Argentine Peso Descends into Abyss Despite Show-stopping Central Bank Action and IMF Assurance, Analysts say "Hold" Bonds

-Peso plunges to fresh record lows after Argentine IMF bailout plea. 

-Currency shrugs at show-stopping rate rise from the Central bank. 

-Analysts still backing the nation's bonds, "hold" ratings reiterated.

© kasto, Adobe Stock

The Peso hit a fresh record low Thursday even after the central bank raised its interest rate by a show-stopping 15% and the International Monetary Fund (IMF) said it will speed up the pace at which Argentina can access funds from a $50 billion bailout, but some analysts are still willing to back the nation's bonds.

Argentina's central bank raised its interest rate by 15% in one fell swoop Thursday, taking it up to 60%, in order to stave off pressure on the currency and provide incentive for investors to lend to the government. With inflation at 31.2% in July, this amounts to a real interest rate that is close to 30%.

This came hard on the heels of a statement from the IMF pledging to speed up the pace at which Argentina can access its "stand-by" fund, a kind of short term lending facility, which is designed to repair market confidence in the government's balance sheet and its ability to service Argentina's debts.

“In consideration of the more adverse international market conditions, which had not been fully anticipated in the original program with Argentina, the authorities will be working to revise the government’s economic plan with a focus on better insulating Argentina from the recent shifts in global financial markets," says Christine Lagarde, managing director of the IMF. “I stressed my support for Argentina’s policy efforts and our readiness to assist the government." 

However, rather than stemming the sell-off in the currency, both of the interventions appear to have served only to deepen the rout. The USD/ARS rate was up by 10% at the London noon, after the IMF statement but before the central bank intervention, but that gain had risen to 18.8% by the London close. Similar is true of the Pound-to-Peso rate.

Argentina's currency and bonds have been hit hard this year amid a general rout in emerging markets, which has compounded preexisting pressures on the South American country. The USD/ARS rate has risen 116% so far in 2018 and the Pound-to-Peso rate has jumped 107%.

Above: USD/ARS rate shown at daily intervals.

This latest bout of emerging market instability has sprung up partly as a byproduct of the US Federal Reserve having raised its interest rate seven times since December 2015, which raised the cost of borrowing on international markets too, although things only really begun to come to a head when the ongoing US Dollar rally took hold back in April. 

"Turkish and Argentine woes are in the ‘idiosyncratic' category but it's hard to shake the prevailing concern that EM debt levels are too high, and that the gradual turn in global monetary policy is water-torture for highly-indebted current account deficit economies," says Kit Juckes, chief FX strategist at Societe Generale. 

The above pressures are doubly challenging for Argentina, which has long struggled against elevated inflation, high debt levels and a large current account deficit. At the end of 2016, Argentina owed debts to foreigners that are equivalent to 37% of GDP and had a current account deficit equal to almost 5% of GDP, according to IMF figures.

At least some of these external debts will be denominated in foreign currencies. And they, as well as the current account deficit, become more expensive to cover and more difficult to fill every time the Peso takes another leg downward.  

The Peso was already under severe pressure from a deteriorating domestic economy, political uncertainties and a rapidly strengthening US Dollar in June when the government requested the emergency funding facility from the IMF, which has spooked investors, who may have panicked that Argentina was preparing for something they didn't know about. 

Above: Pound-to-Peso rate shown at daily intervals.

"Authorities are taking the right steps to deal with external conditions but have failed to communicate properly, as investors saw yesterday’s announcement as a sign of desperation. Argentina has applied most of the tools to deal with external conditions and time is now necessary for the effects to kick in," says Alejandro Hardziej, a strategist at Swiss wealth manager, Julius Baer. "The collapse of the Argentine peso should support the current account, and the reduction of the fiscal deficit will reduce funding needs. We keep a Hold/Speculative rating on the issuer."

Argentina only recently, in April 2016, regained access to international debt markets after nearly 15 years of being effectively shut out of it. The country defaulted on close to $100 bn of debts back in 2001, opening the door to years of bitter wrangling with investors. 

Many of the holders of Argentine debt agreed to a restructuring that saw them swap their original bonds for new debts worth little more than 30% of their initial investment. However, a group of "holdout" creditors, described by Argentina's then-President as "vulture funds", refused to sign up to either of the restructurings and instead insisted on full repayment. 

This gave way to a lengthy battle in a Manhattan court that culminated in an April 2016 settlement that enabled a series of injunctions to be lifted and paved the way for the country's return to international debt markets as an issuer. 

"The fiscal adjustment under the IMF has become more front-loaded, but it remains a gradual adjustment that requires Argentina to attract additional external financing. In our view, the still-gradual approach reduces the risk of a deep recession and a market-unfriendly political transition. However, the trade-off is that Argentina needs to continue to attract external financing, which will keep it very exposed to global EM risk appetite," says Jane Brauer, a bond strategist at Bank of America Merrill Lynch. 

Brauer says the rise in Argentine borrowing costs over recent months is "too high" and that default risk is low. However, in light of current market conditions she and the Bank of America team have downgraded their rating for Argentine debt from "overweight" to "marketweight".

Regardless of the downgrade, Brauer is still advocating owning Argentine bonds, just in a quantity that is more proportionate to Argentina's share of the broader debt market. Hardziej at Julius Baer offers a very similar recommendation too. 

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