DBRS Morningstar Confirms Argentina at SD

DBRS, Inc. (DBRS Morningstar) confirmed the Republic of Argentina’s Long-Term Foreign Currency – Issuer Rating and Short-Term Foreign Currency – Issuer Rating at SD. As the same time, DBRS Morningstar confirmed the Long-term and Short-Term Local Currency – Issuer Ratings at CC and R-5, respectively. The trend on the Local Currency – Issuer Ratings is Stable.

KEY RATING CONSIDERATIONS
Argentina’s efforts to negotiate a debt restructuring deal that will win sufficient participation from its private creditors have not yet come to a conclusion. The government appears to be close to an agreement, and has set a new deadline of August 4 in its new exchange offer filed with the SEC on July 7. The current restructuring efforts involve $66 billion in foreign law bonds. Payments on local law bonds have already been reprofiled, and Argentina has missed payments on several outstanding foreign law debt securities. Given low levels of reserves, Argentina is unlikely to make additional payments on foreign currency securities until it settles its exchange offer with a reasonably high degree of participation.

Argentina continues to face substantial risks given the lack of an agreement with the IMF and significant questions regarding its fiscal and monetary policy framework. The economy has not grown in roughly eight years – a direct result of macroeconomic policy weaknesses combined with successive external shocks. In spite of efforts to limit monetary financing of the fiscal deficit, deficit reduction remains a major political challenge, exacerbated by the ongoing pandemic. Even if Argentina emerges from restructuring with a more favorable debt profile, it is hard to envision a significant improvement in its credit profile in the absence of a credible macroeconomic stabilization effort. Inflation has come down somewhat as the economy has weakened further due to coronavirus, but this may give authorities a false sense of security with regard to money growth. As long as inflation remains high, Argentina’s economy will be vulnerable to periodic episodes of capital flight.

RATING DRIVERS
The ratings are likely to be upgraded once the government successfully concludes a debt exchange with sufficiently high levels of participation, enabling the country to normalize its relations with external creditors. The extent of any upgrade will nonetheless depend on the government’s commitment to sound fiscal policy, progress in achieving durably lower inflation, and the sustainability of the resulting debt profile. Alternatively, the local currency issuer ratings could be downgraded if the government fails to reach a restructuring agreement and faces additional difficulties rolling over short-term local currency debt.

RATING RATIONALE

Coronavirus Batters an Already Weak Economy

Inconsistent macroeconomic management has weakened growth performance and left Argentina with a high degree of vulnerability to external shocks. Real economic growth has averaged -0.3% over the past eight years. The economy contracted 4.8% (Q/Q) in the first quarter of 2020, as authorities put restrictions in place to limit the spread of coronavirus. April appears to have been the weakest month in terms of economic activity, with some recovery in May. Argentina was relatively quick to act in in response to the pandemic, imposing border restrictions and other social distancing measures before the country hit 100 confirmed cases. Nonetheless, Argentina subsequently eased restrictions, and as of the first week of July the country has experienced a sizeable increase in daily cases (averaging over 3,700 per day). Additional mobility restrictions have been put in place in Buenos Aires province through mid-July.

In April, the IMF projected GDP growth of -5.7% for 2020; this forecast has been revised in June to -9.9%, on par with some of the hardest hit economies from the coronavirus shock. In 2021, the IMF projects a relatively modest recovery of 3.9%. However, the timing of such a recovery remains highly uncertain due to the pandemic and the potential for further weakness in global demand. Argentina’s macroeconomic stability and medium-term growth prospects will remain heavily reliant on the government’s ability to durably reduce inflation through fiscal and monetary policy discipline.

Argentina’s Fiscal Position Is Deteriorating Rapidly Amid Severely Constrained Access to External Financing

Argentina’s government continues to face serious fiscal challenges given the response to the pandemic and the high real interest rates associated with market borrowing. The Macri administration (2015-2019) made some headway in reducing the fiscal deficit, delivering a primary deficit of just 0.4% of GDP in 2019. However, this came at a considerable cost, including substantial cuts to capital expenditure (from 2.2% of GDP in 2016 to a mere 1.1% of GDP in 2019). Current spending was reduced from 21.8% of GDP in 2016 to 17.7% of GDP in 2019. The Fernandez administration campaigned with an anti-austerity message, but has acknowledged the lack of easy options to address Argentina’s fiscal challenges.

For now, the pandemic response has taken precedence over additional fiscal consolidation efforts, with the government’s relief to affected households and businesses estimated to cost nearly 5% of GDP. Measured from January to May (the latest data available), the primary balance has swung from a surplus of ARS 534 billion in 2019 to a deficit of ARS 636 billion in 2020. This rapid deterioration has been driven by rising current expenditure (up 79% y/y in nominal terms) and revenue growth well below the rate of inflation (up 23% y/y). Furthermore, some of the increased current spending may be difficult to roll back after the pandemic eases, including increased payments to low income households, retirees, and workers in the informal sector. Capital expenditure fell in the first quarter of 2020, likely due to administrative delays as the new government came into place, but accelerated significantly in April and May as the pandemic response included additional spending on roads and other infrastructure. The deteriorating fiscal outlook combined with historical weaknesses in fiscal policy formulation weigh negatively on the Building Block Assessment for ’Fiscal Management & Policy.’ DBRS Morningstar notes that Argentina has made some progress in improving the quality of public statistics and in making available additional analysis around fiscal policy measures , including with the creation in 2016 of the Congressional Budget Office (OPC), but it remains to be seen whether this will durably improve fiscal policy outcomes.

Argentina’s public debt burden has risen dramatically over recent years due to a combustible mix of high inflation and extensive dollarization. Over 77% of Argentina’s public debt is denominated in foreign currency. As of end-2019, the IMF estimates gross debt reached 88% of GDP, up from 57% in 2017. The precipitous decline in the peso from April 2018 to the present (down over 70%) has contributed to the IMF’s assessment that Argentina’s debt burden is unsustainable. The sustainability of the debt profile resulting from the current restructuring efforts will depend on Argentina’s ability to bring down inflation and stabilize the peso. Given the fiscal response to coronavirus and without a macroeconomic adjustment and external financing in place, Argentina’s ability to reduce monetization and get inflation under control will be severely constrained.

Authorities may be reluctant to rely on the IMF for anything more than a modest extension of existing funding. Unfortunately, in the context of current global conditions, DBRS Morningstar considers the probability of a successful macroeconomic adjustment without multilateral support to be very low. The black market peso exchange rate, currently trading at ARS 122 per dollar (over a 40% discount to the official rate), is indicative of a general lack of confidence in Argentina’s macroeconomic policies. These considerable risks to debt sustainability, Argentina’s severely weakened liquidity position, and growing contingent liability risks to the government’s balance sheet have a substantial negative impact on our Building Block Assessment for ’Debt & Liquidity.’

Inflation Remains the Central Challenge, Though Recent Disinflation May Present an Opportunity

The annual inflation rate has come down from its May 2019 peak of 57% (y/y), decelerating sharply in the past few months to 43% as of May 2020. Measured month-on-month, May inflation was only 20% (annualized). This reflects the continued decline in economic activity, accentuated by the pandemic. In addition, authorities have enacted emergency price controls covering food and medical supplies. The exchange rate has been partially stabilized, depreciating at a steady pace of 2.5-3.0% per month. ¬The monetary policy target rate, which was reduced from 63% in December to just 38% in March, has remained stable since that time. With disciplined wage agreements that reflect this deceleration in inflation, the government has an opportunity to durably reduce inflation. However, the lack of available financing and growing primary deficit are likely to result in increased monetization of the deficit, which will put price stability at risk. Moreover, if price controls are sustained for too long, renewed shortages may emerge.

Argentina’s financial system remains small in size and provides only a limited capacity to finance government deficits domestically. State-owned Banco Nacion remains a dominant player in the banking sector. Thus far, evidence suggests that the banking system is well-positioned to weather asset-quality deterioration associated with the sharp downturn. The BCRA’s latest financial stability report notes that the banking system has limited exposure to the consolidated public sector, and banks have also avoided net FX exposure.

External Accounts Have Adjusted, But External Vulnerabilities Remain.

Argentina is undergoing another significant adjustment in external accounts. As the Macri administration relaxed trade restrictions and foreign exchange controls while attempting to gradually reduce inflation, Argentina’s current account deficit widened from roughly 3% of GDP in 2016 to over 6% in mid-2018. A surge of imports drove this deterioration, largely reflecting a rise in capital and intermediate goods imports. Net investment income also fell deeper into negative territory, as the administration relied increasingly on market financing to curb monetization. Since April 2018, the peso has lost over 70% of its value against the U.S. dollar. Combined with the effects of the ongoing recession, this has precipitated a sharp adjustment in the current account deficit, mostly through import compression, bringing the current account roughly into balance as of end-2019. The postponement of interest payments has also contributed to reduce the deficit.

Argentina retains a considerable stock of external assets, largely driven by the preference of Argentine savers for hard currency assets. Argentina’s net international investment position (NIIP) reached an all-time high of $122 billion in Q1 2020 (over 27% of GDP). Currency and deposits held abroad by Argentine residents have increased by over $72 billion since end-2016, a nearly 50% increase. Portfolio investment claims also increased substantially over this period (up $25 billion), though half of this gain was erased in Q1 2020 as global markets plunged. Portfolio investment liabilities, which surged from under $60 billion to $165 billion in just over two years (Q4 2015 to Q1 2018) with a significant ramp-up in external borrowing, have subsequently plummeted to under $50 billion as foreign investors have fled the country and debt default has further reduced the value of external claims.

Foreign exchange reserves have stabilized at $43 billion as of end-June 2020, though net reserves are considerably lower (less than $12 billion). Argentina’s external position remains weak and the current account adjustment is unlikely to be durable without a sustained effort to reduce inflation and foster increased export competitiveness. The government’s recent announcement regarding the expropriation of the soybean exporter, Vicentin, has increased concern within the business community regarding the environment for investment. Consequently, and in spite of Argentina’s positive NIIP, DBRS Morningstar continues to see considerable external risks, reflected in a negative adjustment to our Building Block Assessment for ’Balance of Payments.’ In addition, the negative adjustments reflect the more rigid exchange rate regime that has come into place since December.

The New Administration’s Response to Coronavirus Is Following a Familiar Peronist Playbook

Argentina’s latest presidential election again generated a significant shift in economic policy, with another Peronist administration back in power. Alberto Fernandez won the 2019 election by a comfortable margin (48% against incumbent President Macri’s 40%), with the prior President Cristina Fernandez as his Vice-Presidential pick and running mate. In many respects, Argentina’s presidential republic remains resilient, with a substantial degree of policy accountability, competitive elections, and credible institutions. Nonetheless, executive powers are quite strong, and public confidence in the integrity of the judiciary and other branches of government is generally low. This contributes to a high degree of unpredictability with regard to economic and tax policies.

Several institutional and governance weaknesses remain a source of concern. The lack of central bank independence and the ability of presidents to replace central bank governors at will tends to weaken monetary policy discipline and contributes to Argentina’s perennial challenges with high inflation. President Fernandez’s popularity has increased significantly due to public perceptions regarding his government’s response to Coronavirus, which compares particularly favorably to neighboring Brazil. The policy response has nonetheless included a number of potentially damaging policies popular with the last Peronist administration – including price controls, export taxes, rapid (and unfunded) growth in subsidies to low-income households, and an announced expropriation of a major soybean processor and agribusiness. These heightened political risks continue to weigh on this Building Block Assessment.

ESG CONSIDERATIONS
Human Capital & Human Rights (S), Bribery, Corruption & Political Risks (G), and Governance & Transparency (G) were among key drivers behind this rating action. Similar to many emerging market peers, per capita GDP is relatively low, at US$9.7k (US$20.1k on a PPP basis). According to World Bank Governance Indicators, Argentina ranks in the 54th percentile for Control of Corruption, the 67th percentile for Voice & Accountability, the 46th percentile for Rule of Law, and the 55th percentile for Government Effectiveness. These considerations have been taken into account within the following Building Blocks: Fiscal Management & Policy, Economic Structure & Performance, and Political Environment.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/363980.

Notes:
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments, September 17, 2019.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Ministry of Economy, INDEC, BCRA, IMF, World Bank, UN, Ambito, EconViews, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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