Argentina's EM return: what it means for investors
In 1903, Schroders completed its first business in Argentina, a £185,000 bond issue for the Buenos Aires Electric Tramways Company. At the time, Argentina’s economy ranked among the leading countries in the world on a GDP per capita basis, rivalling major European nations such as France and Italy. As at the end of 2017, its equivalent ranking was 89, and for much of the last ten years the country has been deemed a frontier market from an investment perspective.
On 28 May, index provider MSCI upgraded the country to its widely followed Emerging Markets Index. Argentina was a founding member at the launch of the index in 1988, but was downgraded to frontier markets status in 2009 due to restrictions on the flow of capital into and out of the country.
How should investors interpret the upgrade?
“Argentina’s return to emerging market status is positive for its stock market on a short-term basis, and may drive net capital inflows from passive investors in excess of $1 billion. For long-term active investors, however, the key focus is likely to be on government policy continuity post elections. The latest opinion polls reflect a polarised electorate.
“Beyond elections, even with policy continuity, the path for economic recovery remains sensitive to swings in global growth, as well as global financial conditions, given ongoing fiscal funding requirements. We are monitoring developments closely but maintain a cautious view for now.”
Pablo Riveroll, Head of Latin American equities
Background on investing in Argentina
Over the years, investors in Argentina have experienced a volatile ride, even by emerging markets standards. This has been evident in recent years with the MSCI Argentina Index returning close to 74% in US dollar terms in 2017, before declining by almost 51% in 2018. In fact, the country has been among the most volatile emerging stock markets since the launch of MSCI Emerging Markets Index. Although the country’s index weight peaked above 5% in the infancy of the index, its weight today is just 0.3%, with only 2.5% in the MSCI Latin America Index. Consequently, the impact on the overall performance of the indices is limited.
As mentioned at the outset, at the turn of the 20th century, Argentina was among the most prosperous economies in the world. However, its more open, export-led nature, and a dependence on agricultural exports left it exposed to external shocks. Various periods of interventionist government policy, much of it under different factions of the Peronist Party, served to create imbalances in the economy. This included periods of hyperinflation, accumulation of foreign debt and subsequent default (most recently in 2014), contributing to a number of currency devaluations.
As a result, the country has a record for serially defaulting on its debt, including the largest default ever.
Why Argentina was upgraded
The election of President Mauricio Macri, from the Republican Proposal Party, in 2015 spurred optimism that a return to more conventional economic policy, together with market friendly reforms, could support a sustainable recovery in the economy.
Under Macri, currency controls were removed, and this was the major factor that contributed to Argentina’s upgrade from MSCI. Index providers consider a range of factors when determining their definition of an emerging market. In addition to size and liquidity requirements, significant emphasis is also placed on market access.
Macri took measures to reduce a bloated public sector and to cut the fiscal deficit. As part of the austerity drive, government subsidies were lowered in sectors such as energy and transportation, and both tax and pension reforms were passed. However, partly due to his coalition’s lack of a majority in congress, Macri pursued a slower pace to economic adjustment, referred to by many as Gradualismo, funded by external finance.
The reform process worked well over the first few years of the administration, but high inflation persisted, stuck at above 20% per annum. In 2018, the country suffered a fresh currency crisis and the economy fell into recession. This was due to a rising US dollar, as the Federal Reserve increased US interest rates, deterioration in the external and fiscal accounts, and a fall in agricultural exports due to drought.
With the peso depreciating sharply, the central bank hiked interest rates to over 60% and the government was forced to agree a $56 billion loan programme with the International Monetary Fund (IMF), the largest ever made by the institution.
The crisis resulted in some curtailment to policy improvement, and export tariffs were temporarily reintroduced until then end of 2020. Meanwhile the prices of a series of staple goods were frozen, in an effort to limit inflation and support consumers ahead of elections.
In our view, Argentina’s index upgrade has potential to be very positive in widening the institutional investment base in the country. A reimplementation of capital controls is also less likely as their removal was a condition for the upgrade. However, the upgrade comes at an uncertain time, with the economy in recession, inflation uncontrolled and presidential elections scheduled in October. President Macri’s approval rating has declined and the prospect of a return to power for the Peronist Party has increased.
The most immediate concern for investors is the outcome of elections. A key determinant is likely to be the degree to which the government is able to quell rising inflation and restart economic growth. The outlook for these measures is unclear, and by extension the prospect of long term reform and the country’s ability to target the large external deficit. Further clarity could come after 22 June, the deadline for candidates to announce their intention to run for president, but first round polls do not take place until 27 October.
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