Why Argentina is Not an Emerging Market
Argentina failed to win back its status as an emerging market in June, remaining in the ranks of the frontier markets until at least 2018. The Argentinian stock market the Merval dropped more than 5% on the day after the announcement, while the currency peso fell 2%. Indexer MSCI, which reviews market classification once a year, said Argentina was moving in the right direction, but it was too soon to upgrade the country.
“Although the Argentinian equity market meets most of the accessibility criteria for emerging markets, the irreversibility of the relatively recent changes still remains to be assessed, including the removal of capital controls and currency restrictions, needed to remain in place for a longer time period to be deemed irreversible,” MSCI said in a published statement.
In December 2015, the Argentinian Central Bank abolished foreign exchange restrictions and the capital controls that had been in place for a number of years. These changes have resulted in a floating currency, the elimination of cash reserves and monthly repatriation limits affecting the equity market and the abolishment of the capital lock-up period for investments, MSCI added.
What Does Frontier Market Status Mean?
As the market was expecting the upgrade into emerging status, Argentine equities and currencies took a hammering following the announcement. But investors should not let the MSCI index decision put them off Argentina, Jan Dehn, head of research at Ashmore argued.
“The truth is that the index inclusion is a decision taken by a small company in New York, which has very little impact on policies in Argentina. Sometimes the decision on whether to include the country or not is really related to the broad interests of the global credit market,” said Dehn.
It is only the matter of time before Argentina is included in the MSCI Emerging Market index, said Dehn – and the upcoming mid-term election in October will be a key factor.
Mid-Term Election in October is Key
Since President Mauricio Macri was elected in December 2015, Argentina has been one of the best performing equity market in Latin America, up by around 54% in US dollar terms since the end 2015, according to data from BlackRock.
“The government has made good progress in dismantling the protectionist structures of the economy, addressing currency controls, export taxes and energy subsidies under President Macri’s administration,” said Emily Fletchter, director and portfolio manager at BlackRock.
“Perhaps one of the most significant is the resolution of the dispute with the hold-out creditors, a legacy from the 2001 debt crisis, which allowed Argentina to return to international capital markets for the first time in over a decade. These have created supportive conditions for GDP growth, which is expected to accelerate to 2.8 percent in 2017 after contracting in 2016.”
However, the current Macri administration does not have a very strong political position or a majority in Parliament, resulting in a fragile coalition. While the result of the mid-term election in October could end up a better majority for Macri’s government, it could go another way.
“The former President Cristina Fernández de Kirchner is gaining in the polls ahead of October’s midterm elections and her newly launched coalition is now seemingly neck-and-neck with President Macri’s Cambiemos collation in the pivotal Province of Buenos Aries,” explained Paul Greer, senior emerging market debt trader at Fidelity.
“Fernández de Kirchner is competing for a place in the Senate and the vote should be a good political signpost for the next Presidential elections in 2019. While it is still very unlikely to happen, a return to the days of Kirchnerism would most likely jeopardise the incumbent government’s market friendly reform programme and spark a major reversal in Argentina market sentiment.”
Greer added that he was happy to “sit on the sidelines until the Argentine local markets have their day in the sun again”.
Claudia Calich, manager of the M&G Emerging Markets Bond fund agreed, saying that the key risk is the sustainability of Macri’s market-friendly and orthodox economic policies, of which an initial test will be the outcome of the midterm elections this October. However, the litmus test will be the presidential elections in 2019.
“In absence of economic improvements, higher growth, lower inflation and improvement of real wages, the return of populist policies should the Peronist party start recovering lost ground and win the 2019 elections cannot be ruled out. That will be very bearish for asset prices,” said Calich.
A Mixed Outlook
BlackRock’s Fletchter remains positive on Argentina, believing it to be a compelling investment destination for long-term investors under a significant growth story.
However, Ashmore’s Dehn argued that although Mauricio Macri administration obviously attracted a lot of investors to take exposures in Argentina, he does not think it is ambiguously a bullish story.
“As a long term investor, I am not comfortable with Argentina. In the past Argentina has been doing very similar policies- they did couple times in the past and we knew what the results were: growth in the private sector was weaker mainly because many government bonds got issued; secondly debt levels got higher, which is happening now,” said Dehn.
“Thirdly, you end up with a lot of hot money flows because obviously investors are going to be attracted by rising real interest rates – but those bonds are going into the government instead of the private sector, so at some point the current has been pushed up to such a high level– however as the growth not picking up, the money will just be pulled out by investors, ending up a lot of volatility.”