Courtesy of ZeroHedge. View original post here.
“Today is a historic day. It’s the changing of an era.”
That’s what Mauricio Macri, the son of Italian-born construction tycoon Francesco Macri, told thousands of supporters on Sunday after winning the Presidency in a landmark election in Argentina. As Reuters notes, Macri, a conservative who served two terms as mayor of Buenos Aires, will become only the third non-Peronist President since the end of military rule more than three decades ago.
("Yes. Just… yes.")
The defeat of ruling party candidate Daniel Scioli is “seen as a rejection of departing leader Cristina Kirchner’s interventionist economic policies and a turn to the right after 12 years of leftist rule,” WSJ said on Monday. “There has never been a period in government with such tangible economic progress,” Kirchner lamented, adding that “it would be painful to see these achievements being eroded.”
("Wait, what?")
But voters apparently did not agree. High inflation, falling FX reserves, and a legacy of defaults cast a long shadow and in a testament to just how ready the market was to see a voter repudiation of Kirchner and her policies, a bevy of hedge funds racked up outsized gains starting late last month as the market cheered a strong showing in the Oct. 25 first-round election by Macri. Here’s Goldman’s take on what the new President will be forced to confront:
There are four main economic challenges facing the next administration: (1) the large fiscal deficit; (2) elevated inflation; (3) exchange rate overvaluation and unwinding of capital controls; and (4) a normalization of external debt conditions. But in spite of this categorization, these issues will have to be addressed together due to their tight interconnectedness. Moreover, advancing solely in one front could lead to further deterioration on the others.
Yes a “large fiscal deficit,” and by “large” Goldman means 7%. That’s a marked deterioration from the 2.2% surplus the country ran just ten years ago.
As for inflation, well, Goldman says it’s likely to “soon resume its rise” after falling to “just” 24% Y/Y in September.
“They gave me a raise in January, but the costs nearly doubled,” one voter said. “Yesterday I went to buy bread and it rose 20% from last week.”
Macri will also need to address the exchange rate. As WSJ reminds us, Kirchner “encouraged the sale of U.S. dollar derivatives by the central bank to contain rising demand for greenbacks,” but Macri says that strategy will likely cost Argentina “billions.” He “proposes a rapid lifting of most exchange rate restrictions to achieve a unified exchange rate that he expects would stabilize between the official and parallel parities (9.60 and 15.50 ARS/USD, respectively),” Goldman adds. But as The Australian wrote this morning, Macri's promise to lift controls on USD purchases and thus eliminate the black market for FX "would likely lead to a sharp devaluation of the Argentine peso [and] with low foreign reserves, the government would desperately need an immediate infusion of dollars."
While the new President vows to eliminate poverty and help ensure that all citizens “can aspire to have homes with running water and a sewage system,” some voters who remember Macri’s tenure as mayor of Buenos Aires are fearful of what a shift away from the Left could mean. “Teachers in the capital went through a lot of suffering,” she said. “We had to stage a very tough fight to secure wage increases. He thinks we are ranch hands,” Buenos Aires schoolteacher Laura Lemes told The Journal.
And then there is of course of the default "problem" which Macri intends to solve. Here's Bloomberg:
In the 14 years since the country carried out the biggest default the world had ever seen, international investors watched an economy that had long been one of their favorites turn into a pariah in global capital markets. Under the Kirchners — first Nestor and then his wife, Cristina — Argentina became best known for its byzantine foreign-exchange system, the seizure of privately-owned assets and the under-reporting of inflation.
Investor excitement is tangible, a rarity nowadays in a region that’s suddenly fallen out of favor. Companies, including Germany’s BayWa AG and Brazil’s BRF SA, are prepping to expand their presence in the country and Argentina’s benchmark stock index soared 30 percent in the past three months as traders anticipated a Macri victory. Even the country’s defaulted debt — the government fell back into default last year on legal grounds stemming from the 2001 debacle — has been rallying, with prices on benchmark bonds climbing well over par value. Eager to reinsert the country in foreign markets, Macri has said that settling the old debts will be a top priority after he’s sworn in as president on Dec. 10.
With 98 percent of the ballots counted, Argentine bonds extended their rally. The benchmark securities due in 2033 gained to a price — which includes interest owed since last year’s default — of 114 cents on the dollar, an eight-year high.
As Bloomberg goes on to note, "there’s no shortage of big-name investors — George Soros, Daniel Loeb and Richard Perry, to name a few — betting on Macri to successfully resolving the debt dispute and regaining access to international credit markets." A big part of putting the 2001 default (a $95 billion fiasco) in the rearview will be resolving a dispute with Paul Singer, who was seen by the Kirchners as a "vulture."
Below, find some further color from sell-side desks.
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From Citi
At the time of writing and with 99.1% of the voting stations already counted, Mauricio Macri is Argentina’s new President Elect, after obtaining 51.4% of the votes in the November 22 second round. While Macri’s victory should not be a surprise, he won by a narrower margin than expected.
We are concerned the narrow victory may limit Macri’s room to deliver a series of much needed adjustments. The next administration will need to adjust FX, monetary and fiscal policy, in a context of an economy that is already contracting and seems to be heading to a new recession.
Strategy – Argentina bonds have rallied considerably in anticipation of a resolution of the long-standing holdouts conflict and a potential Macri victory. After the election, we think that spreads could move tighter yet most of the upside is behind us.
The most urgent challenge on the economic front is the FX policy, we believe. Over the last few weeks, the Central Bank of Argentina (BCRA) has tightened the FX controls faced by importers, has increased interest rates and has announced that the local banks will have to sell a fraction of their foreign currency denominated assets. The fact that the BCRA has been undertaking all these measures ahead of the second round reveals that the current FX policy is becoming increasingly difficult to sustain. According to an article (which had a great level of detail) from the local newspaper La Nación (see “Afirman que las reservas del Banco Central entraron en un punto muy crítico”), the BCRA has USD25.9bn of foreign currency liabilities. Thus, the non-borrowed reserves are none, roughly speaking.
The challenge on the FX front is twofold. On the one hand, the ARS is grossly overvalued. On the other hand, there is a clear monetary imbalance. Regarding the real overvaluation of the ARS, we estimate that real effective exchange rate has dropped (appreciated) 44% since 2011. Thus, for Argentina to have the same REER than four years ago, the USDARS should stand at 17. A different approach would be to compare the evolution of the real exchange rate vis-à-vis the USD in Argentina and other countries in the region. While the LatAm currencies (BRL, CLP, COP, MXN, PEN and UYU) real exchange rates relative to the USD have increased on average 36% since 2011, the USDARS has dropped 19% in real terms. Thus, from this point of view, the USDARS should stand 68% higher at 16.1.
On the monetary front, the next administration will need to deal with a monetary overhang – i.e, an excess of local currency. The monetary overhang puts pressure on the FX market, as people try to get rid of an excess of pesos by purchasing foreign currency – that is the reason why Argentina has FX controls, to prevent this from happening.
There is also a flows problem. Besides the accumulated stock of trapped pesos, money printing is out of control. This is the first time that a marked increase in BCRA’s interventions in the FX market has not led to a deceleration in money printing (Figure 5). As shown below, money printing remains unabated, with the M0 increasing at a rate slightly above 35%. Basically, this means that despite that the BCRA is absorbing pesos by selling foreign currency, the other sources of money printing have increased.
From BofAML
We see potential for a significant policy shift after this Sunday election, following 12 years of a Kirchner-led government. In our view, the incoming government has an opportunity to bring Argentina back to a sustainable growth path after years of inward policies, distortionary regulations, financial repression and capital controls.
We expect the next administration to remove capital controls and some inefficient regulations, while implementing a strong FX and fiscal adjustment to restore debt sustainability. We forecast true growth at only 0.7% in 2016, due to the fiscal contraction, the crisis in Brazil and lower commodity prices. But we expect growth to rebound to 3.6% in 2017 amid a confidence shock due to the policy shift and the return to international capital markets.
We expect the next administration to remove most capital controls within a year. The government will likely move faster to remove restrictions on dollars allocated for production (capital and inputs) and slower on stocks (arrears with importers of up to $9bn and remittances of trapped dividends for about $7bn at current FX). While we also expect restrictions on dollars to be removed for savers and tourism eventually, we would not be surprised if the government keeps some restrictions on these for a while if the financial situation is worse than expected. In this sense, the large negative position of the Central Bank in the FX futures market generate incentives to postpone a full FX-unification before the future contracts mature, to avoid realizing quasi-fiscal losses.
To stop the drain of international reserves, we expect the central bank to allow a strong depreciation of the official FX. We forecast the official FX at ARS13 and 16 by yearends 2015 and 2016, respectively. To improve the FX flow rapidly, we expect the government will negotiate with exporters the reduction of grain stocks, which we estimate at $4bn, offering a higher FX, elimination of export permits and an export tax cut of about 0.4% of GDP. Fiscal. The fiscal consolidation is a pre-condition to generate a confidence shock to stimulate investment and stabilize inflation and FX expectations, in our view. We expect the next government to reduce the fiscal deficit from our estimated 7.3% of GDP in 2015 to 4.3% by the end of the 2017, mostly by cutting subsidies by about 2% of GDP in stages in 2016 (see The fiscal gift). We estimate the government could also reduce the fiscal deficit by another 1.4% of GDP in two years, keeping the spending pace below GDP growth and cutting capex, more than offsetting a tax cut to exporters of about 0.4% of GDP.
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The bottom line, as Jody LaNasa, the founder of the $1.5 billion hedge fund Serengeti Asset Management, told Bloomberg: "The question is whether this is going to be something like the rebirth of Argentina or another failed dream that people get excited about, but then they can’t overcome the challenges.”
