DBRS Downgrades Republic of Argentina to CCC (high)

DBRS, Inc. (DBRS) has downgraded Argentina’s long-term foreign and local currency issuer ratings to CCC (high) and B (low), respectively. The short-term local currency rating has been downgraded to R-5, while the short-term foreign currency rating has been confirmed at R-5. The Under Review with Negative Implications on the long-term ratings and short-term local currency rating has been removed. The trend on the long-term ratings is Negative, while the trend on short-term ratings is Stable.

The downgrade and Negative trend on Argentina’s long-term ratings reflect the ongoing deterioration in macroeconomic, fiscal and external performance. The 18.6% decline in the peso during the month of January 2014 could help reduce existing imbalances but is only part of a broader set of policy adjustments that are likely needed to stem reserve losses. Real interest rates appear likely to remain negative despite recent hikes, and the fiscal position of the central government has continued to deteriorate.

A failure to adjust fiscal, monetary, wage and other policies to stem Argentina’s reserve losses and curb inflationary pressures could result in further ratings downgrades. Furthermore, although DBRS no longer has the ratings under review, developments in U.S. courts that result in a lifting of the stay on the district court ruling and raise questions regarding upcoming payments on Argentina’s exchange bonds could also trigger a downgrade. Conversely, a strong effort by the government to reduce the fiscal deficit, alleviate inflationary and exchange rate pressures, and improve its relations with external creditors could stabilize the ratings.

Argentina continues to benefit from a diverse economy, an educated population, a highly productive agricultural sector, economic ties with other fast-growing emerging markets, and abundant natural resources. A prolonged period of negative real interest rates has significantly reduced indebtedness, both for the public and the private sector. In the earlier part of the past decade, the central government’s primary fiscal surpluses and high levels of participation in the two debt exchanges also contributed to the rapid decline in indebtedness. The central government’s deficit has widened in recent years, but financing has come from other public entities, such as the social security administration, or ANSES, and the central bank, or BCRA, and net debt remains low. Although limited financial intermediation in the economy acts as a constraint on investment, the low degree of leverage has insulated the Argentine economy from the potentially adverse impact of global financial shocks.

In spite of Argentina’s strengths, the strains from its inconsistent economic policies have become increasingly evident over time. Fiscal and monetary policies have remained highly accommodative even as the economy has operated at or above potential, leading to high and entrenched inflation. Energy subsidies and import substitution policies have amplified Argentina’s challenges, initially generating some positive results in terms of increased local production, but simultaneously undermining incentives to invest in energy production. Argentine firms have become less competitive due to the combination of high local content requirements and real exchange rate appreciation. Following the January devaluation, the central bank increased interest rates sharply. Partly as a result, the economy is likely to fall into recession this year.

The government is likely to slow the pace of reserve losses by deepening controls over the Argentine economy, providing incentives to deposit dollar savings in the local financial system, and increasing export income during the upcoming harvest season. Despite these measures, continued monetization of the fiscal deficit is likely to lead to further reserve losses, and could ultimately jeopardize the repayment of foreign currency debt. Although there appears to be little appetite for fiscal tightening, particularly in the context of a relatively weak economy, the central bank has a limited capacity to finance fiscal deficits without either increasing inflationary pressures or further hiking interest rates. Unless there is a substantial improvement in the external environment, this increasingly costly tradeoff may force the government to rapidly reduce its deficit.

The central government holds significant sway over the economy through wages, subsidies, prices, import licensing, and foreign exchange controls. However, it is unclear how the government will respond to growing economic pressures, and there is a risk that policy missteps will further erode confidence. DBRS believes the authorities have adequate space to make the necessary macroeconomic policy adjustments that would stabilize reserves and help safeguard Argentina’s capacity to repay its external debts. Going forward, it will be important for authorities to devise and communicate a clearer plan for reducing the fiscal deficit, curbing inflation, and expanding the availability of domestic and external financing. Delaying such an effort is likely to be costly in terms of growth and macroeconomic stability.

Notes:
All figures are in Argentine pesos (ARS) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include Ministry of Economy and Finance, Central Bank of the Republic of Argentina, INDEC, BIS, IMF, San Luis Province, Congress of Argentina, UN, the World Bank, U.S. Court of Appeals for the Second Circuit (New York), United States District Court for the Southern District of New York, and various private sector analysts. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance. Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 6 September 2007
Most Recent Rating Update: 30 August 2013