Puente Argentina Report - November 9th, 2018

Argentina Strategy Watch

Is the 2019 fiscal target feasible?

 Is “almost” zero primary deficit good enough?
Under our base scenario, we expect a small deviation in the fiscal consolidation plan in
2019. In numbers, we expect the government to bring the primary deficit down to 0.3- STRATEGY TEAM
0.5% of GDP in 2019. Considering the magnitude of the correction, we don’t expect this 
to create problems with the IMF as the deviation is small enough to be solved via a
JUAN MANUEL PAZOS
waiver. The problem is that we will see close to no compression in the hard currency
curve if the market begins to add an execution premium over the risk premium Head Strategist
associated to next year’s election. Especially if the deviation increases borrowing needs. jpazos@puentenet.com
The revised SBA with the IMF provides a breakdown of the discretionary measures
included in the 2019 Budget to attain a zero primary balance, some of them look hard to
accomplish. We estimate that to reach a zero primary deficit, the government needs BRUNO GENNARI
3.8pp of GDP worth of discretional measures. The problem is that, in our view, the truly
Analyst
feasible discretionary measures total 2.7% of GDP. The rest are divided between
measures with mild execution risks which we expect the government to achieve albeit at bgennari@puentenet.com
a political cost and high execution risks measures which, at this point, we don’t expect
the government to accomplish. Because we don’t expect the IMF to extend the SBA line a
second time, the additional funding requirements could stress 2019’s financial program.
In fact, Argentina’s net borrowing needs look manageable in 2019 provided that the
government achieves to bring down the primary deficit down to zero. Covering a 0.5pp of GDP deviation, however, would
increase the required roll-over ratio of short term debt instruments from high 50s to mid-70s, requiring an additional effort in a
-year in which retail savers will have electoral uncertainty.

 Energy subsidies, political negotiations provincial transfers and FGS revenue: the four big ifs
The first source of potential deviation from the consolidation’s targets is that we don’t expect the government to attain
significant savings in energy subsidies. In fact, we believe that the budget underestimates both the required subsidies to gas
producers and to generation companies under current legislation. In the electricity generation space, resources included in the
2019 Budget are enough to cover the capacity payments of new energy and nuclear, but not to subsidize consumption.
Likewise, the ARS28.7bn allocated for incentives to gas production appear insufficient to cover the agreements with
producers. Looking beyond energy subsidies, the 2019 Budget includes 0.4pp of GDP worth of revenue resulting from the
draw-down of FGS assets, something that we see as politically and legally unfeasible. Finally, political negotiations diluted the
impact of the transfer transportation subsidies and are likely to dilute in the coming days the impact of the wealth tax.
Moreover, Province of BA is negotiating with the Federal government to anticipate the indexation of the Fondo del Conurbano,
seeking to increase transfers to the Province by ARS19bn, covering one-third of Buenos Aires’ net borrowing needs in 2019. At
the end of the day, whatever the sovereign offloads, provinces find a way to be compensated off the Federal Government’s
dime.

 Strategy: Expect little compression in the HC curve until the elections

Given the execution risks in the consolidation plan in 2019, the need to raise USD26bn in the markets in 2020 and the electoral
uncertainty, we remain positioned in the front-end of the sovereign’s hard currency curve. We expect Argentina’s spread over
UST to hover around 600bp until the scenario for next year’s presidential election becomes clearer. In our view, the
improvement in Argentina’s fundamentals is consistent with a tighter risk premium but better fundamentals will not have an
impact on the hard currency curve until 2Q19, when polls will begin to paint a clearer picture of the presidential race. At this
point, we expect the scenario to become binary. If the government’s chances of reelection improve, then we expect the risk
premium to compress to the 350bp range. If not, spreads could widen further depending on who leads the race. In our view,
the most attractive play on the sovereign hard currency curve is to bet on a compression of the spread between the local law
and the global law bonds. All in, the local law curve, which was trading close to the international law curve by end of 2017, is
currently trading well outside and steeper. In our view, this correction in the local law curve is explained by retail investors
reducing their exposure to the sovereign rather than to a change in fundamentals or an increase in the default premium.

1
ARGENTINA STRATEGY WATCH November 9th, 2018

Is the 2019 fiscal target feasible?

Juan Manuel Pazos - Head Strategist Juan Manuel Vazquez - Head of Equity & Credit Research

 2019 Fiscal base scenario: is “almost” zero
primary deficit good enough?
Under our base scenario, we expect
government to bring the primary deficit down
to 0.3-0.5% of GDP in 2019, getting close
albeit not completely to the zero primary
deficit target.
Under our base scenario, we expect a small
deviation in the fiscal consolidation plan in 2019.
When we look at the Budget, we believe that the
discretionary measures passed will be enough to
bring the primary deficit down to 0.3-0.5% of GDP
rather than all the way to a zero primary balance.
Considering the magnitude of the correction, we
don’t expect this to create problems with the IMF as
the deviation is small enough to be solved via a
waiver. In fact, the IMF staff has acknowledged that
the planned fiscal consolidation ‚implies a structural
fiscal adjustment of 3.1 percent of potential GDP, a
1.7 percent of potential GDP larger negative fiscal
impulse than was built into the original SBA‛. The
problem is that we will see close to no compression
in the hard currency curve if the market begins to
add an execution premium over the risk premium
associated to next year’s election. Especially if the
deviation increases borrowing needs. All in, we see
this execution risks tied to an aggresively pro-
cyclical target that’s underpinned by a number of
measures of doubtful success.
revised SBA, that would be enough to correct 2018’s
primary deficit plus 1.1pp of GDP worth of
measures previous to the SBA that will widen 2019’s
the
deficit. The problem is that, in our view, the truly
feasible discretionary measures total 2.7% of GDP.
The rest are divided between measures with mild
execution risks (0.5% of GDP) which we expect the
government to achieve albeit at a political cost and
0.6pp in high execution risks measures which, at this
point, we don’t expect the government to
accomplish. That would leave an 0.6pp of GDP
primary deficit. We come to our expected 0.3%-0.5%
range because 2018’s primary deficit is likely going
to be in the 2.5-2.6% of GDP range, lowering the
initial deficit and because under our base scenario
we expect a cyclical push to revenue by the
combination of economic recover starting in 2Q19
and higher inflation than assumed by the Budget.
Table 1: Consolidation with execution risks

The revised SBA with the IMF provides a

breakdown of the discretionary measures

included in the 2019 Budget to attain a zero

primary balance, some of them look hard to

accomplish.
The 2019 Budget includes discretionary savings
measures totalling 3.8pp of GDP. According to the Source: Puente estimates based on IMF

2
 The problem with a deviation is not so much
the SBA with the IMF, but rather the impact
on the net borrowing needs.
An 0.5pp of GDP deviation in the target would
increase net borrowing needs by USD2.3bn,
requiring additional funding (using the 2019
Budget’s average FX for consistency). We don’t
expect a deviation of such small magnitude to have
an impact on the disbursements agreed in the SBA
given the size of the consolidation, but we don’t
expect the IMF to extend the line a second time,
providing additional funding either. In this context,
the additional funding requirements could stress
2019’s financial program. Argentina’s net borrowing
needs look manageable despite a context of reduced
market access, provided that the government
achieves to bring down the primary deficit down to
zero. In that context, Argentina would have
USD8.3bn in net borrowing needs, which would be
covered with a roll-over of 57% of the USD Letes
and ARS Lecaps maturing. The number looks
reasonable when considering that the roll-over rate
has improved from 60% to around 70%. Covering a
0.5pp of GDP deviation, however, would increase
the required roll-over ratio to 73%, requiring an
additional effort in a year in which retail savers will
have electoral uncertainty.
Table 2: Deviations from the zero primary
deficit target in 2019 will require rolling over a
larger share of short-term instrument
maturities
3
Figure 1: Short-term treasury bill roll-over
ratio is hovering around 70%
6000 1.2
0.9
4000
0.6
2000
0.3
0 0.0
-2000
-0.3
-0.6
-4000
-0.9
-6000 -1.2
Oct-16 Mar-17 Aug-17 Jan-18 Jun-18
Issuances
Monthly USD LETES
dynamics (USDmn)
Maturities
3-month roll over ratio (right)
Source: Puente estimates based on the Treasury
 Sticky energy subsidies: a design problem
We don’t expect the government to attain
significant savings in energy subsidies as the
budget underestimates both the required
subsidies to gas producers and to generation
companies under current legislation.
In our view, the main challenge to the government’s
objective of cutting energy subsidies by 0.2pp of
GDP next year is that the nature of the problem has
changed, but the government’s solution remains the
same. Back in 2015 the government faced two
problems in the energy front, a shortfall of energy
and an unsustainable subsidies bill. The subsidies
problem was the easier to be solved from a technical
point of view, albeit with the highest political cost.
Because energy subsidies were driven by the gap
between the tariff and the generating cost (in
electricity) or the difference between the regulated
wellhead price and the economic cost of producing
gas, resolving the problem was about aligning what
the consumer paid with the economic cost. On the
other hand, the government’s solution to the energy
shortage was to offer significant incentives to
electricity generation via the emergency PPAs and to
key gas producers in Vaca Muerta. The government
now faces a general equilibrium problem, as the
solution to the energy shortage has made close to
impossible the reduction of energy subsidies next
year. At this point, subsidies would continue to exist
even if consumers paid the full economic cost of
energy (which we don’t expect them to do in 2019).
We estimate that the subsidies included in the 2019
Budget are barely enough to cover the production
incentives, leaving little resources to continue
subsidizing consumers.
In the electricity generation space, resources
ameliorating consumers’ electricity bill hikes and
(iii) respecting the large capacity payments agreed in
PPAs. In our view, the government’s attempt to
reconcile this conflicting objectives will end with
larger subisides.
Table 3: CAMMESA’s subsidy credit in 2019 is
barely enough to cover capacity payments and
nuclear

included in the 2019 Budget are enough to

cover the capacity payments of new energy

and nuclear, but not to subsidize

consumption.

The 2019 Budget assigns ARS99.5bn to CAMMESA

for economic subsidies, or about USD2.4bn
assuming the Budget’s FX rate. That figure is
Source: Puente estimates based on the Treasury
basically just enough to cover the USD1.2bn
required by PPAs capacity payments and the Figure 2: Gap between the generation cost and
USD800mn payments for nuclear. The rest is used to the regulated price to demand
subsidize the gap between the generation cost
3500 100%
(currently at ARS/MWh2960) and the regulated price
2019 Budget w/ 90%
3000 FX @ 45
to the demand (ARS/MWh1347), which were 80%
2500 70%
historically the main driver of electricity subsidies. 2019 Budget w/
FX @ 40 60%
2000
In 2018, the Budget allocated around USD481mn to 50%
1500
these concepts. According to the IMF’s SBA, the 40%
30%
government intends to bring tariff coverage of the 1000
20%
economic cost from around 50% this year to 70% in 500
10%

2019, which is roughly consistent with the 2019 0 0%

Dec-15 Dec-16 Dec-17 Dec-18 Dec-19
Budget cutting the rest of CAMMESA’s funds to
Generation cost Regulated price to demand Coverage %
around USD400mn, assuming an FX at
USDARS40.1. The problem is that if the FX is closer Source: Puente estimates based on CAMMESA
to our USDARS45 view, meeting the 2019 Budget’s
subsidy bill would require slashing subidies to Likewise, the ARS28.7bn allocated for
consumers significantly, as CAMMESA allocation incentives to gas production appear
would just be enough to cover the capacity
insufficient to cover the agreements with
payments of PPAs and nuclear. In other words, it
would require doubling electricity prices to producers.
consumers, something which doesn’t look feasible in
an electoral year. At the end of the day, the The 2019 Argentine budget includes ARS28.7bn in
government is trapped between three conflicting payments to the current gas incentive program (Res.
objectives: (i) cutting energy subsidies: (ii) 46 and additional ones). Based on the Budget FX, the

4
government is assuming payments for USD700mn in  Draw-down of FGS assets: politically and
2019. As a reminder, the incentive payment for 2019 legally unfeasible
will be the difference between USD7/MMBtu and an
The 2019 Budget includes 0.4pp of GDP worth
effective price which will be a volume-weighted
of revenue resulting from the draw down of
average price that will be informed every month by
the Secretariat of Hydrocarbon Resources. FGS assets, something that we see as

politically and legally unfeasible.

If that number is, for example, USD3/MMBtu
(USD7/MMBtu less USD4/MMBtu, the latter being The 2016 pension reparation law included the option
the effective price) then only 18MMm3/d would be to draw-down FGS assets to finance the increased
included in 2019. benefits outlays. The problem is that the bill did not
release FGS managers from being personally liable
However, the government is targeting in the 2019
for the trades they decide to make. Given the large
Budget 33.6MMm3/d coming from the incentive. If
drop in valuations of the FGS book, drawing down
that is correct, the implied price to be paid would be
assets next year looks like a sure route for FGS
USD1.6/MMBtu.
managers to get sued by the opposition. During
Looking at current production levels of concessions 1H18, the value of the FGS book dropped -26%YTD
included in the incentive, we believe 33.6MMm3/d in USD terms to USD47.4bn. The drops are
could make sense, but it is still not clear what sort of especially concentrated in equities (-46.3%YTD),
remunerations companies included in the incentive which is the selected asset to do the draw-down.
are expected to receive. We are not discarding a There are also political implications. Left-wing
modification in the Budget line. parties led by Kirchnerism as well as some Peronists
like Mr. Massa and Mr. Bossio have made of the FGS
Additionally, the 2019 Budget does not a linchpin of their opposition to the Administration.
allocate resources to covering the arrears in All in, we believe that the draw-down of the FGS
would be like touching the third rail, repeating the
the 2018 Plan Gas.
saga around the pension indexation formula last
In the past few months, the government may have December.
been falling behind in the payments of the incentives
Table 5: The equity is the hardest hit in the
to gas producers. A clear sign of this could be the
gap between accrued basis energy subsidies (in FGS in 2018
particular gas payments) and cash basis subsidies.
Normally, when the government has arrears, the
following year’s budget allocates funding to cover
them. This is not the case in the 2019 Budget.
Meeting the 2018 primary deficit target leaves little
space to increase cash spending to correct the arrears
and the 2019 Budget already sub-allocates the
required resources to cover next year’s accrued
spending. In this context, there is the risk that the
government might opt to cover the arrears by giving
producers some sort of debt instrument, like it did
Source: Puente estimates based on Anses
with the original Plan Gas arrears.

5
 Measures with mild execution risk: outcome
of the political negotiations around the
wealth tax and transportation subsidies
A recent report by the Congression al Budget
Office shows that political negotiations in the
Lower House increased spending almost six
times as much as revenue.
According to the recently established CBO, an
independent watchdog, the political negotiations in
the Lower House increased spending in the 2019
Budget by ARS24.2bn relative to the original bill, but
it only included ARS2.7bn in additional revenue.
The gap was left unfunded by the House. Political
negotiations diluted the impact of the transfer
transportation subsidies and are likely to dilute in
the coming days the impact of the wealth tax.
Looking ahead, Province of BA is negotiating with
the Federal government an anticipation in the
indexation of the Fondo del Conurbano, seeking to
increase tranfsers to the Province by ARS19bn,
covering one-third of Buenos Aires’ net borrowing
needs in 2019. At the end of the day, whatever the
sovereign offloads, provinces find a way to be
compensated off the Federal Government’s dime.
This puts a question mark on the huge chunk of
discretionary measures dependent on provinces
accepting to get encumbered by the sovereign.
Though we expect the Treasury to secure this
measures, they will have a significant cost. The main
examples are the transportation subsidies and the
wealth tax.
Table 6: The amends introduced in the Lower
House to the Budget increased ARS9 in
spending per every ARS1 in new revenue
Source: Puente estimates based on OPC
6
Provinces secured an SPV funded by the
collection of the new wealth tax to cover a
large part of the transfer of transportation
subsidies while the Senate is expected to
introduce exemptions to the wealth tax.
The initial calculation behind Peronist provinces
approving the transfer of transportation subsidies
was that Province of BA, City of BA, City of
Cordoba and City of Mendoza would be the four
hardest hit districts, all under Cambiemos
administrations. Even then, the impact on provincial
finances was further diluted by creating an
ARS6.5bn SPV funded with the additional revenue
from the wealth tax for Provinces to draw and pay
for the transportation subisides. All in, from the hike
in the wealth tax provinces will not only get their
share via coparticipation but also the revenue of the
SPV. This shaves the IMF deal on two different
sides: on the one deal, it takes a chunk off the
sovereign’s wealth tax intake. Additionally, the
Senate is likely to introduce modifications into the
wealth tax, ammending it to introduce an exemption
to family homes with value up to ARS12mn. The
government puts the cost of the loophole at
ARS1.5bn. All this reduces the impact of the
measure, increasing the risk of deviations from the
fiscal target.
 Strategy: Expect little compression in the HC
curve until the elections
In this context, we don’t expect a significant
compression in the Argy risk premium, which
we expect to remain close to 600bp until the
electoral scenario becomes more certai n.
Given the execution risks in the consolidation plan
in 2019, the need to raise USD26bn in the markets in
2020 and the electoral uncertainty, we remain
positioned in the front-end of the sovereign’s hard
currency curve. We expect Argentina’s spread over
UST to hover around 600bp until the scenario for
next year’s presidential election becomes more clear.
So far this year, Argentina’s curve has suffered a
331bp bear flattening. Of those, 76bp are explained
by a higher risk free rate and 60bp by an increase in
the EM risk premium. In other words, the pure Argy
risk premium is up 195bp YTD. In our view, the
improvement in Argentina’s fundamentals are
consistent with a tighter risk premium, more in line
with that of the average EM country. That said,
better fundamentals will not have an impact on the
hard currency curve until 2Q19, when polls will
begin to paint a clearer picture of the presidential
race. At this point, we expect the scenario to become
binary. If the government’s chances of reelection
improve, then we expect the risk premium to
compress to the 350bp range. If not, spreads could
widen further depending on who leads the race.
Figure 3: The widening of the pure Argy risk
premium explains almost two thirds of the
correction in the hard currency curve
Source: Puente estimates based on Bloomberg
Under our base scenario, we would pay the
spread between local currency and global
bonds, as they offer the best risk-reward
balance.
In our view, the most attractive play on the
sovereign hard currency curve is to bet on a
compression of the spread between the local law and
the global law bonds. We see attractive a pure bet on
a compression of the spread via the Discos. The
spread between the Argy law and the NY law Discos
7
stands at 63bp, up from 55bp a month ago and 10bp
at the end of 2017. Alternatively, the Argentina25 is
also an attractive play at the large spread between
local and NY law hard currency bonds. YTD, its
spread to the NY law curve has widened 183bp to
183bp and is trading wider to the curve than the rest
of the local law bonds (the Argentina20 is trading
154bp wider than the curve, the Argentina24 82bp,
and the Argentina37 112bp). All in, the local law
curve, which was trading close to the international
law curve by end of 2017 is currently trading well
outside and steeper. In our view, this correction in
the local law curve is explained by retail investors
reducing their exposure to the sovereign rather than
to a change in fundamentals or an increase in the
default premium.
Figure 4: Evolution of the spread between the
local law and the NY law Discos in 2018
Source: Puente estimates based on Bloomberg
Figure 5: The spread between the Argentina25
and the global law curve is close to maximums
Source: Puente estimates based on Bloomberg
Figure 6: The local law hard currency curve
has gone from trading inside the global law
curve to trading at a steep discount

Source: Puente estimates based on Bloomberg

8
 Annex 1: Statistics of Foreign and Local Law Hard Currency instruments

 Annex 2: Sovereign Hard Currency Curve

9
 Annex 3: Statistics for Provincial Hard Currency bonds

 Annex 4: Provincial Hard Currency Curve

10
 Annex 5: Statistics for Sovereign ARS/ CER-Linked Fixed rate bonds

 Annex 6: Fixed rate ARS curve

 Annex 7: Fixed Real Curve

11
 Annex 8: Statistics for ARS Lecap

 Annex 9: Statistics for ARS Floaters rate bonds

 Annex 10: Floating rate ARS Curve given our view of the Badlar Rate

12
 Important disclaimer
This document is for distribution only as may be permitted by law. It is not directed to, or intended for distribution to or use by, any person or
entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication,
availability or use would be contrary to law or regulation or would subject PUENTE to any registration or licensing requirement within such
jurisdiction. It is published solely for information purposes; it is not an advertisement nor is it a solicitation or an offer to buy or sell any
financial instruments or to participate in any particular trading strategy. No representation or warranty, expresses or implied, is provided in
relation to the accuracy, completeness or reliability of the information contained in this document (‘the Information’), except with respect to
Information concerning PUENTE. The Information is not intended to be a complete statement or summary of the securities, markets or
developments referred to in the document. PUENTE does not undertake to update or keep current the Information. Any opinions expressed
in this document may change without notice and may differ or be contrary to opinions expressed by other business areas or groups of
PUENTE.

Nothing in this document constitutes a representation that any investment strategy or recommendation is suitable or appropriate to an
investor’s individual circumstances or otherwise constitutes a personal recommendation. Investments involve risks, and investors should
exercise prudence and their own judgment in making their investment decisions. The financial instruments described in the document may
not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all
investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and
may be highly volatile in response to fluctuations in interest rates or other market conditions. Foreign currency rates of exchange may
adversely affect the value, price or income of any security or related instrument referred to in the document. For investment advice, trade
execution or other enquiries, clients should contact their local sales representative. Investors should make their own investment decisions
considering such circumstances and obtain such professional and specialized advice as may be necessary. The contents of this document are
based on information available to the general public that was obtained from sources considered to be reliable. However, such information has
not been independently verified by PUENTE, and therefore no warranty, either express or implicit, is given regarding its accuracy, integrity or
correctness. PUENTE does not assume any liability of any type for any negative results arising from the use of this document or its contents.

Investors interested in making an investment should take into consideration that all the instruments are governed by specific legislation as
well as by certain documents approved by the relevant authorities (e.g., prospectus, registration statements, offering memoranda, notices of
subscription, pricing supplements, et cetera), which should include complete and accurate information about the instrument and shall be
reviewed by the investors, together with their legal and financial advisors, prior to making the investment. Investors should note that the past
performance of securities or instruments or the historical results of investments do not guarantee future performance. The market prices of
securities or instruments or the results of investments could fluctuate against the interests of investors. Trades in securities require a constant
supervision of the financial position. Furthermore, investors shall fully understand the chance of total loss of the investment made.

Trades in equity or credit derivatives and high-yield securities may involve higher risks. In case of some investments, the potential losses may
exceed the amount of the initial investment and, in such circumstances investors may be required to pay more money to support those losses.
Before undertaking any trade with these instruments, investors should be aware of their operation, as well as the rights, liabilities and risks
implied by the same and the underlying securities. Investors should also be aware that secondary markets for such instruments may be
limited or even not exist. PUENTE and/or any of its affiliates, as well as their respective directors, executives and employees, may have a
position in any of the securities or instruments referred to, directly or indirectly, in this document, or in any other related thereto; they may
trade for their own account or for third-party account in those securities, provide consulting or other services to the issuer of the
aforementioned securities or instruments or to companies related thereto or to their shareholders, executives or employees, or may have
interests or perform transactions in those securities or instruments or related investments before or after the publication of this report, to the
extent permitted by the applicable law.

PUENTE or any of its shareholders, executives or employees may provide oral or written market commentary or trading strategies different
from the opinions expressed herein. Under no circumstances PUENTE will be considered liable or accountable for the result of the
investments made by investors. Country and Region Specific Disclosures. United States: Distributed only to ‚Major U.S. Institutional
Investors‛.

No addressee of this document may distribute nor reproduce this report or any of the parts thereof without the prior written consent of
PUENTE. Failure to comply with these restrictions may breach the laws of the relevant jurisdiction where such unauthorized distribution or
reproduction occur. Puente Casa de Bolsa S.A., belongs to Grupo Puente founded in 1915.

13