Argentina’s banks face strategy dilemma

The slow pace of Argentina’s fiscal reform programme finally caught up with its government last week and, compounded by an error in monetary strategy at the end of last year and a deteriorating risk environment for emerging markets, the country is firmly into emergency reaction mode.

Meanwhile, the banks that had been changing their funding mix and business strategy to anticipate economic growth and credit demand face tough operational questions: do they continue with their path to normalization or hunker down and see how long and fierce the storm will prove to be – and what damage it will do?

There are three main impacts to the banking sector from the recent economic drama in Argentina, which saw the central bank intervene three times and increase its policy rate by 1,250 basis points in three inter-meeting decisions to 40%. This was an attempt to stop a run on its currency – the peso fell by 12% last week – and prevent the central bank burning through billions of dollars of FX reserves to fight the peso’s depreciation – followed by the politically risky decision to negotiate a line of credit from the IMF.

The first impact is short term, mixed and related to the new reality of the financial system. The banks should benefit from the higher interest rates through higher net interest margins (NIMs), according to UBS financial analyst Frederic de Mariz. He thinks the recent fallout to Argentine banks’ valuations – Argentine bank ADRs have suffered – leads to a buying opportunity as “higher rates will impact NIMs positively, via higher securities income.

“We currently expect NIM to compress from 10.7% in 2017 to 10.6% in 2018, and now we see upside risk to 2018.” De Mariz estimates that every 50bp increase in NIM would translate into about 9% in earnings per share.

The Argentine central bank (BCRA) also moved to cut the permitted level of foreign currency held as part of banks’ tier-1 capital, from 30% to 10%. However, despite the short deadline for compliance (May 7), a report from BTG Pactual said that the impact on the private banks would be minimal.

“According to February data, only public banks were close to the 30% limit (at 29%) as private banks were around 2%,” it states, although that low figure could have increased if banks had increased their hard currency positions since March.

Rating agency Moody’s believes the main financial impact will be negative, with higher interest rates hurting the system’s delinquency ratios.

“The rate of non-performing loans was a low 1.6% of gross loans as of year-end 2017,” it states. “However, with interest payments on variable-rate loans [which on average constitute roughly one third of banks’ portfolios] set to increase by nearly 50%, we expect impaired loans to increase.”

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Interview: Niall Ferguson

Niall Ferguson has a call in a little over half an hour, he warns, after the introductions are done. He needs to call his immigration lawyer ahead of a naturalization examination he faces in the US on his return. As a professional historian at Stanford, he points out, it would be more than a little embarrassing if he failed to answer questions on the US constitution, for example.

“I know about the first and second amendments for obvious reasons, but I need to find out what the third one is,” he says, presumably joking. (Or perhaps not: Euromoney checked it later and it places restrictions on the quartering of soldiers in private homes without the owner’s consent, forbidding the practice in peacetime.)

Niall Ferguson Ferguson is in São Paulo in early April to deliver a keynote speech to Itaú’s annual MacroVision conference, which in 2018 has the theme of technology. Ferguson delivers a talk derived from the content of his new book ‘The Square and the Tower’, which, among other things, deals with the role of social media and the various models of interaction of these technologies with those who hold the power in nation states.

Whoever at Itaú invited Ferguson to address the conference couldn’t possibly have known that he would be speaking on the same day that Mark Zuckerberg faced questions from a panel of US senators.

His speech focuses on the US, Europe and China. Afterwards a Q&A session saw the historian pulled a little off his main theme; there was a question about Brexit and one about the Brazilian elections.

On the latter, Ferguson predicts that the use of social media will favour right-wing candidate Jair Bolsonaro, who has most followers. This goes against the local consensus that TV time and the machinery of the big parties’ local networks will still be more decisive than social media, given the relatively low influence of the internet across the country.

Mostly, however, he sticks to the US, China and Europe.

Euromoney meets with Ferguson later that day, a little uncertain about Ferguson’s range of knowledge and experience of Latin America. Such concerns were laid quickly to rest with Ferguson’s response to the opening question, which picked up on a point that he had made in his speech about the relative speeds of adoption of mobile payments in Asia (and China in particular) compared with the US. Could emerging markets in Latin America reach Asian levels of near-universal adoption of new payment technologies?

His answer revealed that he is on the board of directors of Argentinian financial technology firm Ualá, which already has 130,000 users of its mobile app that links to a pre-paid MasterCard, enabling payments and building credit histories for the large unbanked population in Argentina.

The reason, he says, that the US has been slow to adopt mobile payment apps is that the US system was good enough not to need urgent replacement, whereas in many emerging markets – and Asia is leading the way – the banking systems have evolved leaving large sections of the population behind.

He points out to another specific example of M-Pesa in Kenya.

“Any system of electronic, digital banking that lowers the entry barrier [for individuals] is likely to take off faster in emerging markets than in developed markets. We see this very clearly in Asia today, with Alibaba and Wechat; in different ways, these create very attractive and effective payment platforms that most Chinese people use. Even beggars take money on smartphones,” he says.

As an interviewee, then, Ferguson has range. And if the sheer breadth of his argument seems implausible, he peppers it with personal experience to back up the expansive oratory. In January he was in Hangzhou meeting the people from what he calls “financial Alibaba”, and he believes their technology is attractive to deploy in other emerging markets, in large part because it is a benefit to the many small businesses in these countries that are not being well served by the traditional banks.

“I think this is a huge deal,” he says, “and it gives China a large edge in EM. And that’s already becoming apparent in India and parts of southeast Asia.”

He says Chinese companies have been quick to partner with local fintech startups to enable these domestic firms to scale up effectively.

“This is happening in India and then these markets get drawn into the Chinese fintech empire,” he says, which could end up being a problem.

“The obvious unintended consequence of getting involved in Chinese platforms is that there is just no data privacy at all,” he adds.

Unfortunately for Silicon Valley companies, the recent Facebook data scandals have weakened their ability to contrast themselves favourably in terms of privacy: “But there is still a counter argument to be made that, ultimately, the US will do better than China on this front – though we are not there yet. As long as the platforms that the US produce are less effective for e-commerce then China is likely to win this global competition.”

However, presumably Ferguson will be wary of Ualá getting involved with any Chinese partner. “You have to look very carefully about what you are getting involved with,” he says.

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Argentina: Two confessions

I am going to confess an unpopular opinion: I am getting worried about Argentina.­

I am also going to confess to embarrassing naivety: I have been testing my hypothesis with the wrong bankers.

But first, my concerns about Argentina. The mess up in monetary policy at the end of last year and the beginning of this one saw a delicate communications challenge around the changes to the central bank’s targets trampled on by the clumsy and damaging decision to accompany this policy change with two 75 basis point cuts to interest rates.

The central bank was beginning to get some traction in its very difficult and long job of bringing inflation down in a country that is synonymous with the phrase ‘unanchored expectations’.

As night follows day, inflation – and expectations of future inflation – have turned reversed and are now rising. At the very least, the authorities have wasted precious time in getting inflation down to levels where the private sector sees exchange rates and interest rates at stable levels – where investments make financial sense.

Credibility, as the maxim goes, is hard to win and easy to lose. Argentina just lost a big chunk of credibility.

There are persistent rumours at home and abroad that the mistake was the result of a fight between economy minister Nicolás Dujovne, who wanted to provide some monetary relief in a bid to drive economic growth above 3%, and the central bank governor Federico Sturzenegger.

If true, the loser wasn’t really Sturzenegger, it was Dujovne’s economy and the country’s population that must, soon enough, restart its painful fight against inflation. Because how can you lower inflation without hiking interest rates? Where’s a case study economy that managed to lower persistent double-digit inflation at the same time as increasing GDP growth? If there is one, I’d love to see it.

Just a cursory look across Argentina’s border to Brazil shows that there are no short cuts. There, the central bank increased interest rates, pushing a slowing economy into a deep recession. Pain followed – most notably high unemployment. But the central bank sat on those high interest rates until inflation collapsed. That is what Argentina needed – and needs – to do. You can’t get back on the path of reform that they were on.

Contrarians might argue that president Mauricio Macri’s economic model requires 3% growth to boost government revenues to finance and make possible the gradual fiscal adjustment. In turn, that fiscal adjustment will help monetary policy, which was doing most of the work (and capping growth). Also, this model needs a stable exchange rate to give stability for foreign investment and to help with inflation. But of all these interacting forces inflation is the most important. Without low and controlled inflation, you cannot achieve a stable currency.

So, recently I have been asking senior bankers about their views on the potential importance of Argentina’s monetary misstep. To me, it seemed like a genuinely big mistake and one that makes an already perilously narrow path to orthodoxy razor thin. Wouldn’t resurgent inflation delay investment? Without GDP growth of 3% – and it is still below this crucial level – isn’t there a risk of dangerous fiscal imbalance? And for how long can they finance this fiscal shortfall in foreign currency? If investors lose patience – maybe they start to fear repayment problems, should the Argentine peso collapse and leave their large dollar external debt commitments exposed – what happens to the currency? And then inflation? And then what, ultimately?

But the bankers all say that they can’t see this ending badly. And that’s when my naivety hit me – I had been speaking almost exclusively to capital markets bankers and economists. The latter are usually centrists and consensualists, and the former are making so much money from selling Argentine debt to international investors that they don’t want to see any problems. And even if they do, they certainly won’t articulate them to the press, on or off the record. This gravy train could still have years to run. A recent phrase used by Paul Krugman about the US Republican party, “motivated gullibility”, came to mind.

But talk to traders, and the conversation has a starker quality. ‘No way out’ Like me, some can’t see a way that Argentina can finesse its way out of this. Interest rates will have to go up again – and stay up until they actually manage to get inflation on a sustainably downward trajectory. That will mean economic slowdown, if not recession. So the fiscal adjustment will need to be sped up or risk fiscal collapse and an unsustainable debt build-up – with a large proportion in foreign currency.

The other way in emerging markets history has been to inflate your way out of the problem through a weaker currency, but that means a swift end to Macri’s attempt to cast the Argentine economy in a new economically orthodox light. The working assumption must be an increase in rates and that the government will switch its priorities to reflect the supremacy of the inflation fight over growth.

As one FX trader told me: “You can’t get back on the path of reform that they were on. Argentina is now on a permanently worse trajectory than it was before. The inflation leg of the ‘trilemma’ is the most important. Eventually they will have to raise interest rates to tame inflation via the currency, and everything else – the growth rate – will be sacrificed.”

Read all this together and there is little chance that the Argentine peso will appreciate on spot in the longer term. But the downside to talking to traders is that their timeframes are much, much shorter than mine.

When I asked what our shared view of peril for Argentina meant to him strategically, he shrugged: “At the moment, the central bank is supporting the Argie, so tactically it’s a buy.”

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Argentina leaves markets worried about ability to grow

“It’s like chemotherapy. If you have it all at once, you are going to kill the patient. You need to find a dose that won’t kill the patient.”

The patient being discussed by a senior capital markets banker in New York is the Argentine economy. The dispute that still rages domestically and internationally is about president Mauricio Macri’s medicine. How large should the dose of adjustment be? And just how quickly should the government implement its reforms?

Many abroad and in Argentina are in a favour of upping the speed at which the medicine is administered, especially in light of Macri’s success in last October’s mid-term elections.

“I think Macri needs to stop the gradualism policy,” says Exotix’s Rafael Elias. “It got him through the mid-terms and he [still] has a very high popularity rating. But the country is spending more than it is making and the debt is growing exponentially.”

To keep the adjustment moving forward at a viable tempo, the government needs to keep growth above 3%. That needs real investment, both local capex and foreign direct investment, rather than large capital flows that heat up the exchange rate and have been the financial feature to date.

“From Macri’s point of view, FDI has been sluggish, and they need to get GDP to above 3%,” says Elias. “This will be a massive year.”

Roberto Sifon, head of the Americas’ sovereign team at S&P Global, says: “To use a soccer analogy: we are headed into the last minute and Argentina needs to score a goal. That goal is 3%-plus growth. So they really need to start seeing some real domestic investment.”

And, although nobody is saying that international investors are about to stop funding Argentina, the performance of the sovereign’s debt at the beginning of this year has been notable. The bonds came under pressure in January, when Argentina was one of the few emerging market sovereigns to see its spreads widen (and remember, Argentina is still classed as a frontier economy because of its structural risks).

The $9 billion of issuance on January 4 certainly played a part, creating technical concerns as it came with large new issues concessions that repriced the existing curve wider (estimated to have been 10 basis points for the five-year, 25bp for the 10-year and 20bp for the 30-year tranche). Underwriters say that the overhang has now been cleared and no further large deals are to be expected this year. But with slow progress on the development of the local markets, 2019 should see similar issuance levels.

Then, when volatility hit the international debt markets in mid February, the bonds continued to underperform. The country’s spread widening accelerated. This dynamic was the result of investors being overweight the credit and, according to bankers, investors realizing the structural advances of recent years were largely priced in.

“The room for positive surprises has diminished and the ‘beta’ to the market has increased again, suggesting that in a large market movement, Argentina bonds would underperform,” a report by Citi summarizes.

The large price movement is also, in part, investor reaction to monetary policy, after a change to the inflation-targeting regime and a couple of cuts to the base rate, despite high inflationary pressures in the economy, led many to question the government’s commitment to this fight.

In early March there was further bad news. The 2017 GDP growth number was announced and it came in lower than the psychologically important 3% barrier. This lowers the statistical carry-over from 2017 to 2018’s growth, which is already being forecast lower because of a combination of the expected impact of a drought on agricultural production and the negative effect of higher inflation expectations on consumption.

JPMorgan sliced 10bp off its forecast for 2018’s GDP growth due to the lower carry-over, as well as 25bp for the drought and a further 10bp for the negative impact of inflation. The bank now predicts GDP growth of 2.8% in 2018, down from 3.3% (below that 3% barrier again), as well as increasing its forecasts for inflation.  Other banks have also lowered GDP and raised inflation forecasts (not great for a government about to enter into sensitive negotiations for 2018 pay increases). Capital Economics is more bearish: “Economic growth in Argentina appears to have peaked,” it says.

For the full article visit Euromoney Latin America

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How the markets now run Brazil …

… with or without Henrique Meirelles.

Brazil’s democracy has added a new feature in the last few years: people can vote for a president, but the markets retain the right to deploy an ‘impeachment put’ if that president is messing up the economy.

For proof, look no further than the fate of former president Dilma Rousseff. Her impeachment in 2016 was legally based on fiscais pedaladas (accounting irregularities). That she was almost alone among powerful politicians not to be cited in the sweeping Lava Jato corruption enquiry was not enough to save her. External forces still found a way to oust her from office.

Now, two years later, few senior market participants even bother to pretend the accounting charge was anything other than a markets-driven constitutional fig leaf to remove a bad president, whose terrible economic policies pushed the country into its deepest ever recession.

Speaking at a Credit Suisse Investors Forum earlier this year, Luis Stuhlberger, chief executive and chief investment officer of Verde Asset Management, said: “The conclusion that one reaches is that any candidate will do [fiscal] reforms in 2019, either proactively or reactively, because if we have a [president] with very different ideas, he or she will be impeached. Because if GDP goes down, the recession will come back, and he or she will be ousted. This has been clearly demonstrated.”

Stuhlberger, an investor revered by many in Brazil, added: “In the past, when I was more pessimistic and I thought [Rousseff’s] impeachment wouldn’t happen, a senator told me: ‘If you are in the presidency without the ability to govern, we will find a way to get you out.’ I think this is clear in the minds of everyone.“

Paulo Guedes, another well-known Brazilian financier, populist candidate Jair Bolsonaro’s economic adviser and potential minister of finance, effectively said the same thing: “It used to be that inflation had to be 2,000% to be impeached, but now if it’s at 10%, the president is ousted.”

Guedes then also compared the impeachment on accounting grounds with Al Capone’s prosecution for tax evasion.

Stuhlberger and Guedes were just saying in public what many are now increasingly happy to say in private.

“Our system has checks and balances, and Dilma was ousted according to the constitution,” one banker tells Euromoney. “One can argue whether the pedaladas were the real reason – and of course they weren’t, she was running the country into the ground and if she hadn’t been impeached in 2016, god knows where we would have been today. At the beginning of 2016, our economic team forecast a 4% contraction in GDP, but they said it might very well be 5%. Can you imagine?”

As Euromoney reported in May 2016, powerful business leaders were in fact the ones pushing politicians to remove Rousseff, as refinancing risks threatened to create a wave of corporate defaults throughout Brazil.

In 2012, Brazilian corporates and financial institutions raised $46.8 billion in the international markets – a much cheaper source of finance than local banks or capital markets. By contrast, in 2015, the total raised in the international markets was just $7.2 billion. In the first five months of 2016, no deals had come to those markets. The markets had given their own vote of no confidence in Rousseff.

Banks did the same. Their provisions against the threat of corporate insolvencies spiked; in 2015, 5,500 companies sought bankruptcy protection – the most since 2008 – with forecasts of many thousands more to come as financial market liquidity evaporated.

Pressure built. The vent was impeachment.

For the full article visit Euromoney Latin America’s first issue


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Twisting Mexican risk

According to bankers and analysts in New York, the first questions that corporate clients and investors always ask about Mexico relate to Nafta. Questions about the political risk from this year’s election are secondary, almost an afterthought.

However, this is getting Mexico risk the wrong way around in terms of importance.  That is because, first, the Nafta risks have been broadly overstated.

Even if Nafta negotiations break down and US president Donald Trump terminates the trade deal (and that is a big ‘if’, given the growing recognition among the border states of the inter-connectedness of supply chains), Mexico would likely revert to most-favoured nation WTO status.  There would be disruption, but because of Mexico’s competitiveness as a manufacturer today, it would not be catastrophic. Second, the risk of a presidential victory by leftist candidate Andrés Manuel Lépez Obrador, or Amlo as he is known, is both important and growing.

An Obrador presidency could be catastrophic for Mexico For an interconnected set of reasons, it is beginning to look like Amlo’s third attempt at the presidency could be lucky for him. But not so for Mexico – it would likely be catastrophic.  Amlo advocates nationalizing the banks. He proposes reversing all of Mexico’s recent reforms, including the energy reform. He has ambitious – and unfunded – proposals aimed at creating almost two million more public-sector jobs.

Comparisons abound between Amlo and Brazil’s Lula da Silva. For example, Lula won the presidency at his third attempt. However, whereas Lula became markedly more moderate with every campaign, Amlo is becoming increasingly belligerent.  Lula’s Workers Party calmed the markets on taking power and the fiscal deterioration only really hit the country in its third administration. Amlo would likely cause an economic crisis much more quickly.

At the moment investors remain calm. If they realize the threat – Amlo has a double-digit lead in many polls – they discount it because they reason it is still early days. The election campaign doesn’t formally start until the end of March.

Wise heads point out that although Amlo has a 98% recognition rate in the country, his support seems to have a ceiling in the early 30 percentage points, with nearly 70% likely to vote against him.  The argument goes that during the campaign the quality of the PRI’s candidate, Jose Meade, will come through. After all, Meade has been a secretary in five different ministries under two different presidents from two different parties.  As well as unrivalled experience, Meade holds two bachelor degrees (economics and law from prestigious Mexican universities) and a PhD in economics from Yale.

In contrast, bankers sniff that it took Amlo 10 years to get a bachelor degree in political science. Perhaps a slightly more practical point is that the incumbent PRI party has the better organization. In last year’s election for the city of Mexico, Amlo’s candidate Delfina Gómez was narrowly beaten by the PRI’s Alfredo del Mazo.

Many credit that to the machinery of the PRI getting people out to vote. The logic is that this will apply nationally in July.  That logic would hold – normally. Except this is not a normal time in Mexico. Seldom has there been such disconnect with the incumbent party than there is today.

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Brazil’s Stone looks to follow PagSeguro in snubbing

The success of Brazil’s PagSeguro’s recent IPO on the NYSE has led its competitor, Stone, to draw up plans to launch on the US stock exchange this year, according to market sources.

PagSeguro, which provides online and in-store payment services, raised $2.3 billion in January this year.

This general rarity of technology company IPOs from Brazilian companies helped the IPO launch above its pricing range and the stock traded up 33% on its first day of trading. If Stone follows PagSeguro to the NYSE, it will be bad news for Brazilian exchange B3, which is trying to attract other Brazilian tech companies to list locally. That could then become a strategic issue for investors looking for onshore Brazilian investments.

Stephen Dover, head of equity for Franklin Templeton, says he believes Latin America is falling in relative importance in his firm’s emerging market investment allocation because of his firm’s focus on EM technology.

“There are not enough technology companies or innovative companies listed in Brazil,” he says. He adds that B3’s skew to commodity stocks is a problem for international investors because the exchange is not representative of the country’s real economy.

He says index funds do not match the potential upside to the country’s future economic growth, and that means that investors pursuing stock-picking strategies in certain sectors, such as consumer-orientated companies, face challenging valuations.

However, Dover does confirm the consensus view among Latin American equity capital markets bankers that the markets are very receptive to Latin American IPOs and political uncertainty in the region is not an obstacle. “We would absolutely look at IPO stories in the first half of this year,” he says. “We are long-term investor, and there is an IPO deficit in the region – there is a lot of catch-up that needs to be done in Latin America.”

For the full article visit Euromoney Magazine


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