Argentina Elections Unlikely to Change Downward Trajectory

Argentina Elections Unlikely to Change Downward Trajectory

The upcoming election could keep Argentina on the path towards further misery.  The most market-friendly outcome would be an opposition win.  Without a change in governments, it’s hard to envision a significant step back from the unorthodox policies set forth by Presidents Kirchner and Fernandez.

POLITICAL OUTLOOK

Argentina will hold its presidential and legislative elections on October 25.  The main candidates are ruling party candidate Daniel Scioli, opposition alliance Cambiemos candidate Mauricio Macri, and opposition alliance UNA candidate Sergio Massa.  Current President Kirchner is barred from running for a third consecutive term, and ideas about changing the constitution were squashed when her party failed to win a super-majority in the 2013 mid-term elections.

The most recent polls show Scioli leading, and he may barely win in the first round.  Scioli is polling about 40%, with Macri polling 29% and Massa polling 22%.  A run-off will be held on November 22 if no candidate 1) wins 45% of the votes or 2) wins 40% of the votes and has a 10 percentage point advantage over the nearest rival.

With regards to the legislative elections, a third of the 72-seat Senate will be up for grabs.  Similarly, around half of the 257-seat lower house will be elected.

Obviously, a win for the ruling party would be negative for Argentina assets since it would likely mean continuation of the existing unorthodox policy framework – but this is probably already priced in.   The 2001 default remains unresolved as the holdout issue festers.  Despite the 2012 ruling by US Federal Judge Griesa, Argentina has yet to resolve the matter.  Until it does, Argentina will remain locked out of global capital markets at a time when its funding needs are growing.

ECONOMIC OUTLOOK

That the ruling party could remain in power is, quite frankly, astounding.  Years of economic mismanagement coupled with low commodity prices have left the economy in a shambles.  GDP is expected to grow 0.5% this year, barely changed from 0.4% last year.  The IMF expects 1.3% growth in 2016.

Inflation remains too high.  The official CPI reading is 14.4% y/y, but unofficial opposition estimates put inflation closer to 27% y/y.  The IMF has criticized Argentina for its data standards, but the nation has not really responded.  High inflation and a slow pace of peso depreciation have led to significant real appreciation (REER) of the peso since early 2014.

Due in part to the strong REER, the external balances are worsening.  After running current account surpluses from 2002 to 2010, Argentina moved back into deficit from 2011 on.  The 2015 gap is expected at near -2% of GDP, with risk of further widening next year.  Foreign reserves fell steadily through much of 2014 before stabilizing, even as the central bank tries to manage the pace of peso depreciation.

The fiscal accounts are a growing problem.  Spending has been ramped up ahead of the elections, and the deficit is expected at over -5% of GDP this year.  On the other hand, revenues have sagged due to the sluggish economy and low commodity prices.  With the international bond market closed off, the government will have to either 1) ramp up domestic debt issuance, 2) run the printing presses, or 3) both.  We think it will be 3), with clear negative ramifications for bond holders.  Note that M3 rose 36% y/y in September.

INVESTMENT OUTLOOK

The peso is one of the worst performers in EM, with the official rate -11%% YTD against the dollar.  Using the unofficial “Blue Chip” rate, the peso is down -15% YTD to trade at record lows near 14.20.  With the official rate around 9.5, the Blue Chip is trading at nearly a 50% discount.  The only EM currencies doing worse are BRL (-31% YTD), TRY (-19% YTD), COP (-19% YTD), and MYR (-18% YTD).  We think it’s likely that the next government will have to speed up the pace of depreciation, as the current situation cannot be maintained indefinitely.