Surging budget gap hurts longer maturity bonds

Argentina's budget deficit is swelling to the widest in at least a decade as government spending surges, eroding confidence in the outlook for economic growth and reducing demand for longer-term bonds.

Argentina posted a 2.7 billion peso ($619 million) deficit in January and February, a record in data going back to 2000, after spending jumped 34 percent last month from a year earlier while revenue increased 30 percent. The gap will rise to about 3 percent of gross domestic product this year from an estimated 1.8 percent last year, according to Juan Pablo Fuentes, an economist at Moody's Analytics in West Chester, Pennsylvania.

Demand is increasing for debt due in one year or less and falling for longer-term bonds as concern grows that the Argentine government will lose its ability to boost slower economic growth in coming years by further ratcheting up spending, Fuentes said. The shift in demand widened the yield gap between debt due next year and bonds due 2033 to a record 488 basis points, or 4.88 percentage point, yesterday.

“The outlook is looking bleak for the government because a growing deficit is especially complicated for Argentina, which doesn't have external sources of financing,” Fuentes said in a telephone interview. “This forces them to reduce spending, the main source of economic growth, so the risk for longer-term debt increases and demand goes to shorter term bonds.”

Credit markets

Argentina hasn't tapped global credit markets since it defaulted on $95 billion of bonds in 2001. The country's bonds are the third-riskiest among major emerging markets tracked by JPMorgan Chase & Co., with investors demanding an extra 779 basis points in yield to hold Argentine government bonds instead of U.S. Treasuries.

Yields on government dollar bonds due in 2033 rose 21 basis points in the past month to 10.93 percent, while yields on debt due next year plunged 95 basis points to 6.24 percent. Yields on Brazilian government dollar bonds due in 2013 rose 10 basis points to 0.8 percent in the same period. Brazil's deficit will fall to 1.2 percent of GDP this year from 2.6 percent last year, Finance Minister Guido Mantega said on Feb. 15.

Argentina's government had a surplus of 95.5 million pesos in February, the Economy Ministry reported March 19, after a deficit of 2.8 billion pesos in January. Last year, South America's second-biggest economy had a record 30.7 billion peso shortfall after a surplus of 3 billion pesos the previous year.

‘Slower growth'

“The swing was significant,” Boris Segura, a strategist at Nomura Securities International, said in a phone interview from New York. “The problem going forward is that tax revenue will continue to fall because of slower growth and the resolve that the government showed at the end of last year to limit subsidies is waning.”

Spending fell 23 percent to 46.8 billion pesos in February from a record 60.5 billion pesos in December as revenue also declined 9.3 percent to 47.5 billion pesos in the same period.

President Cristina Fernandez de Kirchner cut subsidies on water, gas and electricity to some commercial users and the wealthiest households at the end of last year. She hasn't made further subsidy reductions since then.

Subsidies, which help offset the cost of living for Argentines, are the biggest government expenditure after social security payments. The 9.7 billion pesos in subsidy outlays in February accounted for 31 percent of spending.

Officials at the Economy Ministry didn't return a message seeking comment.

The peso was little changed at 4.3638 per U.S. dollar yesterday. Warrants tied to economic growth fell 0.22 cent to 13.50 cents.

Default swaps

The cost of protecting Argentine debt against non-payment for five years with credit-default swaps rose six basis points yesterday to 724, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Argentina may be able to stem its deficit by weakening the peso to boost exports, said Walter Molano, an emerging markets analyst with BCP Securities in Greenwich, Connecticut. The peso has weakened every year after 2003 as the central bank pursues an administered floating rate by buying dollars in the spot market to accumulate reserves.

“The good thing about Argentina is that it has a flexible exchange rate and it can use that flexibility to solve many of its problems,” Molano said. “The cost of servicing debt is also low.”

Spending

Fernandez signaled she won't cut back on spending by proposing changes to the central bank's charter this month that would eliminate a requirement for international reserves to equal or exceed the monetary base, according to Maximiliano Castillo, a former manager of macroeconomic analysis at the central bank. The change allows Fernandez to use the current $47.2 billion of reserves to pay debt and finance government spending, which may fuel inflation, Castillo said.

Economists estimate Argentina's annual inflation is at 23 percent, the second fastest in the world after Venezuela and more than double the government's official figure.

Appetite for higher-yielding bonds will continue boosting Argentine government dollar debt due in less than five years, while concern about the economic outlook is hurting longer-term notes, Segura at Nomura Securities said.

“The yields on the short-term bonds are attractive compared with other emerging-market debt,” he said. “There's no sponsorship for the longer bonds because the market isn't comfortable with Argentina's credit trajectory.”