Crisis-hit Argentina urges faster IMF intervention

global perspectives

Crisis-hit Argentina urges faster IMF intervention

Charles St-Arnaud - Senior Investment Strategist

Charles St-Arnaud

Senior Investment Strategist

Argentina’s crisis has intensified over the past week, after President Macri requested a faster disbursement of a $50bn loan from the IMF.

The crisis that started earlier this year had eased somewhat following the intervention of the IMF in June, but this latest development has spooked foreign investors and led to a sizeable currency depreciation. The Argentine Peso has depreciated by almost 30% since 20 August, which has prompted the central bank to hike interest rates to the unprecedented level of 60%.

This comes in sharp contrast to last year when Argentina was the darling of emerging market investors. Investors expected that the arrival of President Macri would herald an era of structural reforms that would boost growth, reduce inflation, eliminate the government deficit, and reduce reliance on foreign capital.

Argentina’s problems started earlier this year when foreign investors started to question the government’s ability to meet its objectives, especially following upward revisions to the inflation target. This resulted in a sharp depreciation of the peso and prompted the central bank to hike rates to 40%.  It quickly became apparent that the IMF would need to step in to stabilise the economy.

The pressure mounted in August, despite the policy response by the government and central bank and the involvement of the IMF, as the crisis in Turkey forced some investors to reconsider their exposure to emerging markets, especially those with weak fundamentals. However, Argentina’s woes deepened when President Macri made an unexpected demand for the IMF accelerate the disbursement of the programme, leading investors to seriously question Argentina’s financial situation. This pushed the currency dramatically lower, forcing the central bank to hike its policy rate to 60%.

The Argentinean government has announced new policy adjustments, including the introduction of a tax on exports and further fiscal consolidation, to provide a better starting point in its negotiations with the IMF on an updated programme.

Nevertheless, while an accelerated disbursement from the IMF would be a positive, investors remain concerned by the risk of economic deterioration. As such, the sharp depreciation of the Argentinean peso – down more than 50% so far this year - will push inflation dramatically higher, reducing the purchasing power of households. Moreover, with interest rates at 60% (or about 30% in real term), the economy is likely to slow meaningfully. Even before the events of August, the economy was already considered likely to enter into recession in the second half of 2018. Now, the contraction is likely to be more pronounced, which may require further action if the fiscal target of a primary balance in 2019 is going to be met.

The crisis may also have some important political consequences. President Macri is up for re-election in the autumn of 2019 and his handling of the crisis and upcoming recession is likely to hinder his chances of remaining in office. This could see the current pro-reform and pro-market government replaced by a less reform-friendly and likely populist one, a possibility market participants are already contemplating.

 

Investment implications

  • The involvement of the IMF and a revised programme should help to stabilise the situation and provide some stability for the bond market and the currency. Nevertheless, uncertainty remains given the deterioration in the economic and political outlook.
  • While the crisis has been so far more acute in Argentina than in Turkey, there are major differences between the two countries. 1) Argentina is a much smaller part of the EM bond universe. 2) Argentina has been quick to use orthodox policies (hiking rates, ask help from the IMF, announce further fiscal announcement, fighting inflation). This is in contrast to Turkey where the government continues to resist rate hikes and appears to view the crisis as a conspiracy rather than as the result of bad policy decisions.
  • Argentina has a history of defaulting on its obligations. However, we believe that the risk of a default remains low in the near term because of the involvement of the IMF and the pro-reform, market-friendly government. A change of government in the election next year could change that view.

important information.

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