INSIGHT: Argentina’s petchems brace for deep downturn as Milei delivers shock therapy

Jonathan Lopez

24-Nov-2023

SAO PAULO (ICIS)–Argentina’s petrochemicals players are bracing for a severe and potentially year-long economic contraction as President Elect Javier Milei implements his shock recipes for the country’s beleaguered economy.

Last week, Argentinians showed with clarity their desire for change electing far-right and libertarian Milei for the highest office with more than 56% of the votes.

His outlandish proposals during the campaign – dollarization and dismantling the central bank, among others – have given way this week to more moderate statements, although he maintains he is ready to apply a shock therapy soon after being sworn in on 10 December.

Large-scale privatizations, including the country’s oil and gas major YPF, a devaluation of the peso and unification of dollar exchange rates, and the withdrawal of the subsidies which distort competition are all on the cards.

Most petrochemicals sources agree that the measures will be a shock to the system, both for corporations and households; but they also seem to think that, if applied correctly, Argentina’s decades-long financial woes could start to be fixed.

Outside Argentina, credit rating agencies Fitch and S&P Global said this week that Milei will need a very soft hand to negotiate with other parties in a Congress where his Freedom Advances (La Libertad Avanza) party is in a minority.

Milei has said he does not intend to collaborate with the outgoing centre-left Peronists, whom he accuses of having created the current dire situation with their never-ending printing of pesos. Milei is expected to count on the conservatives of Together for Change (Juntos por el Cambio), who have shown willingness to engage.

However, Fitch went further and said “a default event of some sort” is likely in coming years as Argentina’s debt with foreign creditors as well as domestic ones has shot up in the past decade. A potential default would be Argentina’s fourth since 2001.

FULL INVENTORIES FOR A DOWNTURN 
Argentina’s economy has been in the doldrums for months now but, so far, the downturn has not hit petrochemicals hard. Economic activity in September stood flat, compared with August, but fell 0.7% year on year, according to Argentina’s statistical office Indec earlier this week.

However, the petrochemicals-intensive manufacturing sectors posted a fall in activity of 3.6%, year on year.

The extraordinary restrictions to imports imposed in the past few months have made domestic output the only source for material, with some producers reporting booming sales.

Moreover, inventories up and down the country are full because the inflationary spiral has worked as expected: companies have filled up their warehouses in anticipation of ever higher prices.

What sources differ about is the duration of the potential economic depression which Milei’s shock therapy is to cause.

“It will destroy economic activity for around six months, and then things should start improving – if the government is not defeated in parliament, that is,” said a source at a large chemicals distributor.

“Right now, most companies have two-three months of inventories. When the economy comes to a standstill after the shock therapy, those two or three months of inventory will become five or six months of inventory.”

But others are more pessimistic and expect the downturn to last up to 12 months, with the dire effects of employment destruction and increasing poverty levels, which are already at an unbearable 40%, according to official figures.

“The downturn could last 12 months, or even 18 in the worst-case scenario. But people did vote for it, even those in the lowest income scales who are heavily dependent on subsidies. The general feeling is that the current system is untenable,” said a source at a distributor.

“People probably voted knowing that any shock therapy will cause immediate, deep financial pain. But they preferred that instead of having little doses of pain continuously, as it has been happening in the past years.”

DOLLAR, PESO: IT’S COMPLICATED
Argentina has for decades now been obsessed with the dollar. In 1991, when Carlos Menem was elected, the parity between the peso and the dollar and large-scale privatizations caused a temporary economic boom which ended badly in 2001 with a default.

Post-crisis, the official dollar exchange rate started living side by side with the unofficial, ‘blue dollar’, which has always been weaker than the official rate.

But not just that. In the past few years, as the financial woes grew, a maddening exchange rate system was created, with the consent of the state, and as many as 10 exchange rates for different economic sectors co-exist. Financial daily Ambito Financiero keeps track of them here.

Milei’s devaluation would be seeking to bring the unofficial dollar rate close to the official values, and ultimately end up just with one rate agaist the dollar.

The other problem Argentina has is the printing of pesos to finance recurrent spending by the state. In the end, the Banco Central de la Republica Argentina (BCRA) has acted as the lender of last resort to pay for public services, as Argentina has struggled to find financing overseas due to investors’ weariness towards a country that has defaulted three times in the past 22 years.

That printing of pesos is one key reason why inflation reached nearly 143% in October, and it is why Milei wants to blow up the BCRA: without a central bank issuing pesos, hyperinflation would dissipate, his theory goes.

To make things worse, the COVID-19 pandemic caused more strain in the public purse, and Argentina ultimately went to the IMF seeking emergency funding, a bail-out still being deployed.

Argentina owes $37bn to the IMF – and counting – and another $67bn to other foreign investors, according to analysts.

At home, debts are estimated to be three times those with foreign investors at around $300bn. This is mostly bonds issued by the BCRA to finance domestic spending, a practice generalized under the governments of Peronist politician Cristina Fernandez de Kircher (2007-2015).

A third source in Argentina, from another distributor, said: “I think the domestic debt generated by the BCRA bonds to finance state spending will be the hardest nut to crack, because it’s three times bigger than the external debt.

“I don’t think Argentina will default this time, but it will be a challenge to find the money to pay for all our debts.”

That money will not be in the central bank reserves; according to Fitch, foreign exchange reserves currently stand at minus $10.0bn.

‘SOME SORT OF DEFAULT’
Credit rating agencies were more sanguine and, in the case of Fitch, still consider a default likely.

They cannot be accused of catastrophism: when it comes to Argentinian defaults, it is not just the last three since 2001, but the total nine since the country’s independence in 1816.

“Detailed policy plans have yet to emerge, but given the dire macroeconomic starting point and governability challenges, we think a default event of some sort is likely over the coming years, as reflected in our ‘CC’ sovereign rating,” said Fitch this week.

According to the agency’s methodology, ‘CC’ National Ratings denote the level of default risk is among the highest relative to other issuers or obligations in the same country or monetary union.

“Milei’s success with adjustments, combined with better harvests and the FX [foreign exchange] windfall from Vaca Muerta energy resources, would determine how deep this prospective restructuring needs to be,” concluded Fitch.

“However, refinancing rather than restructuring obligations hinges on recovering market access, which will require confidence in governability and a new policy direction that can withstand future election cycles. This could be harder for Milei to deliver.”

Front page picture source: Shutterstock

Insight by Jonathan Lopez

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