By Delfina Cavanagh, Sebastian Briozzo,
Roberto H Sifon-arevalo, & Joydeep Mukherji
Standard & Poor's Ratings Services
BUENOS AIRES -- On April 15, 2016, Standard & Poor's Ratings Services assigned its 'B-' issue rating on Argentina's planned global bond issuance of around US$15 billion.
At the same time, we have affirmed and changed to "solicited" our 'B-/B' formerly unsolicited local currency long-term and short-term sovereign credit ratings on Argentina. We will also change Argentina's long-term foreign currency sovereign credit rating (which remains at 'SD' reflecting its default in July 2014) to "solicited."
In addition, we affirmed our transfer and convertibility (T&C) assessment at 'B-'.RATIONALE
The U.S. Court of Appeals for the Second Circuit recently upheld an earlier lower court ruling that had lifted an injunction that blocked Argentina from paying its foreign currency debt. The lower court had ruled that it would lift its injunction on payments once Argentina's Congress authorized payment to the holdouts from the 2005 and 2010 debt exchanges and once payment had been made.
Subsequently, the Argentine Congress approved a new "Holdouts Law" on March, 31, 2016, authorizing the government to issue new debt to pay holdouts once the injunction against payments were lifted, opening the path to cure that default. The recent Court of Appeals decision has facilitated the lifting of the injunction on debt payments.
According to our ratings methodology ("Post-Default Ratings Methodology: When Does Standard & Poor's Raise A Rating From 'D' Or 'SD'?," published March 25, 2015, "Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009, and "Sovereign Rating Methodology," published Dec. 23, 2014, all on RatingsDirect), we will assign a 'B-' rating on the global bonds issued to fund payment to the holdouts; our selective default ('SD') foreign currency ratings that stem from Argentina's nonpayment of part of its external debt will remain.
On July 30, 2014, Argentina failed to make a $539 million interest payment on its discount bonds due in December 2033. As of the end of March 2016, the government has missed an estimated $2.1 billion in interest payments on debt issued after its 2005 debt exchange. Once Argentina cures its 2014 default by resuming payment on those bonds, we will reassess its general credit standing and assign a new long-term foreign currency sovereign credit rating, subject to our assessment of any remaining legal issues that could impair payment of future debt service.
Our ratings on Argentina reflect ongoing challenges to successfully implement difficult measures that address the country's substantial economic imbalances, including high inflation and a large fiscal deficit, in a context of a still polarized society and an unfavorable external environment. The Macri Administration has been able to cut fiscal subsidies, liberalize and unify the exchange rate, eliminate capital controls, reduce and eliminate some export duties, and begin the restructuring of Argentina's statistical agency.
Importantly, it was able to gain Congressional approval of the "Holdouts Law," despite lacking a majority in the Congress. Nevertheless, inflation remains high, likely above 40%, and we expect GDP to contract this year (in part because of fiscal and monetary tightening), demonstrating the political and economic challenges that lie ahead.
We expect a slow economic recovery for Argentina. We expect GDP to contract 0.5% in 2016 and only expand around 1.9% in 2017. Successful implementation of economic reform would improve investor and consumer confidence and could boost GDP growth toward 3.5% in 2018. A recovery in external demand, as well as good access to external funding from official and private sources, would facilitate economic recovery. However, prolonged low commodity prices, recession in Brazil, and general uncertainty in global markets could dampen Argentina's 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.
We expect investment and external sectors to be the key sources of economic growth and to depend to a large extent on external financing by multilaterals and capital markets. Argentina continues to suffer from high inflation, as well as poor inflation data.
Currently, Argentina has no official inflation index because the government is reviewing the methodology for inflation calculation.
Using an average of the inflation in the province of San Luis and the City of Buenos Aires, inflation stood at 29.3% in 2015, higher than the 23.9% published by INDEC, the government's statistical agency, for the previous year. We expect inflation to increase to 42% in 2016 (above the central bank's target of 20%-25% by year-end) as a result of pass through to prices from the depreciation of the peso, as well as increases in administered prices. The government increased tariffs for electricity, water, gas and transportation in order to reduce its subsidy bill and stabilize fiscal accounts. The central bank has raised its benchmark interest rate to almost 40% and reduced the growth of the monetary base to counteract inflationary pressures.
We expect inflation to decelerate in 2017 toward 30% and decline thereafter.
However, success in gradually stabilizing the economy will depend, in large part, on containing salary increases for government and private-sector employees consistent with a declining inflation trajectory. Regaining access to external commercial funding will help the government reduce its reliance on central bank funding, thereby improving the conduct of monetary policy and contributing to lower inflation.
Cutting the fiscal deficit through spending cuts, including subsides, will require skillful management by the Administration in the context of low economic growth, high inflation, and high political polarization. With preliminary official information, we estimate the general government fiscal deficit at about 6.3% of GDP for 2015, the largest deficit for the past 20 years. We expect that the fiscal deficit may decline modestly in 2016 to about 5.8% of GDP, assuming some expenditure control. Reductions in energy, transportation, gas, and water subsidies would save about 1.5% of GDP (overall subsidies are estimated at 4% of GDP). However, some other recent actions, such as the reduction of export duties and a narrowing of the income tax base, could reduce tax revenues (an estimated loss of 1.5% of GDP). Midterm Congressional elections in 2017 could also make it difficult for the Macri Administration to maintain austerity policies, especially if the economy performs worse than we expect.
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 52.2% of GDP at year-end 2016 from 41% in 2014. We estimate the change in general government debt at an average of nearly 10.1% of GDP in 2016-2018. Nonetheless, as a result of limited access to international capital markets, the government has relied mostly on the local market for debt issuance in recent years. Partly as a result, 62% of its total debt stock is held by government-owned agencies--mainly the social security agency (ANSES), Banco de la Nacion, and the central bank--diminishing the roll-over risk on that debt.
Gross central government debt totaled $222.7 billion at the end of December 2015, equivalent to 54% of GDP. Argentina's debt burden will depend strongly on the value of the pesos versus the dollar because around 67% of the government's debt is denominated in foreign currency, a ratio that could increase further as the government finances its fiscal deficits with external funding. Keeping sustainable debt levels will depend to a large extent on the government's capability to reduce fiscal deficits over the next couple of years while promoting economic growth.
Our expectation for deterioration in the current account deficit for 2016 at 3.1% of GDP from 2.7% in 2015 is explained by lower external demand (mainly from Brazil) together with low commodity prices that would offset the positive effect of the devaluation and the elimination of export taxes and restrictions. We expect current account deficits to be lower in 2017 and onward on the expectation of a gradual recovery in commodity prices, lower dependence on oil imports, and trade partners' gradual recovery. Argentina is exposed to significant volatility in terms of trade because of its dependence on commodity exports.
Regaining access to international capital markets will be important for the government to implement 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 the government to use $8.5 billion (from the total planned issuance of around $15 billion, equivalent to 6.7% of the central government's total debt as of end December 2015 and 2.6% of 2015's estimated GDP) to pay holdout creditors and the remaining to finance part of the projected fiscal deficit. On top of that, we expect several provinces to tap the external market.
However, more external financing will moderately weaken Argentina's external indicators. We expect that narrow net external debt to current account receipts will reach 184% in 2016, up from an average of 140.5% in 2013-2015, and could average 177% in the next three years.
We expect gross external financing needs to usable reserves and current account receipts to reach 115.3% in 2016, up from an average 103.4% in 2013-2015. After the nominal depreciation of the exchange rate of about 49% since Dec. 10, 2015, as of today´s exchange rate of 14.5 Argentine peso/1 U.S. dollar, Argentina's GDP per capita is estimated at $11,213 for 2016.OUTLOOK
The stable outlook on the local currency rating balances our expection for improvement in economic policies and gradual stabilization of the economy with the political challenges facing the new Administration. Within the next 12 to 14 months, we expect the government to implement policies that gradually contain the fiscal deficit, bring inflation down toward the central bank's targets, and set the stage for greater investment and a return to GDP growth.
The foreign currency ratings will remain 'SD' until Argentina cures the 2014 default. Once Argentina resumes payment on those bonds, we will re-assess its general credit standing and likely assign a new long-term foreign currency sovereign credit rating similar to the one we have assigned to the planned issue of global bonds, subject to our assessment of any lingering legal threats that could impair future debt service.
A track record of consistent policies that gradually reduce economic imbalances and maintain access to market funding would boost investor confidence. The combination of greater policy predictability and credibility, along with improving macroeconomic performance, could lead to a higher credit rating.
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.
Argentina - Market ReEntry Bonds - Preliminary Offering Memorandum (Final) by Latin American Herald Tribune