The IMF board finally approved the new programme for Argentina on Friday, as expected; a 30-month extended fund facility (EFF) for an amount of US$44bn (1,001% of quota). The staff report was also published, providing – for the first time – detailed programme modalities and macroeconomic projections (see here). Board approval allowed the immediate disbursement of cUS$10bn.
Board approval follows the staff-level agreement on 3 March and the IMF's statement on 19 March, which confirmed the date of the board meeting after its recent ratification by Argentina's National Congress.
But now comes the hard part – programme implementation; amid a politically challenging fiscal consolidation, monetary tightening to deliver disinflation, a still high and fragile public debt burden, weak growth, external vulnerabilities and high financing needs.
Will the government, after all this time getting here – and with an election approaching in 2023 – be willing and able to stick to it?
Programme design
The new programme now becomes comfortably the IMF's largest current programme (both in terms of absolute size and as a share of quota), outstripping Ecuador's EFF (US$6.5bn, 661% of quota), and is the IMF's biggest programme in absolute terms since... since Argentina's last programme (the 2018 augmented stand-by arrangement (SBA), which amounted to US$56.3bn, 1277% of quota).
It is the Fund's second-largest programme ever in absolute terms, after the SBA (excluding Mexico's flexible credit line (FCL), which isn't really a programme), although in relative terms (share of quota) other programmes have been bigger (eg Greece, Portugal and Ireland during the eurozone debt crisis in 2010-12).
It is so large because it essentially refinances the repayments due to the Fund under the previous SBA, which would have peaked this year and next, instead pushing back the IMF's repayment profile with an average maturity extension of c7-8 years. This should give the authorities a lot more breathing space in the near term, as the country still faces considerably high gross financing needs, while debt service on the restructured bonds will begin to pick up more markedly from 2024-25. Programme disbursements will also help to rebuild external buffers.
And, because of its size, the programme is made available under the Fund's exceptional access criteria (EAC), meeting three out of the four conditions – exceptional access sets a higher bar for compliance and implementation compared to programmes under normal access limits. Of the four criteria, EA1 (the member is or has experienced balance of payments – BOP – pressures resulting in the need for Fund financing beyond normal access limits) and EA3 (prospects for gaining market access) seem the more straightforward. EA2 (debt sustainability) is also met but it is not so obvious. The IMF's debt sustainability analysis (DSA) indicates that public debt is sustainable but not with high probability, although staff assesses adequate safeguards are in place to meet this criterion. EA4 (likelihood of programme success) is, however, not met – it is too early to say.
Programme reviews (and, hence, the disbursement schedule) are quarterly. Disbursements are frontloaded. A further US$15bn is available for the remainder of 2022, with the next disbursement, amounting to US$4.1bn, available upon completion of the first review scheduled from June 2022.
As well as the usual macro performance criteria, we count six structural benchmarks by June (the time of the first review) and 18 structural benchmarks in all this year.
Now for the hard part
But after a two-year wait since the government of President Alberto Fernandez took office in December 2019 and which eventually and reluctantly signalled its intention to seek an IMF programme, now comes the hard part – delivery.
For a government lacking any kind of policy credibility, and facing declining popularity amid fractures in the ruling coalition, and with elections looming again in 2023, it now – because of its ideology and dithering – only has a short window to make progress and implement necessary policies under the programme in order to put the economy on a more sustainable path. The usual adage that a new government should take the tough decisions early in its term so that it can benefit later on has been lost on this government. It is already over half way through its term.
But, ironically, it has deferred the repayments to the Fund, which it inherited from the Macri government to the next one (and, more so, the one after that). And, of course, it did secure a generous bond restructuring.
Moreover, the programme is still subject to a lot of uncertainty and implementation risk (EA4), amid criticism that it is not demanding enough and that the Fund has gone soft. The IMF statement noted that risks to the programme are "exceptionally high". Indeed, with the programme barely even started, the IMF cautioned that spillover risks from the war in Ukraine may require early "recalibration".
Policy framework
The programme is underpinned by a "growth-friendly fiscal consolidation path, with an upfront reduction in monetary financing to reduce inflation and strengthen stability". The key policy anchor is fiscal.
It aims at a 2.1ppts fiscal adjustment over the programme period, before achieving primary balance by 2025, and targets a primary surplus of c1¼% of GDP over the medium term (from -3% in 2021).
This facilitates an improvement in the overall federal and consolidated public sector balance, from -4.5% to -2.0% and -7.8% to -2.4%, respectively, over 2021-27.
Inflation is expected to fall due to tighter policies although the disinflation process is gradual. Inflation falls, albeit to a still-high 33% by the end of the programme, from 50.9% at the end of 2021, due to tighter monetary and fiscal policies and a better policy mix. That said, inflation is not expected to fall to below 20% until 2027.
The central bank has already raised interest rates, with the policy rate increasing from 38% to 44.5% in three moves this year, although more will be needed in the shift towards positive real interest rates, and it will seek to control base money growth.
The narrowing in the fiscal deficit also facilities the gradual withdrawal of monetary financing, on which the government has had to rely over the past three years, and which itself has been a source of inflation.
A better policy mix, policy tightening and IMF financing may also help ease pressure on the currency which may, in turn, reduce inflation pass-through and help to re-anchor inflation expectations.
Fiscal consolidation
The core of the programme is the targeted reduction in the federal government primary deficit from 3% of GDP in 2021 to 0.9% in 2024 (averaging 0.7% of GDP per annum over the programme period), reaching balance in 2025, and heading for a surplus of 1.3% by 2027.
The planned fiscal adjustment over the programme period seems to rely almost entirely on cutting subsidies. While the targeted fiscal adjustment of 2.1pts of GDP over 2021-24 is evenly split between revenue (1.1pts) and spending cuts (1pts), subsidy reduction (most of which relates to energy subsidies) accounts for the bulk of it. The programme envisages a 0.6% of GDP reduction in the energy subsidy bill this year and further reductions during 2023-24, taking cumulative savings to 1% of GDP. This will be delivered through a number of measures, including a commitment to raise wholesale energy prices by June.
Elsewhere on the spending side, wages are unchanged and pensions and capital spending increase, while the increase in revenue is relatively backloaded (and itself rests on compliance and improving efficiency in the tax system, rather than any revenue-raising measures per se). The reduction in Covid-related spending also helps to deliver the fiscal adjustment (although this is somewhat automatic and not really the result of a policy decision).
Hence, if the government can deliver the planned subsidy reduction, the programme has every chance of being a success (albeit subsidy reduction alone won't determine this – a necessary but not sufficient condition perhaps). If it cannot, the programme looks likely to fail (or at least shift the burden onto other areas, which could prove even more politically elusive). If so, it is not clear what will happen next.
Debt sustainability
Public debt is expected to fall towards 70% of GDP by the end of the programme (73% in 2024), under the planned fiscal adjustment path and with strong programme implementation. This is down from 81% in 2021 and its recent peak of 103% in 2020. Public debt is projected at just 63% in 2027.
However, this might overstate perceived sustainability risks given the high share of intra-public sector indebtedness. Netting out the share of public sector debt owed to public entities (38% of the total in 2021, c31% of GDP), public sector debt was only 50% of GDP in 2021, down from 67% in 2020, and is projected to remain at around this level by the end of the programme. That said, intra-public sector debt still has to be serviced and that remains an ongoing fiscal drain.
Moreover, public debt is still somewhat on a knife edge, given the DSA finding that debt is sustainable but not with high probability (EA2).
Growth outlook
Real GDP growth is projected to ease to 4% this year, after the post-Covid bounce-back last year (which saw growth hit 10%), and slow to 3% next year. While not stellar in terms of post-crisis recoveries, presumably growth would have been weaker without the "growth-friendly fiscal consolidation path" (ie not tightening fiscal policy too soon).
However, nor is there any positive growth impact over the longer term, ie on-trend growth (usually, an IMF programme signals a structural break in terms of confidence and structural reforms). This might reflect Fund caution, after being over-optimistic in the past. Growth converges only to 1.75-2.25% over the medium term, consistent with Argentina’s 20-year average.
Moreover, Argentina has a history of volatile growth, given its high degree of external vulnerability and political business cycles, such that it is unlikely the expected growth outlook will be so smooth. Argentina has spent 40% of the past 20 years in recession. Another shock could easily cause the programme to go off-track. And we already have one of those, with Russia's war in Ukraine.
External accounts
On the external side, gross international reserves increase from US$39.7bn in 2021 to US$55.5bn in 2024 (at the end of the programme period), although this is of course aided by IMF money (borrowed money). Net international reserves (programme definition) – a better gauge of underlying and self-generated reserves – increase from US$2.3bn in 2021 to US$17.3bn in 2024.
Reserves accumulation is also supported by the contribution from net trade, with a 3% of GDP trade surplus, and the continuing expected (small) current account surplus (the improvement in the fiscal balance and lower inflation, helping to maintain currency competitiveness, also helps the external balance). However, stronger exports performance and non-debt creating flows (net FDI) will also be needed to improve external resilience, and this will depend on structural reforms, improvements in the business environment and greater political stability.
Still high financing needs
Gross financing needs (GFNs) both public sector (fiscal) and external, remain high and, with the IMF's new dual focus on the debt burden and debt service in its integrated sovereign risk and debt sustainability framework (SRDSF), this might explain why debt sustainability is still in doubt. Public sector GFNs (net of the IMF) average 16% of GDP over 2022-24, according to our calculations, before falling – outside the programme period – to 14% in 2025 and 11% in 2026.
Financing sources will rely on private sector issuance, especially given the decreasing contribution from central bank monetary financing, while private sector issuance in turn relies on domestic issuance given international bond issuance is not expected until 2025. The IMF assumes private sector rollover rates of well over 100% – averaging 118% this year (albeit falling to a low of 109% in Q2 before rising to 141% in Q4) and 139% in 2023. Rollover will clearly be sensitive to domestic and external conditions.
The IMF's DSA notes the risks from "large and sustained" domestic financing assumed in the programme.
The programme also envisages the gradual resumption of international market access, starting in 2025 (with US$2bn being pencilled in). Restoring market access will be essential in providing the funds to allow for the repayment of the IMF money when it begins to fall due under the re-phased schedule (commencing in the second half of 2026).
With yields currently at c25% at the front end (2030s), and 17-20% across the rest of the curve (excluding the '29s PDI bond), market access seems some way off. It is going to require prices nearly to double (on the '30s) even to bring spreads down to 1,000bps (an indicative threshold for loss of market access). For yields to reach 8%, a more likely target for accessing the market, that would imply a price of cUS$70 on the '30s, which seems a long way off, although we might expect to see some price gains upon satisfactory performance heading towards the first review.
Investment recommendation
We maintain our Hold on Argentina's US$ bonds, with the 2030s priced at US$32.4 (yield of 25.2%) as of cob 25 March on Bloomberg (mid-price basis).
Despite some reasons to be positive now the IMF programme is in the bag, with financing secured and – finally – a policy anchor, we remain cautious as we assess further the programme's credibility in more detail and look for signs as to whether the Fernandez government will be willing and able to stick to it, and any domestic push-back.
Increased generalised risk aversion given the global rate outlook and following Russia's invasion of Ukraine, and the global macroeconomic consequences, provide other headwinds.
On a positive note, investors may see the bonds as more attractive now the coupon step-ups are underway, potentially offering interesting current yields at these prices, even if default concerns linger over the medium term, while still rock-bottom prices offer some downside protection. For example, at prevailing prices, the current yield on the 41s will increase from c7.5% to c10.5% later this year when the coupon steps up from 2.5% to 3.5% and, similarly, the current yield on the 38s will increase from c5.5% to c10.5% later this year when its coupon steps up from 2% to 3.875%. The 35s will offer a current yield of c12.5% at prevailing prices when its coupon steps up to 3.625% in 2024. That said, given the market weakness since Russia’s invasion of Ukraine, there might be more compelling opportunities elsewhere.
