid a default, the exchange had to be voluntary.  During two rounds of exchanges, the government offered untenable coupon payment rates to attract more bond holders to exchange their holdings.  The debt exchange failed as the government was pushed further into insolvency.

On July 30th, 2014, Argentina entered into default again when it failed to make payments on its bonds.  The 2001 default sowed the seeds for the current default.  Argentina renegotiated the terms of its portfolio when it defaulted in 2001.

Most of its creditors exchanged their defaulted debt in the two restructurings that took place in 2005 and 2010.  However, there were a few investors who saw an arbitrage opportunity in buying up the defaulted debt.  Since the debt was issued under New York legal framework, these investors decided to pursue the full principal amount, plus interest, via American courts. These bond holders, called “the holdouts,” were led by Paul Singer’s Elliott Management. They fought the case succesfully in US courts and forced the issuance of new “US regulated bonds”

Simon Kuznets, a Nobel-laureate economist, remarked at the time , “There are four kinds of countries in the world: developed countries, undeveloped countries, Japan and Argentina.” 

Argentina does indeed have its own kind of a mess to deal with, and serves as a cautionary tale for countries that are considering government intervention in their economies, and this is EXACTLY what the market is fearing today with the victory of the Peronist camp on Sunday.

Will Argentina default ?

Monday’s sharp fall in Argentinian Assets does not automatically mean that Argentina will default this time round.

There are several reasons to keep a balanced view of the situation

  1. The popular discontent expressed through Sunday’s vote is may not be a desire of the population to return to Peronist State intervention policies. Argentinians knows full well that getting out of the 2001 and 2014 crises has been extremely difficult, large chunks of the population had to emigrate and find jobs in Europe and the US to flee poverty. They are not willing to go back to that era even if poverty has skyrocketed in recent years.
  2. The violent market reaction of Monday is in itself a new form of hardship the will make all the abstentions head to the poll in October and support Macri, while forcing Fernandez to tone down his political agenda during the tree month campaign. The markets will re-assess its knee-jerk reaction and fear of a default
  3. Fernandez and the Peronist Party themselves will not return to economic populism. They know full well that these policies and the 2014 default were the cause of their electoral defeat against Macri and will be held against them in the campaign. They will focus on social issues and reducing poverty but probably pursue the work done by Macri with the IMF.
    They know full well that the INF will NOT avail Argentina again after their largest bailout in history only two years ago.
  4.  Argentina is the third largest soybean producer in the world.  At the heart of the China -US trade war, Soybean is clearly the weapon used by China to affect Dondal Trump’s voters in the US farmland. The most recent devaluation of the peso and the concern that another devaluation may be forthcoming, will make Argentine farmers selling soybeans to China in a big way to replace American farmers and bring in hard currencies while making them richer over night through the devaluation of the Peso.
  5. Argentina’s economic travails are yet another opportunity for China to step-in and lend a helping land in America’s own backyard. Expect China to mount a support plan for Argentina lending the Government money at low rates, buying its Government bonds, investing in infrastructure, buying its agricultural products and its mineral resources.
    For China, every crisis in. the Western world is an opportunity to extend its geo-political lead and gather supporters.
  6. The Argentinian economy is not in such a bad shape and the violent reaction of the markets is more an indication of how fickle and nervous global investors have become – helped by algorithmic trading – rather than a reflection of a sudden deterioration of the underlying Argentinian economy

With 519 Bln. of GDP and a 45 million population, Argentina is a semi-developed economy that has never managed to get rid of hyper inflation. It is plagued with the second highest inflation rate in the world.

The recent weakness in economic growth, 4 consecutive quarters of contraction, has all to do with the orthodox policies of Macri to keep interest rates higher than inflation to finally bring it under control..

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ARGENTINA’S GDP

Inflation was finally on the mend and turning down in recent months.

ARGENTINA;’S INFLATION

Argentina’s trade balance shifted to a USD 1061 million surplus in June 2019 from a USD 322 million gap in the same month a year earlier. It was the tenth straight monthly trade surplus, as imports plunged 23.5 percent year-on-year to USD 4174 million, mainly dragged by lower purchases of vehicles (-59.8 percent); fuels (-32.2 percent); consumption goods (-24.5 percent); and capital goods (-24.1 percent). Meantime, exports rose 1.9 percent to USD 5136 million, boosted by higher sales of agricultural manufactures (12.1 percent); fuels & energy (33.6 percent); and primary products (22.4 percent) while industrial manufactures fell (-11.9 percent).

ARGENTINA’S TRADE BALANCE

Interest rates have followed Inflation higher

ARGENTINA’S INTEREST RATES

Argentina’s real Achilles’ Heel is its Current Account deficit

IMF Bailout

When the IMF completed its third review of Argentina’s economy in April 2018, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

Less than a month later, amid darkening political prospects for incumbent president Mauricio Macri, the country’s currency crisis reignited and bond yields spiked, threatening not only the IMF’s Argentina programme but its reputation and that of its leader.

A victory of Fernandez would be devastating for the IMF given its strong backing of Mr Macri.

The IMF program is the largest ever implemented and this week’s crisis is going to put the institution under the spotlights again.

In September 2018 , the IMF announced it would lend an additional $7.1bn to Argentina and allow the country to receive more cash upfront in exchange for a harsher austerity programme.

The deal required Argentina to run a balanced budget by 2019 and to shrink its external deficit. On both counts, the country has seen success. By the end of last year, the primary fiscal deficit sat at 2.6 per cent of GDP — lower than the IMF’s target and a far cry from the 3.8 per cent level posted in 2017.

Argentina has also made significant progress on the trade balance, which has swung from a large deficit to a surplus of $1.18bn as of March, amid a deepening recession.

Yet on other metrics, Argentina has struggled. Inflation remains elevated at nearly 55 per cent, despite the central bank tightening the monetary screws.

Poverty levels have also skyrocketed to more than 30 per cent of the population, dredging up haunting memories of past crises and IMF programmes and explaining last Sunday’s elections results.  For many locals, the IMF has become a comic-book villain given its long and chequered history with the country.

Since it first sought the fund’s help in 1958, Argentina has signed 22 agreements with it, most of which ended with bitterness on both sides.  Few forget the disastrous finale of the IMF’s last Argentina programme, when, just two months before the country defaulted in 2001, it borrowed another $8bn from the fund — most of which was used to buy pesos from institutional investors wanting to get out of Argentina.

Could This be the beginning of a major Emerging Market debt crisis

Every global debt crisis started with weakness in the weakest links in emerging markets and Argentina has been part of that group.

We have warned several times that the next financial crisis would come from the excess of debt accumulated around the world and in particular in the western world.

Argentina debt to GDP ratio remains well below the threshold of 100 % and its external debt has been reduced considerably. The IMF bailout has given it the financial leeway to deal with crises like the one we are going through.

However, signs of tensions in emerging markets started last summer with the US sanctions on Turkey and Russia and since then the currencies of several countries gave started to weaken.

Could Argentina’s knee jerk reaction cause a co talion effect to the rest of the world ?

We doubt it.

Indeed, the market’s estimate of a probability of a default in Argentina jumped yesterday to 75 %, but we still think that today’s Argentina is NOT Christian Kirchner’s Argentina.

In fact, we see this sharp fall as an opportunity to dip a toe in Argentinian US Dollar Bonds which, at 18 % yield, offer a huge risk premium over comparable sovereign default risk.

Moreover, the risks that have caused the fall have not materialised yet and may not materialize in the October elections