Morningstar DBRS Upgrades Argentina to B (low), Stable Trend

DBRS, Inc. (Morningstar DBRS) upgraded the Republic of Argentina's (Argentina) Long-Term Foreign and Local Currency -- Issuer Ratings to B (low) from CCC. At the same time, Morningstar DBRS confirmed Argentina's Short-Term Foreign and Local Currency -- Issuer Ratings at R-5. The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS

The upgrade reflects Argentina's improving macroeconomic outlook and the government's strengthening repayment capacity. The Milei administration has enacted a large fiscal adjustment this year, which is expected to result in Argentina's first fiscal surplus since 2008. The scale and front-loaded design of the consolidation has improved the outlook for public finances, reduced rollover risks in the local bond market, and acted as an anchor for macroeconomic stabilization. Monthly inflation declined to 2.7% in October 2024, sharply down from the start of the year. The elimination of monetary financing has helped restore price stability even as the government has cut subsidies that were distorting relative prices. In addition, President Milei remains popular despite the deep economic recession in the first half of 2024. Midterm elections in October 2025 will be important to the outlook, as the President aims to increase his legislative base and secure the reform agenda. The credit rating action reflects improvements in the "Fiscal Management and Policy" and "Monetary Policy and Financial Stability" building blocks.

The B (low) credit ratings reflect the significant economic and political challenges still facing Argentina. The lack of reserves is a key vulnerability to the near-term outlook. Without reserves or access to international markets, Argentina runs the risk of having insufficient hard currency to make its external debt payments. The crawling peg exchange rate may also be contributing to an overvalued peso, which could make it difficult to generate reserves. While the economy bottomed out in the second quarter of 2024, the pace of recovery is unclear. The IMF forecasts GDP growth of 5.0% in 2025 and 4.7% in 2026. Morningstar DBRS views the forecast as a reasonable baseline but believes there are material downside risks. Furthermore, Argentina's history of macroeconomic mismanagement and extreme shifts in policy orientation over the course of the electoral cycle weigh on the credit ratings.

CREDIT RATING DRIVERS

The credit ratings could be upgraded if 1) policy actions significantly increase reserves and restore market access, and 2) the political commitment to policies that support macroeconomic stabilization is sustained through the electoral cycle. Reforms that improve medium-term growth prospects would also be credit positive.

The credit ratings could be downgraded if government debt dynamics or funding conditions deteriorate such that the odds of a restructuring of bonds held by the private sector materially increase.

CREDIT RATING RATIONALE

The Milei administration has Implemented a Large and Rapid Fiscal Adjustment

The fiscal adjustment in 2024 is equal to more than 5% of GDP and is consistent with running an overall balanced budget for the year. The consolidation is almost entirely expenditure-based, composed of lower social security spending, cuts to energy and transport subsidies, and a decline in capital spending. Budgetary results through the first ten months of the year are broadly in line with the zero-deficit target. The consolidation is not only large; it is front-loaded. Almost all the adjustment takes place in 2024, with little additional tightening expected during the remaining three years of the President Milei's 4-year term. As a result, the fiscal stance presented in the 2025 Budget shifts from highly contractionary in 2024 to more neutral next year. The government is targeting another balanced budget. Spending is expected to decline by 0.5% of GDP next year, reflecting lower subsidies and transfers, but expenditure cuts will be more than offset by tax cuts.

However, risks to the fiscal outlook remain high, in our view. The elimination of the PAIS tax on dollar purchases and the one-off nature of the tax amnesty in 2024 will contribute to lower revenues in 2025. At the same time, public investment will likely need to increase from a very low level. While we expect the Milei administration to take whatever measures are necessary to maintain a balanced, or close to balanced, budget in 2025, permanent consolidation measures will eventually be needed to underpin the durability of the adjustment.

The Fiscal Correction and Elimination of Monetary Financing has Helped Tame Inflation

The introduction of a crawling peg exchange rate (2% monthly depreciation relative to USD), the elimination of monetary financing, and a deep economic recession are helping restore price stability. When the Milei administration quickly devalued the currency upon assuming office in December 2023, inflation surged to 25.5% month-over-month. Since then, monthly inflation has declined sharply, reaching 2.7% in October 2024. The decline in inflation was achieved even as the Milei administration cut energy and transportation subsidies that were distorting relative pricing. Inflation is expected to continue easing, albeit gradually. According to the central bank's October Market Expectations Survey, monthly inflation is anticipated to average 2.5% over the next 12 months. President Milei has signaled that if inflation trends downwards in the coming months, the pace of the `crawl' could be lowered and, eventually, the exchange rate could be allowed to float and the capital controls could be lifted. Notwithstanding clear progress, durably reducing inflation continues to present a significant policy challenge. Monetary policy transmission is weak, some administered prices still require upward adjustment to achieve market rates, and wage negotiations across the economy could reinforce inertial price pressures.

Macroeconomic stabilization and regulatory changes are having a positive impact on Argentina's banking system. In the absence of large fiscal deficits to finance, banks are resuming their traditional role as financial intermediaries to the private sector. Banks' exposure to the public sector has started to decline from historically high levels. Credit to the private sector is increasing at a solid pace, albeit from a very low level. Moreover, the banking system is weathering the recession relatively well. In aggregate, banks are highly capitalized, liquid, and hold low levels of non-performing loans. The shift in the composition of assets, combined with the elimination of minimum deposit rates, has also supported banks profitability.

The Exchange Rate Regime May Pose Challenges to Reserve Accumulation

The low level of reserves is a vulnerability given the large FX obligations coming due over the next few years. With inflation still outpacing the crawling peg, the real effective exchange rate (REER) has appreciated and now looks strong relative to historical levels. The FX spread has declined from its peak in July but is still around 10%. In this context, the process of reserve accumulation, which got off to a good start in early 2024, has stalled over the last five months. Net reserves (gross reserves minus FX bank reserve requirements, swap lines, and other FX obligations) were approximately $5 billion in the red in early November.

Boosting reserves with the current policy settings looks difficult. The current account shifted from a deficit of 3.2% of GDP to a modest surplus in the first half of 2024. The shift was due to a recovery in agricultural exports following a year of drought and strong import compression. The surplus could diminish in the second half of the year, especially if the economic recovery accelerates and an overvalued currency leads to higher imports. At the same time, dollar inflows through the financial account are limited due to capital controls and the country's inability to tap international markets. Argentina's holds a sizable net international asset position amounting to $81 billion, or 43% of GDP. However, this largely reflects a lack of confidence in the local market. From Q2 2019, just before capital controls where imposed, to Q2 2024, currency and deposits held abroad by Argentine residents increased by $61 billion, thereby lifting the stock to $262 billion. Therefore, despite a current account surplus and a net positive asset position, we see considerable external risks that warrant a sizable negative adjustment to our assessment of the Balance of Payments building block.

Medium-Term Debt Sustainability Outlook is Improving But Near-Term Risks are Elevated

Without reserves or access to international markets, Argentina runs the risk of having insufficient hard currency to make its external debt payments. Principal and interest payments on Argentina's hard-currency bond obligations total $9.2 billion in 2025, including payments of $4.3 billion in January and July. However, prospects for repayment appear to be improving. Sovereign bond yields have declined over the last few months and are approaching levels that would allow a return to the global bond market. The government is also seeking other sources of external funding. There is a possible three-year $2.7 billion repurchase agreement with several commercial banks. The Milei administration is seeking official financing from multilateral lenders. The IMF and Argentina are negotiating a new program, although it is unclear whether the IMF would agree to any net new financing.

The Milei administration is rebuilding the domestic bond market. The government's fiscal consolidation, combined with market operations to extend the maturity profile of local currency bonds, has reduced financing pressures in the near term. However, rollover rates have benefited from the maintenance of capital controls. Rolling domestic debt could be more challenging once capital controls are lifted, potentially requiring higher real rates to attract buyers.

Risks to debt sustainability elevated, in Morningstar DBRS' view. Government debt-to-GDP jumped to 155% in 2023 as the step devaluation in December led to a sharp decline in nominal GDP in USD terms. Under the IMF's baseline scenario, the debt-to-GDP will decline to 91% in 2024 as the overshooting of the real effective exchange rate reverses. The ratio trends downward - reaching 60% in 2027 - on the back of sizable primary surpluses. However, uncertainty around the outlook is very high. Risks include reversals in the fiscal consolidation, tighter global financing conditions, and potential international court rulings against Argentina. The considerable risks to debt sustainability combined with Argentina's weak liquidity position lead us to make a negative adjustment in the Building Block Assessment for Debt & Liquidity.

Milei Looks to Advance His Agenda With Legislative Gains in the October 2025 Midterm Elections

President Milei has deftly built congressional alliances to advance his agenda and used his cross-party appeal to mollify the opposition. Public confidence in the administration remains high, despite the pain of the policy adjustment. The administration's performance in the October 2024 midterm elections will be important to the economic outlook. Milei's party, La Libertad Avanza (LLA), only holds 38 seats out of 257 in the lower house and 7 seats of 72 in the Senate. A strong outcome for LLA and allied parties could reinforce the reform agenda and bolster market confidence. On the other hand, a strengthened opposition could weaken Milei's reform momentum and raise governability risks.

Morningstar DBRS views the broader issue of institutional quality in Argentina 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 media and 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 Political Environment Building Block Assessment.

Argentina's Growth Performance has been Poor; Reforms Could Strengthen the Medium-Term Outlook

Over the last ten years, real GDP per capita in Argentina declined by 10%. This poor growth performance has been due to macroeconomic mismanagement, an onerous and costly regulatory environment, and limited global integration. Investment averaged 17.2% of GDP over the last decade, one of the lowest rates among emerging markets. Labor market conditions have also fared poorly. The cumulative number of salaried private sector jobs created was 355,000 at a time when the economically active population increased by 3.4 million, implying that jobs increasingly shifted towards public and informal employment.

The Milei administration has steered reforms through Congress that should strengthen medium-term growth. Measures include labor market liberalization, widespread deregulation efforts, the privatization of state-owned firms, and the introduction of an incentive regime for large investments in strategic sectors (RIGI). The IMF estimates Argentina's potential growth at 2.4%, which is better than its historical performance (growth averaged 2.0% over the last 30 years). We see risks around the IMF's medium-term forecast as balanced. Recent measures could have a bigger than expected impact on growth. Another source of upside risk to growth comes from the energy and mining sector, which could rapidly expand if investment conditions are strengthened. However, absent macroeconomic stability and structural reforms over time, the Argentine economy could underperform the baseline growth outlook.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors
The following Social factor had a significant effect on the credit analysis: Human Capital and Human Rights. Similar to other emerging market economies and many of its regional peers, Argentina's per capita GDP is relatively low, at US$13.8k (US$29.3k on a PPP basis). This reflects the low level of labor productivity. In addition, labor and social conflicts have at times been a source of economic volatility in Argentina. This factor has been taken into account in the Economic Structure and Performance building block.

Governance (G) Factors
The following Governance factors had a significant effect on the credit analysis: (1) Bribery, Corruption and Political Risks, and (2) Institutional Strength, Governance, and Transparency. According to Worldwide Governance Indicators, Argentina ranks in the 37th percentile for Rule of Law and 41st percentile for Control of Corruption. Argentina ranks in the 36th percentile for Government Effectiveness and 35th percentile for Regulatory Quality. These factors have been taken into account in the Fiscal Management & Policy and the Political Environment building blocks.

There were no Environmental factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/443469.

Notes:
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 (July 15, 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

The primary sources of information used for these credit ratings include Ministry of Economy, BCRA, INDEC, Dirección de Estadística y Censos San Luis, International Monetary Fund, World Bank/NRGI/Brookings, Bank for International Settlements, Ambito, World Bank, and Macrobond.

Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

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

This is a solicited credit rating.

The last credit rating action on this issuer took place on March 01, 2024.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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