[Monetary and FX] Forex market remains under stress. The BCS premium increased to 86% this week, reaching new highs since capital controls were imposed and also surpassing records of the previous episode (2011-15 had a maximum premium of 82%). The central bank maintains a slowly increasing crawling peg, which seems unsustainable with a premium rising to pre-1990s records.
Meanwhile, the volume traded in the official FX market decreases to historical lows, Central Bank continues to sell in Spot and Futures FX markets and net reserves are now below USD 10bn. We estimate that, from Monday to Thursday this week, CB sold around USD 140m. Net reserves are now 9.5bn or 1.3bn less than one month ago. Additionally, we also estimate that CB has sold USD Futures in the ROFEX market. We understand that CB’s total position in the ROFEX market is still less than USD 2bn, but growing at a significant pace.
[Debt & Markets] The government’s debt exchange offer was turned down, as expected. Though official numbers were not released, market information points to less than 20%. Thus. Though the offer was rejected, the deadline extension was well received. Bond prices increased, signaling expectations of a better offer.
Phase two of debt negotiations is underway, with both sides claiming they want to reach an agreement. The government now expects bondholders to submit a proposal, which they will consider only if it meets the “sustainability objective”. We speculate that the government is willing to improve the offer and close a deal, but the tight schedule (Global bonds’ grace period ends on May 22nd) and differences between negotiating parties keep the “default scenario” as a real possibility. Rumors are that if the NPV of the offer increases to somewhere close to USD 55, an agreement might be reached.
[Activity] April’s early data suggests a collapse in activity, Released data so far points down, and we expect GDP to fall as much as -20% YoY in April, in line with expectations. However, considering the extension of the lockdown and the severity of the damage it is imposing, we revise down our 2020 GDP forecast to -8.5 (from -6.6%)
[Prices] Inflation slowed down in April to 1.5%, through all categories, in line with our estimates. For May we expect an inflation printing around 1.5% MoM, with downside riskFX Spot interventions and Net reserves
FX Spot interventions and Net reserves
[Monetary and FX]
Forex market remains under stress. The BCS premium increased to 86% this week, reaching new highs since capital controls were imposed and also surpassing records of the previous episode (2011-15 had a maximum premium of 82%). New regulations try to curtail demand for both the official and alternative FX rates, but have proven (so far) ineffective. Monetary imbalances are prevailing and spilling over to the forex market, thus impacting on the BCS premium. The central bank maintains a slowly increasing crawling peg, which seems unsustainable with a premium rising to pre-1990s records.
Blue Chip Swap Premium
The volume traded in the official FX market decreases to historical lows. During this week, the daily average traded amount in the official FX market was USD 171m compared with USD 790m the same week a year ago. These atypical values for May show that the official FX market is less important since the implementation of the capital controls and continues to reduce its traded volume as the FX premium widens.
Official FX market – Total volume
Central Bank continues to sell USD and net reserves are now below USD 10bn. After a short period at the beginning of May when CB purchased FX, the BCRA has continued to sell both in the spot and futures FX markets. Despite the low traded volume, we estimate that between Monday and Thursday this week, CB has sold around USD 140m. Net reserves are now around 9.5bn or 1.3bn less than one month ago. Additionally, we understand that CB has also intervened in ROFEX Futures given an atypical increase in the open interest with almost no change in prices. We believe that CB’s total position in the ROFEX market is still less than USD 2bn, however, we also think that’s growing at a significant pace. Net purchases and Net reserves
[Debt & markets]
The government’s debt exchange offer was turned down, as expected. The aggressiveness of the offer (an NPV of about USD 35) was not well received, and bondholder acceptance (especially between external creditors) was low. Though official numbers were not released, market information points to less than 20%. Thus, the first phase of negotiations ended up with a sound defeat for the government.
Phase two of negotiations is underway, with both sides claiming they want to reach an agreement. The government now expects bondholders to submit a proposal, which they will consider only if it meets the “sustainability objective”. We speculate that the government is willing to improve the offer and close a deal, but the tight schedule (Global bonds’ grace period ends on May 22nd) and differences between negotiating parties keep the “default scenario” as a real possibility. Rumors are that if the NPV of the offer increases to somewhere close to USD 55, an agreement might be reached.
What can the government offer to increase bondholder acceptance? We simulated some alternatives that, while maintaining the same term structure as the original proposal, could increase USD 10 or more the NPV of the securities offered (see table).
Possible improvements to the government’s debt offer
Would an offer improvement prove costly? We also compared changes to the debt profile: the original proposal would save the Treasury about USD 55bn until 2030 (and USD 20bn until 2050), while the simulated alternatives would imply savings of USD 43bn (USD 2bn). By increasing the NPV of the offer, Alberto Fernández can avoid a default and still obtain significant cash-flow relief during his term. This reinforces our view that there is still time to steer the ship away from the iceberg.
Changes of Debt Profile: Original proposal vs Alternative simulation
Though the offer was rejected, the deadline extension was well received. Bond prices increased, signaling expectations of a better deal (for creditors). Thus, the risk premium (EMBI) decreased to 3,104bps (-215 bps since last Friday), consolidating the downward trend since the offer was released.
Argentina’s Risk Premium (EMBI)
[Activity]
April’s early data suggests a collapse in activity. Released data so far points down (see table), and we expect GDP to fall as much as -20% YoY in April. Considering the extension of the lockdown and the severity of the damage it is imposing, we revise our 2020 GDP forecast to -8.5 (from -6.6%). Even with this revision risks are biased downwards, as the lockdown could be reinforced if “the contagion curve does not flatten” and if the Covid-19 shock proves less temporary than expected. Closed firms might not be able to reopen, workers might remain unemployed for a longer period and productivity might not recover from the shock. For instance, LatinFocus reports that analysts are increasingly expecting the global economy to contract sharply in 2020 and then move to a U-shaped recovery.
Selected activity indicators
Construction activity is falling dramatically. The Construya index (a private estimate of the sector activity) fell -74.3% YoY and -59.1% MoM (seasonally adjusted) in April. Like most other sectors, construction was already falling when the pandemic outbreak begun, shown by the fact that on February the sector employed 19.2% less workers than on 2019. At 74.1 points, the index is below the minimums of 2002 and at under a fifth of the peak reached in late 2017.
Construya index (seasonally adjusted)
Industry worked at almost half its capacity during March. The Use of Industrial Capacity index stood at 51.6% on March (-7.2pp YoY), reaching the lowest level of the series. Essential activities such as Food and Drinks were not much affected by the initial phase of the lockdown, though they still operated with ample capacity (UCI index at 55.6%, virtually the same level than a year ago). Other sectors were not that fortunate. For instance, Textiles operated at 28.7% of capacity (-21pp), Automotive production at 25.9% (-9pp) and Metal production at 58.5% (-16pp).
Output decline is generalized, with heterogeneity across sectors. Manufacturing production dropped -16.8% YoY, with all 16 industrial blocs with figures in red. However, four blocs, which represent 50% of manufacturing output, registered one-digit declines as their activities were exempt from the lockdown. The other 12 blocs presented declines in the range -20/-40% YoY. April’s outlook looks even worse than March, as the lockdown extended through the entire month.
Manufacturing production – Annual variation and Share of total (in parenthesis)
Economic activity is trying to reinitiate, slowly. Apple reports show that mobility in Argentina stands at 30% of early-2020 baseline level. Aggregate data shows that lockdown enforcement is decreasing gradually (as of May 10th, mobility increased 5.6pp WoW and 14.9pp MoM), as more activities were exempted (also, people could be showing signs of “lockdown fatigue”). Nationwide electricity demand points to the same direction, having dropped about -10% YoY in April (with lows of even -15% YoY) and recovering slightly to -6% YoY in early-May.
Electricity Demand – Annual variation (7-day moving average and monthly average)
Share of total rejected not paid checks are higher than in the 2002 crisis. In April, the share of rejected not paid checks reached 8.8% of the total cleared. This register is higher than the one of the 2002 crisis when total rejected checks (which include not paid checks and differed) reached 8.7%.
Total rejected and Rejected – Not paid checks as a % of total cleared
[Prices]
Inflation slowed down, in line with our estimates. INDEC reported that inflation dropped from 3.3% MoM in March to 1.5% MoM in April. Inflation rate was exactly the same as we calculated (see Seido High Frequency CPI) but below market expectations (2.3% according to the latest REM). It should be noted that INDEC could only survey 77.5% of regular information, relying more on non-presential data collection methods (70.4% vs 7.1%). This could have introduced some noise on the official CPI, which showed an annual variation of 45.6% (vs 48.4% of previous month). For May we expect an inflation printing around 1.5% MoM.
Monthly Inflation by items
Inflation slowed down through all categories. Seasonal items showed the least deceleration, moving from 4.9% MoM in March to 4.8% MoM in April, while Core inflation decelerated from 3.1% MoM to 1.7% MoM. On the other hand, regulated prices dropped -0.7% MoM last month, after an increase of 3.3% MoM in March. This was due to price reductions in Communications (-2.9% MoM) and Education (-2.2%) and the “freezing” of other relevant items, such as private medical plans (0%) and public transportation (0.4%).
Our own data also shows a slowdown in inflation in April. Observing the distribution of price increases, we find that 44% of our monitored prices decreased (!), while 21% of them increased less than 1%, 11% increased 1-2% and 2-4% and 13% increased 4% or more. As we mentioned in previous reports, the distribution of price variations has changed in the last two weeks, in favor of minor increases (see graph below).
Inflation slowdown might prove temporary. Several factors explain current dynamic: (1) many prices have not changed or could not be surveyed due to the lockdown (closed businesses); (2) prices have decreased due to a substantial drop in household income; (3) regulated prices incidence remains minimal; and (4) depreciation of the official FX rate was relatively low. Of these factors, we still highlight the FX channel as critical for inflation dynamic. If the BCRA depreciates the FX rate (voluntarily or not), that will move inflation out of its current trend. In this regard, worrying signs are accumulating, as the BCS premium is increasing to record levels and the Central Bank is losing international reserves.
