Argentina Local Currency Ratings Raised To ‘B-/B’; Outlook Stable; Foreign Currency Ratings Remain ‘SD/SD’
The unsolicited foreign currency ratings on Argentina remain ‘SD’ following its July 2014 default.
* The new Administration has presented a credible plan to deal with long-standing macroeconomic imbalances, eliminated foreign-exchange restrictions, and begun negotiations with its holdout creditors.
* As a result, we are raising our long-term unsolicited local currency rating to ‘B-‘ from ‘CCC+’. In addition, we are raising our transfer and convertibility (T&C) assessment to ‘B-‘ from ‘CCC-‘.
* The outlook on the local currency rating is stable, reflecting the new economic policies of the Administration, but also the potential difficulties in passing and implementing those plans.
RATING ACTION On Feb. 3, 2016, Standard & Poor’s Ratings Services raised to ‘B-/B’ from ‘CCC+/C’ its unsolicited local currency long-term and short-term sovereign credit ratings on the Republic of Argentina. The unsolicited foreign currency sovereign credit ratings remain at ‘SD’, reflecting the default in July 2014. The outlook on the long-term local currency rating is stable.
In addition, we raised our transfer and convertibility assessment (T&C) to ‘B-‘ from ‘CCC-‘ and our national scale rating to ‘raBBB’ from ‘raB+’ with a stable outlook.
RATIONALE Our selective default (‘SD’) foreign currency ratings on Argentina stem from the sovereign’s nonpayment of part of its external debt. On July 30, 2014, Argentina failed to make a $539 million interest payment on its discount bonds due in December 2033. Since then, Argentina has not been able to service its external bonds under foreign law.
Raising the local currency rating reflects recent steps to address some of the substantial economic imbalances prevailing in Argentina. The recently elected President Mauricio Macri aims to reduce these imbalances over the next four years, reaching a balanced budget by 2019. After moving quickly to eliminate foreign-exchange restrictions and shifting to a more flexible exchange rate, the government plans to reduce inflation to single digits by 2019. Unofficial estimates suggest that inflation was about 25% in 2015 (official inflation numbers lack market credibility). The inflation rate could spike to about 35% this year based on the depreciation of the Argentine peso in December 2015 and higher regulated energy prices in 2016, among other factors.
We estimate the fiscal deficit for 2015 at about 7.5% of GDP (excluding one-off financing from government agencies). We expect that the fiscal deficit may decline modestly in 2016. The government announced on Jan. 27, 2016, a rapid reduction in energy subsidies that could save about 1.5% of GDP. However, some other recent actions, such as the reduction of export duties and a narrowing of the income tax base, could actually reduce tax revenues. We expect that continued, although declining, fiscal deficits are likely to contribute to a rising debt burden in coming years. We expect Argentina’s net general government debt to gradually increase to 51% of GDP at year-end 2016 from 50% in 2015 and 41% in 2014. Nonetheless, between 50% and 60% of that debt stock is held by government-owned agencies–mainly the social security agency and the central bank–diminishing the roll-over risk on that debt.
The Macri Administration has started negotiations with the holdout creditors. It is difficult to foresee how long the process will take and what the key parameters of a settlement would be. In any case, regaining access to international capital markets is very important for the government to fulfill its strategy of correcting Argentina’s main macroeconomic imbalances. An enhanced inflow of external funding would boost liquidity for the sovereign, as well as for Argentine provinces and the private sector, helping to stabilize the economy. We expect that greater access to commercial and multilateral borrowing will be reflected in likely growing current account deficits in the next two years. As a result, Argentina’s narrow net external debt will likely reach 109% of current account receipts by the end of 2016, compared with 107% last year. We expect gross external financing needs to equal 115% of current account receipts plus usable reserves in 2016, up from 101% in 2015.
The Macri Administration is likely to face important political challenges to implementing its ambitious plans. Macri won the election with only 51% of the votes. A relatively high level of employment in recent years, despite the economic imbalances created by the policies of the previous government, has sustained substantial political support for the opposition Peronist Party, which holds a majority in the Senate and the largest minority in the lower house. The new president may be able to negotiate with different factions of the opposition, along with provincial governors who exert influence over members of Congress from their province. However, a polarized political landscape could block or delay the president’s legislative plans.
Success in gradually stabilizing the economy will depend, in large part, on containing salary increases for government and private-sector employees within levels consistent with a declining inflation trajectory. Salary negotiations that are beginning now in Argentina will represent the first and probably most important political test for the Macri Administration. With that, the government expects to reach a single-digit inflation level by 2019. The new leadership in Argentina’s central bank has set an ambitious goal of shifting toward an inflation-targeting monetary policy over the term of the Administration.
We expect a slow economic recovery for Argentina, in part because of external factors such as recession and major currency depreciation in Brazil, lower agricultural prices, uncertainty related to China’s growth prospects, and the U.S. raising interest rates. We expect 0% GDP growth for 2016 and 2.0% for 2017. However, economic growth could surprise if government policies succeed more rapidly than we expect in regaining investor confidence and boosting investment. On the other hand, renewed political polarization could impair the government’s ability to pursue its economic agenda, weakening growth prospects. Over the long term, one of Argentina’s main challenges is to avoid its historical pattern of very volatile economic performance, with periods of rapid growth followed by crises and low growth.
The rapid and successful recent liberalization of the exchange-rate market supports the improvement in our transfer and convertibility assessment. While this is only the beginning of a long process, we believe the sovereign is now unlikely to interfere with access to and transfer of foreign exchange.
OUTLOOK The stable outlook on the local currency rating balances the improvement of economic policies with the political challenges facing the new Administration. We expect the government to implement policies that gradually contain inflationary pressures and reduce its fiscal deficit, slowly strengthening the macroeconomic pillars of the economy.
The foreign currency ratings will remain ‘SD’ until Argentina cures the 2014 default, either through payment, exchange, or other settlement. If and when that happens, we will reassess the sovereign’s general credit standing, most likely raising the foreign currency rating to the ‘CCC’ or low ‘B’ categories, depending to a large extent on our assessment of the government’s ability to implement its economic reforms and on any possible lingering legal threats that could impair its ability to service future debt.
Conversely, a combination of continued default on foreign currency debt, along with an unexpected deterioration in economic policy and political stability, could reverse the recent increase in investor confidence. The resulting higher risk could put pressure on the local currency rating and lead to a downgrade.