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Capital Markets

Ratings: Uruguay joins IG club, Argentina goes other way

Upgrade will have limited impact; Argentine YPF coup is troubling move

The market has taken account of a likely upgrade of Uruguay for more than a year Franco Uccelli, executive director of emerging markets research at JPMorgan says, of the April 3 Standard & Poor’s upgrade of the sovereign to triple-B minus. "The price of Uruguay’s bonds has been trading on a par with some of the regional investment-grade credits like Brazil, so, despite the fact that this will open the door to a new class of investors, I don’t think the spread will tighten significantly,"

However, Charles Moser, executive director in Morgan Stanley’s Latin American fixed-income capital markets responsible for sovereign issuance, believes there is still room for Latin-American investment-grade spreads to tighten. "There’s such a scarcity," he says. "There hasn’t been much issuance because the sovereigns haven’t needed the money, and so there is still room for the Latin American investment-grade sovereign spreads to compress."

Limited demand

Uruguay has a weight of 1.3% in the JPMorgan EMBI Global index – one of the most broadly used indices – which means that despite its new investment-grade status it is a credit that many investors can afford not to own without risking portfolio performance issues. As close credit substitutes exist, limited demand-side pricing implications for the credit upgrade are expected.

Javier Murcio, deputy portfolio manager at BNY Mellon Standish
Javier Murcio, deputy portfolio manager at BNY Mellon Standish

Investors agree. "As an investor in the emerging market asset class [Latin American investment-grade countries], we think Latin American IG countries’ debt is becoming expensive," says Javier Murcio, deputy portfolio manager at BNY Mellon Standish. "There is nothing wrong with the sovereign risk profile but they trade too tight." He says that with all the big economies in the region now at or very close to investment grade there is "a bit of a drop to the double-Bs or the single Bs," which do not have the same underlying profile of improving economies based on strengthening fundamentals.

Poorer credit outlooks and lower liquidity for other Latin American sovereigns explain why countries such as Bolivia are approaching the market to try to capitalize on the lack of supply for higher-yielding sovereigns in the region. It has also resulted in many emerging market investors looking for yield pick-up in quasi-sovereigns. For example, Pemex generally trades 80 to 120 basis points wider than Mexico for the same implicit guarantee.

"If the quasi-sovereigns are in a strategic sector, you are able to extract additional spread for pretty much the same risk," says Murcio.

Any sovereign issue would theoretically create a benchmark for corporate issuers. However, there are no obvious candidates, according to Uccelli, who says JPMorgan research doesn’t cover any Uruguayan corporates. Bankers point out that, in any event, a Uruguayan corporate or quasi-sovereigns would be able to benchmark off similar credits in countries such as Brazil, without necessitating a new sovereign benchmark.

Moser doesn’t think that Uruguay will tap international markets more now it is of investment grade: "I would say it’s the other way around," he says. "Its investment-grade rating is a reflection of the fact that it is less dependent on international capital markets. I don’t see a need for a statement trade."

Argentina turns off investors

Uruguay’s membership of the Latin American investment-grade club comes in stark contrast to investors’ views of the management of the economy of its neighbour, Argentina. In April the Argentine government ended weeks of speculation by announcing that it would renationalize YPF, the country’s largest oil producer, expelling Spain’s Repsol as majority shareholder.

"[The Argentine government] never fails to surprise us – it’s a sad story," says Steffen Reichold, chief economist at Stone Harbor Investment Partners. "The potential is tremendous, but they manage to take the wrong decision at almost every opportunity they can." The move has angered the Spanish government, which is lobbying its European partners to impose sanctions on Argentina.

Reichold says the Argentine government doesn’t have the resources to increase oil production independently since YPF needs estimated investment of $8 billion to $10 billion, compared with annual profits last year of about $1 billion.

"Nobody in their right mind is going to invest any resources in the Argentine energy sector, and investors are now going to be extremely careful about investing resources in other sectors, given what we have seen from the administration," Reichold says.

If Argentina won’t be able to attract private-sector capital to develop YPF’s production capacity, the prospects of raising international debt look slim when European countries dominate the fitful Paris Club negotiations.

"Argentina has for a long time said that if it were to issue [international debt again it] would be a matter of price," says Reichold. "It will be very hard for it to take a step back from this position; with spreads close to 1,000 basis points again on Argentine debt we are not close to where it would be able to issue again."

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