By Rodrigo Campos and Jorgelina do Rosario
NEW YORK/LONDON Argentina's presidential election run-off next month will pitch big state Peronism against scorched earth liberalism in a clash of economic models that is fuelling investor fears.
The country's $600 billion economy, South America's second-largest behind Brazil, is already in recession, with inflation near 140% and a currency that has lost 42% in value this year and far more on the black market.
"Whoever wins, they have a lot of challenges ahead," said Zulfi Ali, portfolio manager for PGIM Fixed Income's Emerging Markets Debt team, after the first round of the vote.
"You have an exchange rate that is very weak, reserves that are really low, payments to the IMF, and debt repayments coming up as well on the private sector," Ali added.
Argentina's dollar bonds trade in the mid-to-low 20 cents, deep in distressed territory and signalling the possibility of default, while the black market peso closed on Monday at 1,050 per dollar, a 200% gap to the official rate.
Some analysts argue that what Argentina needs most is fiscal discipline, now and beyond its second-round vote on Nov. 19.
For while Economy Minister Sergio Massa of the ruling Peronist party has managed to keep Argentina afloat in turbulent times, Sergei Strigo, co-head of emerging markets fixed income at Amundi Asset Management said "there has been significant fiscal spending and markets do not want to see that".
"Massa has done some destructive things to the economy and ... to the relationship with the IMF," said Christine Reed, Emerging Markets Portfolio Manager at asset manager Ninety One.
Yet Massa's loose fiscal policies since coming third in an early primary have given him a lift. His coalition's share of the vote rose to 37% on Oct. 22 from 27% in August primary.
Meanwhile, right-wing populist Javier Milei's share of the vote stayed around the 30% level that saw him win the August poll, leaving some to ask whether he is nearing a ceiling and to question how much he will be able to achieve if he wins.
"The whole point about Argentina's political change was to have someone new who would then initiate very significant macroeconomic changes, and probably at a very quick pace," Amundi Asset Management's Strigo said.
Milei's promises of dollarization to stem inflation and of shuttering the central bank could be hard to get through a splintered new congress.
Whether it is Massa or Milei who wins, both will have to forge alliances for any reforms to go through, as after Sunday's vote results, no political party holds enough seats in the Senate nor in the lower house to constitute a quorum.
'MUDDLE THROUGH'
For the next few weeks, sentiment will hinge in part on policy moves from Massa as he seeks to ride his recent success.
Massa announced a month-long extension and expansion on Monday of an incentive that was available to soybean exporters and will be offered to all export sectors, who can now claim a higher exchange rate than the official 350 per dollar.
"The government is expected to continue to pull rabbits out of a hat in an attempt to muddle through and avoid a disordered devaluation," wrote JPMorgan analysts on Monday, coinciding with Goldman Sachs' view that "policy announcements will be key."
In addition to domestic politics, investors are also wary of tightening global monetary conditions, with the U.S. 10-year Treasury yield rising to its highest level in 16 years, signalling higher costs for dollar borrowers such as Argentina.
"A testing domestic political environment is further complicated by a challenging external backdrop, characterized by low levels of global liquidity, and high levels of geopolitical risk, all of which is denting global investor appetite for riskier emerging market assets," said Alejo Czerwonko, chief investment officer for Emerging Markets Americas at UBS.
A Milei win would pit the populist against Peronists energized by a very strong showing in the Buenos Aires Province, meaning he will "likely face serious constraints when trying to implement structural reforms", Czerwonko added.
Massa, he said, is leading Argentina down a risky road of recession and inflation and expecting him to change direction "appears wishful thinking at this point".
Whatever the outcome in November, Argentina's future is clouded by the possibility of another failed International Monetary Fund programme and yet another debt default.
"Even if the next administration adopts policies to unwind existing distortions, our baseline scenario anticipates a persistently high risk of default in 2024-25," said Jaime Reusche, Moody's Investors Service's principal analyst for Argentina, which has defaulted nine times in recent history.
(Reporting by Jorgelina do Rosario in London and Rodrigo Campos in New York; additional reporting by Karin Strohecker; editing by Alexander Smith)