After spending time in Argentina, BofA's Marcos Buscaglia is concerned... The perception of many locals is that the risks of an economic/currency crisis before year-end have increased significantly. This compares to a view they had before of a muddle-through till the 2015 presidential elections. Policy decision-making is ever more concentrated, and the administration has radicalized, but the severe economic downturn will change political incentives in 2015, in BofA's view. With the official peso rate at record lows once again, the black-market Dolar-Blue tumbled to over 14/USD - a record low indicating dramatic devaluation ahead (which of course, sends ARS-denominated stocks surge to record highs).
Imagine the headlines on CNBC Argentina... think of the wealth effect...
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as markets price in massive devaluation... 14.04 Black-market Peso...
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A more recent snapshot of the "Dolar Blue" collapse:
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Not pretty, and as BofA warns, Argentina: on a slippery slope?
We spent three days in Buenos Aires last week, meeting government officials, economists, political analysts, market participants, corporates and members of the opposition parties. Below are our main takeaways.
A presidential election that seems too far away
The most striking change compared with our previous visits is that now many of the locals we spoke to think it likely Argentina will undergo an economic/currency crisis before the transfer of power to a new administration in December 2015. Previously, the consensus seemed to be of a muddling through or a small contraction at the worst. In this sense, the presidential elections seem farther away now in economic terms.
What do we mean by economic/currency crisis? We expect the demand for pesos to fall and the demand for dollars to increase. The default will likely increase external restrictions as well as the fiscal deficit and monetary financing. This would mean higher inflation and pressure on the peso and on reserves. Deteriorating sentiment and a wider gap between the official and the parallel FX rates would dent investment, spending and hiring decisions even more. This will likely further hurt fiscal revenues, which will require more peso issuance, and so forth.
What would be the catalysts to trigger a downward fall? We think there are several potential negative news items in coming weeks, while the only potential positive – but surprising – news would be an unexpected remedy to the default.
The local media report a dispute between central bank (BCRA) President Fabrega and Finance Minister Kicillof. Fabrega’s resignation would spur demand for USD, in our view. In addition, unions are pushing for a reopening of wage negotiations. Wages are increasing slower than inflation, so a new round of wage hikes would not be surprising. It is reported a general strike will be called for this Thursday by dissident Peronists unions. In addition, events that cement the view that the absence from voluntary debt markets will be more protracted may destabilize demand for pesos.
In our view, the social situation seems precarious, and the many we spoke to did not rule out additional social conflicts toward year-end. December has been turbulent in recent years. In 2013, amid widespread electricity cuts and a police strike, there were lootings in many provinces. The social situation has not improved since then: employment has dropped and disposable income is probably falling at low double digits yoy at this point.
External conditions tightened
External conditions have not only tightened due to lower expected financing from abroad in coming months, but also because export prices have dropped sharply and because farmers are restricting grain exports. By our estimates, farmers exported about $520mn less in the four weeks after the default compared to before the default.
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On top of this, grain exports are likely to drop next year. Since May/June, soybean, wheat and corn prices have dropped by 20%. At the current international prices and the current exchange rate, planting wheat and corn is not profitable in many areas, according to some locals we met. If there is no sufficient weakening of the peso in coming weeks, the harvest may contract in 2015 compared to in 2014. [ZH: Which would be devastating for Gartman's short Grains trade]
Central bank started moving, where will it end?
BCRA started allowing the peso to weaken, sending it from 8.28 to 8.40 per USD last week, not surprisingly during the first week in which it showed a decline in reserves. In a country where locals compare their ex-ante expected return from peso term deposits with the expected weakening of the peso, the move made clear that returns from term deposits were negative once measured in dollars. In sum, we think the small moves made by the BCRA increase the demand for USD rather than reduce it. This happened in December 2013/January 2014. As a result, pressure for a larger devaluation likely will increase after this move. We think that BCRA will resist a larger FX move as much as possible, but it may have difficulty avoiding a larger devaluation if reserves keep falling.
It takes only two to tango
Local political analysts characterize the current government’s decision process as highly centralized in Cristina Kirchner, with an increased access to her by Kicillof over other members of the administration. Moreover, they believe the government actions in the pari passu case should be understood in political rather than economic terms. According to this view, Cristina Kirchner does not have a candidate for the 2015 presidential elections, so they believe she is more concerned about her legacy than about the elections. Right or wrong, their view is that by fighting the holdouts, she thinks she gains more for her future political career than by giving up to holdouts.
Negotiations with holdouts in 2015 are still feasible
The many we we met expect the government will be able to pass the bill to implement local payment of Exchange Bonds (EB) and to offer a voluntary swap into local law. Most opposition members said they will not vote in favor of the bill, so the real question is whether the government can keep its rank and file united. Although there seem to be some cracks in the government coalition, the combination of electoral rules and fiscal distribution rules makes representatives dependent on the national government, so are unlikely to block this bill.
There is some disagreement among local economists and political analysts over whether the government will be ready to negotiate with holdouts in January once the Right Upon Future Offers (RUFO) clause expires. The RUFO is not the only impediment to negotiations. It seems local laws and the will to negotiate with all holdouts simultaneously – and not just with the plaintiffs of the pari passu case – also weigh on the government’s decisions. We are in the group that believes that the pressure from slumping activity will make the chances of some negotiations with holdouts more feasible in 2015, but these may take the form of a new offer to all holdouts rather than staying with the plaintiffs of the pari passu case.
Massa and Macri on the rise
Many locals believe that Argentina’s economic difficulties will be negative for Daniel Scioli’s chances of carrying the presidential elections. This is in stark contrast with our April 2014 visit amid the adjustments and negotiations with creditors, when Scioli was the favorite. Some recent polls show Mauricio Macri and Sergio Massa may have gained ground against Scioli.
