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Province of Entre Rios Downgraded To 'CCC' From 'B-' On Rising Liquidity Pressures, Outlook Is Negative

  • The COVID-19 pandemic has exacerbated the province's already stressed fiscal profile and will push the operating deficit over 8% of operating revenues from 2% in 2019.
  • A very gradual fiscal consolidation starting in 2021 would result in rising financing needs, amid limited access to the market and a fragile liquidity position.
  • We're lowering our long-term rating on the Argentine province of Entre Rios to 'CCC' from 'B-'.
  • The negative outlook reflects the complex economic dynamic in Argentina, which could erode provincial revenues more rapidly than expected and result in a liquidity crisis, putting at risk timely and in full debt service payment in the next 12 months.

Rating Action

BUENOS AIRES (S&P Global Ratings) April 30, 2020--S&P Global Ratings lowered its long-term issuer credit rating on the province of Entre Rios to 'CCC' from 'B-'. The outlook is negative.

Outlook

The negative outlook reflects our view that the province of Entre Rios is currently vulnerable and depends upon favorable financial and economic conditions to meet its financial commitments. Argentina's recession has worsened because of the measures to contain the COVID-19 pandemic, which could result in higher-than-expected deterioration in the province's fiscal performance. This, coupled with a weakening liquidity position, could increase the risks of default or distressed exchange.
Downside scenario
We could lower the long-term ratings on the province in the next twelve months if we perceive an increasing likelihood of delays in debt servicing or debt exchange amid limited financing options. Given the stressed economic and financial conditions in Argentina and the province, we would likely classify a debt exchange as a tantamount to default, because in a distressed exchange, holders accept less than the original promise because of the risk that the issuer won't fulfill its original obligations.
Upside scenario
We could revise the outlook to stable in the next 12 months if the administration undertakes corrective fiscal measures that strengthen Entre Rios' fiscal profile and liquidity position and sets a clear strategy for timely payment of its financial obligations. Given the various and strong links between Argentina and the province of Entre Rios, the stabilization of the macroeconomic and financial conditions in Argentina and clear policy signals and execution of policies from the national government would be relevant for an upgrade.

Rationale

The downgrade reflects our view that Entre Rios' fiscal dynamics could hamper its ability to service its debt in a timely manner in the next 12 months, without unforeseen positive developments. The COVID-19 outbreak has exacerbated the province's already stressed fiscal needs and resources and will push the operating deficit over 8% of operating revenues from 2% in 2019. These poor fiscal conditions, along with the limited access to sources of liquidity (including the national government), will erode the province's cash position. That said, we highlight that debt service in the next 12 months is limited when compared to the provincial budget. We estimate the province's debt service for the remainder of the year to be ARS5 billion (3% of annual operating revenues).
At the same time, the ratings reflect a weak and deteriorating economic profile, with GDP per capita expected to fall to $5,600 from $6,500 in 2019 given the severe economic contraction this year. These challenging conditions, along with limited liquidity planning, raise questions about the province's capacity and willingness to make full and timely payments on its financial obligations due in the next 12 months.
Fiscal deterioration further pressures Entre Rios' already fragile liquidity position
Our base-case scenario assumes that Entre Rios will post an operating deficit of 8% of operating revenue in 2020, and a deficit after capital expenditures (capex) of 10% of total revenues. We expect the deficit to only gradually narrow in the next two years, since the economy will recover modestly. The widening fiscal deficit reflects both revenue shortfalls and rising spending pressures. Preliminary data already indicated a sharp deterioration in provincial finances before the lockdown measures, because rising spending due to the very high inflation hasn't been accompanied by similar growth in revenue collection. The mismatch between revenues and expenditures reflects the province's inflexible budget structure: payroll and pensions make up 70% of Entre Rios' operating spending. Entre Rios' annual pension deficit has been rising over the last several years and reached almost 9% of operating revenues in 2019, from 7% in 2017. Although the province covers part of this deficit with national government transfers, in our view the rapidly rising deficit signals significant pressure in the provincial budget.
Capital spending will continue to be the main source of adjustment in the budget, and we expect it to reach a record low of only 1% of operating expenditures this year, from 5% in 2017-2019. As room to continue putting off public works becomes more limited, the prudent management of salary policies will mainly determine the province's level of fiscal consolidation.
We expect the province to mainly to use its previously accumulated cash and short-term debt to finance its deficit, given that market access will remain limited amid the renegotiation of the sovereign debt. Although the province's liquidity position is very weak, next month's debt service is low. We estimate the province's debt service for the rest of the year to be ARS5 billion (3% of annual operating revenues). ARS3 billion is due in August, when the province faces a ARS1.6 billion amortization with ANSES and a $21 million coupon payment of its 2025 bond. The province expects to receive funding from the national government for about ARS3 billion to cope with impact from the COVID-19 pandemic. Considering the estimated amount of debt service in 2020, we believe the province could resort to short-term instruments to cover this maturing payment (as it did until December 2017), or further delay capex or payment to suppliers to cover the maturing payment. Debt service payment becomes heftier in 2023 when the international bond starts to amortize.
In our view, debt stock is not a key rating constraint for Entre Rios, although it could rise rapidly if the administration delays the fiscal consolidation. We expect debt stock to reach 40% of operating revenues in 2020, from 38% in 2019, below that of peers like the provinces of Buenos Aires and Mendoza. Afterwards, we expect direct debt and interest payments to gradually decrease in line with the Argentine peso's expected appreciation. Amid limited access to market funding, we consider that the national government could become a more important source of funding for the province.
Rapid deterioration of economic conditions raises management challenges
The hit from COVID-19 and the associated lockdown measures should result in a deep economic contraction this year. We expect the provincial economy to shrink 7% in 2020, in line with our expectation for Argentina. Entre Rios' GDP per capita will be about $5,600 in 2020, down from nearly $7,900 in 2017-2019, reflecting not only the recession but also the peso's depreciation in the last few years. At the same time, we think that the structural weakness of the Argentine economy, present before the pandemic, indicates that the recovery will be only moderate. We expect inflation to remain very high, as it has been in recent years.
The deterioration of the province's socioeconomic profile raises fiscal requirements, while revenues are rapidly eroding. Even though Bordet's administration showed disciplined fiscal policies in the province in 2016-2018, we believe the commitment to fiscal consolidation has diminished as the recession has become more severe. Financial planning has historically been a weakness of the province, partly because of Argentine's volatile economy. However, we note that the fiscal planning horizon has shortened as economic conditions have rapidly worsened. Timely budgetary adjustments in low-priority areas would be key to balance the financial needs of the province while access to external sources of funding, including support from the national government, will remain limited.

Argentina is in a fragile fiscal position and we consider that its ongoing debt restructuring process could result in delays in support to subnational governments. We assess the institutional framework for Argentina's local and regional governments (LRGs) as very volatile and underfunded, reflecting our perception of the sovereign's very weak institutional predictability and volatile intergovernmental system that has been subject to various modifications by fiscal regulations and lack of consistency over the years, which jeopardizes LRGs' financial planning and consequently their credit quality.

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