Argentina and the International Monetary Fund may reach a funding program early next year that will enable Latin America’s third-largest economy to work on its macro imbalances as low international reserves limit the government’s room to apply a mix of unorthodox policies, Morgan Stanley says in a research report.

“We foresee a soft IMF program that is initially centered on a weaker currency, a multi-year fiscal consolidation plan, and tighter monetary policy,” analysts including Fernando Sedano, Simon Waever,Guilherme Paiva, and Cesar Medina, wrote in report published September 9 ahead of the primaries elections held Sunday in the South American nation.

Early results of the elections, known as PASO, showed Argentina’s ruling coalition suffered its biggest political defeat since taking power with the opposition winning most districts, putting the government of President Alberto Fernandez under pressure, Bloomberg News reported. The opposition coalition Juntos por el Cambio won the Province of Buenos Aires by 4.4 percentage points and on a national level leads by twice that margin in the race for the lower house and by almost 16 percentage points in the Senate, according to a tally compiled by newspaper La Nacion.

“We believe that an IMF Extended Fund Facility (EFF) is likely to be signed late in 1Q22 or early in 2Q22,” according to the 37-page report reviewing Argentina’s economy, politics and markets outlook. “We foresee points of tension in FX policy and on how to reduce the fiscal deficit, but common ground is likely to be found,” the analysts said.

Structural reforms needed in Argentina to attract investment and improve long-term growth, in areas such as pension and labor legislations, “might not be part of the initial conditionalities and would probably be discussed later once macro imbalances are reduced,” the analysts argue in the document without mentioning the size of the eventual financing program.

Argentina, a nation that has defaulted nine times on its sovereign debt, has no access to international capital markets and owes USD 4.2 billion to the IMF this year: two payments of USD2.1 billion are due this month and December, followed by USD 18.8 billion in 2022.

In late August, the nation’s economy minister, Martín Guzmán admitted the country is working to reach a “healthy accord” with the Washington-based lender, that will enable Argentina to redefine its obligations in a “sustainable way”, Pagina 12 reported. Guzmán hinted the possibility of reaching a deal with a duration beyond 10 years. A new EFF would replace a failed USD57 billion three-year stand-by program approved on June 2018 and signed by the administration of former President Mauricio Macri.

Morgan Stanley’s analysts believe that the higher the credibility of a multi-year economic program to the implemented, the lower the size of the adjustment needed on fiscal consolidation and in the official exchange rate. They project a primary fiscal deficit of 3.6% of gross domestic product for this year, a number that includes one-off boost in revenues generated by taxes on soybeans exports and the wealth tax.

Autarky Scenario, Unlikely

Morgan Stanley doesn’t rules out an “autarky scenario” in which the government opts to avoid an IMF program and the eventual FX and fiscal adjustments needed. But “we find this scenario unlikely given the lack of FX reserves.” At the same time “muddling through another two years until the 2023 presidential elections is unlikely to work, in our view, as it requires ever-rising capital and import restrictions, which could stifle activity and limit political capital.”

The investment bank says that regardless of the results of Sunday’s and November 14 mid-term elections, the future policy mix to be implemented by the government “will be dictated by the macro backdrop.” Recommends investors to hold a combination of ARGENT 2038 and 2035 dollar-denominated bonds given that it’s still “the most attractive” one.

“Instead of holding ARGENT 2041, we suggested moving half of exposure into the lower cash price 2035 and keeping the other half in ARGENT 2038, thinking that the coupon step-ups were priced in (see Time to Switch it Up, July 26, 2021),” the analysts said. “With the difference today between the 2035 and 2041 at 4.0 points and between the 2038 and 2041 at 2.3 points, we think that it’s worth holding onto this position. Especially in a more bullish outcome, we think that the lower cash price 2035 still has room to outperform.”

The bank continues to recommend a “underweight” position in Argentine equities as current macro distortions and policy distortion as the industry level, “should continue to hinder the profitability of the local companies in the medium term.”

Argentina’s economy contracted 9.9% last year and the IMF projects a 6.4% recovery for 2021 followed by a 2.4% expansion next year. On July 13, Minister Guzman and representatives of the IMF met in Venice, Italy, to discuss technical aspects of a IMF-supported program.