Emerging Markets Bonds
Argentina is once again in the midst of an extreme crisis of confidence given the uncertainty ahead of the upcoming October election, which has caused a panic over the potential return of Cristina Fernandez de Kirchner (CFK).
One might argue that the inflation spiral is also a major cause of the chaos as it weighs on the disposable revenue of the population, which is an important factor of the government’s popularity; or in this case, the lack of it. However, we believe that inflation in Argentina is a political phenomenon, rather than monetary or fiscal one.
While fiscal and monetary orthodoxy stay mandatory, the only way out of the spiral is to restore a certain degree of confidence in the government’s ability to tackle the country`s problems in a credible way. Failing to do so will always end up in a catch-22 situation, where maintaining the currency`s strength to curb inflation adversely affects the growth and has negative consequences on the external accounts, which was the cause of last year’s crisis following the failure of President Mauricio Macri`s “gradualist approach” to easing the country into economic reforms.
But how can Macri possibly restore even a hint of confidence if people think he will soon be replaced by someone (CFK) whom people fear as much as Armageddon?
Although not sufficient to break the spiral, monetary and fiscal discipline are paramount. In addition, both the Central Bank of Argentina (BCRA) and the ministry of finance are playing by the book and complying with the IMF targets in terms of monetary aggregate control and primary surplus.
Until the end of 2020, the government should be able to live off the resources provided by the IMF, and have enough US dollar reserves to meet its financial obligations (e.g. redeeming external debt) so that it does not have to tap the markets for additional capital.
We cannot predict who is going to win the elections but the situation has only marginally deteriorated compared to a few weeks ago. The fact that CFK is now slightly ahead of Macri in the polls is not statistically different from the opposite situation that prevailed until not long ago. The situation will remain fluid over the next six months but until then many things can happen, including a tactical rapprochement between Macri’s Cambiemos and the moderate Peronists (e.g., Lavagna). The fact that polls show CFK ahead of Macri certainly reflects a deterioration of the government’s credibility, but a reversal is very possible. Furthermore, we cannot be certain that CFK would necessarily default on the external debt, as her predecessors did in 2001.
Markets entered the panic zone because Argentina’s history is full of “bad” situations that tend to turn out even worse than they started (e.g. the reputation of being a serial defaulter). However, the market’s reaction is mostly due to cognitive dissonance from people who should not have invested in Argentina in the first place. It is anyone’s guess to find out where the bottom is but it is very likely that the deep value of assets will be revealed once the weak hands have been forced out of the market.
Overall, for dedicated emerging market investors who have the capacity to assess and monitor local developments, the risk/reward profile of Argentina is attractive with a nuanced playground across the sub-asset classes.