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Press release by Fitch Ratings
Fitch Ratings-New York-07 November 2018: Fitch Ratings has affirmed Argentina's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' and revised the Rating Outlook to Negative from Stable.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The revision of Argentina's Outlook to Negative from Stable reflects sharply weaker economic activity and uncertain prospects for multi-year fiscal consolidation and market financing availability as IMF funds are used up, posing risks to sovereign debt sustainability. Fitch assumes that in 2019 the government will achieve the fiscal adjustment targeted in the budget and that the recently renegotiated IMF program will help it fully cover its financing needs, but sees downside risks amid a nascent economic recession and election cycle. After 2019, prospects for further fiscal consolidation, economic recovery and restoration of external market access are uncertain and are likely to be sensitive to the election outcome.
Intense macroeconomic instability in 2018, marked by a major depreciation in the peso, have dramatically weakened Argentina's near-term growth prospects. Fitch projects real GDP will contract 2.7% in 2018 and 1.7% in 2019, driven by a collapse in confidence and erosion of real incomes as inflation has shot upward. The authorities are pursuing a more aggressive tightening of fiscal and monetary policy as part of a re-negotiated program with the IMF, which will weigh further on growth, although it could also provide some support to the extent that it helps stabilize expectations.
Prospects for economic recovery in the medium term are unclear. Private investment is likely to remain in a cautious mode amid macroeconomic and political uncertainty. Difficult macroeconomic adjustments have involved setbacks to the microeconomic agenda, such as budgeted tax hikes that reverse a prior push toward reducing high tax pressures, and may divert political capital from other reform priorities (e.g. labor reform).
Fitch projects inflation will rise to 47% in 2018 from 25% in 2017 on pass-through from peso depreciation and moderate to 27.5% in 2019 on weak domestic demand and greater peso stability. A faster decline is likely to be hindered by inertial pressures from wage negotiations in 2019 and re-opening of 2018 agreements before then, which are likely to confer large nominal hikes to compensate for real wage losses this year.
Against this difficult backdrop, the government appears to be on track to meet its more ambitious fiscal consolidation targets - the key criterion in the new IMF program. Fitch expects the authorities will meet (and likely outperform) their target to reduce the primary deficit to 2.7% of GDP in 2018, from 3.8% in 2017, and secure approval of a proposed 2019 budget that targets an ambitious reduction to 0% via tax hikes (namely new export duties) and spending cuts. Its ability to advance an austere budget for an election year without a congressional majority appears to be an encouraging sign that the opposition has incentives to support rather than obstruct fiscal adjustment at this juncture. Fitch expects these targets to be met, lowering the overall deficit to 5.5% of GDP in 2018 and 3.7% in 2019.
However, fiscal risks are tilted to the downside. Social security already represents most of primary spending and could continue growing in real terms given indexation to higher past inflation. The authorities expect revenues (net of export duties) to be resilient to the recession, but this could pose a greater downside risk following real declines in tax collections and social security contributions in recent months. The fiscal outlook after 2019 is more uncertain given elections. The implementation of a major reduction in discretionary spending will leave narrower room for further cuts, and political will to take up a reform of social security - the major source of budget pressure - is not yet clear.
Fitch estimates that sovereign financing needs of USD39 billion in 2019 will be covered by USD23 billion in scheduled IMF disbursements, loans from other IFIs, and rollover of intra-public sector borrowings. This availability of funds and some over-financing in 2018 should allow the sovereign to avoid seeking new external market financing and only partially roll over short-term Letes. External market access will become important again starting in 2020 as scheduled IMF disbursements wind down and a year later as repayments come due, but market sentiment is likely to be sensitive to an uncertain economic and political outlook.
Fitch projects central government debt will jump to 93% of GDP in 2018 from 57% in 2017 due to peso depreciation, and decline to 89% in 2019. This projected decline primarily reflects the transitory effect of a high GDP deflator relative to peso depreciation, underscoring risks to debt sustainability given uncertainty in these variables, contracting real GDP, high real interest rates on new debt, and persistent albeit lower fiscal deficits. Argentina's net borrowing has also widely exceeded reported deficits in recent years, reflecting additional below-the-line borrowing needs that may challenge debt reduction. General government debt (consolidating central and provincial debt with social security holdings) estimated to reach 92% of GDP in 2018 is well above the current 'B' median of 58%, even net of around 24pp held by the central bank.
The central bank's (BCRA) new monetary strategy, in place as of October, targets money supply growth instead of inflation and centers exchange rate policy around a crawling "non-intervention" band. Stability in the exchange rate will rely fundamentally on the BCRA's influence over market forces, via the interest rates it validates to control peso supply, rather than on FX intervention, for which its ammunition is very limited. Reserves stood at USD54 billion as of end-October but have been propped up by multilateral loans, while "own" reserves net of such FX liabilities have fallen to just USD15 billion from USD30 billion at end-2017 owing to FX intervention throughout the year.
The new monetary strategy has involved a hike in interest rates to around 6% in monthly terms. These rates amount to around 70% in annual terms (over 100% compounded), posing risks to the real economy and BCRA balance sheet if sustained for long. The new regime has succeeded in supporting a recovery in the peso so far, but the key test will come as the BCRA seeks to lower rates without stoking FX pressures. Its adoption of the Leliq as its main sterilisation instrument could help smooth this process, as these can only be held by banks regulated by the BCRA, unlike the prior Lebac which was used by diverse actors in carry trade activity.
Fitch projects that the current account deficit will fall to 4.5% of GDP in 2018 from 6.5% in the four quarters through 2018Q2, and to 2.1% in 2019, on the weaker peso, contraction in domestic demand and a much better agricultural harvest. However, external adjustment could remain sensitive to the value of the peso. As of end-October, the peso was 10% below its 20-year average in real, trade weighted terms, having already recovered from a low of 25% a month earlier.
Argentina's 'B' rating reflects high inflation and economic volatility that have persisted despite efforts to tighten policies in recent years, a weak external liquidity position, and a heavy and highly dollarized sovereign debt burden. These weaknesses are balanced by high per-capita income, a large and diversified economy, and improved governance scores, although these structural strengths have provided a limited support to the sovereign's credit profile as demonstrated by its weak debt repayment record.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Argentina a score equivalent to a rating of 'B' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR. Large revisions to macroeconomic input variables - including real GDP growth, inflation, per-capita income and debt-to-GDP (largely capturing peso depreciation) - have resulted in a lower SRM score, and thus making it better reflective of the high macroeconomic volatility that Fitch had previously incorporated via a downward notch in the QO. As such, this downward notching has been removed.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main risk factors that, individually or collectively, could trigger a downgrade are:
--Policy and political developments and/or economic weakness that heighten risks to debt sustainability or jeopardise access to IMF funding;
--Further bouts of macroeconomic instability and/or erosion of international reserves.
--Failure to recover access to external market financing;
The Rating Outlook is Negative. Consequently, Fitch does not currently anticipate developments with a high likelihood of leading to a positive rating change. However, the main factors that, individually or collectively, could lead to a stabilization of the Outlook are:
--Compliance with near-term fiscal targets, greater confidence that fiscal consolidation can be sustained and external market financing access re-established beyond 2019;
--Evidence of recovery in economic activity, avoidance of renewed macroeconomic instability;
--A sustained strengthening of the external liquidity position.
--Fitch expects growth in key trading partner Brazil to accelerate to 2.2% in 2019 from 1.3% in 2018.
Fitch has affirmed Argentina's ratings as follows:
--Long-Term Foreign-Currency IDR at 'B; Outlook Negative;
--Long-Term Local-Currency IDR at 'B; Outlook Negative;
--Short-Term Foreign-Currency IDR at 'B';
--Short-Term Local-Currency IDR at 'B';
--Country Ceiling at 'B';
--Issue ratings on long-term senior unsecured foreign-currency bonds at 'B'.
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004