It is crystal clear what the country’s challenges are and what needs to be done. What is less clear is how gradual Scioli will be in addressing these challenges and how long his honeymoon with the markets will last
I expect the markets to allow him between 3 and 6 months before they start getting impatient and begin to test Scioli’s gradual and non-confrontational style.
Argentina faces a couple of challenges:
First, net international reserves have reached very low levels. Argentina’s access to the capital markets has been severely restricted due to the ongoing dispute with the debt holdouts. Until this is sorted, capital controls (“cepo”) remain in place, hindering foreign direct investment and maintaining elevated spreads as the country’s liquidity buffer vanishes. An agreement – at least with the main holdouts – is a necessary but not sufficient condition for stabilising the country’s challenging macroeconomic outlook. This would allow the country to gradually lift the capital controls, allowing for some foreign direct investment to resume and for the country to issue new external debt to recompose its reserves. An agreement will need to be rectified by the Argentine Congress, which despite no candidate achieving an absolute majority, is expected to pass. The devil is in the details.
Second, in addition to the holdout agreement, Argentina needs to move towards equilibrium in three areas:
- The official exchange rate is clearly overvalued and will likely be devalued to some midpoint between the current official rate (9.50) and the parallel market (16.00), with a dual-exchange regime also being a possibility;
- Real interest rates (Badlar) remain in negative territory and will need to rise for the devaluation to have some anchor;
- The fiscal position (-6 to -7% of GDP) is unsustainable in the medium-term, unless growth rebounds strongly. At best however, we will see an adjustment of 1-2% through spending cuts and energy subsidy reduction in late Q1 2016.
In conclusion, I expect Argentine debt to continue to trade near current levels over the next few months, assuming a Scioli victory (and a rally should the opposition win, which is currently not priced in). I also see a binary scenario after Q2 2016: a sell-off to 12-13% yields should the issues listed above not be addressed adequately, or a rally to under 8% yields should they be.
Claudia Calich - Emerging markets and Sovereign bonds Specialist - M&G Investments