Bonds soar as creditors favor Guzmán’s first initiatives
Be it due to a natural market bounce after staying for too long in oversold conditions, be it due to a miss-pricing of the default risks implied in an Alberto Fernández’s government, or be it due to Martín Guzmán’s fiscally-oriented reforms during his first days as Economy Minister: Argentine bonds have been among the most lucrative assets in the world so far in December.
The benchmark Bonar 2024 bottomed on December 5 at 30.6 US dollars each, and has since soared to 39.85 dollars by Wednesday close, a surge of slightly more than 30 percent in a mere two weeks.
Shorter-term bonds such as the Argentine Treasury’s TJ20 have jumped at an even faster pace since Guzmán made his first press conference on December 11, gaining 43 percent between December 12 and December 18.
Argentina’s JP Morgan’s EMBI+ country risk index, which measures the extra cost that the country would have to face to raise debt when compared to the benchmark US Treasury notes, has also dropped by 16.5 percent so far in December, although it remains at a sky-high 1,897 points, far from the roughly 600 points needed for new foreign debt raising to become feasible.
Despite these gains, investors who bought in at the peak of Argentina’s debt bubble are still holding on to significant losses, as bonds are trading at close to 50 percent of their face value on average.
Opportunists among pessimists
For those who took advantage of the cheap prices seen in the last few months, however, the gains have been significant.
“The market is coming from almost twenty months of very severe losses, with the fear of a default gaining steam until it finally took place in a covert way at the end of (former president Mauricio) Macri’s term,” Balanz Capital analyst Marcos Gaona told The Essential.
According to Gaona, some were thinking of a full-on default like in Adolfo Rodríguez Saa’s interim presidency in 2001, but he doesn’t see that scenario as likely for the moment. “(Guzmán’s) new reform package included the issuing of a Treasury note to be deposited at the Central Bank in exchange for 4.5 billion USD of its reserves. This is the typical approach used during the Kirchnerite years to pay back debt, so it was seen as a positive sign by bondholders (regarding short-term payments). If you add in other factors such as the increase in tax collection also mentioned in the bill, and the fact that the demand for some bonds is rising due to arbitrage reasons, the rise seen over the last few days makes sense,” Gaona said.
Those who were on the right side on trade saw the weeks of sideways movement in stocks and bonds during October and November as a classic accumulation period in which new hands take over from the exhausted old investors, who have given up all hopes. Despite (or even because of) the pessimism in the air, everyone who wanted to sell has already done so, and any news can be a trigger to turn the market around as the selling pressure is exhausted.
“The market over-reacted. They were expecting a total default and now it seems that an adjustment process that is politically and socially feasible is possible,” Martín Rajnerman from the Ecolatina consultancy agency formerly run by Roberto Lavagna, who came in third in the presidential election, told The Essential.
A fiscal approach
Despite his academic history as an heterodox economist close to IMF critic Joseph Stiglitz, Guzmán’s approach has so far prioritized fiscal consolidation, raising taxes and possibly even slashing spending in some areas at the expense of pro-growth economic policies.
Guzmán is likely to resort to some amount of money printing, as a small primary deficit is likely to remain in 2020 even if debt payments are postponed. But he has so far focused on raising cash to make the Treasury’s numbers look more orderly and minimize the use of the printing press as much as possible due to fears of runaway inflation.
Experts consulted by The Essential estimated that an additional 1.5 percent to 1.8 percent of GDP in taxes could be raised by the new reform package, although the fine print of the bill is still up in the air and much could still change, with other market research ranging from 1 percent to 2.2 percent of GDP in new income for the national administration.
“The 30 percent tax on foreign purchases could bring in around 0.5 percent of GDP, and a similar figure could be raised by the hike in labor contributions. Increased export duties could amount to 0.3 percent and property taxes might add up to 0.3 percent as well,” Fausto Spotorno from the market-friendly Ferreres consultancy agency told The Essential. “It depends on many factors. The reform is pushing those saving abroad to bring money back to Argentina, so foreign banks might not be as helpful with tax collection as they were during Macri’s tax amnesty, as they’d rather keep their clients, which might lower the amount collected,” Spotorno argued.
But the bigger X factor is that of pension reform. Guzmán’s bill suspends the automatic indexation formula used to update payments to pensioners to compensate them for inflation. Instead, it gives President Fernández discretionary power to raise or freeze payments according to his own criteria over the next 180 days.
This would, in all likelihood, mean that Fernández will raise the lowest pensions above inflation, while reducing hikes to the highest earners in order to save money while not hurting his voting base or raising poverty figures too much.
Pensions and other social security payments amount to roughly two thirds of Argentina’s national budget, so any saving in this area could be very significant from a fiscal perspective, but the discretionary nature of the bill means the final amount will not be easy to predict.
Longer term problems
Despite the euphoria in bond markets, the path to economic recovery is still in question. While there’s certainly room to the upside in both bonds and stocks over the coming months if Argentina reaches an agreement with bondholders, Guzmán’s plan is predicated on a need for growth over the long run in order to make payments sustainable, even if they are postponed for a couple of years.
Here, Rajnerman is slightly more optimistic than Spotorno. “Before these reforms were presented, our forecast had Argentina’s Gross Domestic Product (GDP) contracting by 1.7 percent in 2020. But I don’t think the reforms will increase this contraction. They might be contractive for the middle classes, which are likely to lose in the re-design of the pension formula, but the lower income sectors, which are more prone to consumption, might see a recovery in their purchasing power.”
Rajnerman thinks Guzmán might eventually be able to show a path forward in terms of correcting the deficit that the markets see as believable, and start paying back part of the debt while re-financing other maturities if country risk keeps falling.
But the bet has big risks. Even if the reforms soften the recession at some point, they are also unlikely to be significantly expansive in the long run, a premise of Guzmán’s quest for sustainability. This might lead Fernández’s plan to a similar path than Macri’s: with lots of debt maturities, no one looking to re-finance them, and a stagnant economy with no more room to raise money for creditors.
“I think it’s important to distinguish between two types of growth. You can bounce back a bit by injecting money for consumption. But structural growth requires investment and higher productivity. And who is going to invest in an economy with high tax pressure and emergency hikes like this? I fear this might end like the reforms of (Fernando De La Rúa’s first economy minister José Luis) Machinea, who tried to distribute money from the middle class to the lowest earners but was eventually swallowed up by the growing recession, and ended up seeing tax collection going down,” Spotorno said.
That, however, could be a problem that comes a couple of years down the road, and markets can be much more short-sighted. For now, they are celebrating – or at least breathing with some relief.