Public debt fell in the first half of 2006, despite a quarter-on-quarter rise of 2.2% in the second quarter. However, public spending is rising faster than revenues with implications for the fiscal surplus.
EVENT: Country risk fell below 300 basis points this week to its lowest level since 1996.
SIGNIFICANCE: Public debt fell in the first half of 2006, despite a quarter-on-quarter rise of 2.2% in the second quarter. However, public spending is rising faster than revenues with implications for the fiscal surplus.
ANALYSIS: Between December 2005 and June 2006, total public debt fell by 6.7 billion dollars, to just over 106.8 billion, largely as a result of the payment of outstanding debts to the IMF (see ARGENTINA/BRAZIL: Debt plan cuts IMF monitoring role - December 21, 2005). However, the debt increased by 2.2% quarter-on-quarter in the second quarter, representing a rise of over 2.3 billion dollars. The current account surplus in the second quarter reached 2.5 billion dollars, up 34% year-on-year as a result of higher exports and lower interest obligations, while the financial account reached a surplus of 1.07 billion dollars, up 32%.
The rise in debt in the second quarter related primarily to placements of public debt instruments and a series of transactions with international institutions:
The Central Bank (BCRA) and non-financial public sector reported income of 1.046 billion dollars arising from debt placements, partially compensated by net capital payments to international bodies of 287 million dollars. Total payments to international institutions reached 451 million dollars.
Bond placements included 600 million dollars worth of Boden 2012 bonds sold to Venezuela and 446 million dollars in Bonar V bonds sold to non-residents.
Debt management. The government of President Nestor Kirchner can point to a number of achievements in managing the debt:
The 2005 bond swap reduced debt servicing costs to manageable levels (see ARGENTINA: Bond swap opens window of opportunity - March 7, 2005). The entire debt with the IMF was also cancelled, reducing short-term financing needs. However, there has been no resolution of the situation of holdouts who did not accept the bond swap, accounting for over 20 billion dollars.
Twelve separate provincial bonds, or 'quasi-currencies', were withdrawn, a difficult operation given the potential inflationary impact.
Repayments strategy. The government now plans to continue reducing the debt, in order to reach a debt-to-GDP ratio of 65% in 2007. The maintenance of the fiscal surplus is crucial to the official debt repayment scheme. The fiscal surplus, new bonds, temporary advances and buy-backs of the bonds involved in the 2005 swap are the main components of the government's plan to pay the debt, both in 2007 and in the future. Official plans for debt reduction and the sustainability of public financial commitments, imply, on the one hand, reducing the debt as a percentage of GDP, while, at the same time, avoiding the need to resort to significant extra-budgetary financing:
The current year is virtually closed. Argentina needs some 500-700 million dollars by year-end which it hopes to finance through an Inter-American Development Bank credit. If these funds do not arrive on time, the Economy Ministry has a range of options to place debt or seek a temporary advance.
In the absence of a significant international crisis, the panorama for 2007 is also under control. There is international interest in lending to Argentina, despite the fact that the bond market is 'limited' due to the default and debt swap.
While the nominal debt rose in the second quarter, debt is declining as a percentage of GDP. The surplus is sufficient to meet interest payments and amortise part of the capital. Moreover, following the restructuring, nearly half the debt burden is in pesos, much of it in the hands of local bondholders. As long as the economy continues to expand more rapidly than indexed debt, the country will benefit, although if this process should be reversed it will generate problems owing to the high debt stock.
The government does not currently plan to buy back high-cost debt, currently a more high-cost strategy than to pay maturing debt. Argentina is obliged to buy back par, discount and quasi-par bonds issued under the swap, but it will do so with cheaper paper if international interest rates do not rise significantly.
'Mega-swap' indictments. On September 28, former President Fernando de la Rua and his then economy minister, Domingo Cavallo, were indicted for the 'mega-swap' operation carried out in 2001 (see ARGENTINA: Debts deferred but risks remain - June 5, 2001), which represented a failed attempt to avoid the default later that year. They are charged with the crime of 'unfaithful administration', which carries a penalty of up to six years in prison. The investigation proposes to demonstrate that part of the debt was contracted fraudulently and should therefore not be paid. However, this is likely to prove difficult legally:
The judge will find it difficult to find clear evidence that the accused acted in bad faith, even if their decisions were poorly judged. In the same period, other countries -- such as Turkey and Brazil -- took similar decisions to avoid default in a critical period.
A judicial resolution in such a case, which would appear to be in line with official interests and could be perceived as arbitrary, would leave open the possibility that in future the same criteria could be applied to judge any other political decision.
Pending concerns. The fundamental question centres on the deterioration of public accounts: public spending is rising faster than revenues, while the fiscal position in some provinces is worsening and could have an effect on the national accounts. While a primary surplus is likely to be sustained next year, the situation may become more complicated in the medium term. The placement of new debt will depend on the behaviour of international interest rates, although financing needs are not significant and could be obtained on the domestic market. At the same time, the recent Supreme Court ruling increasing pensions, together with the rise in subsidies granted by the government, could reduce the surplus in 2007. The key for the government is to maintain a primary surplus close to 3.2% of GDP.
The government has some breathing space:
There is little short- and medium-term pressure given that much of the debt is long-term and at relatively low interest rates. The weight of interest payments is around 2.0-2.5% of GDP, with total debt repayments not exceeding 4.0% of GDP. With the exception of 2008, when some significant maturities fall due, financing needs do not exceed 50% of repayments.
There should be little difficulty in obtaining the 5 billion dollars needed in 2007, which in any case represent funds to cancel earlier obligations rather than new debt. In practice, there will be a net fall of some 3 billion dollars in total debt.
Given doubts over the international panorama, it could prove beneficial to place debt now to cover 2007 maturities.
Policy pressures. Despite efforts to reduce the debt burden, it remains a significant factor in tax and spending policies:
Although price controls have temporarily helped to contain inflation, inflationary pressures may increase in the absence of consistent fiscal policy.
Although investment levels have risen significantly, they remain too low to guarantee sustained growth rates of 5% (see ARGENTINA: Investment uncertainties continue - August 18, 2006).
The main challenge is to resolve the energy deficit, which threatens to become a serious bottleneck for sustained growth.
CONCLUSION: With increasing pressure on installed capacity, growth can be sustained only if investment rises significantly. Lower growth rates will generate a fall in revenues, while increasing public spending in the context of an election year may begin to erode the fiscal surplus. This raises the medium-term risk that the debt burden could again become unsustainable.