Argentina
Press Release

Fitch affirms Argentina at 'B'; revises outlook to stable

Bnamericas
Fitch affirms Argentina at 'B'; revises outlook to stable

By Fitch Ratings

Fitch Ratings has affirmed Argentina's long-term foreign-currency issuer default rating (IDR) at 'B' and revised the outlook to stable from positive.

KEY RATING DRIVERS

Argentina's 'B' rating reflects high inflation and economic volatility, a weak albeit improved external liquidity position, and large fiscal and current account deficits implying heavy external borrowing (but from a favorable starting point in terms of leverage). These weaknesses are balanced by structural strengths including high per-capita income, a large and diversified economy, and improved governance scores.

The revision of Argentina's Outlook to Stable from Positive reflects macroeconomic policy frictions and political headwinds that have intensified beyond Fitch's prior expectations, highlighting risks surrounding the gradual policy adjustment process. Fitch expects policy adjustments underway to progress despite recent political noise and market volatility, gradually reducing still high inflation and fiscal imbalances, and supporting a stronger and more stable growth outlook. Nevertheless, recent developments have highlighted the vulnerability of the current policy strategy amid market sentiment and political support.

Slow progress in the disinflation process and monetary policy shifts have highlighted frictions in the current policy framework that have hindered improvement in its credibility. Inflation of 25% in 2017 overshot the 12%-17% target and stood at a similar level as of March, reflecting headwinds including utility rate hikes, peso depreciation, high money supply growth emanating from fiscal pressures, and wage inertia. In December, the government hiked its 2018 and 2019 inflation targets. While this made them more realistic, subsequent policy rate cuts may have dented market sentiment and central bank (BCRA) credibility, and inflation expectations jumped above the new targets.

Since the December policy shift, the BCRA has relied more on containing peso depreciation to contain inflation pressures given its other transmission channels remain weak. Amid a sharp selloff of the peso in recent weeks, this has involved aggressive FX intervention and 12.75 percentage points in hikes to its policy rate to 40%. Fitch expects inflation to decline to 23% in 2018 and 16.5% in 2019, above the targets and the highest in the 'B' category, with additional risk given recent peso depreciation. Wage negotiations pose another key test; so far in 2018 these have involved nominal hikes in line with the executive guidance of 15% but have included clauses that would re-open negotiations in the likely event that inflation exceeds this level, adding uncertainty and inertia to wage dynamics.

The current account deficit reached 4.8% of GDP in 2017, its highest level in decades. The higher CAD reflects the country's reintegration into global capital markets and a rising investment cycle, but less benign trends are also contributing, such as surging outbound tourism that drove the services deficit to a record high. The CAD has been financed primarily via external borrowing, highlighting the vulnerability of the current growth cycle to external shocks. FDI inflows remain relatively low but recovered to historic average levels of 1.9% of GDP in 2017 and could rise further on reform efforts.

Heavy inflows from external borrowing enabled the BCRA to build its reserve holdings to USD64 billion by early 2018, from USD38.4 billion at end-2016, but aggressive FX intervention to prop up the peso in recent weeks amid capital outflows and a resident portfolio shift out of peso assets has brought the stock down to around USD55 billion as of early May. The external liquidity

position has improved but remains weak relative to 'B' peers and in the context of persisting capital account volatility, given a sizeable part of the gains in FX reserves has corresponded to build-up in liquid external liabilities (short-term debt and non-resident holdings of local debt instruments), and a large portion still consists of assets with corresponding FX liabilities (eg the China swap, bank USD reserve requirements).

The Macri administration quickly used its political capital after the 2017 midterms with several legislative victories: a tax reform to boost competitiveness, a cost-saving change to the formula used to calculate pension benefits, and a pact with the provinces to contain spending and resolve complex revenue-sharing issues. Although these successes show improved governance and capacity to advance on unpopular measures in pursuit of sustainable growth, political resistance has recently intensified. Negotiations around measures such as the pension change and utility rate hikes have been resolved with only minor concessions so far. However, Fitch sees limited scope for a much more ambitious pace of adjustment or unpopular reforms.

Fiscal consolidation has emerged as a key policy priority in 2018, after two years in which deficits rose due to measures to preserve social support and reduce distortions that entailed a net fiscal cost. The government originally aimed to lower the central government primary deficit to 3.2% of GDP, from 3.8% in 2017, but recently announced a more ambitious target of 2.7% in response to deteriorating market sentiment. Fitch believes the new target is feasible, assuming subsidy cuts remain on track despite recent political resistance and tax revenue growth remains buoyant. Fitch projects the total general government deficit (consolidating federal and provincial finances, and including BCRA profit transfers) to fall to 5.7% of GDP in 2018 from 6.6% in 2017, still above the 'B' median.

Fitch assumes the government will meet its consolidation goal in 2019, and its pact with the provinces could encourage the spending restraint needed to achieve this. However, risks are on the downside given the absence of a clear multi-year strategy, a smaller subsidy bill to cut, and political headwinds ahead of 2019 elections. The pension formula change could help avoid additional budgetary pressures but is unlikely to lower pensions as a share of GDP given demographics and indexation to higher past inflation. Revenues losses from the tax reform could be offset by gains from growth and formalisation, although this is uncertain.

Having issued USD9 billion in external bonds in January 2018, securing additional financing via repo facilities with foreign banks, the sovereign plans to rely on domestic markets for the remainder of its 2018 financing. However, sovereign external borrowing needs will remain sizeable in the forecast horizon. Fitch projects gross central government debt to rise to 62.9% of GDP in 2018 from an estimated 56.5% in 2017, driven by borrowing as well as real peso depreciation (reversing a trend that had previously flattered the trajectory). At the general government level (federal and provincial debt consolidated with FGS social security holdings), Fitch projects debt to surpass the 'B' median of 61% of GDP in 2018, although remain lower net of 17pp-of-GDP in holdings by the BCRA (easily refinanced). Interest-to-revenues converged with the 'B' median of 9.3% in 2017 and are set to rise above.

Policy improvements, removal of distortions and reforms have put the economy on a more stable, albeit moderate growth path. Fitch projects growth to slow slightly to 2.6% in 2018 from 2.9% in 2017, rather than accelerate as previously expected, due to a drought in the agriculture sector. The underlying trend has been positive, however, with greater dynamism in the private sector balancing gradual retrenchment by the public sector. Nevertheless, risks are to the downside given greater fiscal tightening, peso depreciation and its likely confidence impact, and deteriorating financing conditions that could complicate investment plans.

Fitch projects stronger private investment will support growth around 3% in the coming years, ending an erratic pattern seen in the past decade. Prospects are particularly bright in several sectors due to targeted government efforts, namely infrastructure (via an ambitious pipeline of PPP projects) and energy. The tax reform could boost investment appetite by shifting the burden from businesses to individuals and reducing distortions.

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 adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

Macro Policies and Performance: -1 notch, to reflect a record of macroeconomic instability in terms of growth, inflation, interest rates and the exchange rate, which has not yet been overcome.

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.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to an upgrade are:

--An improved outlook for growth and inflation;

--Consolidation of a more consistent policy framework and progress on reforms;

--Progress on fiscal consolidation and maintenance of favourable sovereign financing access;

--A sustained strengthening of the external liquidity position.

The main factors that could, individually or collectively, lead to a stabilization of the outlook are:

--Fiscal slippage and/or re-emergence of fiscal financing constraints;

--Erosion of international reserves.

KEY ASSUMPTIONS

--Fitch expects the economy of key trading partner Brazil to accelerate moderately in 2018 after returning to positive growth in 2017.

--Fitch expects monetary policy normalisation in the U.S. will proceed gradually, and will not materially impair Argentina's external financing access.

Fitch has affirmed Argentina's ratings as follows:

--Long-Term Foreign-Currency IDR at 'B'; Outlook Stable;

--Long-Term Local-Currency IDR at 'B'; Outlook Stable;

--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'.

Subscribe to the leading business intelligence platform in Latin America with different tools for Providers, Contractors, Operators, Government, Legal, Financial and Insurance industries.

Subscribe to Latin America’s most trusted business intelligence platform.

Other projects

Get key information on thousands of projects in Latin America, from current stage, to capex, related companies, key contacts and more.

  • Project: Field Cheek
  • Current stage: Blurred
  • Updated: 5 hours ago

Other companies

Get key information on thousands of companies in Latin America, from projects, to contacts, shareholders, related news and more.

  • Company: Tepsi S.A.  (Tepsi)
  • The description contained in this profile was taken directly from an official source and has not been edited or modified by BNamericas researchers, but may have been automatical...
  • Company: Programa Nacional de Saneamiento Urbano  (PNSU)
  • The description included in this profile was taken directly from an official source and has not been modified or edited by BNamericas’ content team. However, it may have been au...