We suspect that Argentina’s government and the IMF will thrash out a new deal, the 22nd in their history, but we doubt that this will lead to the sustained turnaround in policymaking that is needed to put public debt onto a sustainable path. The upshot is that, even if there is a fresh IMF arrangement, another Argentine sovereign debt crisis in the second half of this decade seems more likely than not.
- We suspect that Argentina’s government and the IMF will thrash out a new deal, the 22nd in their history, but we doubt that this will lead to the sustained turnaround in policymaking that is needed to put public debt onto a sustainable path. The upshot is that, even if there is a fresh IMF arrangement, another Argentine sovereign debt crisis in the second half of this decade seems more likely than not.
- The restructuring of $65bn in sovereign international bonds last year was one step towards restoring public debt sustainability in Argentina. But there is still a long way to go. Next up is securing a new IMF deal.
- The 2018 Stand-By Arrangement has left Argentina saddled with $44bn in loan repayments to the Fund over the next three years. With FX reserves running low and the door currently closed to international capital markets, Argentina will need fresh funding via a new IMF deal to meet its existing obligations.
- Argentine politics is currently the main hurdle to a new IMF agreement. The government had initially wanted a deal by May, but it now seeks to delay any agreement until after October’s legislative elections. This is to avoid a backlash from voters from any painful (but necessary) policy adjustments.
- Even so, we suspect that both sides will thrash out a deal before a crunch point emerges next year. Argentina could dip into its FX reserves to pay its $5bn debt to the Fund this year, but it will be very difficult to pay the near-$20bn in loan repayments due in 2022. When push comes to shove, we think that the government will agree to a fresh IMF deal in order to make these payments next year.
- The conditions attached to a new deal should aim to tackle Argentina’s economic imbalances and high public debt. The IMF will presumably push for an end to deficit monetisation and higher real interest rates to quell inflation. It may also advocate a more flexible exchange rate. This would help to restore external competitiveness – we think that the real exchange rate needs to fall by about 15% from its current level.
- Fiscal consolidation will also be required in order to repair the tattered public finances. All else equal, Argentina will have to flip its 6.5% of GDP primary budget deficit into sustained surpluses by the second half of the decade to put the public debt-to-GDP ratio on a steady downward trajectory.
- However, even with the IMF on side, we doubt that Argentina will follow the path to success. The country’s history gives little confidence that there will be a prolonged shift towards economic orthodoxy. And the harsh economic hit from the pandemic will make policy tightening politically unpalatable (as evidenced by the government’s current hesitancy to agree to an IMF deal). In any case, fixing Argentina’s deep economic mess is a mammoth task and policymakers could simply get it wrong.
- The most likely scenario is that the government tries to muddle through, but there is not a significant or sustained turnaround in policymaking. Economic imbalances may continue to build, and the public debt-to-GDP ratio will probably remain high at around 100% of GDP over the coming years. This would presumably keep Argentina locked out of international capital markets.
- The situation will be even more precarious if policymakers move too slowly on reducing inflation while maintaining strict capital controls. That could store up a bigger adjustment in the real exchange rate further down the line, which would put significant upward pressure on the FX-heavy public debt burden.
- Overall, we think that a new IMF deal would merely delay rather than prevent another debt crisis in Argentina. The debt restructuring in 2020 gave the government some breathing space, so another crisis is not imminent. But there is a significant risk of default when repayments on international bonds ramp up in the second half of this decade. Ultimately, given the most plausible path of policymaking, last year’s restructuring did not go far enough to restore debt sustainability in Argentina.
Argentina & the IMF: 22nd time lucky?
Argentina and the IMF are back at the negotiating table to discuss yet another deal – one that would be the 22nd in their tumultuous history. This Focus outlines what a fresh agreement might look like and argues that, ultimately, a new IMF deal would be unlikely to prevent another Argentine sovereign debt crisis within the next 5-10 years.
Setting the scene
The last few years have been quite the ordeal for Argentina’s economy. Sharp currency falls in 2018 and 2019 caused the FX-heavy public debt burden to skyrocket from less than 60% of GDP in 2017 to over 90% in 2019. The IMF deemed Argentina’s public debt to be unsustainable in February 2020, which meant it could no longer lend to Argentina without a sovereign debt restructuring.
Then the pandemic hit. GDP slumped by almost 10% last year – one of the largest downturns of any country. And the public finances deteriorated even further. In the midst of the turmoil, the federal government defaulted on its international bonds, worth around $65bn. An orderly restructuring deal was later agreed with private creditors. It included a small nominal haircut of 3% on most bonds; a delay on principal payments until 2024; and a reduction in average interest rates, which will now gradually rise from 0.125% this year to a maximum of 5% by 2025. At the same time, around $40bn in local-law FX debts were restructured under similar terms.
Next up is securing a new IMF deal. Argentina has yet to regain the trust of foreign investors and sovereign dollar bond yields are still prohibitively high at around 17%. (See Chart 1.) Bondholders will hope that a new IMF arrangement binds Argentina to more credible policies over the medium term, which would help the sovereign to regain access to international capital markets (more on this later).
Chart 1: Argentina JP Morgan EMBI Yield (%)
Sources: Refinitiv, Capital Economics
The more pressing issue in the meantime is that Argentina owes the IMF almost $45bn in loan repayments over the next three years – a legacy of the 2018 Stand-By Arrangement (SBA). As things stand, meeting these obligations in full will be nigh-on impossible – a point that the government has been keen to emphasise recently. They surpass Argentina’s gross FX reserves, which are hovering around $40bn. Worse still, net FX reserves (which strip out FX liabilities such as the $20bn swap line with China) are barely above zero. (See Chart 2.) A mooted $650bn increase in IMF Special Drawing Rights allocations wouldn’t be a gamechanger, adding just $4.4bn to Argentina’s coffers.
Chart 2: BCRA FX Reserves ($bn)
Sources: Refinitiv, BCRA, Capital Economics
Without access to foreign capital, and with FX reserves dwindling, the most plausible way for Argentina to meet its existing obligations with the Fund is, somewhat ironically, by acquiring fresh funding via a new IMF deal. In practice, this would be similar to a maturity extension on the current repayments. To that end, Argentina applied for a new arrangement with the Fund in August 2020.
Stalled talks, but an IMF deal is in the pipeline
There has been little sign of progress since formal discussions over a new deal began over six months ago. The Argentine government had initially wanted a deal done by May, but it has since pushed back its deadline until after October’s legislative elections. This is to avoid a backlash from voters from the painful, but necessary, policy adjustments that will come as part of a fresh IMF deal.
Nonetheless, we think that a new IMF deal will be agreed within the next 12 months or so. While negotiations are ongoing, Argentina could dip into its FX reserves to pay off its IMF debts this year, including $3.7bn in principal payments. But it would be a tall order to cough up the funds when repayments surge to nearly $20bn in 2022. (See Chart 3.) We suspect that the government will agree to a fresh IMF agreement in advance of these hefty repayments. Indeed, once the legislative elections are out of the way, policymakers may dial down their anti-IMF rhetoric and focus on the task at hand. Moreover, last year’s debt restructuring suggests that the government would prefer to strike an orderly deal with its creditors rather than be cast as an international pariah.
Chart 3: IMF Debt Repayment Schedule (US$bn)
Sources: Ministerio de Hacienda, Capital Economics
That said, it’s worth acknowledging that the government could choose to default on its IMF loan. That wouldn’t be without precedent; in September 2003, Argentina ran arrears with the IMF for a few days before agreeing to a new SBA. In a similar vein, though, we suspect that a possible default would only be used as a tactic to get better terms for a new deal, rather than to walk away from the negotiating table altogether.
On the other side of the table, Argentina looks too big to fail for the IMF. A whopping 36% of the IMF’s loans on its books have gone to Argentina, while the next largest is Egypt at 15%. The best chance for the Fund to recoup its money is through a new deal. What’s more, the IMF may extend an olive branch and offer more lenient conditions than in the past given the severe fallout from the pandemic. This could help to get a fresh agreement over the line.
The potential make-up of a fresh IMF deal
A new arrangement will presumably be an Extended Fund Facility (EFF) which is repaid over 10 years – a much longer horizon than the existing SBA. We think that the conditions attached to such a deal will aim at four main targets.
First, bringing down inflation. It is on the rise once again and we think that inflation will climb back towards 50% y/y in the coming months. (See Chart 4.) That’s partly because of the unorthodox monetary policies implemented in the past year. The central bank’s printing presses were fired up in 2020 as it transferred over 2 billion Argentine pesos to the Treasury (~7% of GDP), and the 2021 Budget points to further transfers worth 2.7% of GDP this year. Meanwhile, the benchmark Leliq interest rate has been slashed from over 80% in September 2019 to 38% now, taking real interest rates into negative territory. The IMF will presumably advocate an end to outright deficit monetisation, higher real rates, as well as structural reforms (e.g. de-indexing wages) to drive down inflation over the medium term.
Chart 4: Consumer Prices (% y/y)
Sources: Refinitiv, Capital Economics
Second, achieving sustainable economic growth. Argentina’s economy is on course to rebound reasonably strongly from last year’s slump. Output has already recovered quicker than many had initially expected (ourselves included), and by January this year it was just 1.3% off its February 2020 level. This will result in a strong statistical carryover to the 2021 growth figures. Otherwise, we are cautiously optimistic that the rollout of vaccines will allow most lockdown measures to be lifted later this year, giving a boost to output. As a result, we now expect GDP growth of 8.0% in 2021, compared to 6.5% previously. We continue to forecast growth of 2.5% in 2022. (See Chart 5.)
Chart 5: Real GDP (% y/y)
Sources: Refinitiv, Capital Economics
However, sustaining solid economic growth will be a different matter altogether. Argentina’s economic cycles have been notoriously volatile, especially in the past decade, which has contributed to its poor potential growth rate (last year, the IMF estimated it to be just 1.5%). The Fund is likely to prescribe similar policies to lift potential growth as it did in its mid-2019 Article IV review, such as lowering trade barriers, incentivising FDI, and eliminating distortionary price controls.
The third, and related, target of a new IMF deal will be boosting the external sector. This is crucial to rebuild the central bank’s depleted FX reserves and, more broadly, to raise GDP growth.
Unlike after the 2001/02 economic crash, we don’t think that Argentina can bank on higher commodity prices to boost exports – we’re not expecting another agricultural ‘supercycle’ anytime soon. (See our Commodities Update.) Instead, the key will be a weaker real exchange rate.
Admittedly, at first glance, the peso may not look overvalued given that Argentina’s current account swung into a surplus of 0.8% of GDP last year. But this move largely reflects the collapse in domestic demand, rather than the economic rebalancing brought about by a weaker currency.
One indication that the peso is overvalued is the emergence of a large spread between the official and unofficial exchange rates since capital controls were re-introduced in September 2019. While this spread has eased in recent months, it is still close to where it was in the mid-2010s, when the official exchange rate needed a large adjustment (which later materialised when the peso was floated at the onset of President Macri’s reign). (See Chart 6.)
Chart 6: Difference between Official & Unofficial Peso vs US$ (%, 3-day Moving Ave.)
Sources: Refinitiv, Capital Economics
For our part, we think that the fair value for the real exchange rate lies close to where it was in the mid-2000s, when the economy ran current account surpluses and enjoyed sustainable growth. On this basis, we estimate that the real exchange rate is still about 15% above its fair value. (See Chart 7.) To achieve an orderly adjustment, it will require a faster rate of depreciation in the nominal exchange rate and a gradual easing of capital controls.
Chart 7: CE Argentina Real Effective Exchange Rate
Sources: Refinitiv, Intracen, Capital Economics
The fourth, and arguably most important, aim of a fresh IMF agreement will be to repair the public finances. The fallout from the pandemic caused the federal government debt to rise to around 100% of GDP in 2020. That is not especially high by global standards. But investors are currently concerned by its sustainability, and a lower public debt ratio will be required to restore market confidence and open the door to foreign capital once again. In its technical report in March 2020, the IMF suggested a sustainable public debt-to-GDP ratio would be 60% by 2030. The Fund may be more lenient now given the harsh impact of the pandemic, so that goal may be adjusted to something like 80% of GDP.
It is useful to explore the three avenues which could, in theory, push down the public debt ratio. One is higher inflation, as this reduces the real value of local currency debt. Given that the lion’s share of Argentina’s federal government debt (~75%) is denominated in foreign currency, though, the real value of this would only decline if higher inflation coincidences with real exchange rate appreciation. However, as we argued before, real exchange rate depreciation is needed to boost external competitiveness, so other solutions to the debt problem would be more desirable (and sustainable).
Another option would be faster economic growth. This would help to lift government revenues and reduce public spending on things like unemployment benefits (i.e. ‘automatic stabilisers’), thus allowing the budget deficit to narrow. In turn, the government would have more scope to pay down maturing debts. At the same time, higher growth would arithmetically reduce the debt-to-GDP ratio.
These dynamics should play out this year. We think that the economic rebound from last year’s slump will cause the primary budget deficit to narrow from 6.5% of GDP in 2020 to around 3.5% in 2021. (See Chart 8.) And the public debt is likely to edge down to around 95% of GDP. However, further ahead, higher GDP growth alone would not be enough to reduce the debt ratio. This leaves policymakers with one solution – fiscal austerity.
Chart 8: Public Sector Primary Budget Balance
Sources: Refinitiv, Capital Economics
To demonstrate this point, we have outlined a few illustrative scenarios for the public debt ratio over the rest of the decade. We assume real GDP growth of 8.0% in 2021, 2.5% in 2022, then an above-potential 2.0% thereafter; the real exchange rate falls to its fair value by end-2022; and the average interest rate on outstanding debt gradually rises, in line with the new ‘step-up’ international bonds.
Against this (rosy) backdrop, without any fiscal austerity, the public debt would start to drift back towards 100% of GDP over the coming years. In contrast, it would require a balanced primary budget by 2024 (i.e. a 3.5% of GDP fiscal squeeze from 2022-2024), and primary budget surpluses of around 1.5% of GDP thereafter, to push the public debt ratio down to 80% by 2030. (See Chart 9.)
Chart 9: Federal Government Debt (% of GDP)
Sources: Refinitiv, IMF, Capital Economics
All in all, a new IMF deal should target lower inflation, sustainable economic growth, a more competitive currency, and prolonged fiscal austerity to ensure that Argentina’s public debt ratio declines over the medium term.
Slim chance of success
However, even with another IMF agreement in place, there are several reasons why we doubt that Argentina will follow the path to success.
For one thing, Argentina’s history offers little comfort about the road ahead. High inflation, an overvalued exchange rate and fiscal imprudence have been perennial issues in Argentina. For instance, Chart 10 shows the government budget balance over the past 100 years. In only a quarter of this time has there been a primary surplus above 1% of GDP. And shifts towards austerity do not tend to last very long. Over the same period, there have only been four instances when the primary budget balance has improved for three successive years, after which point the public finances quickly deteriorated once again.
Chart 10: Public Sector Budget Balance (% of GDP)
Sources: IMF, Capital Economics
Part of the problem lies with Argentina’s institutional set-up. It incentivises overspending at a provincial level, largely funded by transfers from the federal government. (For more, see this Focus.) Additionally, with legislative and/or presidential elections occurring every two years, policymakers are regularly persuaded to loosen the purse strings to bolster their support at the ballot box. That’s why the current government is hesitant to agree to an IMF deal until after October’s legislative elections.
Related to that, the fallout from the pandemic will make reforms especially unpalatable. Argentines have suffered a substantial hit to their living standards, with the unemployment rate rising into the double digits and the poverty rate climbing above 40%. Against this backdrop, it’s difficult to imagine that workers would accept the real wage cuts that is needed to tame inflation, or that voters would opt for fiscal austerity. This seems to be an emerging theme in Latin America, as governments in Brazil and Colombia are moving away from their initial plans for fiscal consolidation. A similar situation may arise in Argentina, in which there is slippage on IMF-mandated plans for policy tightening.
Finally, putting politics to one side, it will be a mammoth task to fix Argentina’s current economic mess and policymakers could simply get it wrong. There could be damaging unintended consequences from attempts to put Argentina on the right path. One clear example is that, in a bid to quell inflation and reduce the budget deficit, President Macri’s government tightened fiscal and monetary policy too far and too soon for the economy to handle, leading to a recession in 2018 and 2019. Policymakers may not strike the right balance again in the coming years.
Another headache will be making the currency more competitive without causing inflation or FX debts to jump. The government already appears to be moving cautiously on this front. When the peso came under pressure last year, the central bank tightened capital controls and intervened in FX markets to prop up the currency. What’s more, the government is targeting the nominal exchange rate to fall from 92/$ now to 102/$ by end-2021. We estimate that it will have to weaken much further to 120/$ by end-2021, and then to $170/$ by end-2022, to align with its fair value. Delaying a necessary currency adjustment, for instance by maintaining strict capital controls, will deter FDI and keep a lid on potential growth. This strategy will also keep exports and FX reserves depressed, and may store up a more destabilising correction in the peso further down the line.
Meanwhile, there’s no guarantee that the IMF will outline the right strategy to fix Argentina’s economy. The Fund clearly made mistakes in Argentina ahead of the 2001/02 crash – something it later admitted. (See here for the IMF’s Independent Evaluation Office Report.) And the 2018 SBA can hardly be deemed a success. The difficulty now is that there is not much margin for error given the precarious nature of the public finances.
Heading towards yet another restructuring
The upshot is that, even with a fresh IMF deal, there is a significant risk that Argentina is heading towards the 10th sovereign default in its history.
The most plausible scenario is that the government tries to muddle through, but that there is not a sustained turnaround in policymaking. This would mean that the budget deficit remains wide, economic growth underwhelms, and the public debt ratio would stay close to 100% of GDP over the coming years. The situation would be even worse if there is a disorderly currency adjustment which causes the value of FX debts to surge.
If we’re right, investors will presumably remain on edge and Argentina will be unable to regain access to international capital markets. This would breach a condition of continued IMF lending, so the Fund may have to declare the public debt as unsustainable within a few years, as it did in early 2020. Even if the IMF does not step in, without a significant buffer of FX reserves or the ability to rollover its debts, the government may struggle to meet its obligations with international bondholders.
One crumb of comfort is that another debt crisis is not imminent. The restructuring last year gave the government some breathing room, as sovereign international bond repayments are fairly low over the next few years. However, issues may arise in the second half of the decade when repayments kick up to at, or above, $10bn a year. (See Chart 11.)
Chart 11: Sovereign International Bond Payment Schedule (Principal & Interest, US$bn)
Sources: Ministerio de Hacienda, Capital Economics
This all reaffirms our initial view when the restructuring deal was announced that it did not offer enough debt relief to Argentina. Bondholders appear to be coming round to this view, as the price of Argentine sovereign dollar bonds has slumped since the restructuring was finalised in September. (See Chart 12.)
Chart 12: Argentina Sovereign Dollar Bond Prices
To be clear, there may be a relief rally in the next year or so if a new IMF deal is agreed and there are tentative steps towards policy reforms. But, ultimately, we doubt that public debt sustainability will be restored in Argentina, suggesting that sovereign bonds will probably continue to trade in distressed territory over the coming years.
Nikhil Sanghani, Latin America Economist, email@example.com