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Unsolicited Ratings On Argentina Lowered To 'B-' On Increasing Risks To Policymaking; Outlook Is Negative

Overview

- On Oct. 26, the US Second Circuit Court of Appeals affirmed the ruling by a District Court in New York on the effect of the equal treatment provision in the terms of certain Argentinean bonds.

- This, along with recent events, including the payment in local currency of a provincial bond denominated in US dollars and the blocking of an Argentinean Navy ship in Ghana by holders of defaulted sovereign debt, highlight the increasing challenges the government will likely continue to face to design its economic and debt management policy.

- We are lowering our unsolicited ratings on the Republic of Argentina to 'B-' from 'B' to reflect our view of these risks.

- The outlook is negative, reflecting the risks we believe Argentina will likely continue to face to withstand pressures on its external liquidity.

Rating Action

On Oct. 30, 2012, Standard & Poor's Ratings Services lowered its unsolicited long-term sovereign credit ratings on the Republic of Argentina to 'B-' from 'B'. The outlook on the longterm ratings is negative. We also lowered our transfer and convertibility assessment on Argentina to 'B-' from 'B'.

Rationale

The downgrade reflects our view that the government of Argentina could face increasing debt management risks. This follows the ruling by the Second Circuit Court of Appeals of the USaffirming the judgment of the New York District Court granting summary judgment to plaintiffs on their claims for breach of an equal treatment provision in the terms of the bonds. This ruling could effectively increase Argentina's liabilities and the government's debt service. In addition, we consider that recent negative events highlight the increasing challenges the government of

Argentina will likely continue to face to define its economic policy management and financial program over the near term. These events include the payment in local currency of a province liability denominated in US dollars issued under Argentinean law and the blocking of a navy ship in Ghana by litigants from the 2001 sovereign default.

Although we don't expect the Appeal Court rule in New York to have an immediate impact on debt service because the procedure for implementing the equal treatment provision has not yet been defined, it will make it more difficult for Argentina to normalize its relationship with private, bilateral, and multilateral lenders. Argentina has now been in default with Paris Club lenders for 11 years.

Our rating on Argentina is also based on our view that policies enacted since the October 2011 presidential elections could, over time, increase the risk of a deterioration in the country's macroeconomic framework, put pressure on its external liquidity, and weaken its medium-term growth prospects. These policies include rising restrictions on international trade and access to foreign currency, a modification to the Central Bank charter, and growing public-sector intervention into different sectors of the economy.

We believe that these actions could exacerbate the existing weaknesses in Argentina's economy, including high inflation (which continues to appreciate Argentina's real exchange rate) and increasingly rigid government expenditures, and result in a deteriorating medium-term fiscal outlook and investment conditions. We expect real GDP to expand about 1.5% in 2012.

Although Argentina had $45.3 billion of international reserves at the end of September 2012, equal to five months of current account payments, we see risks to the nation's external liquidity over the medium term. The combination of a weak global economy, growing uncertainty from both foreign and local market participants, and restricted access to foreign financing could, over time, raise the risk of a loss of external liquidity.

High inflation contributed to a decrease in the real value of government local currency debt over the past five years. That, along with balanced budgets or small deficits until 2011 and rapid GDP growth, led to a decline in debt versus GDP since 2007. Argentina's gross general government debt is falling toward 39% of GDP at the end of 2012 from 60% in 2007. The central government relies on public-sector entities to refinance maturing market debt, a policy that has moderated its rollover risk. In addition, principle payments on capital market debt are expected to decrease significantly in 2013. However, the government will still need to service a significant payment on the GDP warrants bond on Dec. 15, 2012, for a combination of US$2.8 billion denominated in U.S. dollars and US$834 million denominated in Argentinean pesos. After that, we expect external debt payments with private creditors (excluding multilateral and bilateral entities) to fall from $7.0 billion in 2012 (about 1.4% of GDP) to $4.0 billion in 2013 (0.7% of GDP) and $2.0 billion in 2014 (0.3% of GDP). We assume government agencies will continue to cover financing for budget deficits.

Outlook

The negative outlook indicates at least a one-in-three chance of a downgrade over the next 12 months. We could consider lowering our ratings as a result of increasing risks on external debt payments stemming from the legal actions against Argentina in international courts; a worsening external position, mostly likely from financial outflows; or additional policy actions that exacerbate political polarization and further diminish Argentina's growth prospects. On the other hand, the ratings could stabilize if we see that the government takes actions that restore investor confidence about the economy's medium-term prospects (on the monetary or structural front) and, thus, reduce uncertainty about its external liquidity position.