Last month Argentines went to the polls to cast ballots in their national primary election, otherwise known as the PASO. While it is only an indication of voting intentions in the general presidential election that takes place on October 27, the primary elections in Argentina historically have had a strong degree of predictive power on election outcomes. With that said, the Fernandez-Fernandez opposition candidacy won in the PASO by more than enough to avoid a runoff and results suggest that they will be the next leaders of Argentina.
We believe the poll result is not to be discarded, and if it does hold true in the coming general election, it could carry negative implications for the economy and bond holders as the vice president of this ticket is Cristina Kirchner Fernandez, who ran the country for nearly 12 years. The incumbent who lost the PASO appeared to be the market's clear preference, the one that the IMF "bet" on, and the one that has overseen the economic austerity of the last 18 months despite his poor showing in the recent primary election.
In the second quarter, the odds of a default were roughly 20%, based on our research. At that time, we cautioned that if Fernandez-Fernandez were indeed elected President and Vice President, they would likely either pro-actively restructure, or the markets will force a restructuring if Argentina cannot roll its large stock of maturing external debt. The PASO results may have started this negative feedback loop.
In our opinion, the odds of a positive outcome now hinge on: 1) the PASO results were an aberration and come the October 27 election, Macri can win; 2) the new Fernandez-Fernandez ticket can calm markets with favorable rhetoric; 3) the IMF stays engaged even with Cristina Kirchner Fernandez in power—although, they would have to put past difficulties aside. Each of these scenarios seem somewhat unlikely.
Post PASO, the sovereign CDS markets implied a greater than 75% odds of default. Given the glimmer of hope that remains and the dire pricing, we advocated a hold and assess over the very near-term to wait for any signals from the positive scenario while we evaluate relative value opportunities.
So far, the markets have not calmed post-PASO and the government announced a potential debt re-profiling and was forced to implement capital controls. Argentina's Finance Minister Lacunza announced the intention to re-profile their short-term debt, seek an extension of other (later to be determined) bonds, and rework the International Monetary Fund (IMF) program, too. Their immediate stated goal was to reduce near-term maturities out of fear that investors would not roll-over these debt obligations in the current environment.
A few weeks after the re-profiling announcement, Argentina's government was forced to enact capital controls to stem the drain on Central Bank reserves. Immediately following the imposition of capital controls, the peso market reacted positively; however, the (still nascent) black market is trading weaker than before the announcement. While 56 is the official rate, we increasingly look at the black market or "blue-chip" rate for an indication of true foreign exchange (FX) pressures and effectiveness of the capital controls. Capital controls rarely decrease the underlying demand for the US dollar, and often create second round effects as market participants anticipate stricter capital controls.
These measures should slow the drain on central bank reserves, now thought to be below $15 billion on a net basis. One should recall that when Mauricio Macri began his term, one of the first things to be revoked were the capital control measures of the previous administration. Ironically, assuming polls are correct, Macri will depart office having returned the country to the Peronists with the same capital controls he decried upon taking office as well as a debt re-profiling.
With respect to the recent re-profiling announcement, there remains substantial ambiguity as to what the final plan will entail—if it takes final form at all. Specifically, a maturity extension of three or six months on short-term local debt does not strike us as a sufficiently long time to regain investor appetite. For the current proposal to be successful, if it is enacted, at a minimum, we expect another extension and the Fernandez regime to positively "shock" markets (a Macri victory would also satisfy this criteria as unlikely as it is). The proposal will also require the $5 billion IMF disbursement that is currently under review and due this month. Hard currency fixed income investors should prepare themselves for a possible negative NPV re-profiling, even though the current proposal is for non-negative NPV re-profiling. The success of the capital controls, the probable Fernandez economic team, and the IMF, among other factors, will likely determine if bond prices are too optimistic or not depressed enough.
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