DBRS Confirms Argentina at SD

DBRS, Inc. (DBRS) has confirmed Argentina’s long-term foreign and local currency issuer ratings at SD and B (low), respectively. The short-term foreign and local currency ratings have been confirmed at D and R-5, respectively. The trend on the long-term local currency issuer rating is Negative, while the trend on the short-term local currency rating is Stable.

The confirmation of Argentina’s ratings reflect DBRS’ view that the default on foreign law exchange bonds is unlikely to be resolved prior to 2016. With regard to debt issued under local law, recent policy actions have been sufficient to curb reserve losses and preserve the government’s debt service capacity. The trend remains Negative because a tightening of controls over private business, trade and capital flows have had an adverse impact on growth. Macroeconomic stability could deteriorate, particularly if fiscal dynamics worsen and the government resorts to increased monetization.

A failure to adjust fiscal, monetary, exchange rate, and wage policies to curb inflationary pressures and restore confidence in the peso could result in further rating downgrades. Conversely, a strong effort by the government to gradually reduce the fiscal deficit, achieve disinflation and improve the business environment could stabilize the ratings. A resolution to the dispute with holdout creditors would enable a resumption of debt service on the exchange bonds and remove the rationale for the SD rating. A comprehensive effort to address these challenges could put upward pressures on Argentina’s ratings.

Argentina continues to benefit from a diverse economy, an educated population, a highly productive agricultural sector, economic ties with other emerging markets, and abundant natural resources. Real growth has averaged 3.5% over the past twenty years, in spite of the deep, multi-year recession between 1999 and 2002. Argentina exhibits relatively high levels of productivity compared to other emerging economies in the region, with per capita output measured in PPP terms estimated at 22,100 (current international dollars).

A prolonged period of negative real interest rates has significantly reduced indebtedness, both for the public and the private sector. Several years of primary fiscal surpluses and high levels of participation in the 2005 and 2010 debt exchanges also contributed to the rapid decline in public debt. The central government’s deficit has widened in recent years, but financing has come from other public entities, such as the social security administration (ANSES) and the central bank (BCRA), and net debt remains low. Although limited financial intermediation in the economy acts as a constraint on investment, the low degree of leverage has insulated the Argentine economy from the potentially adverse impact of global financial shocks.

In spite of Argentina’s strengths, the strains from its inconsistent economic policies have become increasingly evident over time. Fiscal and monetary policies have remained highly accommodative even as the economy has operated at or above its potential, leading to high and entrenched inflation. Energy subsidies and import substitution policies have amplified Argentina’s challenges, initially generating some positive results in terms of increased local production, but simultaneously undermining incentives to invest in energy production and boost productivity. Argentine firms have become less competitive internationally due to the combination of high local content requirements and real exchange rate appreciation. Following the January 2014 devaluation, the central bank increased interest rates sharply and continues to maintain tighter monetary policies in an effort to safeguard FX reserves. The economy fell into recession in 2014 and is likely to remain there in 2015.

With much of the rising deficit financed through money creation and various forms of financial repression, the resulting high inflation has eroded confidence in the peso, forced households to look for alternative forms of saving, and reduced access to credit for Argentine businesses and households. The government has attempted to limit access to dollars by imposing exchange controls, restricting imports, forcing exporters to surrender hard currency, and preventing businesses from building up inventories. This broad range of invasive controls has increased the cost of doing business in Argentina and has spurred a growing informal market.

The government continues to meet a substantial portion of its gross financing needs through outright monetization. Government efforts to raise financing in domestic markets have thus far been met with limited success. The central bank has nonetheless increased its own debt issuance to absorb liquidity and slow the pace of money growth, but its net interest margins are deteriorating rapidly and generating quasi-fiscal losses now likely in excess of 1% of GDP. Unless there is a substantial improvement in the external environment, this increasingly costly tradeoff may force the government to devalue the peso or dramatically reduce the public sector deficit.

Argentina defaulted on its foreign law exchange bonds in July 2014. New York court rulings have forced the trustee for the exchange bonds to withhold interest payments made by Argentina, preventing the ultimate beneficiaries from receiving payment on the bonds. Although the rights under future offerings clause in the exchange bonds expired at the end of 2014, Argentina has consistently maintained that holdout creditors should not receive more than the participants in the 2005 and 2010 exchanges. However, the ruling has effectively increased the leverage of holdout creditors to demand full payment, and it is unclear how long it will take for the two parties to come to an agreement. The New York Southern District Court has recently broadened the application of its injunction to include payments on U.S. dollar denominated exchange bonds issued under Argentine law (and remitted by Citibank to foreign clearing houses). This could lead to a default on additional exchange bonds, though the Argentine government could intervene in Citibank’s branch in Argentina in an effort to resolve any deadlock. The latest rulings may also complicate Argentina’s efforts to issue a new foreign currency bond in advance of its October 2015 Boden redemption. DBRS does not expect the current administration to compromise its stance, but the incoming government may place a higher premium on restoring Argentina’s access to external borrowing.

Notes:
All figures are in ARS unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include BCRA, Argentine Ministry of Economy and Finance, ANSES, INDEC, Universidad Torcuato Di Tella, IMF, World Bank, UN, Congreso, City of Buenos Aires, Province of San Luis, various private analysts, and Haver. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Alan Reid
Initial Rating Date: 6 September 2007
Most Recent Rating Update: 31 July 2014