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Industry Voices

Commentary: Argentina — persistent opportunity in spite of challenges and volatility

Many investors in emerging market private markets overweight top-down macro screens, including the country decision, in their allocation process.

Argentina's current unpopularity offers an example of how this phenomenon regularly creates capital shortage across markets, creating opportunity for those with the right navigational skills.

It is not an epiphany that Argentina has historically mismanaged its economy and mistreated foreign investors. Few countries have suffered more from misguided political interference and policies than Argentina, which began the 20th century as one of the wealthiest countries in the world. These historical difficulties are largely reflected in current valuations while Argentina remains the third-largest economy in Latin America, with a highly educated, urbanized population.

Following the election of Mauricio Macri in 2015, Argentina temporarily returned to favor with foreign investors. Mr. Macri's policies offered a refreshing change from previous administrations, including pension reform, tax reform, rationalization of provincial fiscal policies, liberalization of price and capital controls, and normalization of monetary policy. These policies, including final resolution with all creditors from Argentina's 2001 default, allowed a resumption of sovereign, provincial and corporate access to the international capital markets. But the market response was too much too fast, a frequent phenomenon across the volatile emerging markets landscape, as investors failed to fully appreciate the woeful state of affairs that Mr. Macri inherited. Understandably leery of "shock therapy," he attempted a gradualist path — but a seamless transition to sustainable growth was probably always unrealistic.

When liquidity conditions recently tightened across all emerging markets, Argentina was particularly vulnerable given its large current account deficits and need for external financing, and the government was compelled to initiate discussions with the International Monetary Fund. The ensuing three-year, $50 billion IMF facility exceeded market expectations and essentially covers all of Argentina's net external financing needs until the end of 2019.

As usual, the IMF agreement requires Argentina to implement certain necessary reforms and policies. There is strong evidence that the Macri administration was inclined to implement these policies over time anyway, including working toward elimination of its primary deficit by the end of 2020. The IMF plan really represents acceleration of reform, essentially the "shock therapy" Mr. Macri had previously tried to finesse.

Fiscal tightening, credible inflation targeting and implementation of structural reforms will initially be contractionary but should provide a more solid foundation to further restore Argentina's credibility and competitiveness and lead to sustainable long-term growth.

The risk to this positive outlook is political. Many Argentines harbor deep-seated distrust of the IMF since the 2001 default and the painful recession that followed IMF-imposed conditions for the last bailout. A near-term economic contraction could impact Mr. Macri's re-election prospects in 2019. That said, regardless of who the next president is, a reversion to unorthodox economic policies is unlikely because Argentines now widely understand that such policies have damaged the country.

Recent revelations of widespread bribery among officials from the Cristina Fernandez de Kirchner administration and private-sector business leaders might reinforce investors' notions of the difficulties associated with doing business in Argentina. Ironically, it might also serve to insulate the Macri administration from the stigma of IMF assistance.

Argentina is thus a great example of how investor aversion and capital shortage creates opportunity, such as those listed below.

Oil and gas services. After a century of energy independence and despite having arguably the second-best shale resources in the world in the Vaca Muerta basin, underinvestment over the past decade has forced Argentina to import natural gas to meet domestic demand. An extreme scarcity of oil and gas services — and particularly horizontal drilling equipment and expertise — has inhibited the development of these formidable sources of domestic energy. Importing natural gas from Bolivia (among other sources) is an unnecessary drain on Argentina's balance of payments. Moreover, failure to develop these resources in an environmentally sensitive manner carries the opportunity cost of not exporting excess natural gas to its neighbors (like Chile).

Telecommunications infrastructure. Argentina is the third largest mobile market in Latin America, with some 60 million mobile connections. Its 91% subscriber penetration rate is the second highest in the region, and smartphone adoption is expected to reach 71% by 2020. Nonetheless, Argentina has never developed the independent tower company model prevalent in many jurisdictions globally. Spain offers a useful comparison. The nations' populations are comparable, but Spain has three times the number of cell towers and Argentina has roughly three times the number of connections per tower, highlighting Argentina's network congestion and need for new towers.

Power. Argentina is Latin America's third largest power market. A combination of increased energy demand and low investment over the past few decades has led to the grid operating at near capacity with little reserve, leading to blackouts and consumption restrictions. The government plans to add approximately 22,500 megawatts of generating capacity by 2025.

Conclusion

Argentina's policies have resulted in years of underinvestment, creating a fertile environment for investors who seek the negotiating leverage and attractive investment structures that can flow from capital shortage. Careful selectivity and structuring can mitigate emerging markets risks on a deal-by-deal basis, thereby transcending conventional wisdom related to any given country or region.

Across all jurisdictions, the primary formula for success in emerging markets private markets is a strong management team focused on resolving a significant market inefficiency. In fact, those inefficiencies are more abundant in emerging markets than developed markets. Investors who overweight top-down macro screens and adhere to consensus country-level assessments, will miss a lot of underlying bottom-up opportunity.

Gregory Bowes is a co-founder and managing principal at Albright Capital, Washington. This content represents the views of the authors. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.