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Feature

Argentina: Noisy path to election

Patrick Esteruelas
Patrick Esteruelas
Investment Team
February 2019

Argentina finds itself in the cross hairs once again as we enter the start of a long and noisy election cycle that will test President Mauricio Macri’s ability to keep voters’ faith in his project under the auspices of the current International Monetary Fund (IMF) program. There are reasons to believe that growth has bottomed out and has already started a shallow recovery that will gain traction in the second quarter of 2019, but signs of persistent inflation inertia are more troubling while the FX remains vulnerable to an electoral shock despite the fact that locals are more dollarized today and the authorities have some leeway to control FX volatility. Fiscal and current account dynamics are meanwhile improving at a rapid pace. While the path to October’s Presidential election will inevitably be noisy, on balance, we still see President Macri as favored to win in a tight second round run-off against former President Cristina Fernández de Kirchner under a scenario of a mild economic recovery, tolerable inflation, and FX volatility, which we believe should likely result in a significant tightening in spreads.

Growth is showing early signs of having bottomed out and starting a shallow sequential recovery. The monthly GDP proxy for December printed at 0.7% month-on-month, while additional data suggests that we could see another monthly positive read in January. Industrial activity increased 0.3% month-on-month, cement sales increased 5.8% month-on-month, steel production increased 9.7% month-on-month, and consumer confidence increased 6.8% quarter-to-quarter in February. While we believe that monetary and fiscal tightening will work against a robust recovery, we expect that strong second quarter growth will be led by a strong agricultural harvest as well as the impact that recovering real wages will begin to have on consumption. Furthermore, we believe that this will then be followed by a broader sector recovery in the third quarter.

Monthly inflation on the other hand is, in our view, likely to remain elevated above 3% over the next couple of months and will not converge to 2% month-on-month until closer to May. This not only complicates the start of public and private sector wage negotiations, but also puts pressure on the FX. Much of this price stickiness in the first quarter is attributable to the fact that the administration has frontloaded all public utility tariff adjustments so not to coincide with the peak of the election cycle in the summer. There is, however, still some persistent inflation inertia beyond that as companies are largely more focused on raising prices to protect profit margins even if that carries a risk of losing market share. The Central Bank of Argentina (BCRA) has, in response, proactively and quickly enhanced its tight money policy over this period of expected high inflation, recently announcing that they will outperform the zero-money base growth target, which was imposed under the IMF program, by 3% (equivalent to approximately ARS 40 billion) every month until May. This results in further draining of peso liquidity from the system, resulting in higher rates.

The FX remains the only relatively effective nominal anchor in Argentina today, which, in our view, explains why Argentina and the IMF are working under what is a crawling pegged FX rate dressed up as a floating FX regime with the objective of ironing out FX volatility, even if that means validating higher rates. On the positive side, we believe that the real exchange rate, while not as cheap as it was in October, is still undervalued, the trade balance and external accounts are adjusting at a fast clip, and locals are already heavily dollarized with fewer pesos left circulating to dollarize as a result of the BCRA’s tight money policy. Retail, however, has a tendency to dollarize whenever the FX moves more than one full peso. After two traumatic episodes in April and August 2018, Argentine citizens have trouble distinguishing between natural FX moves and the beginning of a deeper FX adjustment. The government can, however, count on some ammunition to contain the FX despite being prohibited by the monetary policy program from intervening in spot rates within a wide non-intervention zone that adjusts on a monthly basis. This includes a willingness to tighten monetary policy, expectations of a strong soy harvest, and a plan developed by the treasury to sell directly to the market up to an estimated USD 10 billion from the IMF starting in May before peso funding needs pick up significantly in June due to mid-year salary bonus payments. However, this may all prove insufficient if Ms. Kirchner is seen ahead in the polls, which could result in low rollovers of peso debt maturities and unwinding of some peso term deposits by retail accounts.

Fiscal and current account dynamics are meanwhile improving at a rapid pace. In January, the primary fiscal balance posted its largest monthly surplus in almost eight years (in real terms), bringing the 12-month rolling primary deficit to 2.6% of GDP versus 2.7% in January and an ambitious target of zero by year-end. Given the program’s recent fiscal outperformance, helped by expenditure cuts and inflation, we believe that the government is likely to use all available fiscal space to prop up its support in November. The trade balance and external accounts are continuing to adjust positively, with the monthly trade balance posting a surplus for the fifth month in a row while three-month to three-month trade balance shifting comfortably into surplus thanks to a recovering agricultural sector and collapsing imports. The current account was also helped further by a sharp correction in the tourism deficit. The IMF expects the current account deficit to close at approximately 1.5% of GDP by year-end, a significant improvement from an estimated 4.5% of GDP last year.

Under a scenario of a mild recovery in growth and tolerable inflation and FX volatility, we still on balance see President Macri as favored to win in a tight second round run-off against Ms. Kirchner. There are three fundamental reasons why he’s still seen as the favorite, despite the fact that social mood indicators are still at very depressed levels after recovering slightly from the October and November lows.

First, despite a recessionary cycle with massive FX volatility, a spike in inflation, and a collapse in real wages, President Macri, who according to various polls, holds approval ratings from 34% to 40%, has been able to keep roughly a third of the electorate who value institutional strength and a clampdown on corruption. This virtually guarantees him a path to a hypothetical second round run-off in November.

Second, the Peronist party remains divided between Ms. Kirchner and a number of other Presidential aspirants, which guarantees that there will be a second-round run-off. Ms. Kirchner remains highly likely to run for election because she is convinced she can win, believes it’s the most effective way to protect her and her family from the multiple legal proceedings against her, and her movement is encouraging her so that they can they ride her coat tails to office and retain their own political space. With Ms. Kirchner in the running, the rest of the Peronist camp remains conflicted and divided over who to field as an alternative Presidential candidate. While Ms. Kirchner and the rest of the Peronist party have forged united lists in as many as ten of the provinces that will be holding gubernatorial and provincial legislative elections ahead of the October general elections, the Presidency and the governorship of the Province of Buenos Aires are prizes that nobody wants to give up in favor of the other.

Finally, we believe that President Macri remains a favorite candidate as Ms. Kirchner, in our view, remains the most competitive candidate of this divided Peronist field with solid 30% approval ratings and stands at barely 2 to 3 points (on average) behind President Macri in the second round polls. However, she is also one of the most vulnerable candidates to stand against President Macri. While President Macri’s and Ms. Kirchner’s approval ratings are somewhat similar, President Macri, in our view, has an edge in voter intentions. Ms. Kirchner’s high rejection ratings and inability to grow much beyond her core voter base contributes somewhat to President Macri’s edge. However, unlike Ms. Kirchner, President Macri also has a number of members within the ruling Cambiemos party (namely Buenos Aires Governor María Eugenia Vidal and Buenos Aires Mayor Horacio Larreta) with higher approval ratings who also enhance the Cambiemos brand’s electoral prospects and have allowed President Macri to consistently outperform his own numbers.

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21 February 2019
Mentorship among women in finance
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