Strategy Note /
Argentina

Argentina: End of road for Macri; straight over, fork or U-turn for Fernandez

  • Presidential and legislative elections on Sunday, 27 October; Alberto Fernandez set to win

  • We don’t expect a big (negative) market reaction; Fernandez victory is now almost fully discounted

  • What has always been clear is that the winner will inherit an economic crisis

Argentina: End of road for Macri; straight over, fork or U-turn for Fernandez
Stuart Culverhouse
Stuart Culverhouse

Head of Sovereign & Fixed Income Research

Contributors
Alejandro Quelch
Hasnain Malik
Tellimer Research
23 October 2019
Published by

Argentina goes to the polls this Sunday (27 October) for presidential and legislative elections. The main opposition candidate Alberto Fernandez, and his vice-president Cristina Fernandez de Kirchner (CFK) look set to win, following their resounding victory in the primaries (PASO) on 11 August.

We think the best that incumbent President Mauricio Macri can hope for is to force a second round in November, and if so, he might stand a chance by collecting losing votes (and the market response might then be very different). But it still looks pretty unlikely given the size of the deficit he has to overcome, against a worsening domestic economic situation. 

We don’t expect a big (negative) market reaction, similar to the PASO result, following a Fernandez victory. This is now almost fully discounted, although we could see some mild weakness to the extent that there was any residual hope left for Macri and reflecting the cold hard reality of the shift in power. What will matter more for investors after the election will be what Fernandez says and does, and who he appoints to his cabinet; the sooner he puts forward a serious and credible economic programme, the better. The market will look for reassuring signals immediately, but with the inauguration not until 10 December, there could be a period of time before there is greater visibility on this. A smooth and cooperative transition will therefore be welcome.

What has always been clear, however, is that the winner will inherit an economic crisis, and crucial for investors will be the nature of engagement with the IMF and what to do with the debt. 

We think it is inevitable that Argentina will restructure and/or default under the next president, whoever that might be; either under a Fernandez government, inside or outside an IMF programme, if – as widely expected – he wins on Sunday (or in November’s second round); or in the seemingly still possible, but unlikely event that President Macri is re-elected. What restructuring would look like under each candidate might differ, however. We recently upgraded our recommendation on the US$ bonds to Hold from Sell, which we assigned after the PASO (although lower cash price bonds are preferred).

On equities, we think Argentina is too wild to ignore. Equity investors can walk away until, at least, the new government’s economic policy, restructuring with bond holders and relations with the IMF are more clearly visible. Or they can take a very long-term view that there are business models in Argentina, eg the banks, that will sustain through this latest crisis and that, after a lot of uncertainty, volatility and damage to earnings, there will be greater equity value left on the table than is currently reflected in share prices.

The first round

It appears all but inevitable that Fernandez will win in the first round of Argentina’s presidential election on Sunday. Indeed, opinion polls suggest Fernandez’s lead over Macri in the PASO has widened, with some reporting a 20-point lead. Recall that to win in the first round, a candidate needs either 45% of the vote, or 40% plus a 10-point lead.

There seems little hope for Macri. Despite his daily effort to reverse the primaries’ tremendous defeat, re-energising his campaign, under the slogan “Yes we can”, and organising a series of marches (including his March of the Million), he has failed to make any major dent on the Fernandez-CFK (FF) ticket. And although there have been some Provincial victories of his Cambiemos Party, in the decisive Buenos Aires Province, which holds approximately 17 million persons (37% country population) the defeat was even larger, by a negative 17ppts. 

Opinion polls could be wrong (they were in the PASO with most failing to predict its outcome), but the huge deficit with the FF ticket in the PASO seems too much of an uphill battle for Macri to overcome. We think Macri’s best chance is if he gets into a second round, but that still looks like a tall order (but if he succeeds, the market reaction could be positive).

Moreover, following his shock defeat in the PASO, the economy has deteriorated further. The rush on the peso, which prompted the introduction of capital controls, has had a devastating effect on inflation – September’s inflation reached 5.9% mom, the third highest for the Macri administration, leaving it at an estimated 53% for 2019 (48% in 2018). GDP is expected to fall by 3.0% this year and by 2.0% next year.

Hence, Macri’s unpopularity is not because people have all become Kirchnerites. It is more to do with the Macri administration’s inability to reverse Argentina’s fortunes and put it on a path towards sustainable growth. 

The question, then, is not if Fernandez will win, but by how much, and what happens to governance and governability. 

The outcome of the election will also be of utmost significance for the future composition of Congress. If the primaries’ results are replicated this Sunday, in the Lower Chamber of 257 seats (required quorum of 129 seats), Peronists would have 117 seats and Cambiemos 111. In the Senate, out of 72 seats (quorum of 37), Peronists would have 36 seats and Cambiemos 28. Although the new administration, possibly led by Fernandez, could easily pass laws with some support from the Cambiemos, however, passing structural laws, such as Constitutional reforms, would still prove to be very difficult. 

It remains to be seen what a Fernandez win might look like, and whether the transition will be smooth. Investors will also be concerned about the influence of CFK in a Fernandez administration. Will she remain quiet, as she has been in much of the campaign, content in the protection from prosecution from numerous alleged corruption allegations against her that her new position would afford? Or would she become more vocal with power and a stronger support base than Fernandez in this marriage of convenience? Investors will hope Fernandez, along with moderates in his economic team, will tread a more orthodox and pragmatic path, but may fear the worst. 

Sovereign bonds, restructuring and the role of the IMF

There are clearly many unknowns at this point, but one thing we do know is that Fernandez’s model is Uruguay’s 2003 restructuring, which involved a simple maturity extension.

A simple maturity extension would help to ease the medium-term repayment profile, given looming maturities of its international bonds over 2020-23, and allow space for the necessary policy adjustment. Bond maturities falling due over this period amount to cUS$12.4bn (equivalent) on our calculations. However, interest payments on bonds (US$4bn next year) and domestic debt payments are also sizable.

For what it’s worth, our calculations show that a Uruguay-style maturity extension leads to decent recovery prospects on foreign bonds from current prices under some plausible scenarios. For example, we estimate recoveries range from a PV of c55-60 under different coupon profiles and no nominal haircut at a 12% exit yield. This compares to current prices in the low-40s.

While the Uruguay model might therefore have some appeal, we think there are also reasons why that approach may not work in Argentina, not least whether such a restructuring would provide enough “private sector involvement” (PSI) to satisfy the IMF, consistent with its own debt sustainability analysis (DSA) and lending criteria.

Indeed, investor optimism over the viability of such a market friendly operation has been dented following “downbeat” meetings with investors during the IMF Annual Meetings in Washington last week (see the Financial Times).

Crucially, we think the success of any kind of restructuring – Uruguay or otherwise – will depend on a number of factors, including:

  1. the authorities’ commitment to, and ownership of, a strong economic and fiscal adjustment;
  2. engagement with the IMF – where, according to the talk at the IMF Annual Meetings, programme discussions (unsurprisingly) seem now to be on hold pending the outcome of the election (see IMF WHD press briefing); and
  3. good faith discussions with private creditors.

While Fernandez and his team have made placatory noises to this end, it remains to be seen what he says and does in office. And if one must take place, a reprofiling (or restructuring) should take place quickly.

We recently upgraded our recommendation on the US$ bonds to Hold from Sell. We see upside potential from current prices in “restructuring-light” scenarios, and more generally from an illiquidity versus insolvency diagnosis, but the outlook is uncertain. Further downside is possible if there are policy missteps or if Fernandez’s stance towards the IMF or creditors hardens, but downside may be limited at current prices (few performing sovereign bonds, let alone defaulted ones, have traded this low).

Crucially, the outlook for Argentina’s sovereign bonds is dependent on Fernandez’s policy objectives, and the IMF. We think the IMF will seek more from PSI and that it could take longer to secure a new IMF programme.

Part of this report is derived from our recent Tellimer-Capital Markets Argentina analyst call, held on 22 October. If you would like a recording or transcript of the full call, please contact sales@tellimer.com or your Tellimer contact directly. Note that the recommendations in the report are from Tellimer. Click here for more on Capital Markets Argentina views.