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August 11, 2020

ARGENTINA: The Week at a Glance

BY Miguel A. Kiguel, Andrés Borenstein, Lorena Giorgio, Mariela Díaz Romero, Rafael Aguilar, Isaías Marini

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( 18 mins)

The Implications of the Debt Restructuring Deal

It took its time, but it happened. The government finally struck a deal with their main creditors and everything points to the fact that, when figures are disclosed on August 24, Argentina will get the special majorities to trigger the collective action clauses and finish the debt restructuring without holdouts. Defaults usually leave skeletons in the cupboard, but at least this time they would not be associated to legal claims. The local section of the debt has already been approved by both houses of congress and there seems to be no problems in the forthcoming launch of this deal.

The negotiation strategy that led to such a long process is questionable, but it would have been quite hard to close a better deal. Argentina achieved a 45% discount on the debt’s present value, but. more importantly, it secured that debt maturities will be almost imperceptible in the next 4 years since they do not amount to USD 6 billion while they were around USD 40 billion in the previous scheme.

The Market’s reaction was an initial rally that later lost steam, a kind of reality check in the sense that the agreement is important, but the agenda is still very heavy. In addition, the market was a believer, so to a great extent the deal was already priced in. The reason behind the initial rally was to confirm that the tail risks were not materializing. The FX spread widened again towards the weekend, partly due to local bond arbitrage, but partly because monetary issues are not yet solved. The CB remained a net seller of reserves, and it changed its 6 cents a day policy on the margin to something similar, but less certain.

The communication with the market and the agreement to be sealed with the IMF will probably be functional to regain access to the market. In our base scenario Argentina could place debt again in 2022, but with a pro-market set of policies and within a framework of a global mega liquidity; doing it in 2021 should not be ruled out. This is very important because it would relieve the Central Bank from being the first-call lender, and therefore, would leave more freedom to think of a monetary policy that aims at gradually lowering inflation.

However, the agreement with the IMF is anything but easy. Perhaps to lower expectations, minister Guzman stated that it could take several months. It is a hefty agenda. Argentina will have to find ways of achieving fiscal equilibrium (something this Government had set out to do at the beginning of its term, but with a mixture of higher spending and taxation), looking for monetary policy forms that anchor expectations and solving some issues such as tariff freezes. A big question will be whether the Government will be willing to make any structural reforms. The list is long: from tax reform, something in the labor area that reduces conflict, a more open economy, deregulation, among others. As with many issues, the government has been ambiguous, perhaps showing some of the differences within the coalition.

It is also unclear which IMF is going to meet Argentina. Whether a “guilty” IMF due to the failure of the previous program that validated the USD 40 billion of the first offer as financially sustainable, or an institution that will try to protect its reputation with a very hard conditionality. Beyond the hawks and doves that will undoubtedly be present, it will be important to see what the US Treasury, always a powerful voice on the board, does.

The Monetary-Exchange Rate Inconsistency Gains Relevance

– In July, the monetary base accelerated its annual growth rate to 67.5%, reaching its highest record in the series that began in 2003

– Other broader monetary aggregates such as private M2 (cash holdings plus sight deposits) showed an even higher nominal growth (107% yearly)

– As in previous months, assistance to the Treasury was the reason behind most monetary expansion, and it must be added that the CB untightened sterilization this month

– In terms of exchange rates, monetary imbalances are beginning to press: in the first days of August there was an increase in the purchase of the solidarity dollar, while the Central Bank marginally accelerated the crawling-peg

In July, the monetary base accelerated its annual growth speed to 67.5%, measured on average. This way, it reached its highest record in the series beginning in 2003. Money held by the public continued to be the component with most acceleration, increasing over 80% annually, while reserve requirements grew to a lesser extent, at 50%. Wider monetary aggregates such as private M2 (cash holdings plus sight deposits) showed an even higher nominal growth: in this case, M2 increased almost 107% over a year ago, influenced by government transfers to the private sector to alleviate the crisis, and also partly by a slower speed of money circulation due to lockdown restrictions.

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Within the monetary base, the most expansionary factor in July was the assistance to the Treasury, which was ARS 171 billion in net terms, with ARS 120 billion in temporary advances, ARS 100 billion in profits and the rest contracted via operations with the Treasury. In addition, the fact that the Central Bank relaxed with sterilization contributed to the monthly growth of the monetary base. Via reverse repos (1 day) and Leliqs (28 days) it expanded by ARS 63 billion and ARS 10.8 billion, respectively. Interest rates also favored growth in the money supply, expanding by ARS 62.3 billion. On the absorption side, the sale of reserves equivalent to ARS 40.5 billion (USD 568 million) helped.

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Thus, the stock of interest-bearing liabilities finished at ARS 2.3 trillion (equivalent to 9 GDP points), almost tying the monetary base stock at 9.3 GDP points. So far this year, the monetary base has only grown ARS 534 billion, and the increase would have been much greater had it not been for the CB’s sterilization effort. It is worth recalling that assistance to the Treasury until July was 5.6% of GDP. In this sense, the stock of interest-bearing liabilities more than doubled in 2020, bringing the debate on the quasi-fiscal deficit to main stage. The CB pays a 38% rate via Leliqs and 19% via repos to prevent all pesos from circulating. While these rates are not as high as on other occasions, they do create problems because of the amount of money that will need to be sterilized to prevent the monetary imbalance from persisting.

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If no action is taken, the monetary imbalance will sooner or later begin to influence exchange rates, and therefore inflation. The first days of August saw an acceleration in the purchase of the solidarity dollar. The CB sold USD 224 million in only two working days, versus USD 178 million in the first two working days of July. For this reason, the daily depreciation rate or crawling-peg had to accelerate on the margin, from 0.07-0.08% daily to 0.11% last Thursday and Friday.

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Another Poor Performance in July’s Revenues

– They amounted to ARS 559.1 billion and grew 24% compared to July 2019, which meant a 13.5% drop in real terms

– The main taxes that make up the mass of automatic transfers to provinces, linked to the domestic market, again deteriorated strongly: VAT-DGI grew scarcely 3.2% y/y and Income Tax 8.7%

– After the slight recovery in June, taxes on foreign trade deteriorated again in July: export taxes grew only 12.6%, import taxes 4.5% and VAT-DGA 20.9%

– So far this year, tax revenues have increased 26.2% compared to the same period a year ago

Tax revenues did not continue to deteriorate but did not take off either. Although they cut their decline in real terms for the third month in a row, July’s revenues again grew well below inflation. On the one hand, the greater lockdown flexibility that led to a slight rebound in economic activity, the greater adhesion to the various payment plans for the regularization of overdue obligations, and the extra collection via the P.A.I.S. and personal assets tax, contributed to moderating the real drop in collection. But, on the other hand, the lockdown’s negative impact still affected taxes, in particular those linked to the domestic market, which have a close connection to the evolution of consumption and employment. As for taxes levying the external market, they performed very poorly in line with the drops in exports and imports that have been taking place in recent months.

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In July, tax revenues totaled ARS 559.1 billion, 24% above their level a year ago. This result meant around a 13.5% drop in real terms according to our estimates, their seventh in a row.

Once again taxes linked to the domestic market grew way below inflation, particularly VAT-DGI and Income Tax, which together make up almost half of the total revenues: they recorded another real decline of 26% on average. The collection of VAT-DGI continues without showing positive real variations so far this year and scarcely grew 3.2% in nominal terms compared to a year ago, below June’s 3.9%, which had been the best record in the last three months. In addition to the effect of lower consumption due to the lockdown, revenues for this concept deteriorated again, although to a much lesser extent, due to increased compensation for taxes such as profits or fuel.

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On the other hand, Income Tax was only 8.7% above its level one year ago, affected by several factors: real profits last year were lower than those of 2018 ─the balance sheets deflated with inflation in 2019, which was the highest since the 90s─ reducing the taxable base, the non-taxable base was increased, the rates table was updated and advances for individuals and rates for companies were reduced.

As for Social Security, it recorded an 18.5% y/y increase, after growing 22.4% in June, and is still far from the 40% increase recorded in March. This way, the fall in real terms amounted to 17.5%, hand in hand with the 95% reduction in the rates for essential sectors, the suspension of staff who received less than the usual pay, and greater layoffs in sectors that had already been dragging a strong recession. On the other hand, although the extension of the payment of employer’s contributions provided by the Government for the activities most affected by the crisis expired in June, so that the April charges had to be paid, AFIP enabled a special payment plan that offers up to two additional months before starting payments of the deferred obligations in each fiscal period. Thus, those obligations accrued in March, due in April, and postponed until June, which are regularized through this mechanism, will begin to be paid in August.

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Meanwhile, the tax on Credits and Debits grew again above total revenues, 26.6% above its record from a year ago. In fact, this item is partially offsetting the negative impact of the weakening of consumption thanks to the greater use of electronic means of payment.

The collapse shown both in exports and imports once again had an impact on foreign trade taxes, which together grew 15% year-on-year. After having grown 28.1% in June, export taxes grew only 12.6% in July, affected by the collapse of trade volumes. Despite the increase in rates compared to July 2019, the poor performance of this item was also explained by the wide FX spread that continued to discourage sales, while the comparison basis from a year ago included the last part of the income from a record gross crop. As for import taxes, they grew scarcely 4.5%, in a month in which imports in volume plummeted again, while customs VAT grew 20.9%.

Lastly, among the taxes that contributed to improving the year-on-year performance of tax revenues, the personal assets tax stood out again growing almost 340% due to the increase in rates, and the P.A.I.S. tax, which totaled ARS 20.018 million in a month in which the sale of the “solidarity” dollar was around USD 800 million.

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In this scenario, automatic transfers to provinces totaled ARS 173.6 billion in July growing 22.7% compared to a year ago, which represents around 14.3% actual fall.

This way, so far this year, tax revenues have increased 26.2% compared to the same period in 2019. Taxes linked to foreign trade grew 26.8% on average, while those corresponding to the domestic market were 26.1% above their level of the first seven months of 2019.

Signs of a V-Shaped Recovery for the Industry in June

– In June, the Production Index of the Manufacturing Industry increased 13.8% compared to May, ending 10.3% over its March level, although still below its pre-pandemic levels

– As for the official indicator, it cut its y/y fall down to 6.6%, recovering from the slumps in May (-26.2% y/y) and April (-33.3% y/y)

– All main sectors reduced their y/y falls and three of them recorded growth compared to one year ago: food, beverages and tobacco (+5.9%), furniture and other industries (+3.5%), and the petrochemical industry (+1.5%)

– Thus, industrial production accumulated a 14.6% fall during the first half of 2020

The lockdown continued to be gradually loosened in June, and the greater opening of the economy was reflected in industrial activity. According to INDEC, 46% of the surveyed facilities could operate normally, compared to the 38.7% record in May.

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The Industrial Manufacturing Index (IPI) ─seasonally adjusted series─ improved 13.8% m/m in June, after growing 12.5% in May (revised from 9%), after the floor it hit it April. In fact, the rebound in activity allowed it to recover some of what it lost due to the quarantine, and June’s record was 10.3% over March’s, although it was still 13.2% below February’s, before the pandemic struck. As for the official indicator, it cut its y/y fall abruptly from -26,2% and -33.4% in May and April respectively to -6.6% during the sixth month of the year.

Among the main sectors, there was a heterogeneous behavior, although those recording contractions were way less affected than in May. The steepest fall was scored by the automotive sector (-33.4% y/y), which, although it illustrates that this industry still has a lot of room for recovery, it had a way more favorable performance than the previous month (in which it fell -73.7% y/y). In fact, the production of automobiles went from 4,082 units in May to 15,657 in June according to ADEFA’s data. And July will display good figures again since 21,316 automobiles were manufactured, almost 39% more in seasonally adjusted terms.

The textile sector followed with a 28.8% y/y fall (from -57.2% in May), still affected by the null or very partial activity in some industries due to the lockdown, and a conditioned demand product of closed stores. As for the sector that produces non-metallic minerals and basic metal industries fell 27.8% y/y (compared to May’s 52.5% y/y record). Although activity in construction and in the automotive sector, the sector’s main demanders, gave signs of improvement in June, they are still way below their levels from one year ago.

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The production of equipment, devices and instruments scored a 15.7% y/y fall (vs. -51.6%), while the sector that produces metal, machinery, and equipment saw its activity cut 11.6% y/y (vs. -34.3%). In turn, the wood, paper, editing, and printing sector recorded a scarcely 1.5% y/y drop (vs. -9.7%).

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In contrast with the previous month, in June three of the main sectors managed to take their production to higher levels than those from a year ago. In effect, the food, beverages and tobacco sector grew 5.9%, partly boosted by the wine sector and dairy production. The furniture sector and other industries displayed a 3.5% y/y growth, while the petrochemical sector increased 1.5% y/y. Even though the oil sector is performing poorly, affected by a severe reduction in demand, the growth in the production of disinfection and personal hygiene products, which fall under this category, compensated for this performance.

With these results, during the first half of 2020 industrial activity scored a 14.6% contraction compared to the same period in 2019. The only main sector that managed to grow was food, beverages and tobacco, though scarcely 1%.

Although the lockdown restrictions continued to loosen in the interior of the country in July, in AMBA it was decided to go back to a previous phase in view of the increase in the amount of infections. Therefore we expect a more moderate recovery for this month.

Strong Rebound of Construction in June

– Activity in the construction sector increased 38.2% m/m in June according to the Synthetic Indicator of Construction Activity (ISAC) released by INDEC ─seasonally adjusted series

– The official indicator cut its y/y fall to 14.8%, compared to May’s 48.6% y/y drop

– In line with the evolution of activity, the demand for the main building materials grew again in June: hollow bricks consumption went up 65.3% m/m, while cement increased 16.4% m/m and asphalt 13.1% m/m

– This way, the sector accumulated a 37.8% contraction during the first half of the year

Construction activity gave signs of a better-than-expected recovery in June as quarantine restrictions started loosening up and the sector started resuming its activities. In effect, the ISAC index made by INDEC rose 38.2% m/m in June, after growing 117.9% m/m in May (revised from 99%). Thus, activity was 50.6% over its March records, though it is still below its levels in January and February. As for the official indicator, it cut its y/y fall from 48.6% in May down to 14.8% in June.

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In line with the general index, the demand for the main building materials went up for the second month in a row. Among the materials linked to private works, the use of cement increased 16.4% m/m, finishing 7.3% below its level one year ago. Meanwhile, hollow bricks consumption grew 65.3% m/m, 17.3% over its level in June 2019.

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As for the use of asphalt, linked to public works, it went up 13.1% compared to May, although it is still 65% below its level one year ago, basically because capital expenditure has been the adjustment variable in view of the strong increase in current expenditure, particularly in social benefits.

The data corresponding to formal employment, which is released with a certain lag, accounted for the loss of 7,000 jobs in the sector in May, way below the over 40,000 recorded in April.

All things considered, activity in construction accumulated a 37.8% fall during the first half of the year compared to the same period in 2019, accounting for the strong blow it experienced with the Coronavirus outbreak and the isolation measures to face it.

In July, despite the return to the previous phase of the lockdown in AMBA, activity kept recovering. The Construya index, which records sales of the sector’s lead companies, grew 13.5% m/m in seasonally adjusted terms. In turn, cement shipments grew 2.5% compared to June, according to our own estimations based on the data released by the Chamber of Portland Cement. Sadly, due to the sanitary crisis, INDEC was unable to gather information concerning the granting of permits for new works, a good indicator of activity in the medium run. We must point out that ISAC is still more than 30% away from its November 2017 level.

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The sector’s future looks promising, given that the cost of construction measured in market dollars has gone down. Construction activity emerges as one of the main propellers of the post-pandemic recovery, given its great towing effect on other activities of the economy. Well aware of this, the Government has announced the return of the ProCrear plan, which entails a ARS 25 billion investment for this year. However, referents of the sector seem to be wary, and in ISAC’s latest report over half of them opined activity will go down in the following three months.

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