Money worries

tauringhuang.

Aug 22nd 2008
From the Economist Intelligence Unit ViewsWire

Concern over Argentina's creditworthiness grows


Doubts are growing over Argentina’s creditworthiness, with a high-yielding US$1bn bond issue to Venezuela underlining concerns over the country’s limited access to foreign financing at a time when the fiscal surplus is starting to erode. In the short term, Argentina has the ability to meet its debt obligations. But with its financial needs set to increase and the government’s credibility and intentions being questioned, the medium-term outlook is increasingly uncertain.

Costly credit
Argentina’s government is now into its second week of a local debt buyback programme designed to bolster investor confidence. Earlier this month, the government issued US$1bn in bonds to Venezuela at nearly 15%, some two percentage points higher than in a previous US$1bn bond sale to Venezuela in May. The high yield sent shivers down investors’ spines as it reinforced concerns about Argentina’s poor access to international debt markets in the context of a more complicated fiscal and financial outlook.

Following news of the latest Venezuelan bond deal, Argentina’s risk premium—the spread demanded by investors compared with comparable US government instruments—widened to nearly 700 basis points. Following the announcement on August 10th of plans for a buy-back of local bonds, which would alleviate US$2-3bn of amortizations per annum and so cut reliance on market finance in 2009 to around US$4bn, Argentina’s risk premium fell below 700 basis points.

Investors have already shown signs of nervousness regarding Argentina: in the second quarter, this resulted in US$8bn in capital flight. Public debt currently stands at 50% of GDP, which is only marginally lower than the level (53%) immediately before the financial crisis of 2001. Although then the ratio was artificially depressed by currency overvaluation within the framework of a currency board, the current figure does not include US$23.5bn in debt held by the so-called holdouts—those who refused to accept the terms of the 2005 restructuring. If this were included, the ratio would be over 60% of GDP, which is very high for a middle-income emerging market with a strong fiscal dependence on commodity prices.

Dependent on Chavez
Thus, public debt stands at over 50% of GDP and the government has no access to voluntary foreign finance because it has not resolved the “holdouts” issue. A first step would be reaching a deal with the Paris Club on over US$6bn of bilateral debt, but talks that began tentatively in early 2007 have made little progress because of Argentina’s refusal to succumb to IMF conditionalities, which is the norm in a deal with the Paris Club.

Cut off from international credit markets, Argentina has relied heavily on Venezuela. Caracas has taken up US$2bn in Argentinian bonds this year, on top of US$2.2bn in 2007, US$2.3bn in 2006 and US$1.3bn in 2005. Venezuela has typically covered about 50% of market issuance.

About half of the US$13bn financing requirement in 2008 will be met by the fiscal surplus. With US$2bn covered by the bond sales to Venezuela, the remainder is likely to be absorbed the local market, including the pension fund industry. Reserves stood at over US$47bn in late July, providing quite a cushion, and the government would probably tap its reserves to meet any uncovered financing needs in 2009.

Unsustainable path
With financing needs rising in the medium term, and with fiscal revenue vulnerable to an inflation-driven collapse in domestic demand and a commodity price fall—the public finances have become increasingly exposed to commodity prices in recent years as the governments of Nestor Kirchner and now his wife, Cristina Fernández de Kirchner, have ramped up export taxes—Argentina’s creditworthiness is once again firmly under the spotlight. This is despite the fact that barely three years have passed since the country emerged from the largest debt-restructuring in emerging market history, and despite twin fiscal and current account surpluses and elevated GDP growth in recent years.

In July Ms Kirchner’s government, based mainly around the dominant Partido Justicialista (PJ or Peronist party), lost a vote in the Senate to uphold a new sliding scale system of agricultural export taxes introduced by presidential decree in March. The tax changes were introduced to boost government revenue, on top of tax rises instituted in November 2007 in response to soaring international commodity prices. However, prices for soya—Argentina’s main export—have now fallen 25% from the peak recorded in the first quarter of 2008.

The abolition of the March export tax hike creates a revenue shortfall of around 0.5% of GDP in 2008. This, together with rising spending on subsidies—in the energy and transport sectors as well as cross-subsidies in the agricultural sector—will reduce the primary surplus to 3% of GDP or lower this year and the outlook is for a further mild erosion (assuming a hard landing is avoided for the economy) in the fiscal position in the medium term.

Credibility problem

The Kirchners’ failure to restore faith in inflation statistics, which have been heavily manipulated by the government since January 2007 to render a favourable reading, is weighing on the credibility of the government and its economic policies. Downplaying inflation artificially inflates real GDP growth as well understating the loss of export competitiveness and undercutting households’ buying power.

Should the Kirchners’ fail to adjust economic policies in order to avoid an inflation-driven collapse in domestic demand or massive capital flight, or address fiscal and financial challenges, Argentina could face spiraling debt-servicing costs and renewed bouts of capital flight.

Some pressure to adjust policies will come from within the ranks of Peronists themselves as they fret about the longer-term damage and their own political survival (the next presidential election is due to be held in October 2011), but it remains to be seen whether this will be enough to persuade the Kirchners to change tack.

A debt default is unlikely in the next twelve months, partly because the central bank has sufficient reserves to cover the country’s remaining debt-repayment obligations. But the risks thereafter are higher. The political calendar—mid-term congressional elections in which the Kirchners will try to patch up their battered popularity and weakened political alliance—does not bode well for taking the politically difficult policy decisions needed to put public finances on a sustainable footing.