Argentina: why the buyback?

The Argentine authorities will be hoping to see a rise in investor confidence this week, after announcing on August 10 a new 'integral financing strategy' involving plans to buy back bonds maturing in 2008. Around 100 million dollars worth of bonds were repurchased the following day (out of an estimated total of about 1 billion), and the risk premium on the country’s debt fell by nearly 70 basis points from the post-restructuring high of 727 points seen last week. 

However, the larger impact has so far been limited:

• The day after the announcement, credit rating agency Standard & Poor's (S&P) downgraded Argentina's foreign debt from B+ to B (five levels below investment grade) citing "increasing economic challenges" and diminishing room for manoeuvre for the government in the face of inflation and fiscal pressures. 
• Moody's, which rates Argentina's foreign debt at six levels below investment grade, is expected to cut its outlook for the country from positive in the coming days, owing to the persistent underreporting of inflation. 

The S&P downgrade coincided with the National Statistics Institute's (INDEC's) report that inflation had reached only 0.4% month-on-month in July, far below private estimates, while food prices purportedly fell by 0.8% and the basic consumer basket by 2.5% (implying a fall in poverty levels).  According to the website Inflacion-Verdadera, created by a group of independent economists, food prices and the basic consumer basket in fact rose by 2.6% and 3.3% in July, respectively.

The decision to buy back debt seeks to address criticisms over policymaking and concerns over the deteriorating fiscal position, which has seen tax collection rising more slowly than public spending in recent months -- a trend that may be exacerbated by increasing demands from the provinces to renegotiate current revenue-sharing arrangements.  The pressure on the primary surplus is especially worrying given that debt repayments due next year will exceed 20 billion dollars. 

The buy-back also appears to be a tacit recognition that Argentina cannot continue to depend on Venezuela as its principal foreign lender (a sale of some 1 billion dollars in bonds to Venezuela in recent days, maturing in 2015, carried an annual interest rate of 15%). The government is also seeking to convince investors elsewhere that economic policy is viable, and the risk of a new default is shrinking.  However, while the new strategy may placate markets if it is seen as a genuine change in approach rather than a purely cosmetic exercise, failure to address serious concerns such as the inflation question will see any improvement in investor confidence rapidly undone.