SEIDO Special Report: Black Swan

Coronavirus is finally among us, and the government advanced its contingency plan to contain it. Calculating a precise estimation of its incidence on the economy is beyond our skills and knowledge, with so many moving targets. However, we understand that our previous base case scenario is now out of reach. We now believe that:

  • The external shock comes in an untimely moment, overloading the government in the middle of a debt restructuring process. With a weak fiscal position, no access to voluntary financing and a convalescent money demand that is just recovering from 2019 shocks, the space to adopt riskless countercyclical policies is very small.
  • With global growth forecasts quickly marked down, Argentina’s activity outlook is darker. According to a survey of FocusEconomics, 57% of expert panelists consider that the Coronavirus outbreak will have a toll of 0.5pp or more to global growth, in line with revised forecasts from multilateral agencies.
  • Local activity will be affected by this and the likely lockdown, causing sequential contractions in Q2 and, possibly, Q3. Our early thought is that the shock will subtract at least 1.5pp to our previous forecast (1pp from lower exports and 0.5pp from reduced private consumption). Thus, our revised estimate is now -2.5% GDP growth.
  • We believe inflation pressures will resurge sooner than expected in Q2 and Q3, amid supply squeezes and easy money policy and we expect policy reaction to move in the 2011-2015 direction: tighter import and price controls, tariffs freezing, FX anchoring, soft credit and money financing of expansionary fiscal policy. For the time being, we maintain our forecast of 37% inflation by year-end, though note increasing risks to our view.
  • The reaction of developed countries’ central banks may help contain the fall in commodities (as it did in 2009/2010), but trade flows will be affected by slower global growth (2020 is expected to be the year with the lower global growth in 30 years). We revise down our export forecast from USD 67bn to USD 60bn (with downward risks).
  • Fiscal dynamics will be affected by this new scenario, both by lower tax collection and by what will probably be an expansionary policy response. We revise our forecast of primary deficit up to -2.0% of GDP.
  • We used to believe that the government had the tools to avoid a discrete BoP/FX correction before the mid-term elections. The balance of risks is now tilted against that view. For instance, the shock will most likely affect BCRA’s reserves dynamics and thus shorten the time span to renegotiate the public debt. Our previous forecast of USD 12bn of international net reserves, an amount high enough to cover 2020’s foreign law debt service, now looks overly optimistic.
  • Lacking alternatives, the Central Bank will end up acting as lender of last resort. We believe extra monetary financing for the remainder of 2020 will be at least 1.5% from the additional primary deficit, on top of 1.0% since the beginning of the year and what may result after debt restructuring (ex-ante interest and capital payment are 3.6% of GDP, though the final figure depends on the debt management strategy), stressing the already unstable monetary balance.
  • We believe that the risk of “Accidental” or “Strategic” default is now higher. The Covid shock impact lowers Argentina’s capacity to achieve post- restructuring fiscal and external surpluses necessary to service public debt, thus reducing the value of any particular offer to bondholders, and increasing the exit yield. Negotiation setbacks and implementation risks are just two of many possible issues that could derail debt dynamics and end with default.
  • We revise our 2020 EOP BCS Premium upwards, up to 60%, although the final figure depends on whether the government defaults or not on its debt. The shock pressures an already dire financial situation. The typical flight-to-quality response has reversed capital flows to EMs, increased risk premium and depreciated their currencies. The market is likely to continue moving with a “fear over greed” mood in the near future, thus adding extra pressure on debt negotiations.