Economy

Macri’s debt-fueled bubble bursting after election defeat

15th August 2019

By Ignacio Portes

Macri’s debt-fueled bubble bursting after election defeat

President Mauricio Macri’s dangerous debt-fueled bubble seems to be finally exploding, and the consequences are only starting to come to the light. Argentina could be facing its hardest crisis since 2001, when it suffered the worst recession in the country’s history.

The crash came after Macri’s defeat to Alberto Fernández on Sunday’s presidential primaries. During the campaign, Fernández said he would not default but suggested a (voluntary) re-negotiation of the country’s piling debt-maturities after 2019, as well as cutting the interest rates of the snowballing peso-denominated 7-day Central Bank Leliq notes.

Macri, on the other hand, prioritized keeping creditors happy, hoping markets would loan him the US$16 billion he needed to rollover debt, and cover new deficit in 2020, despite the sudden stop of loans seen after the 2018 crisis. In Macri’s view, investors could be lured through promises of harder austerity as well as pension and labor reform.

</p> <p>After Fernández’s landslide in the primaries, which put him on the verge of the presidential seat, overbought investors ran for the door on Monday.</p> <p>Argentine stocks saw their worst 1-day drop in history, losing a staggering 46 percent of their value. The JP Morgan EMBI+ Argentina index, or “country risk,” which measures the premiums paid by Argentine bonds when compared to US treasuries, roughly doubled, from 900 basis points to 1900. That came after a brutal bond selloff in secondary markets, as investors fear a default is now on the cards.</p> <p>The exchange rate, meanwhile, jumped from 46 pesos to the US dollar on Friday to 60 to 1 in the first two hours of trading. After a slight recovery in the next few hours, it was back at 60 by Wednesday close, a sign that inflation will surely skyrocket in August.</p> <h2><strong>Are Leliq notes unraveling?</strong></h2> <p>The fragility of the peso came as a long-feared moment started to arrive: banks stopped re-purchasing the Central Bank’s 7-day Leliq notes on Monday.</p> <p>The Leliq notes were designed to control inflation in the short term, hoping that budget cuts would eventually balance the country’s books, and thus raising demand for pesos faster than the interest rates accrued through the notes.</p> <p>But this hasn’t worked out. Price hikes are now taking place at twice the speed of 2015, the beginning of Macri’s term. In addition, demand for pesos has been plummeting since the election, a fact that points to even higher inflation in the future.</p> <p>On Monday morning, Central Bank chief Guido Sandleris hiked interest rates from 63 to 74 percent in the first Leliq auction after the vote. But the spike in rates wasn’t enough to tempt banks into renewing their expiring maturities.</p> <p>More than 150 billion pesos in Leliqs could not be sold back to banks, as they opted instead to cash out their capital plus interest. That money could now be used to buy US dollars as protection against the run on the currency.</p> <h2>More fuel for the fire</h2> <p>An additional 1.1 trillion pesos is still sitting in Leliqs at present. If the current dynamic continues and no interest rate hike proves tempting enough for bankers to re-purchase more Leliqs when they expire, bankers would instead be paid in pesos. And those pesos could very rapidly be used to purchase even more dollars, accelerating the run against the currency.</p> <p>“Things can still get worse. The Leliq timebomb hasn’t exploded yet. What’s worrying is that this can turn into a run against the fixed-term peso deposits of bank clients,” Miguel Boggiano, head of Carta Financiera consultancy agency told <em>The Essential</em>. “If clients decide not to renew those deposits (and buy dollars instead), the run against the peso can really take off.”</p> <p>Fixed-term peso deposits are mostly invested into Central Bank’s Leliq notes, so banks not renewing their Leliq holdings is directly tied to investors not renewing their fixed-term peso deposits.</p> <p>So should the Central Bank raise rates even higher to make renewals more attractive? Not necessarily. Much higher rates would make the monetary authority’s weekly interest payment bill skyrocket. And this could lead to the continued “snowball effect” of ever-growing capital + interest payments in Leliq notes, which can only be re-paid when they mature 7 days later by printing more Leliqs. That dynamic is what originally brought the Central Bank to its current predicament.</p> <p>&#8220;Leliqs were always part of the problem, and not of the solution. They have turned into <em>Cambiemos</em>&#8216; Achilles&#8217; Heel, because the government was forced to send interest rates sky-high, killing economic activity in the process. It&#8217;s hard to see how this can be disarmed in an orderly fashion, without affecting people&#8217;s peso deposits,&#8221; Econométrica&#8217;s Ramiro Castiñeira told <em>The Essential</em>. &#8220;Alberto Fernández has all the incentives in the world for the problem to explode during Macri&#8217;s administration instead of during his.&#8221;</p> <h2><strong>Default and depreciation</strong></h2> <p>The consequences of the peso’s collapse are many. Poverty rates and social distress are likely to climb, while the value of most Argentine assets is already going down.</p> <p>With Argentina’s debts mostly denominated in foreign currencies, any new administration will struggle to pay it back after a devaluation. Amid rising social tension, governments are more likely to prioritize local concerns over foreign debt holders.</p> <p>&#8220;This economic model puts policymakers in a narrow and risky trade-off between devaluation and default. Today this tension is more clear than ever. Anything you do to prop up the peso increases chances of default, and vice-versa,&#8221; Leandro Ziccarelli, Coordinator of the Finance and Monetary area at the CEPA think tank said.</p> <p>“With this week’s drop, bonds are being traded at default prices. Bonds with a 2020 maturity are on offer as if a 30 percent haircut was coming,” Boggiano added.</p> <p>Other assets strongly affected by the Leliq-peso dynamic were banks, which saw some of the highest drops among Argentine stocks since Monday. Banco Galicia, the most traded Argentine stock, lost as much as 60 percent, with only a mild bounce since the low. Supervielle was down by 65 percent on Monday, while Banco Francés also dropped by 60 percent.</p> <p>&#8220;Banks are holding Leliqs and Treasury bonds, both of which are falling in prices right now,&#8221; Castiñeira explained.</p> <p>Energy firms also lost more than average. Edenor, an electricity distribution firm, was down by 52 percent on Wednesday close, underperforming Argentina’s Merval index, as a re-negotiation of dollar-tied energy contracts is one of Alberto Fernández’s campaign promises.</p> <h2><strong>Desperate measures</strong></h2> <p>In response to Sunday’s defeat and Monday’s market rout, Macri addressed Argentines early on Wednesday with a series of economic announcements drafted in the 48 hours following the defeat.</p> <p>The measures, which are expected to cost around 40 billion pesos (US $240 million at Wednesday’s rate) included:</p> <p>-Two extra payments of the Universal Child Allowance benefit paid to kids under 18, the biggest cash transfer program in the country’s safety net.</p> <p>-A raise of the minimum wage.</p> <p>-A two-month waiver on labor contributions, meaning that salaried employees will get 2,000 extra pesos in September and October.</p> <p>-Cuts to income taxes for the upper-middle classes.</p> <p>-Increases in state aid for underprivileged students.</p> <p>-The suspension of rate hikes for basic services over the next 90 days.</p> <p>-A bonus payment for security forces.</p> <p>Although some details are yet to be known, overall the moves all point in the same direction: softening the blow of this week’s devaluation, which will hit salaried Argentines extremely hard in terms of their purchasing power.</p> <h2><strong>Worse could be yet to come</strong></h2> <p style="text-align: left;">What took place this week will inevitably extend the recession that the country has been under since the second quarter of 2018 for significantly longer.</p> <p>Deflation of dollar-denominated Argentine assets and inflation for peso-denominated consumer products is likely to get worse.</p> <p>&#8220;This 30 percent devaluation will obviously awaken the inflationary process again, and abort the very mild economic stabilization we saw on the past few months. Hopes for 40 percent inflation this year are now outdated, we will go to 50 at least. And this will also make the recession harder as consumption will fall again,&#8221; Castiñeira said.</p> <p>&#8220;We&#8217;ve been in economic stagnation for eight years now, 10 percent down in terms of GDP per capita. It all depends on what Alberto Fernández&#8217;s agenda will end up being. At the moment there&#8217;s a lot of uncertainty around it.&#8221;</p> <p>

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Ignacio Portes

Ignacio Portes is The Essential's General Editor. Former Economy editor at the Buenos Aires Herald, he has also written for publications such as Naked Capitalism, NSFWCorp and Revista Debate.