The elections – a de facto dry run for the 27 October presidential election – showed a much stronger result than expected for the opposition left-leaning candidate Alberto Fernández. In Argentina, it is mandatory for the candidate of each party to take part in the primary elections and the results are a good indication of the likely outcome of the main presidential election, the first round of which in this case will be on 27 October.
Fernández received 51% of the vote, against 30% for the incumbent, president Macri, with the 20pp gap significantly larger than the 2–8pp gap predicted by different domestic polls just ahead of the primary race. Importantly the 51%, if repeated on 27 October, would mean a high likelihood that Fernández would not need to face a second-round vote in November. Investors reacted very negatively to these results because they were significantly different from what polls and political analysts had been suggesting, and because many were still overweight the country’s hard and local currency bonds.
Last week, average sovereign eurobond prices fell 31%, the peso depreciated by around 21% and the Merval stock index was down 44%. This outsized price move reflected fears that Fernández would break from the current pro-market and IMF-supported economic policies and return to the market-unfriendly policies of Cristina Kirchner – his vice president running mate and former president.
Price levels in Argentine sovereign eurobonds have reached an extreme low with an average price of around 48. Granted, the economic outlook has become a lot more uncertain given the now high chance of Fernández winning the presidential election. Moreover the economic challenges facing Argentina are significant – the country is in a recession and the government has significant dollar funding needs. Morgan Stanley analysts estimate, for example, that the government’s net private financing needs will be USD 6 bn in 2020 and USD 14 bn by 2021, assuming that the IMF is still on board. Government debt was high at 86% of GDP at the end of 2018, with a large portion (around 77%) linked to the exchange rate, implying a volatile relative debt stock.
However, these low bond prices seem unwarranted as a lot of the uncertainty and default-risk is anticipated. This level of 48 is well below the 70 where bonds were trading in 2014, when Argentina last defaulted (but eventually paid in full after the change of government). The low current price likely reflects fears of a repeat of the 28% recovery rates seen in 2005 and the very high implied probability that it will happen again in the next 12 months (63%).
This can be illustrated with this calculation: (63% probability of a default in the next 12m * 28 cents per dollar recovery rate) + (37% probability of distress-but-not-default price of 55) + (collecting one coupon of 3.5/48 + 37% probability of collecting a second coupon of 3.5/48). The 3.5/48 is the average semi-annual coupon divided by average current prices. To be clear, we think the 2005 restructuring is not a good reference point because the outcome of that default was a decade of domestically unpopular economic and financial isolation, plus bruising legislative battles with investors who refused to participate in the initial bond restructuring. Moreover, back when Argentina defaulted in 2001 (eventually reaching a restructuring agreement in 2005), the government debt stock was around 152% of GDP and debt servicing costs used up around 19% of the revenue that the government collected. This compares to 86% and 9% respectively at the end of 2018.
We think no future president wants to run a repeat of the 2005–2014 period. Other factors that make us feel that current prices are too low and leave room for a relief bounce include:
- Comments from Alberto Fernández and his economic advisers, indicating a desire to continue to work with the IMF, albeit with less austere fiscal policy and lower interest rates. Advisers have also talked about a future Fernández government as likely to be a ‘moderate’ Peronist government. While the comments in total have been populist in tone, they are not suggestive of the extreme unorthodoxy that characterised the 2007 to 2015 presidency of Cristina Kirchner. Fernández has repeatedly indicated he doesn’t want capital controls or defaults, given the painful past experience with both.
- Fernández likely has an interest in calming down markets, in case further price drops were to frighten his supporters or galvanise moderate Argentinians into supporting Macri. On Wednesday Macri and Fernández discussed ways to curb the economic impact of the electoral process, which is a helpful step.
- Fernández probably doesn’t want to inherit an economy with a sharply falling peso and investors that are unwilling to roll any debt. This would cut short any policy honeymoon and eventually damage his popularity.
EM Macro and FX Strategist