Argentina running out of options

With Argentina's private sector in disarray, Cristina Fernandez de Kirchner's government has been forced to increasingly bail out failing businesses, particularly importers that are critical to Argentina's stability. The nation's fiscal problems are escalating rapidly as it undertakes what amounts to a form of nationalization.

Source: Goldman Sachs

A great deal of hard currency now goes to support domestic importers (that are forced to sell at a loss to keep prices under control) and the country is becoming desperate for dollars needed to import the products the population needs. In the past, some of the greatest sources of foreign currency for Argentina have been grain exports, particularly soy. Except now there is a problem ...

Cash soy prices (source: barchart)

With fiscal deficit growing rapidly and access to international markets shut off due to the recent default, Argentina's central bank has been doing the only thing a central bank can do in this situation - monetize the deficit by printing more pesos. This has resulted in inflation levels of over 36% this summer and probably even higher currently. Not quite Zimbabwe levels yet, but moving in that direction.

In response to such inflationary pressures and fully aware that further currency devaluation by the Fernandez regime is inevitable, businesses and households are hoarding dollars. One US dollar now trades at over 15 pesos in the unofficial ("blue") exchange market - some 80% premium to the official exchange rate.

Source: Dolar Blue

There are no easy answers at this juncture. With foreign reserves expected to dwindle and risks rising of foreign bondholders accelerating full debt repayment - which they can do now that they are no longer receiving their coupon payments - Argentina is running out of options. The authorities are becoming increasingly desperate as Fernandez, in search of someone to blame other than her own failed policies, turns on Argentina's private sector. New legislation that resembles Venezuela's heavy handed socialist style has now made strong corporate profit margins in Argentina illegal.

The Washington Post: - One of South America's largest countries has passed new measures to cap consumer prices of goods, set profit margins for private businesses and levy fines on companies found to be making "artificial or unjustified" profits.

If that sounds like something they would do in Venezuela, well, that's because they already have.

Now it's Argentina that wants to use the heavy hand of the state to grip the invisible hand of the market.

Earlier this year hopes were rising for a better future in the post-Fernandez Argentina (see post). Those hopes have now been dashed.

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Argentine peso hits record lows on increased uncertainty

Argentina is showing signs of stress, as the official exchange rate has the US dollar now quoted 8.4 pesos - a new record.

Chart shows USD appreciating against ARS (source: Investing.com)

The "parallel" exchange rate also hit a record, with the dollar quoted at 14 pesos - a 67% premium to the official rate. Note that before the first devaluation in 2002 (see this NY Times story) it was one peso to the dollar.

Source: Dolar Blue

As discussed earlier (see post), this peso decline should not be a surprise. The latest development in the default saga however is Argentina's recent attempt to pay the "non-holdout" bondholders by allowing them to convert to local bonds.

NY Times: - The government moved on Wednesday to push legislation through its Congress that would give foreign investors in the country’s debt the ability to swap their defaulted bonds for new ones subject to local law, thus skirting a United States court order that has blocked its ability to make bond payments.

But it seems quite unlikely that these investors will want to convert, leaving this matter unresolved.

NY Times: - But the draft of the legislation, which was first announced on national television late Tuesday by Cristina Fernández de Kirchner, Argentina’s president, has raised more questions than answers among investors who are looking for a solution to the country’s debt predicament.

The uncertainty, combined with deteriorating economic fundamentals is sending depositors and investors out of the country, pressuring the peso. Foreign reserves are likely to dwindle materially by the end of the year as a result, further exacerbating the crisis.
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Argentina's blue dollar market hits 60% premium to official rate

In the face of inflation running at 25-30% - one of the highest rates in the world - Argentina unexpectedly decided to cut interest rates yesterday. It is difficult to say how the government justifies this madness, but here we are. Combined with the nation's recent default and no settlement on the horizon, the rate decision sent the nation's currency to record lows.

WSJ: - The decision to cut rates will likely be seen as a sign that Economy Minister Axel Kicillof's plans to stimulate the economy are prevailing over central bank Governor Juan Carlos Fabrega's effort to curb inflation, analysts said. ...

Argentina's peso weakened to 13.15 to the dollar on the black market Wednesday, breaking the previous record of 13.10 in January when the government devalued the peso 20%, according to newspaper El Cronista, which tracks black-market exchange rates. The peso was stable at 8.2730 on the regulated exchange market.

... The dollar has been especially coveted for the last three years, given rampant government spending that has fueled one of the highest rates of inflation in the world.

Currency controls were imposed almost three years ago to prevent foreigners and locals from depleting the central bank's reserves by changing their pesos into dollars.

The black market peso continued to slide this afternoon, with quotes hitting 13.3 pesos per one dollar. The so-called "blue dollar" is the unofficial market for US dollars in Argentina (there is also the "blue euro" market).

At this rate the blue dollar is at a 60%+ premium to the official exchange rate (dollars cost 60% more in the black market).

Unless we see some sort of settlement on the defaulted debt and the resumption of coupon payments to all the bondholders (see post), Argentina will unravel rapidly. Another official currency devaluation becomes increasingly likely, pushing inflation to new highs and making Argentina look increasingly like Zimbabwe. With no ability to access international debt markets, foreign reserves will begin to run out and shortages of imported goods will become commonplace. Violent unrest is sure to follow.


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Argentina default Q&A

We've had a number of questions on Argentina's latest default. Here is an overview of the situation in a Q&A format.

Q:  Is Argentina officially in default?
A:  While Argentina's government deposited the dollars for distribution to Discount bond holders, the interest was not distributed as scheduled last week. Missed coupon payment represents default, at least as far as S&P is concerned (classified as “selective default”).

Q:  Does Argentina recognize that it is in default?
A:  No. The Economy Minister Kicillof made it clear that as far as Argentina's government is concerned there is no default because it has and will continue to make deposits with BNY Mellon (the trustee) to pay the coupon. The government blames the missed coupon payment on Judge Thomas Griesa's ruling. That ruling held back payments to the bondholders who had accepted the renegotiation of Argentina’s debt in 2005 and 2010.

Q:  Why haven't the funds been distributed?
A:  Funds would have been released if Argentina settled with the "holdouts" (those who didn't agree to the 2005/2010 settlement). The holdouts sued for $1.6bn and the negotiations with the government failed to produce a settlement before the deadline last week, preventing the cash from reaching the bondholdrs.

Q:  Has the sovereign CDS (credit default swap) been "triggered" (have we had an "event of default")?
A:  It is likely that we do indeed have an event of default under the ISDA guidelines. The event would fall under the category of "Failure to Pay". Having deposited funds with the trustee does not prevent default under ISDA because Argentina has an obligation to make sure coupon payments reach the bondholders. And by choosing not to settle with the holdouts on time, the nation failed to deliver such payments. Ultimately it will be the ISDA Determination Committee that will make that call.

Q:  Can a settlement still be reached?
A:  Yes. The government is highly incentivised to reach an agreement in order to be able to access international debt markets. However prospects of a near-term solution are uncertain and the legal ramifications of a settlement are unclear. A number of analysts are suggesting that a settlement will not take place until at least early 2015.

Q:  Would an eventual settlement have an impact on the CDS?
A:  No. The coupon payment has been missed and that should be enough for the event of default trigger. However depending on the timing of the settlement, it could impact the recovery value on the CDS (by impacting the bond prices prior to the CDS settlement).

Q:  Why hasn't Argentina's government settled with the holdouts?
A:  There are a number of reasons, the most important of which is the government's unwillingness to look politically weak by paying $1.6bn to some US hedge funds - far more than it paid other bondholders. Furthermore, it is Argentina's current law that it can't pay more to the holdouts than to the rest of the holders. Of course the law can be changed, but the government is unwilling to do so at this point.

Q:  What is the RUFO clause and what are its implications?
A:  RUFO stands for Rights Upon Future Offer, a clause written into the renegotiated bonds during the restructuring some years ago. It says that if Argentina's government voluntarily offers better terms to the holdouts it would need to match those terms for all the bondholders. This sounds like another reason for Argentina not to settle, but it's just an excuse. That's because the "voluntary" term in the clause would keep RUFO from being triggered - since the settlement with the holdouts is not voluntary but mandated by the US court.

Q:  What are the economic consequences of Argentina not settling this by year-end or beyond?
A:   The consequences could be quite grim. As it is, the Argentina's GDP is contracting again.

And the nation's current account is deep in the negative territory.

Without access to international debt markets many domestic firms will struggle to survive and the country will slip into recession. Currency will come under further pressure and the spread between the official FX rate and the "parallel" exchange will widen sharply (currently the "unofficial" exchange dollars already trade at a 26% premium to the official rate). FX reserves would continue to decline, forcing a second devaluation. Inflation, which is believed to around 25-30%, will spike further. Violent social unrest is sure to follow. This is why Argentina should have every incentive to settle with the holdouts as soon as possible. Sadly, the risk that it won't remains quite high.


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Argentina's holdout debt dilemma

We've received a number of questions regarding the implications of the recent US court ruling on Argentina. In spite of the complexities involved, the situation is quite clear. The country just doesn't have the dollars to pay the 2001 restructuring holdouts (the bond holders that did not accept the restructuring terms). Decades of socialist-style mismanagement, populist policies, cronyism, and incompetent leadership resulted in the nation squandering a great deal of its national wealth. As China-driven natural resource supercycle came to an end, Argentina found itself on the edge of collapse. With inflation running at 35% and foreign reserves near multi-year lows, the country's options are limited.

As usual, the government will try more legal maneuvers in the US (see story) and will continue blaming the bond holdouts for trying to claim what's legally theirs. The creditors however are not a charity that is willing to dump their dollars into the pockets of Argentina's corrupt politicians. In the end, Argentina can either negotiate for a settlement with the holdouts or default. Sovereign bond default could however prove to be devastating.

JPMorgan: - Despite the political rhetoric, the Argentine government finds itself in a position of political and financial weakness; defaulting to avoid payment to holdouts is not easy to embrace. Suffering a credit event would have significant implications for the economy, and Argentina’s ongoing efforts to normalize its relationship with private creditors (settlements with ICSID claims, Repsol, and the Paris Club, and revamping statistics under IMF supervision) would be cut short. Opposition political leaders have generally publicly advocated a negotiation, which reduces the political cost for the president to engage creditors.

But even if negotiations do take place, the risk of default remains substantial.

Natixis: - The Argentinean government will continue to sell its good intentions and play the victim locally. Nevertheless, there is a serious risk of default and the clock is ticking. S&P downgraded this week Argentina to CCC-with a negative outlook since the court decision meant that the country will either default on the payment or face a distressed debt exchange. The execution risk is high as the needs to achieve an 85% participation rate in order to avoid a default.

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Investors cheer upcoming changing of the guard (and policies) in Argentina

Staying with the Argentina theme, it seems that investors are no longer as concerned about a technical event of default. Argentina CDS continues to tighten.

Source: DB

Moreover, investors are looking beyond this legal battle toward a potential changing of the guard in Argentina. Demand for Argentina bonds has been quite strong lately.

Bloomberg: - The country’s dollar bonds have returned 46 percent over the last year on bets a more market-friendly government will replace President Cristina Fernandez de Kirchner when her term ends in 2015 and as she moves to improve relations with international community.

Argentina's law says that by the end of 2015 Fernández de Kirchner will no longer be President, as she finishes her second consecutive mandate. And many hope that some of her populist policies (see discussion) will go as well. The present economic situation - with inflation rate estimated at over 30% and expected to go higher later this year - is simply not sustainable (note that Argentine authorities have not released the latest inflation results as required by the IMF). The current adminisration in Argentina is fully responsible for getting the country into this mess. It is time for them to go.

Argentina YoY inflation rate
(source: Barclays Research) 

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Fox News wins the Hype Award for the Argentina debt story

It is sad to see Fox News publish a horribly written story called "Litigious investors ask US Supreme Court to deny Argentina a 'do-over' on $1.4B debt ruling" from the Associated Press (here). First of all in the US taking someone who defaulted on debt to court is not "litigious", it is standard practice. Americans are generally quite proud of that right. But this clearly pro-Argentina story continues with more nonsense.

Fox News: - The "Aurelius Respondents," another group of hedge funds and holding companies based in the Cayman Islands and the U.S. state of Delaware to avoid taxes and scrutiny, urged the justices to deny Argentina's "do-over" request, saying "a chorus of disinterested parties has recognized that Argentina is without peer in its mistreatment of private-sector creditors."

Just to be clear, the Cayman entities are in the Cayman Islands because they are either owned by foreign organizations who are not supposed to pay US taxes (such as Canadian pensions) or by US corporate pensions who are tax exempt. As far as Delaware, those owners will certainly pay their share of taxes because these are pass-through entities. Fox News - check out something called Schedule K-1. And with respect to avoiding "scrutiny", the managers of these entities are Registered Investment Advisors regulated by the SEC. And for those who have been through an SEC RIA audit know there is no shortage of scutiny there.

Argentina is mocking the US legal system by appealing the court decisions in this case and then saying it won't comply with any final court ruling if it is not in Argentina's favor. Of all the news agencies it is particularly surprising that Fox News did not check the facts on this and is in effect buying Cristina Fernandez's propaganda on the issue. Congratulations on winning the Sober Look Hype Award.

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Argentina's devaluation backfires

Back in early December the government of Argentina raised taxes on credit card purchases in foreign currency to 35% from 20%. Online Christmas shopping abroad became increasingly expensive. However, dollars continued to flow out of the country even with this high levy, pressuring foreign reserves.

Source: GS

The central bank had "printed" enormous amounts of peso in 2013 to fund the public sector. But with the country's fiscal situation still deteriorating (see chart below) and demand for dollars continuing to rise, the Fernandez administration chose last week to devalue the peso.

Source: GS

The gradual depreciation policy that was in place before just didn't work. Even with taxes and other restrictions, the outflows were simply unsustainable - the government could not afford selling dollars below market rate for too long. The idea behind this devaluation was to stem dollar outflows by making the dollar far more expensive (see chart that shows dollar appreciating in the "official" exchange rate).

The goal was to bring the value of the dollar closer to where it trades in the "unofficial" markets. Some clever economists working for Fernandez probably told her that if we make this adjustment, the supply/demand fundamentals will be in balance and the outflows will be halted. Officials even promised to bring the tax on foreign transactions back to 20% after the devaluation. With the dollar now far more expensive, imports and dollar outflows are bound to slow - even with the lower tax. Unfortunately that was wishful thinking.

The devaluation backfired. As the nation's citizens learned about the official devaluation, panic ensued and demand for dollars increased dramatically. Instead of the unofficial-to-official premium on dollars shrinking as planned, it spiked.

About that transaction tax going back to 20% ... the government is now backpedaling.

ABC/AP: - Economy Minister Axel Kicillof told local daily Pagina 12 in an interview published Sunday that the Argentine tax rate on credit card purchases made in dollars will not be lowered Monday from the current 35 percent to 20 percent, as he had announced.

"In the case of currency for tourism and for purchases with a credit card abroad, the 35 to 20 percent move will not be implemented this Monday," Kicillof said. There was no word of when, or if, the tax rate on credit card purchases may be eased.

Now imports will become even more expensive and the central bank will need to print even more pesos to keep the government going. Inflation, already the highest in the Americas, will accelerate further and generate additional demand for dollars - a downward spiral.

GS: - According to our projections, the level of reserves will fall to USD21.6bn by the end of 2014 [vs. $30.9 now], after experiencing a loss in the year of USD9.2bn. We also expect the exchange rate to suffer a yearly depreciation of approximately 55% to finalize the year toward 10 ARS/USD. Additionally, as a result of the discussed additional pass-through effects of this larger exchange rate depreciation, including a higher floor for incoming wage negotiations, we increase our year-end inflation forecast to a range of 35%-40% yoy.

Argentina is not Zimbabwe just yet, but it's only a matter of time.

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Argentina tries to avert default - again

Last week the US appeals court ruled in favor of the NY-law bond houldouts (a group of bondholders who did not participate in the swap some years back when Argentina defaulted), forcing Argentina to make payments on these bonds. And paying these dollars will be a material burden on Argentina, who has limited foreign reserves.

WSJ: - A U.S. appeals court ruled in favor of Argentina's holdout creditors in their bid to be paid in full on long-defaulted bonds.

That sets the stage for a Supreme Court showdown and increases the odds that Argentina will default for the second time in just over a decade.

The U.S. Second Circuit Court of Appeals in New York ruled Friday that if Argentina keeps up its payments to creditors who accepted a discounted restructuring offer, then it also must pay a group of holdout bondholders 100% of the roughly $1.33 billion they are owed in principal and accrued interest. However, it kept a stay in place on enforcement of the ruling while the U.S. Supreme Court decides whether to review the case.

"It's a tough ruling, and it seems they accepted all the plaintiffs' arguments," said Eugenio Bruno, an attorney at Argentine law firm Estudio Garrido, which represents several creditors that accepted the swap offers.

Today Argentina is proposing to swap the NY-law bonds for domestic paper.

Reuters: - Argentina's government is proposing a voluntary bond swap on its foreign debt, shifting payments to Buenos Aires, if it cannot overturn U.S. court rulings that threaten to trigger its second debt crisis in just over a decade.

The bond swap would allow Argentina to keep paying the creditors who agreed to restructure the country's sovereign debt after a record $100 billion default in 2002, President Cristina Fernandez said in a televised address on Monday night.

Investors in international markets would have the option to swap their foreign debt for Argentine bonds if ongoing appeals of the U.S. court rulings are rejected, a government source told Reuters on condition of anonymity.

Of course the devil is in the details, but on the surface this violates the U.S. Second Circuit Court of Appeals ruling which is telling Argentina to make contractual payments on the current bonds. As expected, the NY-law bondholders are skeptical at this stage. Foreign holders know that should there be a problem in the future, they don't stand a chance with some puppet court in Buenos Aires. The ability for foreigners to take their money out of the country is also a potential issue.

Reuters: - But Fernandez's proposal of a new bond swap raised questions about whether investors would be interested in taking Argentine bonds in lieu of foreign debt, given strict currency and capital controls that the left-leaning Fernandez government has imposed.

"Changing the location of the payments to Buenos Aires is going to be extremely complicated amid the currency controls," said Jorge Todesca, a former deputy economy minister who is now head of the Finsoport economic consultancy.

This is particularly painful given Argentina's bloated official exchange rate - the "unofficial" rate now has the peso at 37% discount (around 9 pesos to the dollar - chart below). And given this uncertainty, the unofficial peso is expected to continue weakening further.

Source: El Dolar Blue

Market participants clearly view these events as raising the probability of Argentina's technical default and are awaiting the details of the proposed swap. If the proposal is not acceptable, the nation is likely to default - again. Argentina sovereign CDS premium jumped, with points upfront now approaching 50% (for every $100 of protection you need to pay some $50 in premiums).

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From our sponsor:

Cooking the numbers in Buenos Aires

Argentina's official economic growth surprised analysts with a 7.8% year over year jump in May.

MercoPress: - Argentina's economic activity jumped 7.8% in May from a year earlier, according to the country’s questioned stats office, Indec. President Cristina Fernandez had anticipated the news earlier in the week in a televised speech. ...The monthly EMAE economic activity index is a close proxy for GDP, which is reported quarterly.

Cristina Fernandez should be congratulated for this incredible achievement in the face of numerous adversities faced by the nation. But can the growth numbers be trusted?

MercoPress: - Argentina is widely accused of manipulating inflation data and, to a lesser extent, growth data. It faces potential sanctions by the IMF, which has issued a “declaration of censure” against Argentina over the quality of its statistics.

Even though the inflation number is heavily "understated", the growth numbers reported by the offficials should be more reliable? But this 7.8% number is meant to approximate the "real" instead of the "nominal" measure of the GDP growth. Which means that inflation numbers are key to this determination. The official inflation rate reported by the same government agency is 10.5%, while the actual number is more than double that amount. Computed using a more accurate inflation measure, the real GDP is likely to be negative.

GS: - The official Indec figures (0.8% mom, 10.5% yoy in June) are reporting less than half the inflation in the economy as measured by non-official entities.

Inflation is likely to remain entrenched above 20% during 2013-2014, given inertial pressures, the continuation of very accommodative monetary conditions, a deteriorating fiscal stance, and accelerating ARS [Argentina peso] depreciation. The monetary stance remains very lax (negative real interest rates), and the central bank continued to accommodate inflation at a very high level. In all, we expect the authorities to continue to subordinate low and stable inflation to fiscal and growth imperatives (severe fiscal dominance). This strategy is likely to lead to further pressure on the ARS to depreciate.

And pressure on the ARS continues. Earlier this year when Argentina was expected to default on its dollar debt (see post), the dollar hoarding in the black market forced greenbacks to spike to over 10 pesos. Since then the peso stabilized at around 8, but recently the black market activity has picked up again.

Source: QUARTZ (Note: the official rate is 5.46 pesos to the dollar)

With inflation numbers understated (and unlikely to improve), the real GDP growth is made to look far better than it really is. And given that the economy will be a major determinant of the October 2013 mid-term elections outcome, the Cristina Fernandez government continues to cook the country's key economic indicators.

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From our sponsor:

Think Argentina's economy is mismanaged? Welcome to Venezuela

Venezuelan leader Nicolas Maduro with Cristina Fernandez

One of the very few nations in the Western Hemisphere that rivals Argentina in mismanaging its economy (see post) is Venezuela. The latest economic results show Venezuela's inflation accelerating to recent highs - while declining in most other countries.

Source: GS

A more troubling economic trend however, often endemic in socialist regimes, is scarcity of products. In an attempt to control prices, such economies eliminate incentives for production. And many products that people in more open economies usually take for granted are simply not always available on Venezuela's "official" markets. Shortages in items from chicken to toilet paper are prevalent - often even in stores for the wealthier customers. Those who spent any time in the old USSR will clearly see the similarities. The nation's "scarcity index" hit a new record recently.

Source: GS

To add to this nation's problems, repeated blackouts across the country remind citizens that being one of the largest energy exporters doesn't help with electricity at home when the economy is so mismanaged. Welcome to Venezuela...

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From our sponsor:

Fernandez tries to "buy" midterm elections; dollar trades at 90% premium to "official" rate - a new record

It is remarkable to watch how some repressive governments attempt to address their nations' problems by temporarily plugging economic holes with populist programs (some may argue this applies to the developed world as well). Argentina is a great example, as Fernandez implements unsustainable policies just to get through the next election in October. She needs to keep the poor in her camp in order to retain control of Congress. One effort involves government sponsored grocery stores that will provide food priced below cost in order to keep the poor subdued through October.

Reuters: - The so-called "Argentine Market" was organized by pro-government activists, workers' cooperatives and local entrepreneurs who claim to cut out "parasitic" middlemen. They opened a first outlet last month and plan to expand in May.

The market is just one of many palliative measures and quick fixes being taken by President Cristina Fernandez and her supporters to hold Latin America's No. 3 economy together, and keep Argentine consumers as happy as possible, ahead of mid-term elections in October.

Other unsustainable programs include temporary caps on fuel and credit card rates. All are focused on getting through the October election.

Reuters: - Officials also capped fuel prices for the six months to October and a government proposal to launch a new, cheap alternative credit card pushed banks into offering discounts and lowering the interest rates they charge on credit card debt.

Deeper economic distortions continue to plague businesses, however, especially the small- and medium-sized companies responsible for about 40 percent of Argentina's gross domestic product. Several economists recently lowered their GDP forecasts for this year, with some now seeing just 1 percent growth or so.

Rising government spending ahead of the elections is pressuring government finances. For a nation that will have an increasingly difficult time borrowing even domestically, this is troubling news.

Source: JPMorgan

In the mean time Argentina's private sector fundamentals continue to deteriorate, forcing people to keep buying dollars.

Reuters: - One Argentine who owns a real estate company, and who declined to speak on the record because he fears retribution for admitting he buys dollars illegally, complained Fernandez is relying on "short-term patches that are going to explode in the government's hands."

The man took out a loan in dollars in 2011 to finance a private housing development. That debt has more than doubled since the government virtually banned foreign currency purchases and the black-market price for dollars surged.

Any remaining confidence in the value of the peso is disappearing quickly, with the underground demand for dollars skyrocketing. According to JPMorgan, this week "the informal FX rate was dealt at USD/ARS 9.45 (90% above the official fixing - 5.20), a historical high." The situation in Argentina is clearly unsustainable and it doesn't take an economist to realize it's not going to end well.

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From our sponsor:

Financial repression 101

Sign says: "Cristina don't **** with democracy".

Source: The Nation

That's exactly what Cristina Fernández de Kirchne's government has been doing for some time.

The Nation: - Among several reasons for these accusations could be the country’s current inflation rate (estimated by economists to be 26 percent, while the government cites it as 11.1 percent); the state’s assumption of control of private pension funds valued at 30 billion; the government’s restrictions on currency exchange, making it difficult for citizens to travel outside of Argentina; restricted freedom of speech; and, most significantly, an accusation of widespread corruption.

Argentina's actions don't just threaten the nation's democratic system. The latest policies amount to a harsh form of financial repression that will bring the nation's private sector to its knees. As confidence in Argentina's stability deteriorates, foreign reserves are becoming dangerously low. The latest move to close any loopholes that allowed outflows of dollars from the country is now impacting domestic market liquidity.

WSJ: - Argentina's stocks and bonds tumbled Friday, after the government announced new rules limiting mutual fund investments in the locally traded shares of foreign companies.

The regulations further restrict the ability of Argentines to invest offshore at a time when the Central Bank of Argentina is struggling to rebuild its international reserves due to capital outflows and low grain exports.

Starting April 30, the shares of foreign companies traded in Argentina, known as Cedears, will no longer be classified as local securities under rules that require mutual funds to invest no less than 75% of their assets in domestic securities.

"Cedears are going to have less liquidity, some mutual funds are going to have to unwind, and people are going to have to repatriate funds," said Agusto Farina, a trader at Buenos Aires-based brokerage Amirante Galitis.

Trading in Cedears hit 59 million pesos ($11.5 million) during the session. The turnover in Cedears since the beginning of the year through mid-March was about ARS360 million.

The new mutual fund rules appear to be aimed in part at businesses and sophisticated investors that use the securities market to legally skirt currency controls. The so called "blue-chip swap" transaction involves the purchase of stocks and bonds traded in Argentina, which are then sold offshore for dollars.

With currency controls shutting off hard currency outflows, the premium on dollars has reached new highs. According to JPMorgan, the dollar now trades in the "gray market" at some 70% above the official exchange rate. That's on top of the 26% decline in the peso's "official" value over the past couple of years.

Source: JPMorgan

Foreign investors are staying away. With inflation out of control and a limited ability to take earnings out of the country, investment in Argentina makes no sense. And capital looking for Latin American investments will find a much friendlier climate in Brazil or Mexico (as well as a number of smaller nations). By attempting to stem the flow of dollars out of the country with blunt policies, the government has cut off what the nation really needs - foreign investment.

JPMorgan: - Immediately after they were imposed, capital controls probably had an expansionary impact on the economy owing to the surge in domestic liquidity, bank intermediation, and consumption spending that they triggered. However, that stimulus represents a one-off and may be on the verge of tapering off. Looking ahead, capital controls threaten to exert an adverse toll on expectations of economic performance. Paradoxically, if evidence that tightening capital controls constrains inward investment continues to mount, the government will find it increasingly hard to deliver on its priority goal—economic growth.

Ironically, dollar outflows were caused in part by the government's earlier decision to confiscate private property of a large foreign investor (see post). Welcome to the world of financial repression and its "unintended consequences".

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From our sponsor:

Argentina's downward spiral

The government's mishandling of Argentina's economy has hit new highs recently with the implementation of price controls on food. It is a notoriously ineffective policy that tends to create shortages and spawns black markets.

International Affairs Review: - President Cristina Fernández de Kirchner's temporary price freeze on food products marks the most recent instance of her gross mishandling of Argentina's economy. The price freeze applies to all major food retailers, which account for over 70% of the market. Historically, these types of economic policies have never produced positive results. Most often, food importers stop importing because they would lose money by selling their food at the prices ordered by the government. Customers of large retailers who stand in line hoping to buy at the frozen price will then find the shelves barren. This scarcity of goods will spawn a black market, where food will be sold at actual market prices. While some law enforcement officials may tolerate these black markets, other will try to dismantle them, only to discover more tenacious entrepreneurs setting up shop the next corner over.

Unfortunately, the temporary price freeze is only part of an alarming trend towards financial mismanagement, which includes the expropriation of major foreign investments. Last year’s nationalization of Repsol YPF has infuriated Spain, one of Argentina’s largest foreign investors. Kirchner’s presidency has also been marred by accusations of falsifying CPI statistics (which provoked a strong rebuke from the IMF), a weakening of central bank independence, use of the nation’s currency reserves for political payoffs, and the threat of default on its debt - again. To most outsiders it would appear that Argentina is repeating many of the mistakes that resulted in its economic crisis of the early 2000s.

In a classic case of "wag the dog", Argentina's government is trying to focus the population on external issues. Argentine officials are now taking an aggressive stance with respect to self-determination in the Falkland Islands. Knowing that the upcoming referendum will likely result in a status quo, Argentina's government declared the vote to be "illegal". Tensions with the UK are likely to escalate further.

To make matters worse, fears of Argentina's technical default on its restructured dollar bonds (see discussion) are on the rise once again. That's in spite of recent hopes that Argentina may attempt to settle with the "holdouts" (see WSJ story). As a reflection of this uncertainty, the unofficial currency market is now pricing dollars at a 54% premium to the government's tightly controlled exchange rate.

Another troubling development is the relentless deterioration of Argentina's foreign reserves. Rumors persist that the government has moved dollars into "unofficial" accounts.

JPMorgan: - ... gross international reserves have fallen US$1.6 billion ytd, driven by a US$1.2 billion ytd fall of Treasury deposits at BCRA. What is odd about this is that the decline of the Treasury’s cash position of the past two weeks cannot be related to any scheduled external debt payment.

Some have speculated that the goal is to prevent official dollar accounts from being frozen by US courts if the legal case against the bond holdouts results in an unfavorable ruling for Argentina.

Source: JPMorgan

Whatever the reason, no one expects these reserves to stabilize. That's because the largest single source of hard currency for Argentina is the export of soy and soy products. And this year's soy harvest is projected to be weaker than originally expected, putting additional pressure on foreign reserves.

WSJ: - Hot, dry weather from early January through mid-February reduced soy yields across much of the central region of Argentina's agricultural heartland.

Exports of soybeans and related products are the South American nation's single largest source of foreign currency and a key contributor to the Central Bank of Argentina's international reserves.

President Cristina Kirchner has tapped those reserves to pay foreign creditors since 2010, and her budget this year earmarks several billion dollars of reserves to fund public works projects.

As conditions deteriorate, Kirchner's government will resort to more extreme measures in order to hold on to power. And largely because of government's actions, Argentina, with its significant natural resources, a relatively large middle class, and a fairly developed industrial base is unlikely to participate in the economic stabilization seen in Brazil (see discussion) and elsewhere in emerging markets.

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Argentina's policies culminate in looting outbreak

As looting broke out across Argentina, political analysts scrambled to find the reason for the outbreak. Is it the unions? The opposition? The sad reality is that these events are simply the culmination of horrific government policies, including the recent theft of foreign property (see discussion). The belligerent approach to foreign relations (see post) for a nation whose growth had depended heavily on exports has backfired.

WSJ: - Thousands of people in several Argentine cities ransacked supermarkets for a second day in the latest challenge to President Cristina Kirchner, who is struggling to revive a weak economy and maintain her control over the ruling Peronist Party.

What started with a raid Thursday afternoon of a supermarket in the Patagonian resort town of Bariloche quickly spread to other parts of the country, with thousands of looters attacking supermarkets and shops in the cities of Rosario, Campana and Zárate. In the central city Rosario, two people were killed during the incidents and 137 people arrested.

Source: Reuters

Kirchner's government single-handedly drove the nation's economy into the ground. Here are just a couple of economic data points from Q3: construction spending and private consumption.

What makes this situation extreme is the out-of-control stagflation. Despite such severe economic weakness, inflation is running at 25% yoy, as the currency weakens further (and the government continues to lie about the actual inflation level - see discussion).

Of course Argentina's government (which now relies on children's vote to stay in power - see discussion) is attempting to deflect the blame for the mess it has created.

WSJ: - Mrs. Kirchner's cabinet chief Juan Manuel Abal Medina accused Mr. Moyano's truckers union and other union bosses of organizing the latest looting this week.

"These are isolated incidents that are clearly organized and structured. In none of them did people seek food. They took televisions and drinks," he said.

It seems Mrs. Kirchner wants to be congratulated for the fact that the nation, rich in natural resources and the world's 5th largest wheat exporter, is not yet in full starvation mode.

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Argentina dodges another default - for now

Argentina dodged a technical default this week due to the appeals court ruling. A US appeals court suspended Judge Griesa's ruling to place $1.3 billion into escrow by December 15th (see discussion). The suspension is pending the appeals court ruling.

WSJ: - Argentina's bonds and stocks extended their gains in Buenos Aires on Friday, as investors continued to cheer a U.S. court ruling earlier in the week that temporarily quashed fears the Argentine government might have to default on its debt next month.

"That traders have extended their optimism with greater calm [during the session] after celebrating yesterday's suspension of [judge] Griesa's ruling is reasonable given that valuations continue to be attractive and are out of sync with credit fundamentals," research firm Estudio Ber said in a note.

Dollar-denominated GDP warrants, whose payout is linked to Argentina's economic growth, rose 4.6% to 83.25 pesos ($17.20), adding to Thursday's whopping 21.9% surge. Peso-denominated GDP warrants closed 1% higher at ARS15.66.

The dollar-denominated Bonar 2017 bonds rose 1.1% to ARS532.00, and the Boden 2015 rose 1.3% to ARS580.50.

The hefty gains bonds logged in the last two trading sessions of November follow a decision by a U.S. appeals court Wednesday night to suspend a ruling by federal Judge Thomas Griesa that barred the Argentine government from paying investors who own restructured bonds unless it also fully repays defaulted bonds held by creditors who are suing.

Bond yields and CDS have tightened sharply.

Source: JPMorgan

JPMorgan: - Argentine asset markets have been held captive to the twists and turns of a US$1.3 billion US lawsuit pitting Argentina against a subset (1% of claims) of its holdout creditors (8% of claims). This week the Appeals Court prioritized due process and opted to extend the stays until the end of February 2013—a measure that favors Argentina, which is seeking review. Furthermore, the Appeals Court admitted restructured bondholders (92% of claims) to the judicial dispute by granting their motion to appear as interested third parties (in support of Argentina’s litigating position) in court. As a consequence, credit markets saw relief: bond prices rebounded and short-dated credit default swap spreads collapsed—although longer-dated maturities remain at distress levels.

This means that the dollar denominated bonds will pay the next coupon in December as usual - with all the money going to the bond holders who had participated in the 2001 default restructuring and none going to the holdouts. The ruling therefore has bought Argentina some valuable time, delaying the possibility of default (and CDS trigger) at least until March, 2013, when the next payment on these bonds is due. This case is critically important not just for Argentina but for any sovereign bonds issued under US law. Any future sovereign debt restructuring and market participants' response will be based on the outcome of these proceedings.

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From our sponsor:

Argentina nearing technical default

Argentina CDS spread has blown out to new highs last week. In spite of Argentina's government driving the nation's economy into the ground (see discussion), this widening was caused by increased risks of the so-called "technical default" rather than deteriorating economic conditions.

Argentina sovereign CDS (source: JPMorgan)

For years, bond holders of Argentina's government debt (issued under NY law), who did not participate in Argentina's restructuring plan from the 2001 default, have been fighting to be treated equally (pro rata) with those who had accepted the restructuring terms. But Argentina has insisted that that those who did not play ball in their restructuring plan - the "holdouts" - should get nothing. Last week however a US judge gave Argentina a Thanksgiving surprise by ruling in favor of the holdouts. That means the holdouts will need to be paid everything that the restructuring participants got over the years, including all the interest.

JPMorgan: - Last Wednesday, District Judge Griesa issued his decision in the pari passu ruling ahead of Thanksgiving ... in favor of holdout creditors. Griesa defined a pro rata payment formula that requires full upfront payment by Argentina to holdouts of US$1.3 billion...

The judge told Argentina's lawyers that the nation needs to put $1.3 billion into escrow by December 15th, pending the Appeals Court’s ruling. If Argentina fails to do so and the country's appeals process in the US is exhausted, the sovereign CDS will be triggered.

JPMorgan: - A potential refusal by Argentina to comply with an adverse ruling would threaten “technical” default on 2005 and 2010 restructured claims (92% of total debt defaulted in 2001). This would occur if US courts considered the remedy (pro rata payments) adequate and equitable.

Based on Argentine government's belligerent behavior toward the rest of the world (see discussion), the odds of the $1.3bn showing up in the escrow account next month are not great. That, combined with the Appeals Court (as well as whatever other appeals Argentina can come up with - possibly appealing to the US Supreme Court) agreeing with Judge Griesa, will put the nation into default - again. By the way, those who still don't think Argentina's government is acting like thugs toward foreigners, just read this story from the Mail.

The market-implied peso exchange rate (the so-called "shadow" exchange rate - see discussion) now puts the peso at 42.3% discount to the official rate as the currency continues to decline. Should the technical default take place, the US will begin freezing Argentine government's dollar accounts - which will push the shadow exchange rate to new lows.

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From our sponsor:

Running a nation into the ground

The industrial production chart below shows how you run a country into the ground - which is precisely what Cristina Fernández de Kirchner's government has done with Argentina (see discussion).

Source: tradingeconomics.com

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Lies, damned lies, and Argentina's inflation statistics

Argentina's authorities continue to blatantly lie about the nation's inflation rate. The official numbers coming out of Cristina Fernández de Kirchner's government have been constantly printed at around 10% per year - with vary little variation. It's quite ridiculous actually.

Argentina's official inflation numbers

Stories persist about independent economists being threatened by the government not to publish the real numbers domestically. But the government can't do much about foreign economists. JPMorgan's latest estimate is 25.5% 3m/3m saar (seasonally adjusted) and rising (similar to other non-government estimates). It is one thing to cook the numbers "gently", the way China does for example, but being off by some 15% makes the government lose all credibility. Even the IMF decided enough is enough. Its latest action could lead to Argentina losing its IMF membership.

Bloomberg: - Argentina is on track to be the first country ever censured by the International Monetary Fund for not sharing accurate data about inflation and the economy.

The IMF’s board of directors, meeting yesterday in Washington, gave the country until Dec. 17 to respond to concerns about the quality of its official data, it said today in an e-mailed statement. If the deadline is missed, the board can issue a declaration of censure, a warning that has never been used and which means sanctions may be applied if the concerns aren’t addressed.

“The Executive Board regretted the lack of sufficient progress in implementing the remedial measures since its Feb. 1, 2012, meeting and expressed to the authorities its concern that Argentina has not brought itself into compliance with its obligations,” according to the statement. The board “took note of the ongoing dialogue between the IMF and the authorities regarding the measures, and called on Argentina to implement the measures without delay.”

The IMF’s decision puts Argentina, a member of the Group of 20 nations, closer to sanctions that could eventually force President Cristina Fernandez de Kirchner’s government into a “compulsory withdrawal” from the 188-country institution. Officials at Argentina’s Economy Ministry, who aren’t authorized to speak publicly, declined to comment.

In the mean time elevated food prices and weakening currency are pushing the actual inflation to new highs. Argentina is definitely on the list of countries who are (or at least should be) dealing with inflation surprises this year (discussed here).

JPMorgan: - In August, food prices added upward pressures to the headline; they were up 2.4%m/m, the highest monthly increase since April, bringing annual food price inflation to 28.1%oya. We expect food inflation to gain further momentum in the coming months as the pass-through from higher global agricultural prices should become more evident, even if the government attempts to contain generalized price adjustments via discretionary controls. 

Welcome to Kirchner's Argentina.

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With Argentina reeling from economic downturn, the government is recruiting migrant workers and kids to stay in power

If you govern a nation experiencing a rapid decline in foreign currency deposits, falling consumer confidence, runaway inflation, insurmountable trade issues, zero growth, and multiple other problems, how do you stay in power? If you are Iran, you recruit an army of violent thugs to keep the government in power. If you are Argentina, you throw money at migrant workers and teenagers and then allow them vote.

The Washington Post: - Argentina is rethinking what it means to be a citizen, proposing radical changes that would have both foreigners and 16-year-olds vote to determine who should run the country.

President Cristina Fernandez’s legislative powerbrokers say the proposed electoral laws will enhance democracy and challenge the world to treat voting as a universal human right. Opponents call it a naked attempt to prolong the power of a decade-old government that has showered public money on migrants and young people.
... 

While welcoming immigrants into polling stations would add 1 million voters, lowering the voting age from 18 to 16 would add 2 million more.

Argentina's current government is looking to strengthen its political support at the time when the nation is in fact undergoing all the problems listed above. Here are the facts:

1. Dollar deposits are now down 30% since May.

2. Consumer confidence is declining.

Argentina consumer confidence index

3. Inflation is around 24% (unofficial figure).

4. Argentina's trade disputes are escalating.

Reuters: - The United States and Japan launched complaints against Argentina at the World Trade Organization (WTO) on Tuesday, alleging that its import licensing rules discriminate against foreign goods. 

This follows a similar complaint at the WTO from the EU brought in May.

5. And not surprisingly growth remains a problem.

Source: GS

With the support of foreign migrant workers and 16-year-old children, Cristina Fernandez’s government will have an edge. Of course that's not going to be enough, because in 2015 the presidential term limits will be coming up. But no worries, the constitution can always be "adjusted":

MercoPress: - Several groups allied to Argentine president Cristina Fernandez are actively promoting a constitutional review that would allow re-election for a third consecutive four year mandate [what some call "re-re-election"].

In these times of tremendous economic uncertainty in Argentina, one thing will remain certain: Cristina Fernandez’s government will be in charge for a long time to come. And their policies that brought the nation into its current state will continue unabated.

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