2003 Spring Forum

Guillermo Mondino Reflects on Argentine Election and Economy at EMTA Spring Forum
An overflow crowd of 220 Emerging Markets professionals attended EMTA’s Third Annual Spring  Forum on May 1, 2003, hosted for the second year by Bear Stearns.  Former Argentine Secretary for Economic Policy Guillermo Mondino delivered the event’s keynote address; his presentation was followed by a panel of Emerging Markets experts discussing their thoughts on several Emerging Markets countries, and finally a lively cocktail reception.

EMTA Executive Director Michael Chamberlin welcomed attendees and informed them that EMTA, in collaboration with the Emerging Markets Creditors Association (EMCA), had recently begun publishing a series of charts analyzing the collective action clauses in bonds recently issued by Brazil, Mexico and Uruguay.  Chamberlin noted that he would refrain from making any specific comments on the new clauses but asserted that this aspect of bond documentation and crisis resolution has now moved out of the hands of government policymakers, and trade associations, where it never really belonged, and into the marketplace, where it more properly does.

Governability an Issue in Argentina as Kirchner Victory Based on “Borrowed Votes”
In his speech, Mondino, now an analyst at LatinSource and MacroVision Consulting, geared his remarks towards the results of the first round of the Argentine presidential elections, which had occurred days earlier, and his predictions for the election run-off.  He also addressed the post-election political outlook for Argentina.

In explaining the stronger-than-expected showing of then-presidential candidate Nestor Kirchner in the first round, Mondino declared that Kirchner had “undoubtedly benefited tremendously from the current revival in the economy,” including 1Q GDP growth, slowing inflation, an appreciation of the Argentine peso and the perception among Argentines that these trends would continue.  However, according to Mondino, even more important was the “functioning of the political machinery of President Duhalde in the Province of Buenos Aires.”   Despite the first round results, Mondino declared that Kirchner had run a “poor” campaign, failing to convince the Argentine electorate of his own skills, and was saved only by a perception that he would preserve the status quo, as well as the high negatives for another leading candidate, former President Menem. 

The strongest message coming out of the election, argued Mondino, was that political machineries continue to dominate the Argentine political scene.  Mondino cautioned that this did not bode well for the future.  No one who wins an election because of the strength of an organized political machinery will move to dismantle the system, he reasoned.

Mondino predicted that Kirchner would also win the final election on his combination of “borrowed votes” from Duhalde’s political machinery and the large anti-Menem contingent, but would draw very few (maybe as little as ten percent) “pro-Kirchner” votes.  Thus, governability could be an issue, Mondino warned, as Kirchner would have little personal support going forward.

There is even an incentive, Mondino speculated, for President Duhalde to break ranks with Kirchner at some point during his tenure, as Duhlade harbors “further political ambitions.”  Kirchner might be able to get laws passed, and might be able to present a coherent economic policy, but his ability to push through ambitious structural reform would be limited, Mondino cautioned the audience, and any reform movements would be “gradual and not particularly deep.”

Argentine Economy Recovery Will Depend on Reforms
The recent economic recovery is puzzling, stated Mondino, in light of the dismal economic conditions last year that prompted President Duhalde to call early elections.  The recovery has short legs and will not promote long-term growth unless several structural reforms are carried out, he stressed.  Basic reforms that are needed include (a) a consolidation of the fiscal accounts, (b) a re-working of the tax sharing regime between the federal government and the provinces, (c) banking system reforms, (d) and a debt restructuring.

It is in the Republic’s interest to complete a debt restructuring as quickly as possible, both in terms of taking advantage of current interest rates, and for allowing the economy to continue to grow, Mondino pointed out.  However, obstacles preventing a rapid debt restructuring include a real question of how large the government’s debt really is because Argentina is still dealing with compensation of claims from last year, and the need for the government to adopt a strategy vis-à-vis its creditors.

Debt Restructuring Prospects Analyzed
Mondino summarized that Argentina’s debt could be divided into three categories:  claims unlikely to be restructured (multilateral and bilateral debt, compensation bonds) totaling $90 billion; a gray category (past due interest) of approximately $5 billion currently, which will likely double by the time a deal is completed (and which Mondino conceded he personally believes will be restructured); and the junior debt likely to be restructured (e.g. external bonds) totaling approximately $75 billion. 

By the time the deal is completed, Argentine GDP could reach as much as  $180 billion, stated Mondino.  Assuming a 50% haircut on junior debt and PDI, Argentina will still have a debt to GDP ratio of approximately 70–90%.  “The bottom line is that the restructuring is not going to solve the fundamental problems of the Republic,” he declared, but it will produce breathing room by reducing coupon payments.  Long-term growth will instead be a function of governability, the enactment of structural reforms, and the pace at which reforms are carried out.  He concluded his speech by stating that thus the “boring elections” which don’t “necessarily excite anybody” are “actually quite crucial.”

In response to audience questions, Mondino offered his assessment of the Argentine restructuring.  He predicted a “fairly deep haircut” would occur, with a 35-40% reduction in principal, a “highly significant” reduction in coupons and an extension of maturity.  Mondino estimated the recovery value for owners of Argentine debt would range between 22 and 24 cents on the dollar.

Finally, Mondino also opined on the prospect for Argentina’s relations with the IMF.  Mondino criticized the government for its previous dealings with the Fund but believes there has been a gradual improvement in the discussions, including good IMF-Central Bank relations.  “Now the problems won’t be with overall macro-economic policies but with specific targets,” he asserted.

Panelists See Few Immediate Risks to EM Rally
Moderator Carl Ross of Bear Stearns started the panel that immediately followed Mondino’s remarks by asking panelists for their thoughts on the global economy and possible risks to Emerging Markets debt.  Mike Gagliardi (Trust Company of the Atlantic) admitted that it was a difficult task to specifically identify major risks to the EM debt marketplace, but suggested that the industry could potentially be hurt by a general shift to equity investment from debt, interest rate hikes or a major retreat from the asset class by Wall Street.  (“We’ve had a good 15-20 year run with a couple of big potholes, yet a number of firms still aren’t as committed to this asset class, at least on the sales side, as is warranted,” Gagliardi declared.)  He added that recent events had prompted him to think of the possibility, albeit unlikely, that Russia would become a political pariah, with negative ramifications on EM assets. 

Eric Fine (Morgan Stanley) concurred that risks to the asset class were all “distant” and “not around the corner,” but listed a couple of “red flags” worth monitoring.  Among Fine’s concerns were the possibilities that some recently-invested cross-over money could desert the asset class quickly in the event of a headline that more seasoned dedicated investors might have been expecting and thus would be more likely to shake off.  News from Turkey, Venezuela and Brazil could also lead to a decrease in investor confidence even amongst seasoned investors.  Finally, Fine declared that Russia and Mexico have undergone “no real structural reforms in the past couple of years, but have benefited from high oil prices,” and thus remain somewhat vulnerable to oil pricing.

Ruggero de’Rossi (Oppenheimer Funds) added that the market continued to give Brazilian President Lula da Silva “benefit of the doubt,” but that Lula’s failure to deliver on reforms remained the largest risk to the market.  He later expressed reservations that there is a point at which investors become “too” risk-loving, and suggested that the lack of identifiable risks was itself a potential issue.  De’Rossi described the paradox of the easy marketing of Emerging Markets debt when the asset class was already in a long rally, and the difficulty of finding believers when the market was weak (and therefore has more potential to tighten).  “When I go marketing in Europe at 1200 over, no one wants to buy Emerging Markets; now I see all this money coming in at 400 over and I get worried,” he stated.  He surmised, “it tells you that people are coming in when the party has already started,” adding that in his opinion, “we are at the last fifty basis points of a 5-year rally.”

Ross next asked several of the panelists to assess the prospects for key Emerging Market countries.  Alberto Ades of Goldman Sachs discussed Latin America, beginning with his forecast for slightly higher growth in Mexico.  As for Brazil, Ades pointed out the strong recovery in Brazilian spreads, and estimated Brazilian growth at 1.5% in 2003.  Ades admitted his surprise at how market-friendly the policies and signals have been thus far, but noted the challenges ahead for the Lula administration remain large.  As for Andean countries, Ades recommended overweights in Ecuador, Colombia and Peru and an underweight in Venezuela.

Fine discussed recommendations for the Europe/Middle East/African time zones after acknowledging that his most bullish recommendations were in Latin America.  Fine rated Russia a market perform, and commented that although he still sees Russia moving towards an investment-grade rating, he remains concerned about the trend for Russia to become “Venezuela-ed.”  “The banking system hasn’t really grown, and the culture of government outside of the Duma hasn’t changed,” Fine warned.  Fine declared that Ukraine is a country he is watching with great interest, pointing out that it could be a major manufacturing center for its soon-to-be neighbor the EU, as well as Russia.  New longer-term bonds could possibly be of interest to investors who are currently not attracted to Ukraine’s short-term issues.  As for North Africa, Fine remarked that reforms were “moving in the right direction, just the absolutely wrong pace.” 

Panelists Opine on Uruguay Swap Offer
Ross solicited Gagliardi’s comments on the implications of the recent exchange offer launched by Uruguay, first offering his own opinion that it would have negative implications for the market if indeed the swap were a new model for IMF behavior towards highly indebted countries.  Gagliardi responded that the recent IMF-Uruguay deal did not in fact augur a new paradigm.  “This is Mayberry relative to Argentina,” he declared, continuing that the proposed deal “is something that can get done in a relatively short period of time, and it’s something we can live with at the end of the day.”  He was not concerned with the debate over collective action clauses and preferred to focus more on reaching a financial solution to the country’s economic crisis.  The swap offer would have to succeed, according to Gagliardi, because there was no alternative.  “These guys need a break; they need to do something; that’s the reality.”

Gagliardi also spoke out on “rogue creditors.”  Previous hold-outs (which he termed “loathsome”) had taken years to collect, and most EM debt investors were not interested in pursuing a strategy that was both extremely difficult and could entail a decade of work before being rewarded, he argued.

Panel Recommendations Include Brazil, Mexico
Ross concluded the panel with a request for the panelists’ investment recommendations, Ades suggested investors look into interest rates in Mexico, Israel and South Korea.  He concurred with Mondino’s earlier implication that Argentine debt was currently over-valued, speculated that a Kirchner win would result in a delay in the debt restructuring, and advised that investors consider shorting Argentine debt.

Gagliardi asserted that investors are increasingly dictating higher-grade investment parameters to fund managers, thereby forcing managers to buy countries such as Panama which he personally did not consider attractively priced.  However, Gagliardi reasoned that this was generally a positive trend, and a “more sane” approach to Emerging Markets investment.  He also suggested Argentine corporates, Emerging Market equities and Kazakh debt (where a local pension system will continue to support debt prices) as longs; and expressed bewilderment at the prices of Lebanese debt, an asset he “wouldn’t touch.”

Brazil remained a top pick for Fine, and he concurred with Ades that Mexican and Israeli local markets were enticing, noting that Mexican local debt was increasingly being added to bond indices.  Fine would be reluctant to short any instrument in the current market rally, with any mispricings in the market still having the potential to become “more mispriced.”

De’Rossi believed further tightening was still possible for Brazilian debt, and noted that he had maintained a large overweight position in Brazil for some time.  Emerging Market euro-denominated debt was also an interesting investment based on the potential appreciation of the currency, advised de’Rossi.  Surprised that no one had mentioned Venezuela, he recommended buying default protection for Venezuelan debt.