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November 11, 2020

The Week at a Glance

Argentina: An Opportunity for a Consistent Plan

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

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( 17 mins)

Editorial: An Opportunity for a Consistent Plan

The IMF mission that will begin negotiations for a program with Argentina is arriving today. This is the next milestone in the economic agenda. The Government was not able to take advantage of the good sovereign debt restructuring to stabilize the economy. This is their second chance. Making a consistent and long term plan will not erase the errors of the past, but it can build a new beginning. According to the statements of some public officials, Argentina is going to seek an Extended Fund Facility arrangement (EFF) which allows repayment in a term of up to 10 years (it will probably be in 4.5 years), drifting away from the “stand-by” arrangement which is generally only 3 years.

The bread and butter of the agreement must include three elements. First and foremost, a fiscal plan that, in our opinion, must lean toward a primary balance by 2023. Minister Guzmán has already stated that he will soon send a multi-year plan to Congress. Achieving balance in 2023 is not an easy task. Our vision is that after the rebound of activity in 2021 there will not be so much growth ahead as for the deficit to take care of itself. In other words, they will have to lower spending or rise taxes. If the latter is chosen, the risk is something like what happened in 2000: in trying to solve the fiscal issue they ended up mortgaging investment and growth. It is important to note that the emergency law has already raised taxes, including export taxes, wealth, and employer contributions. We do not see much more room for extra taxes. The Argentine economy is already becoming increasingly informal. More taxes will not change this course. Lowering current spending would be the logical thing to do, but it is politically hard, especially in an election year.

The second item is limiting monetary financing. One approach would be to grant some freedom in 2021 and set tougher limits thereafter. This should bolster discipline in order to better access the market. The third key issue will be creating a new monetary policy framework. Perhaps this can be approached in two phases, but we certainly need an anchor. The IMF is probably more comfortable with a devaluation before signing off on the program so as to start with a clean slate, without any devaluing expectations which will ensure a negative start.

The EFF requires concrete structural reforms. This is good and bad at the same time. Good, because Argentina badly needs structural reforms. Bad, because agreements with the authorities do not seem simple. Looking at articles IV of the past or OECD reports, topics such as deregulation, opening the economy, removing the anti-export or anti-investment bias in the tax structure, something to reduce labor conflict, all things that touch nodes of the governing coalition, appear on the reform menu. This year it became more difficult to import, more regulations were imposed, and taxes were raised as a sign of the potential culture shock. But reaching agreements on these issues could increase the potential growth rate of the economy, which until not long ago was thought to be 3% and which Minister Guzman (correctly in our view) places closer to 2%.

In a pandemic context, the IMF’s goodwill is almost guaranteed, but this does not mean that the program will be soft or with many loose ends. Staff and board will not validate something they do not believe in. And, in our view, the change of administration in the United States will not alter the process. Perhaps it will indirectly help with a weaker dollar and stronger commodities.

The Government seeks explicit congressional support. Institutionally this is important, but it risks delaying the process. The opposition will probably not put any spokes in the wheel, it is more a question of securing discipline within the official coalition. Credibility has been one of the weakest links of this government. It is their opportunity to prove they can change, bury some dogmas, and make up for some of the lost time.

What’s coming up this week…

On Thursday 12 INDEC will release inflation numbers for October. Our perspective, in line with the REM (Market Expectations Survey), is that the monthly variation will be 3.2%.

On Thursday, the CB will release its quarterly foreign debt report, which probably fell in the margin.

 

Argentina: An Opportunity for a Consistent Plan 1

 

A Key Day to Clear the Financial Horizon

– The Treasury swapped three bills in pesos for two other securities in dollars that amount to USD 750 million, mainly to provide an exit for foreign funds

– The swap was successful and all USD 750 million were swapped by holders of Ledes with maturity date on December 30, January 29, and February 26; ARS 43 billion in bills were swapped at an implicit exchange rate of 146 pesos per dollar considering the market value of accepted Ledes and swapped bonds, in line with market prices.

– Guzmán claimed that he will not ask for any more temporary advances from the CB, but our estimations indicate he will need assistance of around ARS 350 billion in the shape of dividends

– The money supply is still almost 20% over its average from the past 15 years; in October, the stock of private M2 adjusted by the activity level put an end to its decline and stood stable compared to September

– The private sector’s sight deposits grew 5.8% in the las 30 days, while term deposits fell 6.6%

 

Argentina: An Opportunity for a Consistent Plan 2

Yesterday was another “D” Day for the Guzmán administration. “Debt” Day, that is. With only one auction, the Government sought to kill two birds with one stone: clear maturities for the next few months through the swap of short-term bills and extending the “exchange calm” from last week, providing an exit for foreign funds that were stuck in pesos and put additional pressure on the financial dollar.

Aimed at refinancing short-term maturities and alleviating pressure in the exchange market, the Treasury offered to swap seven bills issued in pesos for another two securities in dollars worth USD 750 million. For the first time since the debt restructuring under foreign law was closed, hard dollar bonds were auctioned with their maturity set for July 2030 and July 2035 (AL30 and AL35), which can be integrated in pesos, mainly to provide an exit for foreign funds such as PIMCO and Templeton, who put extra pressure on the blue chip swap.

Out of the seven bonds that could take part in the swap, three matured before the end of the year and another three during Q1-2020. However, out of the three bills that matured in December, scarcely USD 396 million Ledes 12-30-20 were swapped, despite receiving swap offers for the three of them for a total of almost USD 2 billion. Out of the seven instruments that were part of the swap, only three of them were allocated (Ledes 01-29-21 for USD 267 million and Ledes 02-26-21 for USD 88 million). ARS 43 billion in bills were swapped, at an implicit exchange rate of around 146 pesos per dollar.

 

Argentina: An Opportunity for a Consistent Plan 3

 

This was a good deal for the funds since their exit price would have been higher if they had waited for the maturities to exit, because that would have put extra pressure on the blue-chip swap. For Guzmán, this means further dollarizing the debt, but he defused a pressure point on the dollar and alleviates issuance needs by ARS 43 billion over the coming months.

Although Guzmán announced he will not ask the Central Bank for any more temporary advances and that they will use the market’s liquidity advantageously to refinance the debt and cover the fiscal deficit, they will surely require extra funding from the CB in the shape of dividends in order to cover the financial needs in November and December. We estimate that the Government will be able to obtain between 450 and 500 billion pesos in the market (without ruling out what they got in yestaerday’s auction), which means they will need about 350 billion extra pesos in funding. Discarding non-transferred, capitalized 2019 profits, the CB still has about ARS 400 billion to Transfer to the Treasury. Just like with temporary advances, the profits transfer to the CB also involves issuing money. So far this year, the net assistance from the CB to the Treasury has risen to ARS 1.6 billion, with an accumulated fiscal deficit worth ARS 1.8 billion.

The Government has announced three other auctions for the rest of November, which will play a key role in continuing with the maturities renewal and obtaining net financing, but they will also absorb part of the excess pesos and take pressure away from the spread. The magnitude of the monetary imbalance is such that the money supply is still almost 20% over its average in the past 15 years. The stock of private M2 adjusted by the activity level, which was falling rapidly after peaking in April due to the lockdown, remained stable in October according to our estimations.

 

Argentina: An Opportunity for a Consistent Plan 4

 

The private sector’s sight deposits regained dynamism and are growing at a 5.8% rate in the last 30 days, while time deposits dropped 6.6%. It feels like the interest rate is not that attractive in view of the escalating inflation. It also seems that money has been moving faster. Cash held by the public is falling in real terms in the last two months.

The main obstacle for the Government’s financing ambitions is that the private sector is not fancying fixed-rate or variable-rate instruments in pesos adjusted by the Badlar rate. During last Tuesday’s auction, during which two bills were auctioned at a variable rate plus some margin, scarcely over ARS 10 billion were sold, with offers from both the private and public sector. Therefore, the Treasury has two options: to either continue indexing their new debt or increase rates. A first step in the right direction would be to start by validating the secondary market rates in the coming auctions.

 

Manufacturing Proudly Shows Its First Year-on-Year Growth in 9 Months

– The Manufacturing Industrial Production Index grew 3.4% y/y in September, helped by the low comparison basis

– In m/m terms, the seasonally adjusted series increased 4.3% and production is already 2.1% below February, the last normal month before Covid-19

– Most main sectors managed to grow: “Furniture and Other Manufacturing Industries” (18% y/y), “Other Equipment, Devices and Instruments (9.8% y/y), and “Metal Products, Machinery, and Equipment” (7.5% y/y) recorded the greatest rises

– Cumulative until September, industrial production cut its fall to 10.8% compared to the same period in 2019

 

Argentina: An Opportunity for a Consistent Plan 5

“I might trip, I never fall.” That was the industrial production’s motto in September. After pausing its recovery in August, the manufacturing IPI grew 4.3% monthly ─seasonally adjusted─ in September and was 2.1% below February’s level, before the quarantine began. The official indicator has managed to grow in y/y terms for the first time since December 2019, 3.4%, although this rise should be taken with a pinch of salt since its distorted by a low comparison basis (industrial production in September 2019 was the lowest that year, according to INDEC’s seasonally adjusted series).

Seven out of the nine main sectors comprised by the indicator displayed y/y growth. The sector with the greatest rise was “Furniture and Other Manufacturing Industries” (18.0%), though its contribution to the general index was limited due to its low relative weight. Boosted by wine production, the sector with the greatest positive contribution to the manufacturing IPI was “Food, Beverage, and Tobacco” (6.1%y/y), although it had a lower y/y growth. In a year in which most of the products surveyed by the index plummeted, wine production managed to score a stunning 28.8% y/y growth.

 

Argentina: An Opportunity for a Consistent Plan 6

 

As for the petrochemical sector (+7.4% y/y), it also made a great contribution to the general index, favored by a low comparison bases in chemical product and by the greater demand for cleaning and personal hygiene products derived from the pandemic. In contrast, oil activity went against the general index due to the lower fuel demand considering the imposed restrictions on mobility.

“Metal Products, Machinery, and Equipment” (7.5% y/y) was boosted by the production of farming machinery, which grew 62.7% y/y in September and accumulated a 31.1% growth so far this year compared to the same period in 2019. This sector’s sales have been stimulated by the considerable FX spread, as a means of protection in view of a potential devaluation. As for “Wood, Paper, Publishing, and Printing” (6.8% y/y) and “Other Equipment, Devices and Instruments” (9.8% y/y), these two sectors also stood at higher levels than the ones in September 2019.

Argentina: An Opportunity for a Consistent Plan 7

 

Just like we forecasted last month, production in the automotive sector recovered 5.3% y/y after seven consecutive months on decline. According to our estimations, the “Vehicles, Autos, Bodywork, Trailers, and Auto parts” increased 25.3% m/m in seasonally-adjusted terms. Due to the stock renewal effect, we expect a drop in this sector. According to ADEFA, 28,706 units were manufactured last month, which means an 11.2% monthly fall seasonally adjusted and a 9.8% y/y drop.

Conversely, the textile industry fell the hardest (20.6% y/y) and was the most affected by the pandemic and the lockdown: it accumulated a 33.5% y/y fall until September. As for the “Non-Metallic Minerals and Basic Metals” sector, it fell 7.0% y/y, but it has been rebounding in view of the greater demand of the construction sector, which also grew in September.

Argentina: An Opportunity for a Consistent Plan 8

With these results, industry accumulated a 10.8% fall during the first nine months of the year compared to the same period in 2019.

For October, we expect industrial activity to carry on with its recovery, although it will not be as favored by a low y/y comparison basis. Industrial electric consumption, a proxy indicator for production, went up 2.8% m/m ─seasonally adjusted─, while the demand for building supplies in the construction sector keeps growing.

 

Construction Improved in September

– Construction activity recorded a seasonally adjusted 3.9% monthly rise which corrected the 1.1% drop in August

– The official indicator cut its y/y contraction to 3.9% in September, its smallest fall since July 2019

– Between August and September, the demand for cement grew 5.5%, but the demand for hollow brick dropped 1.6%; asphalt, which is linked to public works, is keeping its momentum (8%); cement shipments again grew marginally in October

– For the first time since March 2018, the amount of businesspeople in construction who believe activity will increase in the next quarter (24%) is greater than those who think it will drop (22%)

 

Argentina: An Opportunity for a Consistent Plan 9

Construction gained momentum in September after stumbling the previous month. It had already recovered its summer levels in July, but it halted in August, partly due to the stability in the stocks of building supplies after the end of the strict lockdown. With more lax restrictions, a high but not yet out-of-control spread and that encouraged purchasing materials and various support measures from the State helped the sector grow 3.9% during the month according to the seasonally adjusted series of the Synthetic Indicator of Construction Activity (ISAC in Spanish) released by INDEC. Despite it being at greater levels than January and February, the y/y comparison showed a 3.9% decrease. However, this was the lowest fall recorded since July 2019.

Argentina: An Opportunity for a Consistent Plan 10

After an uneven August, the demand for several building supplies rose. Among the most important ones for private works, the use of cement went up 5.5% during the month and was 10.5% greater than September 2019. Hollow bricks consumption decelerated 1.6% during the same period but was 24.3% over one year ago. These figures meant the first y/y increase for cement in 14 months, while hollow bricks show positive variations since June. In addition, various materials which had decreased in usage the previous month, such as lime, plaster, flooring, coating, and ceramics grew in September.

The use of asphalt, linked to public works, grows slowly but steadily. This supply has been recording monthly rises around 8.0% since June and September was no different. Nevertheless, given the magnitude of the adjustment in capital expenditure started by the previous Government and deepened by the quarantine, this improvement implies that asphalt consumption is still very low, 22.9% below one year ago.

 

Argentina: An Opportunity for a Consistent Plan 11

 

Between January and September 2020, construction accumulated a 28.6% rise compared to the same period in 2019. If it stays on the recovery track, this year’s slump will be less than 2002 (28.3%), although it will stand out as one of the worst records in recent history.

The big construction companies are catching a glimpse of the light at the end of the tunnel. For the first time in 30 months, positive expectations (24%) regarding private activity for the coming quarter surpassed negative ones (22%) according to the qualitative construction survey carried out by INDEC. Anyhow, over half of businesspeople believe the situation will hold steady. Regarding employment, 18% of the surveyed believe that hiring will go up, while 16% estimate that layoffs will continue, and the vast majority do not foresee any changes in the level of employed personnel in the short term.

Registered employment showed a slight recovery. INDEC’s data, which are published with a one-month delay, reveal that 5,000 construction jobs were created in August. This is a minor figure considering the 55,000 formal jobs lost since February, but it accounts for a change of trend after several months. The Labor Indicators Survey (EIL in Spanish) carried out by the Ministry of Labor anticipated a new increase in September, just like we mentioned in our previous weekly report. Given the high level of informality in the sector, these values do not paint the full picture of the labor situation.

Some FX spread provides an incentive, but too much spread poses a difficulty. According to the Portland Cement Manufacturers Association, shipments grew 1.7% last month and reached their peak since April 2018.

During the first days of November, the exchange rate with the dollar appeared calmer and the Government decreed the official end of the quarantine. Thus, construction appears as a great candidate to be one of the propellers of the post-pandemic recovery since construction costs measured in alternative dollar rates are among the lowest in history.

More by Miguel A. Kiguel, Andrés Borenstein, Lorena Giorgio, Rafael Aguilar, Isaías Marini