Argentine provincial bonds were one of the most visible victims of the recent credit crunch. Bond prices plunged, in some cases more than 20 points, as international investors lightened non-core positions. This was particularly evident in the case of the Province of Buenos Aires. However, a look at the fundamental picture reveals a robust economic environment, producing very good arbitrage opportunities for investors.
The Province of Buenos Aires represents the heart of the Argentine economy. With 14.4 million inhabitants, it has 38% of the nation’s population and 35% of the country’s economic activity. Blessed with some of the most fertile topsoil on the planet, the Province of Buenos Aires represents 38% of Argentina’s total exports. Not surprisingly, the provincial economy kept pace with the sovereign’s pace of GDP growth, expanding an average of almost 9% y/y during the past 5 years. In addition to agriculture, the Province of Buenos Aires is Argentina’s manufacturing hub. It has 50% of the total manufacturing base, as well as much of the country’s transportation infrastructure. It is for these reasons, that the province slashed its unemployment rate to 11.3% at the end of 2006 from a high of 20.8% in 2000. It also halved the poverty rate to 30.2% in 2006 from 64.4% in 2000. The sharp improvement in economic performance allowed the provincial government to improve its credit ratios, reducing its debt to GDP ratio to 13.3% at the end of 2006 from a high of 24.6% at the end of 2002. The province’s leverage ratio also shrank. The Province of Buenos Aires’ debt to total government revenues ratio dropped to 1.13 times from 2.83 times during the same period. However, there was some deterioration on the fiscal front. The province is expected to post a primary fiscal deficit of $400 million in 2007, versus a deficit of $100 million in 2006 and a $100 million surplus in 2005. The erosion of the fiscal situation can be attributed to several factors. First, heavy election-year spending resulted in large outlays for new infrastructure. Second, increases in wages outstripped the expansion of co-participation receipts—mainly due to the underreporting of inflation statistics. Nevertheless, the erosion in the fiscal balance is not enough to justify the plunge in bond prices.
The more probable reason for the underperformance of provincial bond prices was due to the deleveraging that took place in the aftermath of the global credit crunch. The Province of Buenos Aires issued almost a billion dollars in new bonds over the past year, with much of the paper placed with non-dedicated investors. Argentina was the high Beta play of 2006 and many non-dedicated investors bought the new issues. However, provincial bonds were also some of the first positions to be divested when the credit crunch began to take its toll. As a result, provincial bond prices plunged. Nevertheless, provincial bonds provide very good value. The spread between the bonds of the Province of Buenos Aires and the Argentine sovereign are trading at a historical high. Nevertheless, the Province of Buenos Aires is the heart of the Argentine economy and the soul of its sovereign risk. Moreover, the outlook is stellar. The recent explosion in world grain prices is positioning the Province of Buenos Aires for an unprecedented windfall. China’s decision to increase its demand for foreign grains reflects the shortage of water—a situation that is only going to get worse. Therefore, the erosion in provincial bond prices had nothing to do with changes in fundamental conditions. Hence there is a good opportunity for risk arbitrage on the pampas by taking advantage of the dislocation produced by the ongoing credit crunch.