Following the close election result in Argentina, President-Elect Milei now faces the difficult decisions of sequencing and meeting his election promises which ranged from cutting ties with China l(dangerous given debts and trade) Brazil (ditto given bilateral trade and other regional issues, dollarizing (unrealistic given lack of dollars) and eliminating the central bank. This piece surveys a few of the things I’m watching and offers some ideas about the impact on EM/regional assets.
In the first few days after the election, Milei or rather his advisors have pulled back from some of his more aggressive immediate pledges including rupturing foreign relations, but has been holding to plans for extensive fiscal adjustment to avoid hyperinflation. It remains to be seen how much power he delegates to his advisors and future cabinet officials and how he balances the range of campaign promises. What is clear is that he has a mandate to do things differently, but the mandate is not that large (his lack of support in the legislature is a particular issue), and the population and investors will be watching whether he tries to take symbolic actions, such as the dangerous dollarization or the hard ones of fiscal adjustment.
Milei seems to be reaching out to some potential partners even ahead of his inauguration, hoping to buy time and send a message to investors. This week, after a stop in NY to visit Hasidic rabbis, He heads to Washington to meet with the IMF and some US officials. He also has extended an olive branch to Brazil, inviting Lula to his inauguration. Given extensive bilateral trade, borders and regional links, some degree of working with Brazil is essential. Finessing the links to China too will be important.
What are the things I’m watching:
Sequence and degree of fiscal adjustment. All creditors, official and private, will be looking for clarity on whether Argentina can come up with a viable fiscal option that can both get the country on a more sustainable track with out cutting too much which would lead to an almost equally unsustainable burden and political backlash. Given the limited number of aligned representatives in the legislature, fiscal adjustment may be difficult.
FX plan and what about the Central bank: Milei has already pulled back from unrealistic campaign promises to get rid of the central bank, perhaps in part due to advise from his market-friendly economic advisor and former central banker, who is part of the outreach to investors and the IMF. The current widening parallel rate is unsustainable, but dollarization is not the answer even if it seems appealing as a golden straitjacket that would force fiscal austerity. Beyond anything else, Argentina is short dollars even in private hands and the experience of other dollarizers suggest that multilateral or US would need to at least provide tacit support, something that is unlikely. Addressing a realistic fiscal plan and economic plan, followed by FX reform is key.
Natural gas and critical minerals strategy. Natural resource output has been a major driver of both investment and the external balances. With Vaca muerta volumes set to increase slowly, this will become a more important source of revenue. It remains to be seen what changes to royalty structures may follow. Argentina, like many of its allies is also positioned to add critical mineral supplies.
China outreach: China is the new key source of capital to Argentina, providing swap lines to support Argentina’s unsustainable imports. As a result, rupturing ties could be very painful and Argentina may seek instead to improve the terms of their agreement and play off the US and China. This will be difficult to do, especially given the limited progress that the US has made in establishing partnerships with EM critical mineral producers. This will be a key area for the US and EU if they are to meet their goals of reducing China’s dominance of critical mineral processing. Other issues for Argentina will include whether to join the BRICS or at least hold out the option of doing so. Which countries actually join remain uncertain, and with Russia set to host the next meetings, real tangible progress among the increasingly diverse group remains unlikely.
Impact on other EM: Contagion to other EM seems unlikely given that many of Argentina’s markets have been relatively priced in already. Many of Argentina’s more liquid tradable Latam counterparts stand out in the EM universe for high real interest rates – Brazil and Mexico notably. These countries will likely have more space to ease if the current global inflationary trajectory holds. In both cases, somewhat hawkish central banks are restrained by fiscal support resulting in higher local premia. Still, in a world where rate burdens are rising and consumption easing, including in the US, these countries should have space to cut rates, while they hold off, they may benefit from carry trades, especially funded by weaker G10 FX. Overall, volatility from Argentina wouldn’t be good for the region, but divergence across EM balance sheets suggests that contagion will be limited.
Overall, the broader macro trends including liquidity and the Fed outlook as well as the state of US and Chinese economies will be more important for the outlook for EM assets. The tighter financial conditions are among the reasons explaining the recent oil price downdraft, along with somewhat higher supplies from outside OPEC+ (and a few OPEC+ members who had struggled to meet targets. Given that US ability and willingness to enforce Iran sanctions is unlikely to reduce exports by much, and the US is likely to want to give Venezuela space to partly comply with the electoral framework, we are not expecting major sanctions related output declines. This will offset the impacts of some enforcement of Russia sanctions which will lead more risk-averse shippers out of that market, modestly increasing the discount and reducing the volume. A major OPEC+ further cut could add to the tightening of the market, but it’s hard to see oil prices quickly returning to their late summer highs.
Ziemba Insights 