Argentine President Javier Milei’s first month in power has earned him the nickname “chain-saw austerity” from his detractors. However, investors seem to be pleased with his efforts so far. Alejo Czerwonko, chief investment officer for emerging markets Americas at UBS Global Wealth Management, believes that Milei has a higher chance of success than failure.

Before Milei’s election in November, Argentina’s hard-currency bonds were trading below 30 cents on the dollar. However, since he took office on December 10, they have risen to the mid-30s.

Milei made a promise to reform the Argentine state from top to bottom. The country’s deficits have led to annual inflation exceeding 100%, and overregulation has made it incredibly difficult to conduct business. Milei is determined to tackle these issues.

Just two days into his term, Milei cut the official exchange rate of the peso in half, bringing it closer to a market-driven “offshore” rate. Additionally, he issued a Decree of Necessity and Urgency that aims to remove controls on food prices and rents, ease labor restrictions, and prepare state companies for future privatization, among other measures.

Economy Minister Luis Caputo introduced a package of tax increases and spending cuts to reduce Argentina’s budget deficit by 5% of gross domestic product. This move should theoretically result in a “primary” surplus, not including debt service.

To kick off the new year, Caputo has proposed a $71 billion swap program for peso-denominated bonds that are maturing this year. While few foreign investors hold this type of paper, a successful multiyear restructuring would demonstrate the capability of the new government, according to Gustavo Medeiros, head of research at Ashmore Group. He believes that avoiding a recurring debt crisis every few months is a crucial part of the stabilization plan.

The Emergence of Javier Milei and the Challenges Ahead for Argentina

Javier Milei, a seemingly lone-wolf maverick, has made a surprising alliance with Argentina’s last right-leaning president, Mauricio Macri. This unexpected partnership has led to the formation of a seasoned cabinet headed by Caputo, who previously served as a minister and central bank chief under Macri. Moreover, this alliance has brought Milei within reach of securing majorities in Congress, a remarkable feat for someone who was once viewed as an outsider. However, it is important to note that without the support of the Macri team, Milei’s influence would be greatly diminished, as noted by Thierry Larose, portfolio manager for emerging markets local debt at Vontobel Asset Management.

Fortunately, favorable weather conditions may work in Milei’s favor. Last year, Argentina suffered from a devastating drought, which resulted in a 2.5% decrease in GDP for the agriculture-intensive country, according to the International Monetary Fund. Thankfully, there is hope for a recovery this year.

Nevertheless, rescuing Argentina from its long-standing issues is far from easy. As Medeiros explains, Argentina has been plagued by chronic overspending since Juan Peron’s rise to power in the 1940s.

Despite the challenges, Milei’s emergency decree stands a good chance of surviving due to its existing legal framework. It can only be overturned if both houses of Congress vote against it. On the other hand, the proposed budget cuts and the comprehensive “omnibus law,” which encompasses structural changes, face more complex negotiations in Congress.

It is important to recognize that implementing chain-saw austerity measures will initially worsen the situation for most Argentines before any signs of improvement become noticeable, as Milei himself acknowledges. The decision to abandon the managed peso and cut subsidies on fuel and other necessities is likely to accelerate inflation in the short term.

While protests have been relatively subdued by local standards, the strength of unions will be tested through a general strike scheduled for January 24. UBS’ Czerwonko raises concerns about the government’s ability to manage the social situation in this context.

Looking at Argentina’s bonds, it is evident that they are not currently priced for perfection or even for servicing until maturity. Larose raises important questions about the potential for future debt restructurings and the recovery rate investors can expect.

Notably, Larose sold the bonds when they reached a near 40-cent value due to post-election optimism. Nevertheless, he believes that a new entry point may be on the horizon, signaling potential opportunities for investors.

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