Argentina: Proposed Liability Management Initiatives Welcome by Markets but Steady Fiscal Deterioration Sets a Floor for Debt Spreads

Argentine bonds have rallied in recent weeks lifted by a favorable global market context and increased talk about potential liability management initiatives. The latter could include a swap of CPI-linked debt, a reopening of the debt exchange for holdout creditors, the payment of debt due to the Paris Club, an agreement with the IMF and a swap of bonds to extend payments due during the years 2010-2012. So far, the government has only officially committed to carry out a partial swap of CPI-linked bonds. But authorities do seem inclined to delivering a broader and gradual normalization of relationships with external creditors with the ultimate goal of regaining market access. We caution, though, that the steady trend of fiscal deterioration sets a floor for Argentine spreads.

Global market performance will dictate the feasibility of some of the initiatives mentioned above (recall the announcements made by the government in 3Q08 that never materialized due to the market collapse). Within this category we would include the swap of USD-denominated debt (more effective in terms of reducing near-term financing needs than the CPI-linked paper swap) and a potential reopening of the debt exchange for holdout creditors. An agreement with the Fund, meanwhile, depends on political willingness and appears unlikely in our view given the government’s aversion to be subject to IMF conditionality in terms of economic policy.

We highlight that Argentina’s government paid down almost US$5 billion in amortizations on outstanding bonds and loans last year, and only received “market” financing for US$1.3 billion (excludes sales of bonds to Venezuela’s treasury and intra-public sector financing). These figures imply a net US$3.6 billion repayment of “market” debt. Additionally, Argentina received US$1.9 billion in multilateral financing (from the WB and IADB), but repaid US$2.3 billion to IFIs last year. These net repayments of “market” and multilateral debt were financed by issuance of t-bills to public sector entities other than the treasury, central bank advances and sales of Boden 15s to Venezuela.

While market access remained elusive, Argentina was in a comfortable fiscal situation running consolidated (central government plus provinces) primary fiscal surpluses slightly above 3% of GDP. But hitherto benign fiscal dynamics have changed dramatically. Indeed, note that the central government’s primary fiscal balance declined from 3.9% of GDP in 2004 to 1.5% in July 2009 (measured on a 12-month sum basis). Meanwhile, the provinces’ primary surplus disappeared in the same period: the primary result slid from a record 1.4% of GDP to an estimated balanced result last year (provincial data is only available through 1H08). The trend of fiscal deterioration is only expected to intensify this year: the central government’s primary surplus is expected to decline further to stand at roughly 0.5% of GDP. Meanwhile, no data is available at the provincial level but private estimates look for a negative 0.7% of GDP primary result in 2009. In all, once interest payments are considered, Argentina will likely post an estimated 2.5% of GDP headline deficit in 2009—which stands in sharp contrast to the 1.5% of GDP average headline result during the last seven years.

This year’s fiscal deterioration has resulted from a visible moderation of tax revenue growth (from an average 35%YoY in 2008 to just 10% last July) and persistent primary spending increases ahead of last June’s midterm elections (running at a 31%YoY pace so far this year compared to a 35% advance in 2008). In the past, steady growth of primary spending without significant surplus erosion was made possible by above-potential GDP growth and supportive commodity prices which lifted tax collections.

Commodity prices relevant for Argentina’s exports have come off their peaks but remain supportive and—alongside a significant expected increase in agricultural production next year—will help tax collections. The economy will probably stop contracting, but growth in 2010 is expected to be only modest, rendering the return to +30% tax revenue growth rates highly unlikely (there is little room for additional tax hikes). Thus, fiscal deterioration is likely to continue unless a radical moderation in primary spending growth rates takes place—a decision that does not seem to be in the official agenda at this stage. The normalization of relationships with external creditors would be an undeniably welcome event that would certainly be cheered by markets. That said, we highlight that while the materialization of the initiatives voiced by the government may have been considered sufficient for regaining market access in the past, the steady deterioration of fiscal accounts caps the potential spread compression that Argentine assets may enjoy currently.