DBRS Downgrades Republic of Argentina to Selective Default on Short-Term Debt

DBRS, Inc (DBRS) downgraded the Republic of Argentina’s Long-Term Foreign and Local Currency – Issuer Ratings from B/B (high) to CC. At the same time, DBRS downgraded the Short-Term Foreign and Local Currency – Issuer Ratings to Selective Default (SD). The Long-Term Foreign and Local Currency – Issuer Ratings have also been placed Under Review with Negative implications (URN).

KEY RATING CONSIDERATIONS

The downgrade to SD follows Argentina’s announcement on August 28 that the government would seek an extension of maturities on a range of debt instruments. Details released on August 29 and 30 indicate that the rescheduling will apply to Argentina’s short-term local debt, both peso- and dollar-denominated. It includes a partial deferment of payments on short-term instruments, including some that mature on August 30. This deferment of payments meets DBRS’s definition of default; consequently, the Short-Term ratings have been downgraded to SD. The authorities also announced that they will subsequently launch a “voluntary” debt swap to extend maturities on additional longer-term securities maturing within the next ten years. This expected change in duration combined with the implicit threat of nonpayment if creditors do not participate in the exchange is also likely to meet DBRS’s definition of default, but the terms and timing of the exchange are not yet clear. Consequently, the Long-Term Issuer Ratings have been downgraded to CC and have been placed Under Review with Negative Implications.

Assuming this rescheduling is sufficient to keep Argentina’s IMF program on track (particularly the $5.4 billion September disbursement) and to alleviate near-term financing requirements, Argentina’s outlook is nonetheless expected to remain challenging in the wake of the recent election results and exchange rate pressures. The loss of confidence in the peso, unless reversed quickly, will increase risks to debt sustainability given the high levels of foreign currency debt. IMF forecasts are expected to be revised with material adverse effects on growth forecasts, inflation and on public debt, though the devaluation should reduce somewhat the current account deficit and a sizeable portion of federal government debt is in the hands of other public sector entities. The “Debt and Liquidity”and “Political Environment” Building Blocks are the primary factors contributing to the deterioration in Argentina’s credit fundamentals.

Primary election results from August 11 suggest that the opposition candidate, Alberto Fernandez, is likely to win the general election on October 27. The prospect of a Fernandez victory has increased policy uncertainty, particularly given the track record of his running mate, former President Cristina Fernandez. The market reaction has weakened the peso significantly (down 21.8% in the three weeks since the election), increased spreads significantly, and caused the stock market to plummet. If elected, DBRS expects Fernandez to have limited policy and financing flexibility. In the days following the primary elections, Fernandez signaled that efforts to gradually lower inflation will remain a priority in his administration. Nonetheless, Fernandez has openly questioned the affordability of Argentina’s foreign currency debts, particularly the payments coming due to the IMF during 2021-23. Fernandez’s policy agenda remains unclear, but the return of a less orthodox approach to monetary and fiscal policy would complicate relations with the IMF and could further undermine Argentina’s medium-term prospects.

Political uncertainty has increased, limiting near-term policy options. A Macri victory in the presidential election cannot be entirely ruled out, but appears unlikely. A Fernandez administration may be willing to maintain fiscal discipline in support of the central bank’s disinflationary policies. Nonetheless, risks of prolonged market and exchange rate turmoil have increased since DBRS’s June review. Regardless of who wins, the incoming administration is likely to face persistent inflationary pressures amid a weak economic environment and may struggle to obtain new financing in the absence of continued close engagement with the IMF. A voluntary rescheduling should alleviate the short-term pressures on the exchange rate, but DBRS expects volatile conditions to persist through the election period and subsequent transition. Pressure on Argentina’s foreign exchange reserves may persist, as subsequent negotiations over a new program or precautionary arrangement may take many months. In the absence of continued engagement from the IMF and a well-designed macroeconomic adjustment program, DBRS sees continued risks to debt sustainability in the medium-term.

RATING DRIVERS

The Long-Term Foreign and Local Currency – Issuer Ratings are likely to be downgraded to Selective Default (SD), if Argentina compels creditors to extend maturities or risk non-payment. Otherwise, downward pressure on the ratings could emerge if (1) fiscal or monetary policy discipline weakens considerably in the lead up to or following any change in administration; or (2) the incoming government proves unwilling to make policy commitments similar to those agreed under the current IMF program, generating continued market pressures and limiting the availability of non-inflationary financing heading into 2020 and 2021.

A stabilization of the ratings will likely hinge on the administration’s commitment to (1) preserve fiscal policy discipline; and (2) maintain the main pillars of the existing macroeconomic program, for example through passage of the law on central bank independence.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the B (high) – B (low) range. Additional considerations factoring into the Rating Committee decision included the announced reprofiling of Argentina’s debt obligations and near-term external liquidity position. The main points discussed during the Rating Committee include Argentina’s primary election results, implications of exchange rate dynamics for domestic inflation, external financing requirements, the IMF program and risks to future disbursements, and the potential implications of policy uncertainty through the presidential election and transition period.

KEY INDICATORS

Fiscal Balance (% GDP): -5.0 (2018); -2.7 (2019F); -1.5 (2020F)
Gross Debt (% GDP): 86.0 (2018); 75.9 (2019F); 69.0 (2020F)
Nominal GDP (USD billions): 538.1 (2018); 477.7 (2019F); 515.4 (2020F)
GDP per capita (USD thousands): 11.7 (2018); 10.6 (2019F); 11.3 (2020F)
Real GDP growth (%): -2.5 (2018); -1.2 (2019F); 2.2 (2020F)
Consumer Price Inflation (%, avg): 34.3 (2018); 43.7 (2019F); 23.2 (2020F)
Domestic Credit (% GDP): 14.6 (2018)
Current Account (% GDP): -5.1 (2018); -2.0 (2019F); -2.5 (2020F)
International Investment Position (% GDP): 12.5 (2018)
Gross External Debt (% GDP): 41.7 (2018)
Foreign Exchange Reserves (% short-term external debt + current account deficit): 1.0 (2018); 1.3 (Jun-2019)
Governance Indicator (percentile rank): 57.1 (2017)
Human Development Index: 0.83 (2017)

Notes:

All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Forecasts drawn from IMF. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The primary sources of information used for this rating include INDEC, BCRA, Ministry of Finance, IMF, World Bank, UN, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Lead Analyst: Thomas R. Torgerson, Co-Head of Sovereign Ratings
Rating Committee Chair: Roger Lister, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: September 6, 2007

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