Argentina: Cristina cruising for victory – then what?-FTimes

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Argentina: Cristina cruising for victory – then what?

October 23, 2011

Cristina Fernández is set to win re-election as Argentina’s president on Sunday with well over 50 per cent of the vote. Scarily, the market is betting that the default risk of Latin America’s third biggest economy is nearly as high.

Back in May 2007 (Fernández took office in December that year), five-year credit default swaps on Argentine bonds were trading at 176.3 basis points – meaning the cost of insuring $10m of Argentine debt against default was $176,300. At the end of last week, they were trading at 1032.6 basis points, more than seven time greater – so it would cost you more than $1 to ensure every $10 of Argentine debt.

So it is safe to say that Argentina – which perpetrated the world’ s biggest ever sovereign default in 2001 by defaulting on nearly $100bn of debt – has yet to regain the respect of the world’s investors.

Indeed, traders are now seeing a more than 40 per cent chance that Fernández will stop paying debt during the new four-year term she is virtually assured of winning on Sunday. The widening in Argentine CDSs lags only those of Greece, Portugal and Pakistan.

This could just be excessive pessimism from the market – hardly known (as Fernández loves to point out) for getting it right all the time. After all, Argentina has enjoyed strong growth, more jobs and rising pensions, as well as highly popular education and child support programmes that make many Argentines feel they have never had it so good.

But the government still owes $9bn in principal and interest to the Paris Club of western government creditors. Inflation, while not spiralling, is entrenched at very high levels – estimated at about 25 per cent by private sector economist but much less by the government – and shows no signs of falling.

Then there is a serious problem with capital flight, surely a vote of no confidence in the government. Argentines pulled nearly $10bn out of the country in the first half of this year, only a little short of the $11.4bn which exited in the whole of last year, forcing the central bank to make big sales of foreign reserves to try to contain the resulting slide in the peso. Argentina’s reserves – an important recourse for paying off debt druing the past two years – have slid as a result to $47bn, from $50bn at the end of August.

It is no surprise that investors are getting nervous. Some $8bn of reserves is expected to be used on debt service to in the next year. A similar amount consists of dollar deposits from the local banking system held at the central bank, meaning that the bank has fewer “freely available” reserves (that is, reserves over and above the monetary base) that it can, under current rules, use to pay down debt.

This has left some people wondering whether the government will seek to change the limit on freely available reserves, or raid other sources of funds. Amado Boudou, Fernández’s running mate, is, after all, the man who dreamed up the 2008 nationalisation of private pension funds that was widely seen as an asset grab.

And there are other problems. High inflation will make it hard for the government to target an exchange rate that keeps its producers competitive. Add in rampant state spending and a shrinking trade surplus – not to mention a tougher economic climate as growth slows in China, a key market for Argentina’s agricultural goods – and you have a potentially nasty situation.

Betting on another Argentine default may be going too far. But betting on a hard landing may not be.