DBRS Morningstar Confirms Argentina at CCC, Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the Republic of Argentina’s Long-Term Foreign Currency – Issuer Rating at CCC and Long-Term Local Currency – Issuer Rating at CCC (high). At the same time, DBRS Morningstar confirmed the Republic of Argentina’s Short-Term Foreign and Local Currency – Issuer Ratings at R-5. The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS

The confirmation of the ratings at CCC/CCC (high) reflects DBRS Morningstar’s view that, despite favorable external conditions and a recovering domestic economy, Argentina continues to face significant economic and policy-related challenges. If left unaddressed, these challenges pose material risks to the government’s capacity to repay its debt to private creditors.

In DBRS Morningstar’s view, the Fernández administration has not yet outlined a plan to address the country’s weak economic fundamentals. Fiscal consolidation remains a major political challenge. Inflation is running at 50% year-over-year. Reserves are low and the unofficial peso-dollar exchange rate is about 80% above the official rate. Moreover, Argentina experienced a prolonged period of stagnation prior to pandemic, primarily due to poor macroeconomic management and unpredictable regulation. While the economy is recovering from the shock of the pandemic, we expect growth to remain relatively weak over the medium term. In addition, the debt restructuring agreement in September 2020 with private creditors provided Argentina with substantial debt servicing relief through 2024, but the level of public debt remains elevated and primarily denominated in foreign currency.

Argentina is currently in negotiations with the IMF on a new program. Without market access and with sizable loan repayments coming due in 2022 and 2023, the Argentine government will need to reach an agreement with the Fund by early next year to avoid going into arrears on its obligations to multilateral creditors. Striking a deal would likely entail an extension of payment terms. In return, Argentina would need to commit to a program of economic stabilization and structural reform. In DBRS Morningstar’s view, a credible commitment to address macroeconomic imbalances could help restore market confidence and improve growth prospects. However, it is unclear whether the Fernández administration can garner and sustain sufficient public and congressional support to reach a deal with the IMF and implement the requisite policy changes and reforms.

DBRS Morningstar rates the Long-Term Foreign Currency – Issuer Rating one notch lower than the Long-Term Local Currency – Issuer Rating to reflect additional risks that stem from Argentina’s limited access to foreign exchange and the high share of government debt denominated in foreign currency.

RATING DRIVERS

The ratings could be upgraded if the government implements a credible macroeconomic program that durably lowers inflation and puts fiscal accounts on a sustainable path. Reforms that increase investment and productivity growth would also be credit positive.

The ratings could be downgraded if the government fails to reach an agreement with the IMF and faces difficulties meeting its gross financing needs.

RATING RATIONALE

Negotiations With The IMF Provide Argentina With An Opportunity To Restore Confidence

The debt restructuring agreement in September 2020 with private creditors provided Argentina with substantial debt servicing relief through 2024. However, the deal was not accompanied by an economic plan to rebuild confidence and strengthen competitiveness. As a result, the agreement failed to restore market access. At the conclusion of the debt restructuring, the EMBI Global Diversified Sovereign Spread for Argentina declined from about 2,100 basis points (bps) to 1,100 bps, but then increased in the subsequent months and has hovered around 1,500-1,600 bps during the first six months of the 2021, effectively signaling that markets remain closed to Argentina. Furthermore, while the restructuring reduced near-term financing requirements, it did not materially alter the longer-term debt sustainability risks. Government debt-to-GDP increased to 103% in 2020 from 90% one year earlier (largely due to the economic shock of the pandemic and higher fiscal deficit), and the share of debt denominated in foreign currency – at roughly three-quarters – was left broadly unchanged.

Negotiations with the IMF on a new Extended Fund Facility program started last August. Argentina has $19 billion in principal and interest payments to the Fund coming due in 2022 and again in 2023. Argentina will need to reach an agreement by early next year to avoid arrears on its IMF obligations. A new program would likely entail an extension of IMF loans in return for Argentina committing to a macroeconomic stabilization program that includes tighter fiscal and monetary policies, potentially coupled with a foreign exchange strategy to replenish reserves and reduce the spread between the official and unofficial exchange rates. Given the near-term political costs of such policies, a deal is not expected until after the November mid-term election. Argentina appears to have sufficient dollars to service its debt until then, due to strong export revenues and the expected allocation of $4.6 billion in Special Drawing Rights (SDRs) by the IMF in August or September. Moreover, Argentina reached a separate deal with the Paris Club in June 2021 to defer $2.0 billion in loans until March 2022. Following the mid-term elections, the IMF negotiations present Argentina with an opportunity to formulate a consistent set of macroeconomic policies that reduce imbalances and strengthen growth. But restoring market confidence will depend on the government’s willingness to build and sustain political support for such a program. The considerable risks to debt sustainability combined with Argentina’s weak liquidity position lead DBRS Morningstar to make a negative adjustment in its Building Block Assessment for “Debt & Liquidity”.

The Economy Is Recovering But Growth Prospects Are Weak Without A Shift In Policy Direction

The pandemic has had a severe impact on an Argentine economy that was already suffering from a two-year recession prior to the shock. Cumulatively, the economy contracted 14% from 2018 to 2020. Activity was picking up in the second half of 2020, but growth momentum slowed in early 2021 as new COVID-19 cases surged and restrictions were reimposed. We expect the recovery to resume in the second half of this year as more people are vaccinated and health conditions improve. Only 14% of the population is fully vaccinated, but the pace of vaccinations has accelerated in recent months. In addition to the economic reopening, the growth outlook should benefit from favorable external conditions, including high commodity prices and stronger demand from Brazil. The median GDP growth forecast according to the central bank’s Market Expectations Survey (June 2021) is 6.3% in 2021 and 2.5% in 2022. Despite the return to growth, we expect Argentina’s recovery to be slow and prolonged, with output only returning to its 2017 level in 2026.

Poor macroeconomic management, an unpredictable and onerous regulatory environment, and limited global integration have contributed to Argentina’s poor growth performance. In the eight years prior to the pandemic, GDP growth contracted on average by 0.3% per year. During this time, investment averaged 17.6% of GDP, one of the lowest rates among emerging markets, and the number of private sector jobs created was close to zero. Absent a stabilization plan that restores policy credibility, we expect medium-term growth prospects to remain weak, with Argentine policymakers having limited room to stimulate growth without exacerbating macroeconomic imbalances.

Fiscal Consolidation In The Wake Of A Three-Year Recession Will Be Politically Challenging

One of the most pressing policy issues facing Argentina’s sovereign credit profile is the fiscal deficit. The Macri government made some headway in reducing the fiscal imbalance. The primary deficit narrowed from 4.4% of GDP in 2015 to 0.4% in 2019. However, in the first year of the Fernández administration, fiscal consolidation was subordinated to the pandemic response. Emergency spending and revenue measures amounted to 3.9% of GDP in 2020. In terms of the scale of fiscal support, this placed Argentina’s response close to middle of pack relative to other emerging markets. The pandemic-related support plus the recession led the primary deficit to widen to 6.4% in 2020.

The government looks set to achieve its primary deficit target of 4.5% for this year. This looks likely even if we exclude the IMF’s new special drawing rights, which will likely total about 1% of GDP. In the first six months of the year, the primary deficit was 0.5% of GDP. Revenues were supported by sharply higher export tax receipts and a one-off wealth tax, while expenditure growth was restrained by lower social security spending. Despite the encouraging start to the year, we expect the deficit to quickly widen through December – though still achieve the annual target – as pre-election spending picks up, pensions adjust, and energy subsidies increase.

Implementing a durable consolidation over the next few years will be difficult, particularly as it will require reforming politically sensitive spending items such as energy subsidies at a time when labor market conditions are weak and poverty levels are elevated. The challenging fiscal outlook combined with historical weaknesses in fiscal policy formulation weigh negatively on the Building Block Assessment for “Fiscal Management & Policy”. DBRS Morningstar notes that Argentina has made some progress in improving the quality of public statistics and in making available additional analysis around fiscal policy measures, including with the creation in 2016 of the Congressional Budget Office (OPC), but it remains to be seen whether this will improve fiscal policy outcomes.

High Inflation Is A Symptom Of Weak Policy Credibility On Several Fronts

Headline inflation was 50% y/y in June 2021. On a monthly basis, inflation has recently decelerated: from 4.8% in March to 3.2% in June, a trend aided by weak demand as pandemic-related restrictions were tightened, the widening use of price controls, and policymakers’ decision to slow the pace of peso depreciation. In DBRS Morningstar’s view, the disinflationary trend is not likely to continue. In the run up to the November elections, we think fiscal policy will likely turn more expansionary and rely primarily on monetary financing. This, combined with strengthening aggregate demand as the economy reopens and recent collective bargaining agreements that have increased wages by more than 40%, will reinforce inflationary pressures. According to the June Survey of Market Expectations by the central bank, the median forecast for CPI inflation is 48% in December 2021 and 42% in December 2022.

The central bank has limited room to maneuver in the current environment. Without market access and with a large gap between the official and unofficial exchange rates, expansionary monetary policy to finance fiscal deficits could further damage policy credibility and strengthen inflationary pressures. In DBRS Morningstar’s view, the problem of high inflation is unlikely to be addressed in a durable manner unless accompanied by a credible economic plan that narrows the fiscal deficit, provides greater stability to the currency, and reorients towards more forward-looking wage-setting processes. Moreover, short-term measures such as price controls and capital restrictions will likely end up exacerbating underlying economic imbalances, ultimately leading to a further deterioration in the investment climate and an acceleration of inflation down the road.

Argentina’s financial system remains small in size and provides only a limited capacity to finance government deficits domestically. State-owned Banco Nacion remains a dominant player in the banking sector. While profitability has suffered, evidence suggests that the banking system has high levels of liquidity and is well-positioned to weather asset-quality deterioration associated with the pandemic-induced recession. The banking system has limited exposure to the consolidated public sector, and net FX exposure is modest.

Low Reserves And Capital Controls Signal Currency Vulnerability

Argentina has undergone a significant adjustment in its external accounts. The current account shifted from a deficit of 5.8% of GDP in mid-2018 to a surplus of 0.9% in 2020. The adjustment was led by import compression, as the pre-pandemic recession and Covid-19 shock led to a massive cutback in imports. Lower primary income payments also contributed the adjustment. The current account is likely to remain in a modest surplus position in 2021, notwithstanding an expected recovery in imports, as rising agricultural prices support higher exports receipts.

Foreign exchange reserves increased modestly in the first half of 2021, but they remain very low. Gross reserves amounted to $43 billion in mid-July. However, liquid net reserves (calculated as gross reserves minus dollar deposits from financial institutions, central bank currency swaps and credit lines, and gold) amount to just $4-5 billion. Both gross and net measures are up about $3 billion since the start of the year. The central bank has been able to accumulate reserves while slowing the pace of peso depreciation because of strong export revenues and tight capital controls. However, the spread between the official ARS/USD rate and the unofficial rate was close to 80% in mid-July 2021, highlighting the lack of credibility in the currency. The policy mix along with favorable commodity prices may provide some near-term relief in terms of inflation and the exchange rate, but restrictions on hard currency will diminish incentives to save and invest over time, which will ultimately weaken prospects for robust and durable growth.

Argentina retains a considerable stock of external assets, largely driven by the preference of Argentine savers for hard currency assets. Argentina’s net international investment position (NIIP) reached an all-time high of $129 billion in Q1 2021 (33% of GDP). Currency and deposits held abroad by Argentine residents have jumped by $80 billion since end-2016, an increase of more than 50%. Portfolio investment claims also increased substantially over this period (up $30 billion). On the other side of the ledger, portfolio investment liabilities, which surged from under $60 billion to $165 billion in just over two years (Q4 2015 to Q1 2018) as the country ramped up external borrowing, subsequently plummeted to $56 billion as foreign investors fled the country. The debt default further reduced the value of external claims. Consequently, and in spite of Argentina’s current account surplus and positive NIIP, DBRS Morningstar continues to see considerable external risks, reflected in a negative adjustment to its Building Block Assessment for ’Balance of Payments.’

The Government Faces Populist Political Pressures Amid A Difficult Economic Reality Heading Into Elections

Mid-term elections are scheduled for November 14, 2021. Nearly half of the seats in the lower house and one-third of the seats in the Senate will be up for grabs. Poor economic conditions have hurt the ruling coalition’s electoral prospects. In June 2021, the Confidence in Government Index hit its lowest point during this administration’s term. However, it is unclear if the opposition can capitalize on the public’s discontent. One challenge for the opposition is that it is defending more seats than the ruling coalition in the lower house. While there is a lot of time until the elections, most polls show a divided electorate, with neither major coalition likely to win decisively.

The potential policy formulations available to the Fernández administration in the aftermath of the mid-term elections carry economic and political risks. It is possible that President Fernández will reach an agreement with the IMF while promising to keep a tight grip on spending and limit monetary financing. Such a strategy could help President Fernández avoid the economic pitfalls of taking a more expansionary and interventionist approach. Yet, it could also increase political risk. In addition to anti-austerity voters, a powerful faction within the Peronist government, led by Vice President Cristina Fernández de Kirchner, could act as a forceful opposition to such a “moderate” approach. Any IMF agreement in Argentina must be approved by Congress, which could be difficult without at least the tacit approval from the Vice President. Alternatively, populist political pressures may encourage the government to take a more hardline stance, convinced that it does not need to reach an agreement with the IMF. However, with a large fiscal deficit, high inflation, low reserves, and weak confidence in the peso, the government will not have policy space to stimulate the economy without worsening macroeconomic conditions. Consequently, the economic fallout of a “go-it-alone” strategy could intensify the political risks facing the Fernández administration in the second half of its term.

In addition to an uncertain post-election political environment, DBRS Morningstar views the broader issue of institutional quality as a credit challenge. In many respects, Argentina’s democracy is quite strong: competitive and fair elections are regularly held, basic civil and political freedoms are protected, and an active civil society is engaged in the democratic process. According to the Worldwide Governance Indicators, Argentina scores relatively well compared to regional peers in terms of Voice & Accountability. However, a key governance challenge is the Rule of Law. Public confidence in the integrity of the judiciary and other branches of government is generally low. In addition, we view policy predictability as weak, with frequent and significant changes to policy settings and frameworks over the electoral cycle. The heightened policy-related risks weigh on the Building Block Assessment “Political Environment”.

ESG CONSIDERATIONS

Human Capital & Human Rights (S), Bribery, Corruption & Political Risks (G), and Institutional Strength, Governance, and Transparency (G) were among key drivers behind this rating action. Similar to many emerging market peers, per capita GDP is relatively low, at US$8.6k (US$20.8k on a PPP basis). According to Worldwide Governance Indicators, Argentina ranks in the 37th percentile for Rule of Law and 53rd percentile for Control of Corruption. In addition, Argentina ranks in the 49th percentile for Government Effectiveness and 33rd percentile for Regulatory Quality. These considerations have been taken into account within the following Building Blocks: Fiscal Management & Policy, Economic Structure & Performance, and Political Environment.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/382489.

Notes:
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

All figures are in US dollars unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstarcriteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

The primary sources of information used for this rating include the Ministry of Economy, INDEC, BCRA, Direccion de Estadística y Censos San Luis, International Monetary Fund, World Bank, UN, Bank for International Settlements, Ambito, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

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