Investing in Argentina’s quest for growth

By Stéphane Monier Chief Investment Officer Lombard Odier Private Bank

With Argentina poised for possible inclusion in the MSCI Emerging Markets Index this year, investing in the market now could offer strong rewards – but beware the bumps along the way.

In my bulletin last October, I made the case for Argentina being economically on track following the victory of the ruling Cambiemos coalition in the mid-term legislative elections. Now, as the economic recovery beds down, we see opportunities for investors with an appropriate risk appetite to buy into a positive stage of the cycle.

Growth, disinflation and structural reforms remained the priorities of President Mauricio Macri coming into 2018. On all three fronts he faces challenges, however, the disinflation theme attracted the attention of the market as the authorities’ target of achieving 5% inflation by 2019 was recently pushed back to 2020. Instead, new targets were set for 2018 and 2019 of 15 and 10% respectively.

Reading into the revision

The revision of the inflation target came after a higher-than-expected reading in December pushed the country’s annual inflation rate towards 25% – far exceeding the 12-17% target for 2017. With the revision announced by the minister of economy, and not by Central Bank President Federico Sturzenegger, this change simultaneously raised concerns about the independence of the central bank, particularly at a time when its president is challenged with restoring the institution’s credibility.

While a 75 basis-point rate cut in January reinforced lingering questions about the future direction of monetary policy in Argentina, the central bank sought to clarify the move in its statement: “While high-frequency data shows mixed signals, the central bank considers that the restrictive stance of current monetary policy remains somewhat high.”¹ Although the decision to delay the 5% inflation target to 2020 illustrates the authorities’ dilemma in choosing between delivering growth or disinflation, we believe that the battle against inflation will continue at a gradual pace in the coming months without compromising the recovery.

Over recent weeks, the central bank also announced new fiscal targets and a reduction of its financial transfers to the Treasury (1.1% of GDP in 2018 and 0.5% in 2019). With these measures taking the market by surprise, the Argentina peso weakened 6.4% against the US dollar², hitting to a record low last December.

The Argentine peso was also under pressure during the period as violent protests broke out in Buenos Aires after a major pension reform was adopted by the Congress. While the reform represents a major victory for Macri and confirms the government’s commitment to reduce the fiscal deficit, going forward, the structural reform agenda of Macri’s administration will be essential to attracting investments and supporting sustainable growth. Much as the market might appreciate a ‘big bang’ policy move from the government, in our view Macri is wise to take a more gradual and pragmatic approach.

An upward – but uneven – road ahead

Although, on a long-term view, Argentina has good potential to grow, the economic road ahead is unlikely to be smooth. Investors in this market should, therefore, be prepared for further mixed data even if the overall trajectory of growth should remain positive. In particular, Argentina faces several challenges including its strong dependence on external credit, meaning the country could suffer as central banks across the developed world tighten monetary policy. In our view, while major central banks will gradually raise rates, we believe the global economy will continue to transition from an accommodative cycle into a normalisation phase – however we are not yet in a tight monetary environment.

While decelerating growth is clearly a concern for the government, we think that disinflation will continue at a gradual pace in 2018. From an investment point of view, we still see interesting opportunities in local rates in Argentina, especially in inflation-linked bonds and floating-rate debt given high nominal yields and we remain cautious but constructive on the peso. In this space, more specifically, we expect carry-adjusted returns to stay positive. Macri is opening up Argentina to investment and his recent victory in the mid-tem elections should give him the necessary leeway to continue normalising the economy. Unlike other emerging countries such as Brazil and Mexico, Argentina will not hold elections in 2018 and this should help the administration to pass crucial reforms. We believe that Macri’s administration is making progress in transforming the country and attracting investment – a process that could culminate in Argentina’s promotion to the MSCI Emerging Markets Index this year.

¹ Source: Bloomberg
² For the month of December 2017