|President Mauricio Macri and his team celebrate their election results|
Bankers report that investors and issuers had been waiting for a positive signal from the country’s electorate before committing to further debt and equity transactions. In the end, Macri’s coalition won 41% of all available seats, which is up from the 35% of seats it won in the last presidential election, and better than opinion polls and the strong primary performance predicted.
New debt and equity transactions should swiftly follow these results, which point to increased governability for the next two years of Macri’s term and a possible majority position after the next presidential election in 2019. The banks have been positioning themselves for the estimated $3.5 billion in equity issuance (Bloomberg recently reported that Morgan Stanley had relocated the bank’s head of Latin America equities to Buenos Aires from New York) and the volume of debt issuance should remain high.
However, it is the level of foreign direct investment that will be crucial to sparking the growth that will ease Argentina’s fiscal deficit and, as Euromoney reported in September, there are going to be challenging dynamics even with Macri’s position enhanced by the mid-terms.
Given the nature of the elections – only one-third of the senate and two-thirds of the chamber of deputies were up for election – Macri’s Cambiemos will still be in a minority position in both chambers.
Macri will need to rely on external support for his important list of reforms, covering tax, labour and the domestic capital markets. However, as Itaú noted in a corporate briefing after the election, Macri will benefit from the “fragmentation of the Peronist party” following its poor showing.
Further reforms are essential to attract investment (internal and inward) that will provide the foundation for Macri’s gradualist policy in regards to fiscal readjustment.
As Capital Economics points out, despite the widespread optimism that these election results will probably unleash in some quarters, “there is a more fundamental concern about the still-precarious state of Argentina’s balance sheet. The budget deficit remains large and dollar-denominated debt has risen sharply in recent years. At the same time, inflation seems stuck at around 25% per year, making the peso a one-way bet for further depreciation over the next couple of years. This could ultimately prove a toxic combination.”
Macri’s immediate challenge will be to get a budget approved by December that shrinks the financial deficit. The current plan envisages a fiscal squeeze of about 1% of GDP next year, but this will only reverse the stimulus that was provided to the economy in this crucial election year.
Next year Macri has a primary fiscal target of 3.5% of GDP, down from 4.2% this year, with another two percentage points of debt coming from debt payments and a provincial deficit of 1% of GDP.
This gradual reduction in the fiscal deficit is also predicated on GDP growth of more than 3% (to offset an effective freeze in spending).
Some economists, such as Citi’s Fernando Diaz, question whether or not this is a realistic growth rate without a positive investment shock from the mid-term elections. Diaz believes that without such a boost (one was predicted after Macri’s presidential election win but failed to materialize) Argentina’s trend growth rate could be as low as 1.8%.
According to Diaz’s models, if GDP growth remains below 2%, it will take Argentina nearly a decade to reduce the fiscal deficit to a sustainable level of -2% of GDP – assuming current spending is constant in real terms and capital spending increases a real 5% a year until it reaches 6% of GDP.
Even with benign external conditions, that kind of performance would see a quick increase in government debt levels and could end up testing the patience of the international investors who would need to finance the decade-long adjustment.
A further complication is that this growth would have to face the domestic headwind of a tight monetary environment in 2018 as the central bank desperately fights stubborn inflation down to aggressive single-digit goals.
The central bank has been holding interest rates at 26.25% recently as it seeks to hit a year-end target of 12% to 17% (it is hovering just above 20% from a peak of 40% in Macri’s first year).
Next year, the bank has set an even more aggressive target of between 8% and 12%.
So, for now, enthusiasm about the progress being made should be tempered with the acknowledgment of the great political and economic challenges still to come. Macri still has the confidence of the markets, but if there is any sign of reform slippage that support could begin to drop away.