Argentinian voters blew their country’s presidential race wide open on October 25 with an unexpectedly close vote that will force the country’s first-ever runoff election on November 22. But the victor of that contest will receive a dubious prize: Argentina’s next president will have to deal with a stalled economy, dwindling foreign exchange reserves, an overvalued currency, and a large budget gap.
Polls conducted just before the recent vote suggested that Daniel Scioli, who served as vice-president under the late President Nestor Kirchner and has the support of the current president (and Nestor’s wife), Cristina Kirchner, would win by a comfortable margin. All he managed was a narrow victory (36.9 percent to 34.3 percent) over Buenos Aires Mayor Mauricio Macri, a pro-business candidate who hopes to reverse many of the current administration’s policies. Argentina’s benchmark equity index rallied 9 percent in the three days after the vote.
Credit Suisse believes that both Scioli and Macri would move quickly to negotiate an agreement with Argentina’s international creditors, with a deal as early as mid-2016. After Argentina defaulted on sovereign bonds in 2001, most creditors swapped their existing debt for new paper in 2005 and 2010, taking a considerable haircut in the process. But a small group of holdouts sued Argentina for full repayment, and a U.S. federal judge has ruled repeatedly in their favor. Kirchner refused to pay, and Argentina has been shut out of international capital markets for 14 years as a result. Blocked by American courts in 2012 from making further interest payments on the new bonds before settling with the holdouts, Argentina defaulted again in July 2014.
The government has had to rely on its foreign exchange reserves to pay other debts and its energy needs. In 2014, Argentina, a net importer of both oil and natural gas, bought some 87,000 barrels per day of petroleum products (roughly half of which came from the United States). In 2013, the country brought in 184 billion cubic feet of Bolivian natural gas. Argentina has also used up significant reserves to defend the peso. They’ve barely managed the latter, as the currency has still depreciated 62 percent against the dollar in the past two years. Credit Suisse expects that gross foreign reserves will dwindle to $25.2 billion by the end of December – less than half their 2010 levels.
While the current path has resulted in a multitude of economic problems, coming to terms with creditors creates fresh concerns. Credit Suisse believes a new government will issue at least $20 billion to pay out the creditors, cover accrued interest on existing bonds, and finance government operations. Some of the new bonds will go straight to bondholders, but the government will likely sell some new bonds to raise cash, too. At the same time, the distressed debt funds that hold much of Argentina’s existing debt may sell when they sense a settlement is near or shortly thereafter. Credit Suisse’s Latin America analysts caution that there may not be enough demand if a large supply of Argentine bonds – both old and new – comes up for sale—leaving the country obliged to pay higher rates if it wants to issue more debt.
The country is in need of other economic reforms, too. Argentina spends vast sums of money on subsidies for oil, natural gas, power, and transportation – expenses it can ill afford given a budget deficit that Credit Suisse estimates will reach 6 percent of GDP by the end of this year. The bank’s analysts say Scioli would likely focus cuts on the energy subsidies that are worth 3.5 percent of GDP, while Macri would likely cut deeper and more broadly.
Another pressing issue is the country’s currency, which has become overvalued due to high inflation – unofficial estimates peg the current rate at nearly 27 percent– and a combination of capital and exchange rate controls enacted in 2011. Credit Suisse believes that Scioli would gradually devalue the peso, while Macri would likely move much faster.
Current polls indicate that Macri appears likely to win the runoff, but given how poorly polls predicted the first round, the outcome is anyone’s guess. Either candidate would benefit from an endorsement from second runner-up Sergio Massa, who is reportedly in talks with Macri’s camp.
In the near-term, Credit Suisse says the runoff election has increased the risk of a policy mistake by reducing the amount of time the new government will have to create a post-election transition plan. In the longer term, however, the bank’s analysts are more optimistic. Both candidates are likely to pursue more pragmatic economic policies than Argentina has seen in recent years. Since legislative elections have weakened the power Kirchner can wield within her party once she’s out of office, a new government is more likely to succeed in passing reforms. That’s not to say it will be easy – cutting subsidies and devaluing the currency will soak up plenty of political capital. Whoever wins on November 22 should be prepared for a great deal of hard work ahead.