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Fitch: IMF Deal Supports Argentina but Political Risks Loom
11 JUN 2018 9:39 AM ET
Fitch Ratings-London-11 June 2018: Argentina's IMF program mitigates sovereign financing risks after the erosion in market confidence, supporting the 'B' rating and Stable Outlook, Fitch Ratings says. But future rating prospects depend on executing measures to restore policy credibility and reduce macroeconomic vulnerabilities, which face considerable political uncertainty.
Argentina began talks with the IMF last month after political resistance to the ruling coalition's reform agenda and policy credibility setbacks helped drive a major peso selloff and erosion in market sentiment. Our revision of the sovereign Outlook to Stable from Positive on 4 May reflected the negative implications for economic prospects and the policymaking environment.
Fitch now projects inflation will rise to 27.5% by year-end on pass-through from peso depreciation. This will erode real wages and confidence, while monetary and fiscal tightening weighs on consumption and investment. We have reduced our 2018 real GDP growth forecast to 1.3% from 2.6%, continuing a weak and volatile growth pattern.
The USD50 billion "exceptional access" stand-by arrangement with the IMF should support Argentina's 'B'/Stable rating against this more difficult backdrop by mitigating sovereign financing risks. An initial USD15 billion disbursement will help cover borrowing needs in 2018-2019, with the rest available on a precautionary basis. The program will be accompanied by loans from other multilaterals, and could catalyze additional market funding.
The government has agreed to pursue faster fiscal consolidation, allow the exchange rate to float freely, and grant the central bank formal autonomy and end its financing of the treasury. These policy adjustments could face considerable political risk. President Macri's popularity has dropped sharply, and social protests have intensified. It is not yet clear if the opposition will support or resist adjustments in the run-up to 2019 elections.
Accelerating fiscal consolidation is likely to be most difficult measure. Fitch expects the government to achieve the 2018 primary deficit target of 2.7% of GDP due to new spending cuts, buoyant tax collections early this year, and higher-than-expected inflation (raising revenues more quickly than spending). But achieving subsequent targets - 1.3% in 2019, 0% in 2020, and a 0.5% surplus in 2021 - will be much harder.
Taxes are already high, and set to fall somewhat due to tax reform. The spending profile is rigid, dominated by social benefits (60% of primary spending) that face upward pressure from demographics and a new indexation formula that references higher past inflation. This puts an even greater consolidation burden on capital spending, transfers to provinces, subsidies, and salaries, which are all politically sensitive. Recent protests and Congress' vote to stall utility rate rises - although vetoed - could portend resistance to further energy and transportation subsidy cuts. Public salary or payroll cuts could face resistance from unions.
The government expects to put public debt to GDP on a downward path next year, but debt dynamics are highly sensitive to uncertain macro variables. Abrupt peso depreciation has revealed a steeper underlying debt trajectory that was previously masked while peso depreciation lagged behind inflation. Fitch projects central government debt to surpass 70% of GDP in 2018. The figure is lower net of the easily refinanced debt held by the central bank, at 52%, but this is only moderately below the 'B' median of around 60%. Interest to revenue is already above the median, at 11%.
Debt accumulation has far exceeded reported fiscal deficits in recent years, suggesting that accounting issues may be understating borrowing needs and therefore the effort needed for debt stabilization. For example, last year's government net borrowing of USD55 billion exceeded the USD34 billion deficit, likely reflecting the inclusion of some non-cash items as revenues and below-the-line settlement of some obligations.
11 JUN 2018 9:39 AM ET
Fitch Ratings-London-11 June 2018: Argentina's IMF program mitigates sovereign financing risks after the erosion in market confidence, supporting the 'B' rating and Stable Outlook, Fitch Ratings says. But future rating prospects depend on executing measures to restore policy credibility and reduce macroeconomic vulnerabilities, which face considerable political uncertainty.
Argentina began talks with the IMF last month after political resistance to the ruling coalition's reform agenda and policy credibility setbacks helped drive a major peso selloff and erosion in market sentiment. Our revision of the sovereign Outlook to Stable from Positive on 4 May reflected the negative implications for economic prospects and the policymaking environment.
Fitch now projects inflation will rise to 27.5% by year-end on pass-through from peso depreciation. This will erode real wages and confidence, while monetary and fiscal tightening weighs on consumption and investment. We have reduced our 2018 real GDP growth forecast to 1.3% from 2.6%, continuing a weak and volatile growth pattern.
The USD50 billion "exceptional access" stand-by arrangement with the IMF should support Argentina's 'B'/Stable rating against this more difficult backdrop by mitigating sovereign financing risks. An initial USD15 billion disbursement will help cover borrowing needs in 2018-2019, with the rest available on a precautionary basis. The program will be accompanied by loans from other multilaterals, and could catalyze additional market funding.
The government has agreed to pursue faster fiscal consolidation, allow the exchange rate to float freely, and grant the central bank formal autonomy and end its financing of the treasury. These policy adjustments could face considerable political risk. President Macri's popularity has dropped sharply, and social protests have intensified. It is not yet clear if the opposition will support or resist adjustments in the run-up to 2019 elections.
Accelerating fiscal consolidation is likely to be most difficult measure. Fitch expects the government to achieve the 2018 primary deficit target of 2.7% of GDP due to new spending cuts, buoyant tax collections early this year, and higher-than-expected inflation (raising revenues more quickly than spending). But achieving subsequent targets - 1.3% in 2019, 0% in 2020, and a 0.5% surplus in 2021 - will be much harder.
Taxes are already high, and set to fall somewhat due to tax reform. The spending profile is rigid, dominated by social benefits (60% of primary spending) that face upward pressure from demographics and a new indexation formula that references higher past inflation. This puts an even greater consolidation burden on capital spending, transfers to provinces, subsidies, and salaries, which are all politically sensitive. Recent protests and Congress' vote to stall utility rate rises - although vetoed - could portend resistance to further energy and transportation subsidy cuts. Public salary or payroll cuts could face resistance from unions.
The government expects to put public debt to GDP on a downward path next year, but debt dynamics are highly sensitive to uncertain macro variables. Abrupt peso depreciation has revealed a steeper underlying debt trajectory that was previously masked while peso depreciation lagged behind inflation. Fitch projects central government debt to surpass 70% of GDP in 2018. The figure is lower net of the easily refinanced debt held by the central bank, at 52%, but this is only moderately below the 'B' median of around 60%. Interest to revenue is already above the median, at 11%.
Debt accumulation has far exceeded reported fiscal deficits in recent years, suggesting that accounting issues may be understating borrowing needs and therefore the effort needed for debt stabilization. For example, last year's government net borrowing of USD55 billion exceeded the USD34 billion deficit, likely reflecting the inclusion of some non-cash items as revenues and below-the-line settlement of some obligations.
